UPDATE: S&P Upgrades Greece to 'CCC+'; Outlook to Stable (GREK)

(Updated - July 21, 2015 2:29 PM EDT)

OVERVIEW

• Greece has requested and received consent, in principle, from the Eurogroup for a three-year loan program via the European Stability Mechanism and received €7.16 billion in three-month bridge financing, which it used on July 20 to clear its arrears with the International Monetary Fund and the Bank of Greece, and to repay the European Central Bank.
• We consequently think the possibility of Greece leaving the eurozone has declined to less than 50% within our forecast horizon to 2018, but the risk of an exit is still high if the Greek government doesn't successfully implement what looks to be an ambitious program.
• We are raising our long-term rating on Greece to 'CCC+' from 'CCC-' based on our view that its default on its stock of commercial debt is no longer inevitable in the next six to 12 months.
• The stable outlook indicates our view that, over the next 12 months, risks to our 'CCC+' rating are balanced.

RATING ACTION

MADRID (Standard & Poor's) July 21, 2015--Standard & Poor's Ratings Services said today that it raised its foreign and local currency long-term sovereign credit ratings on Greece (Hellenic Republic) to 'CCC+' from 'CCC-'. The 'C' short-term foreign and local currency sovereign credit ratings were affirmed. The outlook is stable.

As defined in EU CRA Regulation 1060/2009 (EU CRA Regulation), the ratings on Greece are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2015 EMEA Sovereign, Regional, And Local Government Rating Publication Dates: Second-Quarter Update," published July 10, 2015, on Ratings Direct). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation.

In Greece's case, the deviation was prompted by the consent, in principle, of the Eurogroup (euro area member state finance ministers) to Greece's request for a three-year loan program under the European Stability Mechanism (ESM), as well as the disbursement on July 20 to Greece of €7.16 billion in bridge financing, which the government has used to clear arrears with the International Monetary Fund (IMF) and the Bank of Greece and to repay €3.49 billion in Greek government bonds held by the European Central Bank (ECB). The deviation also follows the reopening of Greek bank branches on July 20, and the ECB's increase on July 16 in the ceiling on Emergency Liquidity Assistance to Greece's financial sector.

RATIONALE

The upgrade reflects Greece's improved liquidity perspective following last week's consent, in principle, from the Eurogroup to the three-year loan program for Greece via the ESM, alongside the provision of €7.16 billion in three-month bridge financing to the Greek government, which it used on July 20to clear its arrears with the IMF and the Bank of Greece and to repay the ECB.

We consequently think that Greece's default on its stock of commercial debt is no longer inevitable in the next six to 12 months. Under the three-month bridge financing, Greece repaid the ECB €3.49 billion on July 20 on schedule. We still consider that Greece's solvency over the next few years remains dependent on favorable business, financial, and economic conditions, and any forthcoming funding relief on its official liabilities. Greece's official obligations make up just under three-quarters of Greece's sovereign debt (including Greece's stock of treasury bills in total debt).

Greece's financial commitments appear to us to be unsustainable over the long term, if and when the current official concessional loans are replaced by market funding and the current interest rate holiday on a significant part of Greece's debt to official creditors lapses.

We believe the probability of Greece leaving the eurozone remains higher than one in three but less than 50%, although we think the agreement between Greece and its creditors announced last week has reduced this risk. The probability would increase if Greece doesn't successfully implement the new ESM loan program. We see the risk of such non-implementation as high, given the weakness of the economy, and the implications this might have for further political and social instability.

We think opportunities for Greece to default on commercial debt this year are few. Redemptions owed on commercial debt this year (from the present to end Dec. 31, 2015), excluding treasury bills, amount to a single €176 million payment on a state-guaranteed Hellenic Railway bond due in October. For the last seven months of 2015, interest payments on commercial debt (including on the debt of Hellenic Railways and Athens Urban Transportation Organisation) total €1.5 billion, or less than 1% of GDP. Consequently, we do not anticipate that Greece is likely either to default outright on such commercial debt or to engage in a distressed exchange offer to commercial creditors within the next 12 months.

Still, the new three-year loan program appears to us more onerous than the program that Greek voters rejected in the referendum on July 5.

The Eurogroup's agreement, in principle, to Greece's request for the new three-year ESM program, hinges on approval by eurozone national parliaments and a list of prior actions to be legislated by the Greek parliament. The government has already legislated on most of these prior actions. Negotiating the new program will, we anticipate, take at least a month. We expect that before the start of negotiations on a new memorandum of understanding, Greece's parliament will approve additional prior actions including judicial reform and the adoption of the EU Directive on Bank Recovery and Resolution (BRRD). However, political backing for the reforms is only partial within the governing Syriza party, raising the possibility that the implementation of the new program could be interrupted by another round of general elections (which would be the second this year, and the fourth since May 2012), or by further weakening in growth, financial stability, or both. We note that some comments made by Prime Minister Alexis Tsipras and his finance minister could suggest an absence of commitment to implement the program.

