Scope upgrades Greece’s long-term credit rating to BB from BB-, Outlook remains Positive
Scope Ratings has today upgraded the Hellenic Republic's long-term foreign- and local-currency issuer ratings to BB from BB-, with a Positive Outlook. The sovereign’s senior unsecured debt in both local and foreign currency was also upgraded to BB from BB-, with Outlook Positive. The agency also affirmed the short-term issuer rating at S-3 in both local and foreign currency, with a Stable Outlook.
The one-notch upgrade of Greece’s long-term ratings to BB from BB- is underpinned by the following two drivers: (1) improved medium-term debt sustainability, backed by a track record of sustained fiscal discipline, a substantial cash buffer and a more robust debt profile as a result of Greece’s active debt management, which has also benefitted from debt relief measures coordinated via its multilateral lenders and more favourable financing rates; and (2) Greece’s improved political stability and reform continuity following the formation of a single party majority government after national elections held in July 2019. The new government led by Prime Minister Kyriakos Mitsotakis has prioritised a number of structural and business-friendly reforms aimed at addressing significant structural economic bottlenecks and attracting investment. 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: i) an acceleration in the reduction of a very high ratio of non-performing loans (NPLs) in Greek banks via envisaged portfolio sales and/or a carve-out mechanism, which will strengthen Greek banks’ ability to finance investment and support the real economy; ii) a strengthened credibility of economic policy through continuation of the implementation of business-friendly structural reforms and the speeding up of privatisations, which should increase investor confidence and the growth prospects of the Greek economy; iii) compliance with budgetary targets as agreed with official lenders given the government’s commitment to fiscal discipline; and iv) political stability over the coming years, given the stable parliamentary majority of the new Greek government, reducing the risk of policy reversals in the context of continued surveillance from multilateral creditors, whose period reviews remain a precondition for the activation of medium-term debt relief measures. Each of these factors, or a combination therefore, could, in Scope’s opinion, materially improve long-term macroeconomic sustainability and improve the real economy’s access to required liquidity, thus increasing consumer and business confidence and strengthening Greek borrower’s abilities to handle debt burdens.
In this context, over the next 12-18 months, Scope will monitor the extent of: i) the realised reduction in non-performing loans; ii) the appropriateness of the fiscal policy mix and budgetary measures to ensure a sustained public debt reduction, along the materialisation of further official debt relief provision and/or any relaxation of primary surplus objectives that could support Greece’s long-term debt sustainability; iii) the further broadening of the country’s and its banking system’s capital market access, particularly in view of the low turnover of Greek government securities on secondary markets and their non-eligibility for ECB funding operations; iv) continued reform momentum; and v) the resilience of the economic recovery in the context of a weakening external environment.
The first driver of the upgrade to BB reflects Greece’s improved medium-term public debt sustainability, reflected in a firm downward trajectory of Greece’s public debt stock to around 140% of GDP by 2024 under Scope’s public debt sustainability assessment. This positive development is supported by: i) a robust debt profile as a result of active debt management and support from multilateral lenders, facilitated by the sharp fall in Greek bond yields, ii) a substantial cash buffer that bolsters Greece’s repayment capacity, iii) Scope’s expectation of sustained fiscal discipline, and iv) continued economic recovery, which supports Greece’s ongoing return to sustained market-based funding.
Continued support from euro area official creditors, a more favourable interest environment and proactive debt management, including swap arrangements, have resulted in a very low annual effective weighted average interest rate of 1.6% in June 2019 on Greece’s public debt alongside a high share of fixed-rated debt (93% as of Q2 2019). Consequently, the weighted average time to next refixing stands at 17.4 years and, similarly, Greece’s weighted average residual debt maturity is exceptionally long at 20.8 years as of Q1 2019. Furthermore, the official sector held 76% of Greek central government debt as of Q1 2019, which, given a track record of re-profilings of Greece’s debt owed to the European 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 relief measures are expected from euro area lenders to be reviewed on a semi-annual basis up to mid-2022, subject to Greece’s compliance with reform commitments.
Greece’s improved medium-term public debt sustainability is further supported by a substantial cash buffer of around EUR 34bn in June 2019 (from 27bn or 15% of GDP as of end-2018), fully covering central government debt maturities through 2022. This cash balance represents a significant backstop against sovereign refinancing risks over the rating-relevant horizon. Scope notes that this cash balance has likely increased further in size after the government raised EUR 1.5bn from the reopening of a 10-year bond issue, with the yield set at 1.5% and an increased participation of institutional investors, strengthening Greece’s investor base.
In addition, after recording a larger-than-expected primary fiscal surplus in 2018 of 4.3% of GDP, Greece is set to reach its primary surplus target of 3.5% of GDP in 2019 on account of an adjustment of expenditures to compensate for expansionary fiscal measures adopted since May. Going forward, we expect the prudent track record to be maintained with a projected primary surplus of 3.5% of GDP in 2020 in line with the agreement with Greece’s international creditors.
