Fitch affirms Greece at ‘CCC’

Fitch Ratings has affirmed Greece’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘CCC’. The issue ratings on Greece’s senior unsecured foreign and local currency bonds have also been affirmed at ‘CCC’. The Short-term foreign currency IDR has been affirmed at ‘C’ and the Country Ceiling at ‘B-‘.

According to a Fitch announcement, Greece’s financial assistance programme with the European Stability Mechanism of up to EUR86bn has reduced the risk of Greece defaulting on its private sector debt obligations and supports the rating at ‘CCC’. The risks to the programme remain high. It will take some time for trust to be restored between Greece and its creditors, and further deadlocks in negotiations are possible. Meanwhile, the political situation in Greece remains unpredictable.

Fitch notes: “An initial ESM disbursement of EUR13bn in August relieved the acute liquidity strains on the government. Progress under the programme so far has been steady, although completion of the first review is unlikely before January, in our view. The programme conditionality is demanding and highly front-loaded. However, successful completion of the first review should unlock the promise of limited debt-relief on Greece’s official loans, providing an additional incentive.

The Greek government has completed most of the 49 “prior action” milestones required for a partial disbursement of EUR2bn as well as funds to recapitalise the banking sector. Further milestones will be set for the release of an additional EUR1bn and formal completion of the first review. The politically controversial issue of the Greek household insolvency and foreclosure framework is currently the key sticking point between the authorities and the institutions.

The recapitalisation of Greek banks after the ECB’s Comprehensive Assessment is a step on the long road towards re-establishing the banking system’s viability and restoring financial stability. A capital shortfall of EUR14.4bn was identified, at least EUR4.4bn of which we expect to be raised by the banks themselves, with the remainder to be covered by the authorities. EUR10bn has been set aside in a segregated ESM account for this purpose, but will only be released upon completion of the 49 milestones. This is expected before the end of the year, assuming that the household insolvency and foreclosure framework issue is resolved.

The Greek banks have exceptionally large volumes of problem loans that account for roughly 63% of the country’s GDP and are high relative to their capital bases. Once finally agreed, the new legislative changes to improve Greece’s insolvency framework may facilitate foreclosures and restructurings, but we believe any material improvement in asset quality will only arise in the medium term. Until then, the sector’s viability will remain weak. The ECB is providing sufficient ELA liquidity to the Greek banks although capital controls are likely to persist at least until next year.

The final allocation of parliamentary seats from September’s election was remarkably similar to that of January’s, with Syriza forming a second coalition with the Independent Greeks, with a slim majority of 155 of 300 seats. However, the removal of the more vehemently “anti-memorandum” faction of Syriza looks to have made the government more cohesive in its dealings with the creditor institutions. Should the government lose its majority, alternate coalition formations should be possible with centre-left Potami or PASOK.

Relations between the Greek government and its creditors have improved since their nadir of early July, as illustrated by the speed with which the ESM programme was agreed and the progress made so far in the first review. However, it is reasonable to assume that a repeat of the breakdown in relations seen in 1H15 would substantially increase the risk of Grexit.

The role of the IMF in the context of the third bailout programme remains uncertain. The Fund states that it expects to remain involved in the programme but only if “significant” debt relief is forthcoming. There are likely to be disagreements between the IMF and Europe as to the scale of the debt relief on offer. We do not expect principal haircuts on the official debt stock given the political sensitivities around this issue.

Last year’s recovery in Greek GDP continued into early 2015, with GDP up 0.7% yoy in 1H15. The escalation of the crisis in July led to a contraction in 3Q15 of 0.5% qoq (flash estimate), albeit this was significantly shallower than we had forecast. The combination of continued uncertainty over programme success and fiscal tightening will lead to weak growth dynamics over the coming four quarters. We forecast GDP contractions of 0.3% in 2015, and 1.5% in 2016. Downside risks to the forecast could arise from future uncertainty over Greece’s euro membership, with a knock-on impact on confidence. Conversely, upside risks could arise from a faster rebound in sentiment as Grexit fears fade, and from tourism, which remains a well-performing sector.

The draft 2016 budget targets a primary balance (programme definition) of -0.25% of GDP in 2015 and +0.5% in 2016, based on real GDP forecasts of -2.3% in 2015 and -1.3% in 2016. The bulk of the fiscal adjustment will fall in 2016 (EUR4.3bn compared with EUR2bn in 2015). Overall the budget measures are split roughly 40:60 between expenditure and revenue. The fiscal tightening will be a headwind to growth, although it is an order of magnitude less than that seen over the period 2010-13.

Developments that could, individually or collectively, result in a downgrade include:

– A repeat of the prolonged break-down in relations between Greece and its creditors seen in January to July, for example in the context of a failure to meet ESM programme targets.

– Non-payment, redenomination and/or distressed debt exchange of government debt securities issued in the market or a government-declared moratorium on all debt service.

Future developments that could, individually or collectively, result in an upgrade include:

– A track record of successful implementation of the ESM programme, brought about by an improved working relationship between Greece and its official creditors and a relatively stable political environment.

– An economic recovery, further primary surpluses, and official sector debt relief would put upward pressure on the ratings over the medium term.

The ratings are sensitive to the following key assumptions: Fitch assumes that any debt relief given to Greece under the ESM programme will apply to official-sector debt only, and would not therefore constitute an event of default under the agency’s criteria.

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