Moody’s Investors Service has today downgraded Greece’s government bond rating to Caa3 from Caa2 and placed the rating on review for further downgrade.
“The short-term rating is unaffected by this rating action and remains Not Prime (NP),” the agency said. Moody’s government bond rating applies to privately-held debt only.
Here’s the full analysis by Moody’s:
The key driver for today’s rating action is Moody’s view that the probability of support continuing to be provided over the medium-term has fallen since the assignment of the Caa2 rating in April, regardless of the outcome of Sunday’s referendum. Moody’s believes that without ongoing support from official creditors, Greece will default on its privately-held debt. Events of recent months have illustrated the distance between what Greece’s official creditors will demand as a condition of continued support over the coming years, and what Greece’s institutions are able to do to meet those demands with further meaningful economic and fiscal reforms. This creates significant difficulties for the achievement of a long-lasting support agreement.
The announcement of the referendum adds a further, more acute, risk to private creditors. The review for further downgrade will assess the implications of the outcome of the referendum for Greece’s willingness and ability to reach agreement with its official sector creditors. A “No” vote would likely increase the risk of exit from the euro area which would impose significant losses on private sector creditors.
Concurrently, Moody’s has lowered the country’s local- and foreign-currency bond ceilings to Caa2 from B3, which reflects the increased probability that the outcome of the referendum leads not just to Greece defaulting on its official and privately held debt, but also exiting the euro area.
The local- and foreign-currency bank deposit ceilings remain at Caa3. In Moody’s view, that level appropriately reflects losses expected on bank deposits given both the immediate pressures implied by the bank holiday, deposit withdrawal limitations and capital controls recently put in place, alongside the risks of a broad insolvency of the banking system or an exit from the euro area. The short-term foreign-currency bond and deposit ceilings remain Not Prime (NP).
INCREASED RISK TO PRIVATE SECTOR CREDITORS, REGARDLESS OF THE REFERENDUM AND ITS OUTCOME
In Moody’s view, without support from official creditors, and the economic and fiscal reforms needed to retain that support and to place its own finances on a more sustainable footing, Greece will default on its privately held obligations at some point. If Greece is to continue to service its official and private sector obligations over the coming years, it needs to reach a lasting agreement with its official creditors.
However, even if such an agreement can be reached, it will face high, ongoing implementation risks given political and social discontent in Greece and its weak institutions, which have hampered implementation of agreed measures to date. Today’s rating action reflects Moody’s view that, regardless of the outcome of Sunday’s referendum, the probability of a supportive programme being agreed and remaining in place has fallen since the assignment of the Caa2 rating in April, and that the risks to private creditors have risen to levels commensurate with a Caa3 rating.
While much has been done in recent years to reduce the Greek government’s budget deficit, Greece has had limited success in implementing longer-term structural reform. Recent events have cast doubt over the current government’s willingness to try, but even were it or a future government to adopt a more co-operative stance with official creditors, its capacity to achieve agreed objectives would remain in doubt. Developments over the past few months reflect the distance between what Greece’s official creditors are likely to demand as a condition for further support and the government’s capacity to meet those demands with further economic and fiscal reform.
As a result, the likelihood of an irrevocable breakdown in relations with external creditors and the withdrawal of support over the medium term has risen in recent months in Moody’s view, and will remain high for some time to come. That has significant implications for Greece’s creditworthiness and for the risks to private creditors.
While Greece’s debt is currently affordable due to soft financing terms, it is unsustainable over the long term. In order to bring its debt load down to more manageable levels, the Greek government would need to run large primary surpluses for a number of years. It is increasingly clear that this will be politically and socially untenable. It also seems increasingly likely that progress on the economic reforms needed to boost growth will be gradual. In short, it is unlikely that either growth or fiscal austerity will be successful, even over multiple generations, in reducing Greece’s debt from its current level of over 177% of GDP to a manageable level.
It follows that official sector debt, which forms the dominant share of Greece’s debt burden, will very likely need to be restructured at some point in the coming years. The implications of this for private sector creditors will depend on the circumstances in which that happens. A restructuring undertaken with the agreement of official creditors once Greece has regained market access could be undertaken without imposing losses on private sector creditors: as both sides would have an incentive to avoid a further shock to creditor confidence.
