Scope upgrades Greece’s long-term credit rating to BB- from B+, Outlook Positive
Scope Ratings has today upgraded the Hellenic Republic's long-term foreign- and local-currency issuer ratings to BB- from B+, with the Outlooks affirmed at Positive. The sovereign’s senior unsecured debt in both local and foreign currency was also upgraded to BB- from B+, with Outlook Positive. The agency also upgraded the short-term issuer rating to S-3 from S-4 in both local and foreign currency, with the Outlook revised to Stable.
The one-notch upgrade of Greece’s long-term ratings to BB- from B+ is underpinned by the following three drivers: (1) Greece’s improved near- to medium-term debt repayment capacity, backed by a substantial cash buffer and favourable debt amortisation profile, which should support Greece’s ongoing return to market funding; (2) improving medium-term public debt sustainability, driven by high primary surpluses, a recovering economy and a very low interest-payment burden; and (3) sustained reforms even after Greece’s exit from successive economic adjustment programmes, which address significant structural economic bottlenecks, coupled with constraints on the risk of significant policy reversals, owing to ongoing post-bailout surveillance reviews from Greece’s multilateral lenders alongside political conditions that sees both major political parties supporting a commitment to reform. Under Scope’s sovereign rating methodology, the upgrade reflects improvements in the ‘domestic economic risk’ and ‘public finance risk’ categories of Scope’s assessment.
The affirmation of the Positive Outlook reflects an expectation of continued economic improvements, declines in Greece’s government debt ratio over time and a commitment to fiscal discipline and structural reforms – anchored by post-bailout surveillance. This expectation of possible additional credit-positive developments is linked to Greece’s strengthened liquidity profile, which bolsters its repayment capacity over coming years, and the provision of additional medium-term policy-contingent debt relief measures by official euro area creditors in the period to at least 2022. Discussions with creditors going forward around the maintenance of fiscal commitments – or the possible deviation thereof as highlighted by the government’s announcement on May 7 to reduce the primary surplus objectives to 2.5% of GDP for the 2020 to 2022 budgets – and a robust trajectory of public debt reduction will be decisive for Greece’s ratings going forward. Namely, Scope will monitor the extent of: i) the observance of continued high primary fiscal surpluses and reform momentum both prior to and after the European, local and national elections in 2019; ii) further broadening of the country’s and its banking system’s capital market access, particularly in view of the non-eligibility of Greek government securities for ECB funding operations; iii) relaxation of remaining capital controls as well as reduction in very high non-performing exposures (NPEs); and iv) the realisation of further official debt relief provision and commitment from official creditors to support Greece’s debt sustainability. Each of these measures, or a combination therefore, could, in Scope’s opinion, materially improve macroeconomic sustainability and reduce elevated financial stability risks, thus increasing confidence and strengthening the Hellenic Republic’s ability to handle its debt burden.
The first driver of the upgrade to BB- reflects Greece’s improved near- and medium-term debt repayment capacity, which is backed by a substantial cash buffer of around EUR 27bn (15% of GDP) as of end-2018, fully covering central government debt maturities through 2022. Scope notes that this cash balance has likely increased in size further after successive EUR 2.5bn debt issuances (at 5-year and 10-year maturities) in early 2019 alongside disbursement of EUR 1bn of Eurosystem profits on past Greek bond purchases and savings on EFSF step-up margins on certain loan instalments to Greece. In aggregate, this cash balance represents a significant backstop against sovereign refinancing risks over the rating-relevant horizon and a sizable recourse Greece may use to implement liability management operations – such as the recent request to the IMF for the early repayment of some higher-interest loans – to further enhance Greece’s debt profile.
Unprecedented support from euro area official creditors has facilitated a very low annual effective weighted average interest rate of 1.6% in 2018 on Greece’s public debt (down from 4.5% in 2011) alongside a high share of fixed-rated debt (85% of total debt in September 2018) and very long weighted average residual debt maturity of 18.2 years as of end-2018 (up from 6.3 years in 2011). Furthermore, the official sector held 83% of Greece’s central government debt by the end of 2018, which, given a track record of re-profilings of Greece’s debt owed to the official sector aimed at enhancing debt sustainability, curtails the likelihood of non-repayment on privately-held Greek debt (the debt segment rated by Scope) including under stressed scenarios. Additional policy-contingent debt measures are expected from euro area lenders to Greece, to be reviewed on a semi-annual basis up to mid-2022, subject to Greece’s compliance with reform commitments. The cash balance, favourable debt profile, and continued official sector support have eased Greece’s return to debt capital markets in 2019 despite a very high public debt stock (183.3% of GDP in 2018) and the ineligibility of Greek government securities as collateral for ECB monetary operations.
