Returning to growth
DBRS, Inc. (DBRS) has confirmed the Hellenic Republic’s long-term foreign and local currency issuer ratings at CCC (high) with a Stable trend. DBRS has also confirmed the short-term foreign and local currency issuer ratings at R-5 with a Stable trend.
The Stable trend reflects our view that the current financial support programme is reinforcing the stabilisation of the Greek economy and banking sector. The three-year EUR 86 billion Third Adjustment Programme has eased the liquidity squeeze and, following Greek parliamentary approval of the latest fiscal and structural measures in the first programme review last month, appears to cover the remainder of this year’s debt service payments. This should help foster the economy to return to growth.
However, given Greece’s social and political constraints to meeting the programme objectives, there is a risk of delays in funding support in 2017 should Greece fail to comply with the second programme review, to be concluded in October 2016. The programme has set ambitious targets that will require sustained fiscal consolidation and structural reforms. Implementation risk and large external imbalances make the recovery fragile and exposes Greece to shocks.
Greece’s credit strengths include the benefits the country enjoys from Eurozone membership and access to financial support from European institutions. Since 2009, the country has enacted a large fiscal adjustment, and has made progress in reforming the labor market, improving the tax code and streamlining public administration. The external sector has also shown sustainable improvement, with the conversion of the current account from a large deficit into a small surplus.
However, Greece continues to face considerable challenges in restoring financial stability and returning to sustainable growth while consolidating public finances under a fragile coalition government. After a delay of several months, the ruling SYRIZA-ANEL coalition has approved most of the conditions of the support programme. However, meeting the fiscal and structural reform adjustments of the programme amid social constraints and a slim three-seat majority in the parliament will be challenging.
Following the recapitalization of the banking sector in 2015, bank balance sheets remain weak. Non-performing loans are high, there has been a persistent withdrawal of bank deposits, and bank capital contains a high percentage of deferred tax assets. Combined with capital controls that have yet to be dismantled, these conditions have prevented an easing of financial constraints, and both the supply and demand for credit has remained low.
Given the high dependence on official sector financing, triggers to a rating upgrade include ongoing cooperation between Greece and the institutions to ensure viable policies in return for cash injections, and measures that smooth the debt servicing profile and facilitate the payment of public sector arrears. Structural reforms that enhance product markets to raise potential GDP growth, and structural fiscal adjustment measures such as broadening the tax base and reducing spending on wages and pensions, would improve creditworthiness. (The programme includes a provision to cut pension spending by 1% of GDP this year.)
Strengthening bank balance sheets to facilitate the supply of credit to the economy would put further upward pressure on the ratings.
Downward pressure on the ratings could result in the event of political instability that jeopardises relations with the institutions, calling debt servicing into question; significant fiscal slippage or a reversal of reforms; or an inability to weather external shocks, such as a UK vote to leave the EU on June 23.