However, a write-down which resulted from a period of acrimonious disagreement of the sort seen in recent months would be unlikely to reflect shared longer-term objectives, and more likely to result in losses being imposed on private sector creditors, either as a quid pro quo for losses experienced by official creditors or as a by-product of a shock event such as Greece’s exit from the euro area.
In Moody’s view, events in recent months suggest that the likelihood of a consensual restructuring of debt has reduced. An extended period of time has been spent attempting, so far without success, to reach an agreement to tide Greece over for a short period. Even if agreement is reached, a further programme will be needed containing more far-reaching reforms in exchange for a longer-term financing programme. Recent experience suggests that even if this programme is put in place, implementation risks will remain high for some time to come, as will the risks of a further breakdown in relations between Greece and its creditors.
These dynamics imply a greater risk to private sector creditors over the medium term than previously assumed. They imply a high risk of further default, and of loss. That risk is, in Moody’s view, no longer consistent with a Caa2 rating.
More immediately, the pressures on Greece’s liquidity and its economy remain high. These pressures will not dissipate quickly, whatever the outcome of Sunday’s referendum.
Greece’s failure to make the EUR1.5 billion payment due to the IMF on June 30, resulting in Greece joining the small group of nations that have built up arrears to the IMF, illustrates both the precarious nature of its finances and the difficult relations with its official creditors. Moody’s ratings reflect our views on losses expected on privately held, not official creditor debt. However, the missed payment reflects the extreme credit distress that Greece is facing. Greece will, at a minimum, lose access to further IMF resources until the arrears were cleared.
Greece’s banking system, already impaired, has been further damaged by recent events, with adverse consequences for financial intermediation in the economy in the coming months and years. The calling of the referendum prompted the official creditors not to extend the European Financial Stability Facility (EFSF (P)Aa1, stable) facility, which expired on 30 June as scheduled. Furthermore, the European Central Bank’s (ECB) decision not to allow the Bank of Greece to increase Emergency Liquidity Assistance (ELA) prevents Greek banks from financing further deposit withdrawals. Consequently, the Greek banks have closed and will not reopen until at least 7 July, and the government has imposed capital controls, which essentially restrict cash withdrawals and external payments (subject to approval by the Committee on Banking Transactions Approval) in order to contain deposit outflows.
In response to the referendum announcement, Greek households have withdrawn deposits at an accelerating pace over the past weekend. Moody’s estimates that private-sector deposits have declined by around EUR44 billion since the end of last November to approximately EUR120 billion today. Outflows over the past two weeks alone exceeded EUR8 billion. Elevated uncertainty over the past six months has adversely affected consumer and investor confidence, and economic growth. Growth will be further undermined by the imposition of limits on deposit withdrawals and capital controls, which Moody’s believes will have a long-lasting impact on domestic demand, the more so the longer they remain in place.
RATIONALE FOR THE REVIEW FOR DOWNGRADE
While it is not the principal driver of today’s downgrade, the announcement of a referendum adds a further, more acute, risk which poses additional risks to private creditors. The review for further downgrade will assess the implications of the outcome of the referendum for Greece’s willingness and ability to reach agreement with its official sector creditors. The negative bias of the review reflects Moody’s view that the balance of economic, financial and political risks remains slanted to the downside.
The significance of last weekend’s events lies not simply in the calling of a referendum, but in the manner in which it was called. It was not called in order to allow the Greek electorate to approve a package agreed with Greece’s official lenders and endorsed by the Greek government. Instead, it was the government’s response to the failure to agree to proposals from the official lenders which the Greek government felt were unacceptable, despite recent signs of a rapprochement between the two sides. Accordingly, regardless of the precise question the Greek authorities will put to the electorate, Moody’s views this as a referendum on whether or not Greece should accede to the demands of the official creditors. Since a hardline stance on negotiations would make the likelihood of agreement with creditors remote, the question the government is essentially putting to voters is whether Greece should remain within the euro area.