The second driver of the rating upgrade is Greece’s improved medium-term public debt sustainability, which is reflected by a firm downward trajectory of Greece’s public debt stock to around 145% of GDP by 2024 under Scope’s public debt sustainability analysis. Debt reduction over the forecast period is driven by: i) robust, elevated primary surpluses and ii) moderate economic growth, which, when viewed alongside very low average interest costs on outstanding government debt, supports favourable debt dynamics.
Greece’s sustained, high primary surpluses are the result of structural fiscal improvements in recent years addressing underlying budgetary weaknesses that include low tax collection rates. Supported by the recovery in the economy, Greece over-achieved the primary surplus target in 2018 for the fourth consecutive year. Greece’s primary surplus stood at 4.4% of GDP in 2018, overshooting the programme target of 3.5% and the government’s own target of 4.0% by a significant margin. This budgetary over-achievement is driven by controls on expenditure growth and sustained revenue growth given organisational savings and increased tax collection rates. Moreover, the Greek government has legislated contingent fiscal measures including tax increases and spending cuts, which would be automatically applied if needed to achieve the primary surplus target (of 3.5% of GDP) for the year 2019.
Greece also benefits from strengthened growth momentum vis-à-vis regional peers, which is a credit-positive and a contributing factor to Greece’s improved public debt sustainability in the short-to-medium term. As observed in growth of 2.1% in 2018, Greece’s economic recovery has been supported by past structural reforms, which have buoyed business confidence and investment, as well as private consumption. Scope expects stronger real GDP growth averaging 2.5% in the 2019-2020 period, followed by a moderation to around 1.5% growth in the projection period to 2024. The expectation of growth moderation over the medium-run balances Scope’s view of ongoing steady consumption and accelerating investment growth – the latter which may benefit from a full relaxation of capital controls – with softer export growth going forward.
The third and final driver underpinning Scope’s decision to upgrade Greece’s sovereign rating to BB- is the country’s reform progress even following the country’s exit from its final economic adjustment programme. Recent positive public lender conclusions on Greece’s reform advancement acknowledge that the government has taken the necessary actions to achieve all specific reform commitments by implementing a number of politically challenging measures, including legislation to resume privatisations, reforms of the health care system, and changes to private sector insolvency laws to support banking sector stability.
Scope notes that the reform objectives have been approved by the Greek parliament with cross-parliamentary support, which indicates a significant level of national consensus around a continuation of growth-enhancing reform. Legislative elections will take place no later than 20 October. While the current government led by Prime Minister Alexis Tsipras has a record of fiscal consolidation, the conservative New Democracy opposition party is projected to win the most seats in Parliament. Core to New Democracy’s platform is the promise of fast-tracked, market-friendly policies including closer ties to the EU, indicating that reform momentum would prevail under a future government, whether under the leadership of New Democracy or Syriza. In Scope’s view, both continued post-bailout surveillance reviews alongside the support for the country’s reform commitments from the two main parties support Scope’s anticipation of continued reform post-election, at the same time recognising the risk of policy paralysis in the scenario of a hung parliament.
Despite these credit-positive developments, Greece’s ratings remain constrained by: i) structural weaknesses in the form of low growth potential and high unemployment; and ii) crisis-era legacies in the form of elevated financial stability risks, hindering what might be otherwise a stronger recovery.
First, Greece’s long-term economic growth prospects, estimated at 1.3% – amongst the lowest in the euro area – are constrained by a relatively weak payment discipline and structural bottlenecks, including pronounced labour market rigidity. This is reflected, for example, in the elevated levels of private-sector arrears, signalling that economic reforms have resulted in high social costs, despite efforts to improve social protection, such as via the guaranteed minimum income scheme. Similarly, the labour market is improving but major imbalances remain, with the overall unemployment rate still at 18.5% in February 2019 (down from 20.6% in February 2018) and projected to gradually decline to around 17% by 2020. In Scope’s opinion, recent policy decisions, notably the sharp hike in the minimum wage by 11% to EUR 650 per month, sales tax reductions, restorations of bonus payments and renewed collective bargaining arrangements, will support private household spending power but will also increase costs and reduce firms’ abilities to respond to changing market conditions.
