Fitch Affirms Greece at 'CCC'
KEY RATING DRIVERS
The completion of the first review and approval in May of the second tranche (EUR10.3bn, 6% of GDP) of Greece's EUR86bn European Stability Mechanism (ESM) programme highlights improved relations with creditors, but in Fitch's view implementation risks are still high. The agreement was reached several months later than planned but the delay did not give rise to marked economic volatility.
The country's 2015 primary surplus (programme definition) was confirmed at 0.7% of GDP, better than the target of a deficit of 0.25%. A run-up of government arrears during creditor negotiations led to a fall in general government debt, to 177% of GDP in 2015 from 180% of GDP in 2014, still the second highest of all Fitch-rated countries. Fiscal performance so far this year is consistent with meeting the 2016 primary surplus target of 0.5% of GDP, but the remaining fiscal targets, of 1.75% of GDP in 2017 and 3.5% in 2018, will be progressively harder to meet.
In completing the first review, the government legislated as "prior actions" measures to meet the estimated fiscal gap of 3% of GDP to 2018, of which just above two-thirds come from pension and income tax reform. Relatively weak domestic ownership of programme policy, however, makes their full implementation difficult. The agreement also includes a contingent fiscal mechanism retrospectively triggering further measures if a fiscal target is missed, as well as tax efficiency reforms on which the follow-through is less certain.
The second review is slated to commence in 4Q16, with labour reform expected to be the most contentious component. Fitch estimates that the government will have sufficient buffers (cash, repos and possible arrears build-up) to last into 2Q17 without release of funds on completing the second review, which increases the likelihood of negotiations slipping into next year. The nature of IMF participation is likely to hinge on the scope for relaxation of the medium-term fiscal targets and degree of commitment to debt relief.
So far the Eurogroup has set out only general parameters of a potential debt deal; namely that gross financing needs should remain below 15% of GDP "for the medium term" and below 20% thereafter, and that the more substantial relief such as interest rate caps, coupon deferrals and maturity extensions are conditional on successful programme completion in 2018. Delivering debt relief in stages and contingent on delivery could incentivise performance, but could have the opposite effect if it came to be seen by Greek politicians or the public as a distant or unattainable prospect. Uncertainty around the likely outcome also limits the economic benefits through boosting confidence in the long-term sustainability of Greek debt.
Syriza has been losing ground in the polls to the centre-right New Democracy, which has less ideological opposition to a number of the programme policies but has argued for its renegotiation in particular on fiscal targets. Despite a slim majority, we expect Prime Minister Tsipras to be able to continue to rely on votes from centrist parties, but the potential for political surprises remains. Maintaining sufficient support to deliver on the demanding conditions through to 2018 is highly challenging, particularly in view of the track record of slippage under previous programmes.
GDP contracted 0.75% (annualised) in 1H16, and Fitch expects a modest pick-up in the remainder of 2016 taking full year growth to -0.5%. We forecast GDP growth of 1.8% in 2017, supported by an increase in investment and, to a lesser extent, private consumption, and a moderately positive net trade contribution. Unemployment fell to 23.5% in May 2016 from close to 25.9% at the beginning of 2015 and we expect a further gradual fall, to an average 21.9% in 2018, still the highest in the eurozone. The low oil price and sharp import contraction following imposition of capital controls has taken the current account close to balance from a deficit of 2.1% of GDP in 2014. Fitch expects small current account surpluses in 2016 and 2017, with net external debt remaining elevated at close to 130% of GDP in 2016.
Last year's bank recapitalisation helped stabilise the financial sector but consumer and investor confidence have been slow to recover. Bank deposits have increased only 2% since their 25% (EUR38bn) drop in 1H15, although the relaxation of capital controls in July, in particular the withdrawal of restrictions on new deposits, is expected to lead to some moderate pick-up in deposits in 2H16. As a result, Greek banks continue to face very large funding imbalances, with Emergency Liquidity Assistance (ELA) accounting for 20% of system-wide funding. June's ECB reinstatement of the waiver permitting Greek government bonds to be used as collateral will allow a fairly small share of ELA funding (estimated 7%) to be transferred to ECB's regular financing operations at a 150bp lower interest rate.
The key challenge for the Greek banking sector is tackling non-performing exposures (NPEs) which remain extremely high at above 45% of gross loans. Improvement has been made to the legal and institutional framework for resolving loans, but progress in working through problem assets has been relatively slow. High NPEs, funding imbalances and weak credit demand continue to constrain net private sector lending, which Fitch forecasts will contract 2.8% in 2016 and 1.5% in 2017.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Greece a score equivalent to a rating of BB on the Long-Term Foreign Currency IDR scale.
In accordance with its rating criteria, Fitch's sovereign rating committee decided to adjust the rating indicated by the SRM by more than the usual maximum range of +/-3 notches because of Greece's experience of financial crisis.
Consequently, the overall adjustment of five notches reflects the following adjustments:-
- Macro: -1 notch, to reflect a history of weak macroeconomic management that contributed to financial crises and steep declines in GDP.
- Public Finances: -1 notch, to reflect public debt at close to 180% of GDP; the SRM does not capture "non-linear" vulnerabilities at such a high level.
- External Finances: -2 notches, to reflect: a) Greece's high net external debt which is not captured in the SRM, and restricted market access which reduces financing flexibility; and b) the +2-notch SRM enhancement for "reserve currency flexibility" has been adjusted to +1 notch given Greece's financial crisis experience.
- Structural Features: -1 notch, to reflect political risks to the programme, and a weak banking sector reliant on official funding and with capital controls still largely in place.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Future developments that could, individually or collectively, result in an upgrade include:
- A further track record of successful implementation of the ESM programme, brought about by an orderly working relationship between Greece and its official creditors and a relatively stable political environment.
- An economic recovery, further primary surpluses, and official sector debt relief would provide upward momentum for the ratings over the medium term.
Developments that could, individually or collectively, result in a downgrade include:
-A repeat of the prolonged breakdown in relations between Greece and its creditors seen last year, for example in the context of a failure to meet programme targets and worsening liquidity conditions.
-Non-payment, redenomination or distressed debt exchange of government debt securities issued in the market or a government-declared moratorium on all debt service.
-Any debt relief given to Greece under the ESM programme will apply to official-sector debt only, and would not therefore constitute an event of default under the agency's criteria.