Fitch Revises Outlook on Greece to Negative; Affirms at 'B'

Fitch Ratings has revised the Outlook on Greece's Long-term foreign and local currency Issuer Default Ratings (IDR) to Negative from Stable and affirmed the IDRs at 'B'. The issue ratings on Greece's senior unsecured foreign and local currency bonds have been affirmed at 'B'. The Short-term foreign currency IDR has been affirmed at 'B' and the Country Ceiling at 'BB'.

KEY RATING DRIVERS
The revision of the Outlook to Negative reflects the following key rating drivers and their relative weights:

High
The current period of political uncertainty has increased the risks to Greece's creditworthiness as official financing, and any potential reopening of market access, could be delayed for some months. Early elections to be held on 25 January have made the direction of Greek policymaking more uncertain. Prolonged political deadlock until the summer is not Fitch's expectation, but would increase the risk of financing difficulties and a return to recession.

In Fitch's view, an agreement between a new Greek government and the Troika remains likely as there are strong incentives on both sides for a deal. This holds in the event of a Syriza victory in the election, which opinion polls suggest is the most probable outcome. Nevertheless, there is a wide gap between the policy proposals of both sides, such that negotiations would be complicated and subject to risks.

Syriza has moderated its policy stance since 2012. It advocates remaining in the eurozone and has committed to maintaining a budgetary primary surplus and to honouring Greece's obligations to IMF and private creditors. However, the privatisation programme would most likely stall under a Syriza-led government and there would be upward pressure on the public sector wage bill.

A further round of elections in 2015 is a risk, but not Fitch's baseline. The negotiations with the Troika will exacerbate frictions between and within Greek political parties and could cause a weak coalition to collapse. Alternatively, the initial formation of a coalition may prove impossible, as happened in 2012.

In an adverse scenario, prolonged political turmoil combined with a lack of funding would place serious strains on the government's cash flow by the summer. Tighter liquidity conditions in the general economy would risk derailing the recovery in the Greek economy.

Greece's 'B' IDRs also reflect the following key rating drivers:

The general government budget is on track to meet its 2014 objective, underscoring a remarkable budgetary adjustment in recent years in the face of severe cyclical headwinds. The adjusted primary surplus measure used under the Troika programme is forecast by Fitch at 1.5% of GDP this year. The headline deficit forecast (EDP basis) is 1.6% of GDP. Achieving and maintaining a primary surplus relies on continued tight fiscal discipline and a sustained recovery in growth.

The economy is bottoming out, with real GDP having expanded modestly in 1Q14-3Q14. Fitch forecasts GDP growth of 0.5% in 2014, rising to 1.5% in 2015, a downward revision of 1pp since our last review in November 2014, reflecting domestic policy uncertainty and a weaker growth outlook in the eurozone.

Greece's external debt burden is very large but inexpensive to service due to its largely concessionary nature. Greece is running a current account surplus of 1% of GDP aided by reduced imports, buoyant tourism receipts and a significant step-up in net EU transfers. Fitch considers price competitiveness to have been restored, although the export base remains narrow.

Fitch's Banking System Indicator for Greece is 'b', indicating weak standalone creditworthiness. The banks are well capitalised but their asset quality is weak. No further capital injections are required as a result of the ECB's Comprehensive Assessment.

Greece's ratings are underpinned by high income per capita and measures of governance (well above 'B' and 'BB' medians).

RATING SENSITIVITIES
Fitch's next scheduled review of the Greek rating is 15 May 2015. Future developments that could, individually or collectively, result in a downgrade include:
-Prolonged political deadlock and lack of agreement with the Troika. This would place serious strains on the government's cash flow.
-A worsening of Greece's macroeconomic prospects, for example a return to recession caused by tighter liquidity conditions in the domestic economy.
-Fiscal slippage leading to increased financing requirements.

Future developments that could, individually or collectively, result in positive rating action include:
-Formation of a stable government and a timely agreement with official creditors could stabilise the Rating Outlook. Agreement would unlock delayed Troika disbursements and provide a precautionary credit line supporting Greece's intended return to market funding at affordable rates.
-An acceleration of Greece's economic recovery, further primary surpluses, and official sector debt relief (OSI) would put upward pressure on the ratings over the medium term.

KEY ASSUMPTIONS
The ratings and Outlook are sensitive to a number of key assumptions.

Greek banks make no further material demands on the sovereign balance sheet; EUR37bn (20% of GDP) has been injected to date. If Greek banks incur losses that are not covered by private shareholders, this would lead to a cash call on the government as guaranteed tax credits are converted into equity.

General government gross debt/GDP will have peaked at 178% in 2014, subsiding gradually thereafter. These assumptions do not factor in any OSI on official loans that may be agreed over the medium term. The projections are sensitive to assumptions about growth, the GDP deflator, Greece's primary balance and the realisation of privatisation revenues.

Social stability is maintained. Greece remains a member of the eurozone and does not impose capital controls. Greece and the eurozone as a whole will avoid self-sustaining deflation over the medium term, such as that experienced by Japan from the 1990s. Several more years of deflation, resulting in low growth in nominal GDP, would be highly damaging to Greek public debt dynamics.

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