Fitch Ratings-London-23 May 2014: Fitch Ratings has upgraded Greece's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'B' from 'B-'. The Outlooks are Stable. The issue ratings on Greece's senior unsecured foreign and local currency bonds have also been upgraded to 'B' from 'B-'. The Country Ceiling has been raised to 'BB' from 'B+' and the Short-term foreign currency IDR has been affirmed at 'B'.
KEY RATING DRIVERS
The upgrade of Greece's IDRs reflects the following key rating drivers and their relative weights:
High
Greece achieved a primary surplus in the general government account in 2013, a key target of the EU-IMF programme and an over-performance relative to budget. The "adjusted" primary balance measure used under Greece's programme registered a surplus of 0.8% of GDP last year. The EDP headline deficit excluding bank support was 2.1% of GDP. Taking into account the cost of bank recapitalisation, the headline deficit was 12.7% of GDP. Fitch forecasts the adjusted primary surplus will rise further in 2014 to 1.4% of GDP.
Near-term sovereign liquidity risk has fallen, although this remains contingent on Greece staying on track with its programme. The government is not fully funded by EU and IMF lending over 2014-15 but there are several plausible options for bridging this official funding shortfall. These include the use of subsector deposits through repo transactions, and the unused portion of the official funds earmarked for bank recapitalisation. The recent re-establishment of some limited market access also increases Greece's financing flexibility.
A better fiscal track record is being established. Greece's deficit reduction over the past four years of its two programmes has been remarkable. The headline deficit/GDP excluding bank support, has been brought down by 14 percentage points against severe cyclical headwinds. With the most challenging phase of Greece's adjustment behind it, the rating is becoming less sensitive to policy holdups and political crises.
Medium
Greece recorded its first post-war current account surplus in 2013 (0.7% of GDP). This has been greatly aided by severe import compression and debt interest relief. However, it also reflects buoyant tourism receipts and a significant step up in net EU transfers.
The economy is bottoming out. Economic data outturns have been encouraging and support our baseline expectation that the recovery will gradually take hold this year. Fitch forecasts GDP growth of 0.5% in 2014, rising to 2.5% in 2015. Capital market conditions have improved significantly, with large corporates and the sovereign able to re-access funding.
Greece's 'B' IDRs also reflect the following key rating drivers:
Political risk remains high. The current administration has displayed greater ownership of the official programme, but the loss of a junior coalition partner and defections by individual MPs have significantly eroded its majority. An early general election in 1Q15 is the most likely scenario, although a snap election this year cannot be discounted. Although it is not Fitch's central scenario, there is a risk that the next administration would be less supportive of economic and fiscal reform.
Fitch's average Viability Rating for Greece's banking system is 'b', indicating weak standalone creditworthiness. Greek banks have been recapitalised by the government and to a lesser extent by private sources. Although the capital ratios of some Greek banks compare favourably internationally, this is offset by fragile risk profiles in the context of the prolonged recession. Bank asset quality is weak – 33% of loans were non-performing in 2013 – although credit deterioration should decelerate in the next quarters.
To a large degree, Greece's adjustment has taken place through steep declines in real GDP and employment. However, there has also been a notable wage and price adjustment with the real effective exchange rate (unit labour cost deflated) now back at the level of the mid-1990s. Fitch considers price competitiveness to have been restored, although the export base remains narrow. Consumer prices and the broader GDP deflator are falling, although Fitch forecasts a return to positive inflation in 2015.
Despite mixed progress in carrying out officially-sanctioned structural reform, there have been significant advances in some areas, notably public administration and labour market flexibility. Given the country's extremely high rate of unemployment (27.3% in 2013) the latter could potentially be a major factor in reducing joblessness over the medium and long term. A "multi-bill" of structural reforms passed through parliament in March contains a raft of measures to tackle product market weaknesses previously identified by the OECD.
Greece's sovereign ratings are underpinned by its still high income per capita (this far exceeds 'B' and 'BB' medians), its superior measures of governance and membership of the eurozone, which shields it from exchange rate risks and has facilitated access to unprecedented financial assistance.
The Country Ceiling has been raised to 'BB' reflecting the receding risk of Greek exit from the eurozone, coupled with the demonstrable external market access of both the sovereign and the private sector.
RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, future developments that could, individually or collectively, result in positive rating action include:
-A strong economic recovery; budgetary improvement supporting our baseline of a sustained primary surplus of 4% of GDP; progress in clearing arrears.
-A successful programme exit, with market access at affordable rates and debt relief on official loans (OSI) on terms that significantly improve long-term public debt dynamics.
Future developments that could, individually or collectively, result in negative rating action include:
-A domestic political crisis and/or worsening relations with creditors that casts doubt over Greece's ability and willingness to continue its fiscal and structural adjustment.
-Failure of the economy to recover, leading to funding gaps and higher risks around debt sustainability. Continued price falls over the medium term would damage the macroeconomic outlook.
KEY ASSUMPTIONS
The ratings and Outlook are sensitive to a number of assumptions.
Official creditors continue to support Greece within the framework of the second adjustment programme. Current and future administrations continue to be broadly supportive of the fiscal and economic adjustment. Social stability is maintained.
Greek banks make no further material demands on the sovereign balance sheet; EUR37bn (20% of GDP) has been injected to date.
General government gross debt/GDP will stabilise at 177% in 2014, subsiding gradually thereafter. These assumptions do not factor in any OSI on official loans that may be agreed later this year (as per the Eurogroup's prior commitment of November 2012). The projections are sensitive to assumptions about growth, the GDP deflator, Greece's primary balance and the realisation of privatisation revenues.
Greece remains a member of the eurozone and does not seek to impose capital controls in the face of any renewed strains on sovereign creditworthiness.
Greece and the eurozone as a whole will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. An extended period of deflation, resulting in low growth in nominal GDP would be highly damaging to public debt dynamics.
The gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.
