Compliance with the adjustment programme, improved budgetary performance, economic stabilization and a more favourable policy environment drive the upgrade; fragile public debt sustainability and economic growth prospects are constraints.
Scope Ratings has today upgraded the Hellenic Republic’s long-term foreign- and local-currency issuer ratings to B+ from B-. The sovereign’s senior unsecured debt in both local and foreign currency was also upgraded to B+ from B-. The agency also affirmed the short-term issuer rating of S-4 in both local and foreign currency. All outlooks were changed to Positive from Stable.
The upgrade is underpinned by the following three rating drivers: (1) Scope’s expectation that Greece will successfully conclude the third adjustment programme, driven by Greece’s stabilising macroeconomic indicators along with the government’s strong reform progress addressing underlying weaknesses in its tax and public administration; (2) structurally improving budgetary performance with fiscal results exceeding targets, backed by a robust public debt profile and ongoing build-up of a large cash buffer which should support Greece’s sustainable return to market funding; (3) reduced policy uncertainties given both the demonstrated support and commitments of official euro area creditors to provide Greece with additional debt relief measures if needed, along with all major political parties supporting Greece’s membership in the euro area, providing for a more stable domestic political outlook. Improvements in the ‘domestic economic risk’ and ‘public finance risk’ categories of Scope´s analysis drive the upgrade.
The outlook change to Positive from Stable reflects Scope’s expectations of further credit-positive developments as a result of the exit from the adjustment programme and negotiations over debt relief. Scope will monitor the exit agreement and assess the extent of potential measures aimed at i) broadening the country’s capital market access, in view of the limited eligibility of Greek government securities for monetary operations; ii) conditionality mechanisms with enhanced monitoring in exchange for possible debt relief measures, including the potential further reprofiling of loans to the EFSF on a yet-to-be defined growth-adjustment mechanism; and iii) the system of incentives to encourage continuity in fiscal consolidation over the long term. Each of these measures, or a combination therefore, could, in Scope’s opinion, materially improve the long-term sustainability of Greek public-debt, increasing confidence and strengthen Hellenic Republic’s ability to handle its debt burden.
The first driver for the upgrade reflects Scope’s view that Greece will successfully complete its third support programme, scheduled to end in August 2018, underpinned by structural improvements in the form of broad reform efforts addressing Greece’s underlying weaknesses of low government tax revenues. This view is underpinned by the recent positive public lenders’ conclusions on Greece’s current programme implementation, acknowledging, including by the IMF, that Greece has implemented a number of politically challenging measures, including pension cuts, changes to labour market laws, reforms of the health system and the establishment of independent tax entities.
Greece’s macroeconomic situation is stabilizing, underpinned by some positive trends in terms of job creation, resulting in decreasing economic risks. After a prolonged depression, the Greek economy returned to 1.4% growth in 2017, the first time that real GDP growth exceeded 1% since 2007. It is Scope’s view that the recovery has been supported by the successful completion of the second EU programme review in June 2017, which buoyed confidence and business activities. However, the labour market keeps improving at a slow pace, with overall unemployment still at 21.5% in 2017 (down from 23.6% in 2016). Scope expects stronger real GDP growth by around 2% in 2018-2019, which will remain below the euro area average. Investment is set to accelerate, but from a low level and, depending on further reform progress, the composition of fiscal adjustments, and relaxation of capital controls.
Financing conditions in the economy also keep improving but remain tight, due to continuing, though easing capital controls. Bank liquidity is progressively normalizing, with an ongoing decrease of the Emergency Liquidity Assistance, reflecting positive private sector deposit flows, resulting in more diversified funding sources. Banks have gradually increased interbank funding and proceeded since last October to covered bond issues for the first time since 2014. The recovery of Greek banks remains burdened by weak asset quality with legacy non-performing exposure (NPE), comprising 43.1% of total exposures according to the Bank of Greece at the end of 2017, the largest percentage in the EU. However, recent EBA stress test results on Greek banks have confirmed the banking sectors’ resilience with none of the banks needing additional capital. Despite these positive results, Scope believes that the recovery in the banking sector is likely to be gradual with the successful reduction of NPE to depend on a supportive economic and political backdrop.
