Although the Eurozone agreed to provide Greece with a second bailout earlier this week, risks remain high. Meanwhile, Fitch has downgraded Greece's sovereign debt rating further into "junk" territory.
IHS Global Insight Perspective | |
Significance | Although the Eurozone agreed to provide Greece with a second bailout earlier this week, risks remain high. Meanwhile, Fitch has downgraded Greece's sovereign debt rating further into "junk" territory. |
Implications | The second bailout is still dependent on a successful restructuring of Greece's private debt and on Greece introducing further austerity measures and reforms. In the longer term, Greece will still need to meet quarterly targets in order to receive further funds, and this will be difficult given the dire economic situation. |
Outlook | IHS Global Insight expects the Eurozone to approve the Greek bailout next week, but rating agency Fitch is likely to downgrade Greece's rating to D once the private exchange is completed. Shortly after completion, Fitch will reassess Greece's creditworthiness and move its rating accordingly. |
Risk Ratings | Among the other major rating agencies, Moody's currently rates Greece at Ca (equivalent to CC+ on the generic scale), while the Standard and Poor's (S&P) rating stands at CC. IHS Global Insight's Greek Sovereign Risk Rating sits at 65 (CCC on the generic scale). All of these ratings—with the exception of Fitch's, which stopped providing an outlook on Greece's rating last July—carry a Negative outlook. |
The agreement of a second bailout worth EUR130 billion (USD172 billion) earlier this week (see Eurozone – Greece: 21 February 2012: Eurozone Agrees Second Greek Rescue Deal) has eased some of the immediate concerns about Greece. In particular, it means that the likelihood of Greece suffering a "hard" default in late March—when a bond of EUR14.5 billion is due—has diminished. However, as IHS Global Insight mentioned in its article on Tuesday (21 February), the disbursement of the funds, albeit very likely, is still not a certainty. Moreover, even if the second rescue package is approved, this does not mean that the Greek problem has been solved for good.
Hurdles Still to Overcome
A Successful Debt Restructuring
The text released by the Eurozone finance ministers (Eurogroup) on Tuesday was clear: the disbursement of the funds related to the second bailout will be subject to a successful completion of private sector involvement (PSI). Greece and its private creditors have been locked in negotiations for months in an effort to reach a deal aimed at cutting Greece's debt by around EUR100 billion. Private investors are being asked to swap their existing bonds for new bonds—issued under English law—with a nominal haircut of 53.5%, although their losses on a net present value basis are likely to be around 75%. Once a deal between Greece and the International Institute of Finance (IIF)—which represents private investors—is reached, the offer will be put forward for investors and the results announced on 9 March. Greece's official lenders—the "troika"—are targeting a 95% participation rate, which would cut EUR107 billion of Greek debt. That would certainly mean a success in the troika's view. On a positive note, the "sweeteners" being offered as part of the deal should help to achieve a large participation rate. However, this is not certain. A relatively large proportion of the bonds being negotiated are held by hedge funds and other independent investors, who may not have a strong incentive to take part in the deal, particularly if they hold bonds maturing in the short term (for example, the March bond).
Wary of this, the Greek parliamentary Economic Affairs Committee yesterday (22 February) approved legislation containing collective action clauses (CACs) that would be activated in the event that Greece could not convince bondholders to take part in a voluntary swap. Under the bill, the swap will go ahead once 50% of bondholders have responded to the offer, and the CACs—which will only be applied to existing bonds issued under Greek law (around 90% of the debt currently being negotiated)—will be activated once two-thirds of those have voted in favour of the swap. The legislation will now be taken before a full parliamentary session. Although CACs will help to achieve a larger participation rate, they are likely to trigger a credit event and thus activate credit default swaps (CDSs). European policy-makers have been extremely reluctant to trigger a CDS. Firstly, they believe that this could send shockwaves throughout Europe's financial sector. However, the main reason is reputational: without triggering a credit event, the debt exchange can still be called "voluntary". However, we believe that, given the circumstances, Europe may take the view that triggering a credit event is the "lesser evil".
