Fitch Ratings has downgraded Greece’s Long-term foreign and local currency Issuer Default Ratings (IDRs) by one notch to ‘CC’ from ‘CCC’. The issue ratings on Greece’s senior unsecured foreign and local currency bonds have also been downgraded by one notch to ‘CC’ from ‘CCC’. The Short-term foreign currency IDR has been affirmed at ‘C’. The Country Ceiling has been lowered by one notch to ‘CCC’ from ‘B-‘.
Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch’s sovereign rating on Greece is 13 November 2015, but Fitch believes that developments in Greece warrant such a deviation from the calendar and our rationale for this is laid out below.
KEY RATING DRIVERS
The downgrade of Greece’s IDRs reflects the following key rating drivers and their relative weights:
The breakdown of the negotiations between the Greek government and its creditors has significantly increased the risk that Greece will not be able to honour its debt obligations in the coming months, including bonds held by the private sector. We now view a default on government debt held by private creditors as probable. Recent events have taken us beyond our previous base case that a deal would be struck before the expiry of the programme.
The government has called a referendum for 5 July on whether to accept the 25 June proposals of the creditor institutions regarding policy conditionality and is endorsing a ‘No’ vote to reject the deal. Although early polls suggest a ‘Yes’ vote is the more likely outcome, the risk of a ‘No’ vote is significant. In our view, a ‘No’ vote would dramatically increase the risk of a Greek exit from the eurozone. Such an exit would probably be disorderly as the current government is unlikely to co-operate with the European authorities in such an event.
Although a ‘Yes’ vote may help to avoid some of the more extreme risks face by Greece, the credit situation would remain precarious. A ‘Yes’ could lead to the formation of a new government with a mandate to reach an agreement with creditors on policy conditionality. However, the composition of the Greek parliament (two-thirds of MPs belong to anti-austerity parties) and the short timeframe before Greece’s EUR3.5bn Eurosystem redemption would make this a challenging prospect.
The current situation also means that Greece will most probably begin to run arrears with the IMF (EUR1.6bn loan repayment due 30 June) and risks running arrears on bonds held by the Eurosystem (EUR3.5bn due 20 July). Excluding bonds held by the Eurosystem, coupon payments and redemptions in July amount to about EUR200m.
The breakdown in talks has led the ECB to cap the level of emergency liquidity assistance provided to the domestic banks, requiring the authorities to impose extra bank holidays and capital controls to limit further drains on the system’s liquidity. These measures led Fitch to downgrade the IDRs of the four main Greek banks to ‘RD’ (Restricted Default) because the deposit restrictions affect a material part of the banks’ senior obligations (see ‘Fitch Downgrades Greek Banks to ‘RD’ on Capital Controls’ dated 29 June 2015 at www.fitchratings.com. The deposit restrictions will further damage Greece’s economic prospects; we have revised down our GDP forecast to a contraction of 1.5% in 2015. The risks to the economic outlook remain tilted heavily to the downside, with a deeper recession following from a ‘No’ vote.
The imposition of capital controls in Greece and risk of a disorderly and more permanent break from the Eurozone’s payment system has led us to lower the Country Ceiling by one notch to ‘CCC’. This reflects an increased risk that domestic entities will be unable to service international debt obligations due to the restrictions on capital outflows from the Greek economy.
Developments that could, individually or collectively, result in a downgrade include:
– Non-payment, redenomination and/or distressed debt exchange of government debt securities issued in the market.
– A government-declared moratorium on all debt service.
– As previously stated, arrears to the IMF would not in and of themselves constitute a rating default.
Future developments that could, individually or collectively, result in an upgrade include:
– A rapid rapprochement with Greece’s creditors following the referendum could allow for a disbursement of official funds, although the expiry of the current programme makes this technically more complicated.
– A track record of cooperation between Greece and its official creditors, for example agreement on a follow-up arrangement between Greece and its official creditors. This would probably take the form, if not the name, of a third programme of policy-conditional financial support.
– An economic recovery, further primary surpluses, and official sector debt relief (OSI) would put upward pressure on the ratings over the medium term.
The ratings are sensitive to the following key assumption:
The EFSF would not exercise its right to declare the EUR29.7bn PSI sweetener loan to be due and payable in the event that Greece begins to run arrears on IMF repayments. Such a declaration would trigger a cross-default clause in the privately-held new bonds issued in 2012, which Fitch rates.