The second driver of the upgrade is Greece’s improvements in fiscal performance and debt structure. Following the effective stabilisation of the economic policy underpinned by reforms of the budgetary framework, Greece over-achieved the primary surplus target of the adjustment programme in 2017 for the third consecutive year. Under the programme, the primary surplus stood at 4.2% of GDP in 2017, overshooting the target of 1.75% by a wide margin. The improvement is also driven by better-than-expected revenue growth which is an additional credit positive development, as initial fiscal consolidation measures at the beginning of the adjustment process were rather focused on one-off discretionary spending cuts. It is Scope’s view that the fiscal improvements will be sustained as the result of structural savings, improved tax collection rates, the continuation of capital controls and the partial clearance of state arrears, which have increased private-sector liquidity as well as indirect tax receipts and corporate income tax. This positive development was confirmed in the first quarter of 2018, when the budgetary surplus (on a modified cash basis) more than doubled year on year, due to higher than expected budget revenues while primary expenditure was in line with targets. In addition, the Greek government has legislated contingent fiscal measures including tax increases and spending cuts that would be automatically applied if needed to achieve the primary surplus target (of 3.5% of GDP) for the years 2019-2022.
Unprecedented support from euro area official creditors has resulted in a robust public debt profile, as reflected by lower interest payments relative to revenues (6.3% in 2017 versus 16.4% in 2011) and a very long weighted average residual maturity (18.1 years in Q1 2018 versus 6.3 years in 2011). An ongoing build-up of a sizable cash buffer, together with moderate refinancing requirements strongly support public-debt sustainability within a 5-year period, easing Greece’s return to the capital markets despite the high debt stock (178.6% in 2017 versus 172.0% in 2011).
The third and final driver of the upgrade reflects Scope’s opinion of reduced policy uncertainties given both the demonstrated support and commitments of official euro area creditors to provide Greece with additional debt relief measures if needed, along with all major political parties supporting Greece’s membership in the euro area, providing for a more stable domestic political outlook.
Scope notes that recent Eurogroup statements have confirmed the growing convergence of interests between the Greek government, the European creditors and the IMF in support of a clean exit from the third adjustment programme without a successor arrangement, and, consequently, the commitment and expectation of all involved parties to ensure Greece‘s return to private market funding at sustainable rates. Consequently, Scope views the risk of a disorderly exit of the current adjustment programme as materially lower.
Finally, Scope notes that the targets under the adjustment programme have been approved by the Greek parliament with cross-parliamentary party support, which indicates broad national consensus for policy continuity. In fact, all major political parties have signed at least one Memorandum of Understanding, limiting the risk of policy reversals beyond the end of the programme.
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) range for the Republic of Greece. 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.
Greece’s credit metrics captured by the CVS result are heavily influenced by the successive assistance programmes that the country has entered since 2010 that cannot be captured by the CVS Scorecard. For Greece, relative credit weaknesses are signaled 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, 9) financial imbalances and financial fragility.
An overall negative adjustment was made to the CVS outcome to B+ to incorporate Greece’s experience as a financial crisis country. As a result, the rating committee implemented a greater adjustment beyond the normal +/- 3 notch to account for the following factors. These are: i) remaining uncertainties regarding official creditors’ measures to ensure more robust long-term public debt sustainability; ii) the limited eligibility of Greek government securities for monetary operations; iii) the ongoing persistence of banking sector challenges and decreased confidence due to capital controls.
The results have been discussed and confirmed by a rating committee.
For further details, please see Appendix 2 in the rating report.
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 and Scope’s expectations of potentially further credit-positive outcome as a result of the exit from the adjustment programme and negotiations over debt relief over the coming months.
The ratings could be upgraded if: i) further debt relief measures were applied by official creditors, basically ensuring more robust public debt sustainability; ii) the country’s access to bond markets were broadened; iii) fiscal consolidation and reform progress were continued; iv) banking sector risks were further eased and/or capital controls eliminated; v) economic growth proved to be more sustained.
Conversely, the outlook could be returned to Stable if: i) further debt relief measures were not applied by official creditors; ii) the country’s access to bond markets and eligibility for monetary operations remained limited; iii) fiscal consolidation and reform progress abated; iv) the envisaged reduction of the high stock of non-performing-exposure notably delayed, thereby intensifying banking sector risks; v) economic growth prospects weakened.
The main points discussed by the rating committee were: i) sustainability of the economic recovery, ii) recent fiscal developments, iii) public debt sustainability analysis, iv) policy uncertainties surrounding debt-relief measures; v) banking sector performance; vi) recent political and institutional developments, vii) peers consideration.