More Austerity and Reforms
A successful PSI is just one of the many potential hurdles that Greece needs to overcome to obtain the funds. Other legislation tabled includes bills containing EUR3.2 billion of spending cuts. The legislation—and several other bills, including a 22% reduction in the monthly minimum wage and legislation aimed at making the labour market more flexible—needs to be approved by parliament by next week, as Eurozone finance ministers are due to meet again to give final approval to the deal. Meanwhile, protesters yesterday gathered again outside the Greek parliament, although turnout was dampened by wet weather. Several thousand trades unions, joined by pensioners and other protesters, marched through central Athens. Doctors and health workers also staged a 24-hour strike over pay cuts. Although yesterday's protests were relatively quiet, public anger is likely to result in much larger demonstrations in the weeks to come. Unions have warned that they are not bound by any of the agreements signed by the Greek government and they will continue to organise protests.
Meeting Targets
In total, Greece is set to receive EUR93.5 billion in cash and bonds in March. This includes EUR30 billion in European Financial Stability Facility (EFSF) bonds to be used as sweeteners for private investors taking part in the PSI, EUR23 billion to recapitalise Greek banks (highly exposed to Greek sovereign debt), EUR5.5 billion to settle interest payments on the bonds traded in, and EUR35 billion in EFSF bonds given to banks to use as collateral against European Central Bank (ECB) funding while Greek bonds are in default (see below). However, future disbursements will be dependent on Greece meeting the quarterly targets agreed with the troika. Even the IMF estimates that the risks in this respect are clearly tilted to the downside. This will be very difficult while the Greek economy is immersed in one of the worst crises in its modern history. Not only will more austerity keep the economy under intense pressure, but the risks of a political and social backlash against the austerity measures and reforms will increase the longer the economic situation remains in the doldrums. If Greece wants to stay in the Eurozone, it is imperative that the reforms needed to improve its competitiveness are fully implemented. However, plummeting activity levels will make it very difficult for Greece to reduce its large fiscal deficit and meet the targets agreed with its official creditors. As a result, tensions are likely to resurface every time Greece has to secure a new tranche of official funds.
Fitch Downgrades Greek Rating
Against this background, Fitch downgraded Greece's sovereign rating further into "junk" territory following Tuesday's announcement. The rating was cut by one notch to C. Fitch's action was triggered by its opinion that the PSI, if completed, would constitute a "distressed debt exchange" and thus the rating was moved a step closer to default. When and if the exchange is completed, Fitch will lower the Greek issuer rating again to Restricted Default (RD), while the rating of the bonds included in the exchange will also be lowered to D. Shortly following completion of the exchange, Fitch will then reassess Greece's creditworthiness and move its rating accordingly.
Among the other major rating agencies, Moody's currently rates Greece at Ca (equivalent to CC+ on the generic scale), while the Standard and Poor's (S&P) rating stands at CC. IHS Global Insight's Greek Sovereign Risk Rating sits at 65 (CCC on the generic scale). All of these ratings—with the exception of Fitch's, which stopped providing an outlook on Greece's rating last July—carry a Negative outlook.
Outlook and Implications
All of the above factors lead us to believe that tensions stemming from the Greek situation are likely to resurface. Following the second bailout, Greece's economy is likely to remain in a very difficult situation, while the political landscape following the parliamentary election set to be held in April is still not clear. Meanwhile, public debt levels will remain high even after the restructuring, while the new debt—now mostly owned by official institutions and other Eurozone sovereigns—will be more difficult to restructure in the future.
Over the long term, Greece's ability to remain in the Eurozone will depend on its ability to transform its economy. This will not be easy. IHS Global Insight currently believes that there is a 40% chance of Greece abandoning the common currency area over the next three years, but this probability is likely to be revised shortly given recent events.