DBRS downgrades Greece to CCC (high) negative trend

DBRS, Inc. downgraded the Hellenic Republic’s long-term foreign and local currency issuer ratings to CCC (high) on Friday with a Negative trend from B, and downgraded the short-term foreign and local currency issuer ratings to R-5 with a Stable trend from R-4. The ratings are no longer Under Review with Negative Implications.

The deviation of this review from the next scheduled publication date for ratings on June 12 is due to an increase in uncertainty over government policies and Greece’s capacity to remain current on its debt. DBRS placed the ratings Under Review on February 4 to reflect an elevated concern over the potential for a deterioration in creditworthiness as a result of actions by the Greek government following the general elections on January 25. In light of the change in government, and given the importance of financial assistance from the European Commission, European Central Bank and International Monetary Fund, DBRS’s concern over Greece’s ability to meet its financing needs had increased.

The current downgrade is due to a further increase in uncertainty over whether Greece and its creditors will reach an agreement on a programme that restores macroeconomic stability and improves Greece’s cash position. In the absence of an agreement, financing sources appear to be insufficient to meet Greece’s financing needs over the foreseeable future. This shortfall is due to the lack of access to bond markets, as well as a delay in an agreement between Greece and its official sector creditors over the conditions that the creditors require in exchange for continuing the existing financial assistance programme, or entering a new longer term lending programme.

DBRS’s view is that a new longer term programme is likely to be necessary to restore macroeconomic stabilisation.

The Negative trend reflects the risk of a missed payment to official creditors, or the further buildup of arrears to domestic agents. In the coming weeks, Greece faces a series of payments to the IMF and the ECB. A default to these creditors would likely cause an acceleration in the withdrawal of deposits from Greek banks, and would further undermine growth prospects. This is turn would make it more difficult for Greece to generate primary fiscal surpluses. Such a default could also jeopardise ECB Emergency Liquidity Assistance (ELA), without which Greek banks could face lower liquidity buffers and run the risk of insolvency.

Alternatively, DBRS could move the trend to Stable if Greece and its creditors agree on a financial assistance programme that restores liquidity and bolsters macroeconomic stability. This in turn would likely stabilise bank deposits, i mprove fiscal sustainability and foster economic growth.

The existing financial assistance program, the second economic adjustment programme, was extended to June 30. If Greece meets the conditions of the programme it would be eligible for a final tranche of EUR 7.2 bln. This would help Greece’s cash position, but would be unlikely to remove uncertainty over future payments. As part of the existing programme, the ECB and Single Supervisory Mechanism (SSM) could request from the European Financial Stability Facility (EFSF) an additional EUR 10.9 bln, originally transferred to the Hellenic Financial Stability Fund (HFSF) in the form of EFSF bonds and subsequently returned to the EFSF, to be transferred back to the HFSF for the recapitalisation and resolution of Greek banks, if necessary.

The current negotiations appear to be focused on two technical issues in the labour market and the social security system. Excessive restrictions in the labour market maintain a high cost of doing business, and inhibit the establishment or expansion of large firms. Collective dismissals of workers are not allowed, and this forces firms to offer high severance packages or resort to bankruptcy. The second issue is over reducing social security contribution rates, eliminating loopholes, better targeting lower-end contributions to reduce the cost of doing business for firms and strengthen labour demand, and strengthening the pension system by improving efficiency, achieving actuarial balance over the coming decades, ensuring consistency with fiscal targets, and making other parametric improvements.

The Greek negotiators have allegedly agreed to harmonise value-added tax rates, improve tax collection, and privatise a number of state-owned entities. However, they have not agreed to make further changes to the labour market or social security system. The impact of the delay in an agreement has been a liquidity squeeze, deposit outflows from Greek banks, a setback in the economic recovery, and a slowdown in the fiscal adjustment. From July 2014 to March 2015, deposits declined by EUR 33.7 bln, and are at their lowest level since September 2005. If deposit outflows continue, this could jeopardise financial stability and further lower prospects for economic growth, lead to a larger primary fiscal deficit, and impair debt sustainability.

For the remainder of 2015, Greece’s obligations are mainly in the form of principal and interest charges on IMF loans, principal and interest payments on bonds held mainly by the Eurosystem (the ECB and national central banks within the euro area), and interest payments on bilateral loans under the Greek Loan Facility (GLF).

At the same time, Treasury bill redemptions and monthly public sector wages and pensions are sizeable. There are also minimal principal and interest payments on restructured bonds held by the private sector.

The central government has also slipped into arrears with suppliers of goods and services to the public sector. To improve its cash position, it passed a decree on April 20 requiring local governments, state-owned companies and public pension funds to transfer their cash reserves to the Bank of Greece.