Greece is also benefitting from strengthened growth momentum vis-à-vis regional peers, contributing positively to Greece’s public debt sustainability in the short-to-medium term. Scope expects growth of around 2% in 2019, driven by a rebound in investment as financing conditions have improved, private consumption supported by employment growth and rising exports in line with global demand for tourism and shipping services, reflecting the country’s improved cost competitiveness as a result of structural reforms in the labour market, with more flexible wage bargaining.
In Scope’s opinion, these four positive developments – the robust debt profile, substantive cash buffer, sustained fiscal discipline and economic recovery – have improved Greece’s medium-term debt sustainability and eased Greece’s ongoing return to debt capital markets in 2019 despite a very high public debt stock (181.1% of GDP in 2018) and the ineligibility of Greek government securities as collateral for ECB monetary operations.
The second driver of the rating upgrade to BB is Greece’s reform progress following the country’s national elections in July 2019, addressing significant structural economic bottlenecks. The new government has taken necessary actions by implementing several politically challenging measures including legislation to resume privatisations and is committed to completing key structural reforms initiated under the European Stability Mechanism programme relating to the areas of social welfare, labour and product markets, financial stability and public administration.
Core to New Democracy’s platform is the prioritisation of market-friendly policies including closer ties with the EU. Continued post-bailout surveillance reviews and a stable political majority support Scope’s anticipation of continued reform. Prime Minister Mitsotakis’ fiscal proposals include reducing the corporate tax rate to 22% from 28% and cutting the tax on dividends to 5% from 10% in 2020. In addition, from 1 July 2020, the government plans to gradually reduce social security contributions by five percentage points until 2023 for those in full-time employment. In a bid to boost the property market, which is vital for Greece’s economy, tax incentives for new construction and modernising old buildings via the elimination of value-added taxes for three years are also planned. To attract foreign direct investment, Mitsotakis’ administration has also moved forward with privatisation projects of the state-run gas company and the process of selling a 30% stake in the Athens International Airport.
Despite these credit-positive developments, Greece’s ratings remain constrained by: i) the very high share of non-performing loans on domestic bank balance sheets, weighing on credit supply although improvements are occurring at a slow pace; and ii) structural weaknesses in the form of low investment and high unemployment, curbing the country’s economic recovery and weighing on its growth potential and long-term macroeconomic sustainability.
The banking system remains burdened by a substantial stock of NPLs, which amounted to 45.1% of total loans at the end of the first quarter of 2019. This weighs on bank profitability and banks’ ability to finance investment and support the real economy. The liquidity situation of Greek banks has further improved, regaining depositor confidence, which was a pre-condition for the abolition of remaining capital controls, which, after four years, were lifted in August 2019. Sustained inflows of new money have led to positive private sector deposit growth rates since mid-2016 and have also facilitated loan growth to the corporate sector that recorded positive net flows in H1 2019. However, net flows of private sector credit in total remain slightly negative, as new disbursements by banks are only gradually beginning to counterbalance the repayment of maturing loans.
Although economic activity resumed in 2017, sustainably higher growth rates require the end of banks’ deleveraging. NPLs declined from EUR 82bn at the end of 2018 to EUR 80bn at the end of the first quarter of 2019. The persistently-high NPL stock compared with that of other euro area member states is explained by the protracted economic crisis that occurred in Greece and its adverse impact on businesses and households, the wide range of asset types that are non-performing, including more problematic SME loans, a substantial sovereign-bank nexus, and close relationships between banks and borrowers. These characteristics have prevented a more rigorous collection of claims against households and businesses, arguably avoiding a further deepening of the crisis, but at the same time, placing additional strain on banks’ balance sheet strength and restructuring capacity. Addressing these challenges to reduce the stock of NPLs is a key priority for improving Greece’s credit prospects.
Finally, Greece’s long-term economic growth prospects, estimated at 1.3% – amongst the lowest in the euro area – are constrained by structural bottlenecks, including pronounced labour market rigidity, a low investment share in GDP at around 11% in 2018 and a relatively weak payment discipline. This is reflected, for example, in the still high final consumption relative to disposable income and elevated levels of private-sector arrears, signalling that economic reforms have resulted in high social costs. Similarly, the labour market is improving with employment growth leading to unemployment rate declines, but major imbalances remain, with the seasonally adjusted unemployment rate still at 16.9% in July 2019 (down from 19.1% in July 2018) and a high share of long-term unemployment at 70% of total unemployment. The fact that private consumption still contracted in H1 2019 – despite higher household disposable incomes – is a clear signal that the deleveraging process of private households will need to continue for an extended period.
Core Variable Scorecard (CVS) and qualitative scorecard (QS)
The rating committee reviewed Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals and assigned 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) banking sector performance, and 8) 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 one-notch negative adjustment to account for: i) the persistence of banking sector challenges as evidenced by the elevated ratio of non-performing loans, weighing on domestic investment and the country’s growth potential; and ii) 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 low household disposable incomes compared to final consumption, reflecting households’ efforts to preserve their living standards. The comparatively elevated level of low-income jobs may weigh negatively on 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; 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 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 extending banking sector challenges; 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 and debt management activities, 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. Key sources of information for the rating include: Greek Ministry of 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 10 May 2019.
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
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