Second, while the banking sector has benefitted from more diversified funding sources, with Greek banks having fully repaid costly emergency liquidity assistance provided by the Bank of Greece, the recovery of Greek banks to normality remains challenged by legacy non-performing exposures, which gradually declined to EUR 88.6bn (or 47.6% of total exposures) at the end of the third quarter of 2018, compared with EUR 107bn in March 2016, when the stock of NPEs reached its peak. Scope notes that the NPE reduction in 2018 was supported via sales executed by e-Auctions, producing positive results, a strategy which Scope expects to be maintained in coming years. Bank lending in the economy also continues improving but remains negative on a YoY basis. Scope believes that the recovery in the banking sector is likely to be gradual with the successful reduction of NPEs depending on a supportive and stable economic and political backdrop.
Finally, Scope notes that the aforementioned capital controls and ineligibility of Greek government securities for ECB monetary operations constrain Greece’s sovereign ratings. However, in Scope’s opinion, the cash buffer offers a significant multi-use recourse that may be used to support NPE reduction schemes and/or early repayment and refinancing of debt, supporting domestic investment as well as Greece’s ongoing re-establishment on capital markets.
Core Variable Scorecard (CVS) and qualitative scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, signals an indicative ‘BBB’ (‘bbb’) rating range for the Hellenic Republic. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches, depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative analysis.
For Greece, relative credit weaknesses in the QS are signalled for: 1) growth potential, 2) economic policy framework, 3) macroeconomic stability and sustainability, 4) fiscal policy framework, 5) public debt sustainability, 6) market access and funding sources, 7) perceived willingness to pay, 8) banking sector performance, and 9) financial imbalances and financial fragility.
A further negative adjustment was made at the rating committee level as reflected in Greece’s BB- rating level, to incorporate Greece’s experience since the global financial crisis. The rating committee implemented an additional two-notch negative adjustment to account for: i) the ongoing persistence of banking sector challenges and weakened confidence due to relaxed but remaining capital controls, ii) the ineligibility of Greek government securities for ECB monetary operations, hindering a faster re-establishment of Greece’s access to capital markets, as well as iii) remaining uncertainties regarding official creditors’ measures to ensure robust long-term public debt sustainability.
The results have been discussed and confirmed by a rating committee.
Factoring of Environment, Social and Governance (ESG)
Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, on which Greece has moderate scores on a composite index of six World Bank Worldwide Governance Indicators. Social factors are reflected in Greece’s comparatively moderate GDP per capita, high rates of unemployment, and high old-age dependency ratios. In addition, Scope observes that the comparatively elevated, albeit declining, level of low-skilled and low-income jobs may weigh negatively on productivity levels and the tax base in the long run as well as boost income inequality, poverty and social exclusion among vulnerable groups. Finally, environmental factors are considered during the rating process, but did not play a direct role in this rating action.
Outlook and rating-change drivers
The Positive Outlook reflects Scope’s view that risks to the ratings are titled to the upside over the next 12 to 18 months.
The ratings could be upgraded if, individually or collectively: i) banking sector risks were further eased and/or capital controls eliminated; ii) the country’s access to bond markets were broadened on a sustained basis; iii) further debt relief was provided by official creditors as a result of reform progress, ensuring more robust medium-to-long-term public debt sustainability; iv) fiscal consolidation and reform progress were continued; and/or v) economic growth proved to be stronger and more sustainable than presently foreseen.
Conversely, the ratings could be downgraded and/or the Outlooks revised to Stable if, individually or collectively: i) the envisaged reduction of the high stock of non-performing exposures were to be delayed, thereby intensifying banking sector stresses; ii) the country’s access to bond markets deteriorated; iii) further contingent debt relief measures were not made available by official creditors; iv) fiscal discipline and reform progress weakened materially; and/or iv) economic growth prospects weakened.
The main points discussed by the rating committee were: i) the sustainability of budget performance and economic recovery, ii) recent fiscal developments, iii) public debt sustainability analysis, iv) capital market access, v) policy uncertainties surrounding debt relief measures, vi) banking sector performance, vii) recent political and institutional developments, and viii) peers consideration.
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the rating process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: Greek Ministry of Public Finance, National Bank of Greece, PDMA, European Commission, Eurostat, IMF, ECB, OECD, WB, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Jakob Suwalski, Lead Analyst
Person responsible for approval of the rating: Dr. Giacomo Barisone, Managing Director
The ratings /outlook were first released by Scope in January 2003. The ratings/outlooks were last released on 18.05.2018.
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
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