S&P Keeps Greece on CreditWatch Negative Following Eurogroup Agreement (GREK) (FXE)

OVERVIEW

• We consider that, at least for the short term, there are uncertainties around Greece successfully concluding a funding agreement with its official creditors.
• We also believe that the Greek government's liquidity position is increasingly stretched, requiring additional funding commitments in the second quarter of 2015 to allow for continued timely payment of Greece’s financial obligations.
• Moreover, we believe that the lack of a clear short- and long-term funding plan and the related political uncertainty weigh on GDP recovery prospects and tax compliance, and increase the risk of significant deposit outflows.
• As a consequence, we are keeping our 'B-/B' long- and short-term ratings on Greece on CreditWatch negative.

RATING ACTION

On March 13, 2015, Standard & Poor's Ratings Services said that its 'B-/B' long- and short-term sovereign credit ratings on the Hellenic Republic (Greece) remain on CreditWatch with negative implications where they were placed on Jan. 28, 2015.

RATIONALE

We consider that the Feb. 24, 2015, agreement in principle between Greece and the Eurogroup (the 18 other eurozone finance ministers) on the extension of the Master Financial Assistance Facility Agreement until end of June 2015 has not addressed how Greece’s funding needs will be met in the coming months. The Greek government and its official creditors appear to have a divergence of views regarding the appropriate policy concessions necessary for further official funding. At the same time, we consider it highly unlikely that Greece will regain market access to alternative funding sources in the coming months. We believe that an agreement between Greece and its creditors is a precondition for Greece mitigating its rising liquidity risks.

Between March and June 2015, the Greek government is required to make principle payments of €4.6 billion on its long-term debt, mainly to the International Monetary Fund, and €1.9 billion of interest payments. In parallel, it is facing €11.6 billion of treasury-bill redemptions, in a context where foreign investors have largely exited the market, and where the European Central Bank (ECB) has limited the amount of treasury bills (about €3.6 billion) to be accepted for Emergency Liquidity Assistance refinancing operations currently provided by the central bank of Greece. Greek government securities remain excluded from the Eurosystem's regular channels of liquidity provision, as well as from the ECB’s “Quantitative Easing” bond purchasing program. Furthermore, Greece’s funding needs appear to be rising on the budgetary side: A cumulative shortfall of receipts of €2.5 billion in January and February alone is putting the sustainability of the general government primary budget surplus at risk.

In that context, we believe the coverage of the short-term funding needs may necessitate the accumulation of domestic arrears with suppliers and tapping into cash reserves of public institutions. Drawdowns on the €10 billion (as of January 2015) of central government deposits in the Greek banking system (including €3.4 billion at the central bank) are also possible. We understand that €4 billion of these deposits are liquid on demand. However, we are mindful that a large deposit withdrawal by the government could add to liquidity stresses at Greek financial institutions if not accompanied by increased liquidity provision by the Eurosystem.

Beyond this short-term liquidity challenge, we believe there is considerable uncertainty over the prospects for a multiyear officially funded program to cover Greece’s funding needs beyond the first half of this year. Overall, in 2015, government funding needs should total about €21 billion, including more than €16 billion of redemptions on long-term debt and under the assumption of a budget primary surplus of 1.2%. In 2016-2018, we expect funding needs to diminish to €10.6 billion a year on average, given reduced redemptions but assuming a primary budget surplus of about 1% of GDP. We consider that a 1% budgetary surplus is possible only if Greece’s economic recovery is sustained and the recently observed dip in tax compliance in early 2015 can be reversed.

We believe that lack of clarity on funding over the short and medium term and related political uncertainty could increasingly weigh on Greece’s economic recovery and fiscal position. A key risk remains the possibility of a renewed intensification of pressure on the banking system's liquidity position. Between end-November 2014 and end-January 2015, Greek banks reportedly faced cumulative deposit outflows of about €18 billion, which was approximately one-tenth of the system’s deposit base in November 2014.

We still expect the growth trend that emerged last year to be confirmed in the second half of 2015, assuming that an agreement between Greece and its creditors can be reached and that such an agreement would help boost market confidence.

Although the debt-to-GDP ratio was a very high 176% at year-end 2014, other features of Greece's public debt profile are less onerous. These other features include its unusually long debt maturities--16.2 years for the total stock at year-end 2014 and 30 years on official bilateral financing and financing from the European Financial Stability Facility--and their low effective nominal interest rate, which we estimate is currently about 2%. Including concessional interest rates, Eurosystem retroceded interest earnings, and the interest rate grace period on official debt, we estimate Greece's general government interest at year-end 2014 at less than 3% of GDP.

A Greek exit from the eurozone is not our base-case scenario. We are of the view that the economic, social, and political ramifications for Greece of such an unprecedented step would be severe and would likely be accompanied by a payment default by Greece on both its official and commercial obligations. Early signs of heightened eurozone exit risk could include capital controls and bank deposit withdrawal limits, as well as a cash-strapped government issuing IOUs to pay employees, pensioners, and suppliers. These IOUs could circulate as a secondary means of exchange and, over time, lead to a national currency, which could operate as sole legal tender in Greece after potential government legislation to redenominate its financial obligations where legally possible (see "A Greek Exit From The Eurozone Would Have Limited Direct Contagion Risks For Other Sovereign Ratings," published Feb. 19, 2015, on RatingsDirect).

We note that our sovereign ratings pertain to a central government’s ability and willingness to service financial obligations to commercial creditors, which in Greece’s case hold an estimated 20% of its total debt stock, excluding ECB and other official creditor holdings of bonded debt (see "Eurozone Sovereigns To Decrease Commercial Borrowing By 2% To €916 Billion In 2015," March 6, 2015). Debt redemptions owed to the private sector total less than €500 million in 2015 and €1.09 billion in 2016, less than 0.3% and 0.6% of GDP, respectively, well below redemptions Greece owes to its official
creditors.

A missed payment to an official creditor would not constitute a trigger to lower the rating to 'SD' (selective default) under our criteria, although, other things being equal, it would likely constitute a negative factor in our analysis. Only a missed payment to a commercial creditor would constitute a default under our criteria. The Greek government has repeatedly committed itself to excluding private-sector creditors from any further debt reprofiling, although we consider the incentives for another restructuring could shift if the sovereign debt crisis intensifies.

CREDITWATCH

We aim to update or resolve the CreditWatch within the next two months, by which time we believe Greece’s funding plans will be clearer. We could lower the rating if we perceive that the likelihood of a distressed exchange of Greece's commercial debt will increase further. This could be the case if, for example, we took the view that further official creditor disbursements would remain elusive, resulting in the Greek government's inability to honor all its financial obligations in full and in a timely manner.

We could affirm our sovereign rating on Greece if we believe that a new financial support program will be agreed with policy conditions that satisfy both the political priorities in Greece and the creditor countries. Such a scenario could contribute to promoting political stability, tax compliance, and a gradual economic recovery.

KEY STATISTICS

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RATINGS SCORE SNAPSHOT

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