By unhappy coincidence, Fitch downgraded Greek sovereign and bank debt yesterday from A- to BBB+, the lowest level in the Eurozone. The press release was released at 07:47 EST, about the same time as I was finishing my forecast of Greek public debt. The Fitch downgrade sent the Athens Stock Exchange into a 6.1% tailspin as foreign and domestic investors took flight.
Fitch’s announcement reads:
The downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece, exacerbated by uncertainty over the prospects for a balanced and sustained economic recovery. Though it is probable that fiscal adjustment under the auspices of the Stability and Growth Pact will be sufficient to forestall penalties under the Excessive Deficit Procedure (EDP), Fitch's current assessment is that the government debt burden is likely to rise to close to 130% of GDP before stabilising. Given the poor historical track record of public finance management, Fitch is not convinced that the substantive pension reform and other measures necessary to contain public spending pressures and broaden the tax base will be sufficiently strong to materially reduce debt over the medium- to long-term and hence Greece's vulnerability to future adverse shocks.
While Fitch believes that the government's target to narrow the fiscal deficit by 3.6pp of GDP to 9.1% in 2010 is achievable, the lack of substantive structural policy measures reduces confidence that medium term consolidation efforts will be aggressive enough to ensure public debt ratios are stabilised and then reduced over the next three to five years. Present government proposals rely more heavily on revenue-raising measures, particularly moves to counter tax evasion - where the pay off is highly uncertain - rather than current spending where structural fiscal weaknesses are most acute. About half the proposed cuts in the deficit rely on temporary one-off measures, while little of the recent fiscal deterioration can be attributed to the economic downturn, which has been relatively mild, or to support for the financial sector which has been minimal.
There is little to contradict this judgement, either in Greece’s 2010 budget, or in its historical record of public revenue and expenditure management.
Bloomberg carried an interesting article today on the impact of the downgrade on the Athens Stock Exchange. I personally believe that this is panic selling, and that some Greek stocks are now at very attractive investment valuations. The ASE should rebound within the next week, perhaps sooner.
But the long-term problem persists. The debt forecast I published yesterday shows almost no signs that the public debt will fall to sustainable levels, i.e. certainly below 100%, and preferably below 75%. I will run one more forecast using the government’s forecast for annual deficit levels, once these are published in January.