We expect the Greek economy will shrink by 3% this year. At negative 3%, Greece's economy would be the worst-performing among all 129 sovereigns that Standard & Poor’s rates, except for Ukraine, Venezuela, and Belarus (see "Sovereign Risk Indicators," published June 30, 2015, an interactive version can be accessed at www.spratings.com/SRI). Risks to our GDP projection are substantial and in either direction. On the one hand, the extended bank holiday (which ended on July 20) has severely depressed retail trade and manufacturing (given a shortage of input financing for the latter), and has harmed exports, including tourism. We also think that Greece’s economy is more based on cash transactions than most other EU economies, amplifying the contractionary impact of the cash shortage. Even before capital controls were implemented, liquidity in the Greek economy was constrained, with the public sector having accumulated arrears to the private sector totaling around 4% of GDP, by our estimates. The hike on value added tax (VAT) on July 20, applicable to restaurants and public transport, alongside new expenditure cuts, will exert further fiscal drag on Greece's economy. Although banks are now open again, their operations are limited and capital controls are likely to remain in place.

On the other hand, the agreement to negotiate a new program, which will potentially include refinancing amounting to up to 14% of GDP to recapitalize Greece's distressed banks should help gradually restore confidence in Greece’s financial stability. The very weak current level of GDP compared to potential may drive a statistical recovery commencing in late 2015 and early 2016, given that domestic demand is down about 40% since 2008. In our opinion, the ESM loan agreement between Greece and its official creditors will also repair some of the damage done to tourist bookings from the bank closures, and should eventually support a return of trade financing. Moreover, assuming the ESM financing includes a reduction of public arrears to domestic suppliers (which we anticipate), the small and midsize enterprise (SME) sector will become more liquid, leading to faster payment of wages to the private sector.

A key question for the economy in the next few years, in our view, is whether Greece can attract foreign investment, including equity inflows, to upgrade its capital stock and create jobs, especially in the country's relatively small tradables sector. Since 2008, Greece's gross fixed capital formation has declined by more than 60%. We think the very low foreign direct investment inflows into Greece's private sector (both before and since the financial crisis) reflect both concerns regarding the state's solvency, as well as the weak and unpredictable business and legal environment. A material reduction of the official debt burden could in our view go a long way to reduce uncertainties on the state's solvency over our 2015-2018 ratings horizon. Although Greek debt was not included in the ECB's first round of quantitative easing purchases of sovereign eurozone debt earlier this year, the July 20 payment of about €3.5 billion in Greek government bonds held by the ECB and another €3.6 billion in redemptions in August would reduce Greek commercial sovereign debt held by the ECB to below 33% of all commercial Greek debt, if treasury bills are included. This could make Greek government bonds eligible for purchase by the ECB, subject to compliance with the new ESM program.

The ECB Governing Council's decision on July 16 to raise the ceiling on Emergency Liquidity Assistance to Greece's banks, alongside the reopening of all bank branches in Greece on July 20, are important first steps toward normalizing financial stability. Nevertheless, the uncertain capitalization of Greece's commercial banks may hinder a return of deposits without more credible and explicit guarantees to depositors. We do not anticipate that capital controls will be lifted until European institutions complete their review of the banking system's capital requirements late this year or in early2016.

OUTLOOK

The stable outlook indicates our view over the next 12 months that risks to our 'CCC+' rating are balanced.

We could raise the ratings on Greece if the prospect of further meaningful relief on official debt becomes more tangible, which would in turn depend on the government's successful implementation of the yet-to-be agreed new ESM loan program. Moreover, successful implementation of significant structural reforms would, in our view, also contribute to enhancing Greece's currently depressed investment and growth potential, help it to achieve long-term sustainable public debt, and weigh positively on the ratings.

We could lower the ratings on Greece if the government hinders or halts implementation of the ESM program, which would withhold capital injections into Greece's banks and prevent restored confidence in the Greek economy. If this occurs, it would likely eliminate the possibility that the ECB might purchase Greek sovereign debt under its quantitative easing program. Failure to implement the ESM program would likely lead to Greece's default on its commercial debt and markedly increase the risk of Greece exiting the eurozone.

KEY STATISTICS

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RATINGS SCORE SNAPSHOT

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