The Greek government indicated that it will advise voters to vote ‘No’. Since then it has requested a new programme from the European Stability Mechanism (ESM, Aa1, stable) and an extension to the EFSF programme, which was subsequently denied by the Eurogroup. Most recently, the Prime Minister indicated that the government would be willing to compromise on a number creditor demands. The implications of these developments for the government’s preferred outcome of the referendum, and perhaps even for whether it happens at all, remain unclear. The review will assess all of these uncertainties.
Assuming the referendum happens, Moody’s believes that a ‘Yes’ vote would increase the likelihood of an agreement being reached between Greece and its creditors in time to avoid further defaults on official sector and privately-held debt over the near term. Even in that event, reaching agreement would not be straightforward and at the minimum would herald a period of political uncertainty, especially in the context of a very tight timeframe of payments to private-sector bond holders (around EUR90 million in July) and a payment to the official creditor ECB of EUR3.5 billion on 20 July.
However, a ‘No’ vote would further increase the probability of default on official and private sector debt and, ultimately, exit from the euro area. Should that be the outcome, some form of negotiations might well resume, but the probability of an agreement being reached would be low, and the probability of the two sides reaching a complete impasse commensurately high. In that event, further default on Greece’s official sector obligations would be inevitable, and the probability of a default on privately-held securities much higher than at present. And while default need not necessarily imply exit, the risk of exit would inevitably be high in the event of a complete impasse. In a ‘No’ scenario, Moody’s would expect that Greek banks would remain closed for a longer period with capital controls becoming tighter, and economic and financial conditions would worsen rapidly and significantly.
Even in the event of a ‘No’ vote, the situation would likely be fluid and uncertain. While Moody’s would expect to resolve the review in the period following the referendum, some time is likely to be needed once the result is known to assess the implications for the composition of the Greek government, and for its willingness and ability to reengage with its official sector creditors.
LOCAL- AND FOREIGN-CURRENCY BOND AND DEPOSIT CEILINGS
Moody’s has today also lowered Greece’s local- and foreign-currency bond ceilings to Caa2 from B3. The bond ceilings essentially reflect the risk of Greece leaving the euro area and the impact of the resulting currency redenomination on holders of Greek debt. While default need not necessarily entail exit, recent developments suggest it is increasingly likely that a default in privately held debt would follow on from a disorderly default on official creditors, increasing the probability of exit-given-default.
The local- and foreign-currency bank deposit ceilings remains at Caa3. In Moody’s view, that rating level appropriately reflects losses expected on bank deposits given both the immediate pressures implied by the bank holiday, deposit withdrawal limitations, and capital controls recently put in place, alongside the risks of a broad insolvency of the banking system or an exit from the euro area. The short-term foreign-currency bond and deposit ceilings remain at Not Prime (NP).
WHAT COULD MOVE THE RATING UP/DOWN
Moody’s would further downgrade Greece’s government bond rating if the probability of a default and/or severity of loss to investors in the event of default were to rise to levels that are no longer commensurate with a Caa3 rating. That would most likely occur in the near-term should the referendum yield a ‘No’ result. Even in the event of a ‘Yes’ vote, further deterioration in the Greek government’s relations with its creditors in the ensuing negotiations, or evidence that the Greek electorate is becoming supportive of a more confrontational stance, would raise the probability of default and exit from the euro area, and place downward pressure on the rating.
Although not likely over the near term given the prevailing downside risks, Moody’s would consider upgrading Greece’s government bond rating in the event of (1) an increase in the pace of fiscal consolidation and structural reforms; (2) sustained economic growth and primary surpluses, which would support a continued decline in debt levels; and (3) more certainty and visibility on future external financial support and the political environment.
Prompted by the factors described above, the publication of this credit rating action occurs on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.
GDP per capita (PPP basis, US$): 25,859 (2014 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 0.8% (2014 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): -2.6% (2014 Actual)
Gen. Gov. Financial Balance/GDP: -3.5% (2014 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 0.9% (2014 Actual) (also known as External Balance)
External debt/GDP: [not available]
Level of economic development: Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.