Tuesday 15 June 2010

Moody's Downgrades Greek Debt - Correctly

Moody’s yesterday downgraded Greek government bonds to Ba1. This was met by predictable furor in some Greek media. SBC TV, a financial channel, identified this as a conspiracy yesterday afternoon, suggesting that the reasons this happened was so that the European Union did not develop its own ratings agency. Sofokleous 10, a financial blog, termed this a “terrorist act”.

The Ministry of Finance issued a press release, which I quote and translate from Kathimerini:

Today's downgrade of the Greek economy from the Moody's agency in no way reflects either the progress made in the last few months, nor the prospects created by the public fiscal adjustment and improvement in national competitiveness.

The budget execution figures show with great clarity that the programme which Greece has agreed with the European Union, the European Central Bank and the International Monetary Fund is being implemented normally, with the deficit having fallen by 40% compared to 2009. This important improvement has been recognised by the European Commission, the European Central Bank and the International Monetary Fund. In addition, the recession in the first quarter was smaller than that foreseen for the whole year in the Memorandum. VAT revenues collected in the first quarter were higher by 6%, whereas last year they had fallen by 11%.

All structural adjustment activities foreseen by the Memorandum of Understanding are being implemented regularly and many are already ahead of their established deadline. The progress of the debt, although currently rising, is expected to peak in 2013 or perhaps sooner, depending on the creating of more favourable conditions.

The Hellenic Government remains entirely committed to the adjustment of its public debt and the improvement of the development potential of the country.

From the viewpoint of any potential investor, the Greek reform programme is fraught with risk. The good efforts of the Ministry of Finance notwithstanding, the government has been taking serious measures only in the last 3-4 months, and as I recounted in yesterday’s post, there are still very many questions left unanswered. Moody’s had already announced a negative outlook in its last rating on 22 April 2010.

All three major ratings agencies have now downgraded Greece’s sovereign debt to junk status. Standard & Poor’s and Fitch had already done this in April; Moody’s followed this week.

Whatever criticism we can raise against these agencies on their previous ratings of Greek government debt, or mortgage-backed securities, or European banking issues, I believe that their current rating on Greece is correct.

There remains a critical lack of quantitative data on the full extent of Greek public debt. Beyond this, it is clear that the EUR 110 bln package will not be sufficient to fund Greece's public sector borrowing needs past 2012. Unless it is renewed, Greece and Europe will be hit by a new sovereign debt crisis.

It remains to be seen whether the reform package will actually work. I believe it will, but that at least 10 years of austerity will be needed, together with a more radical reform. At present, it’s clear that neither the wider public sector nor the political party system has made the radical changes needed for competitiveness.

Good intentions and Parliamentary committees notwithstanding, much has been announced, but little accomplished. It requires a major leap of faith to assume that the very politicians and political parties responsible for Greece’s current predicament will be able to change the system.

I copy the Moody’s press release below.

London, 14 June 2010 — Moody's Investors Service has today downgraded Greece's government bond ratings by four notches to Ba1 from A3, reflecting its view of the country's medium-term credit fundamentals. Today's rating action concludes the review for possible downgrade, which Moody's initiated on 22 April 2010. Moody's has also downgraded Greece's short-term issuer rating to Not-Prime from Prime-1. Greece's country ceilings for bonds and bank deposits are unaffected by the review and remain at Aaa (in line with the Eurozone's rating).

The outlook on all ratings is stable. “The Ba1 rating reflects our analysis of the balance of the strengths and risks associated with the Eurozone/IMF support package. The package effectively eliminates any near-term risk of a liquidity-driven default and encourages the implementation of a credible, feasible, and incentive-compatible set of structural reforms, which have a high likelihood of stabilizing debt service requirements at manageable levels,” says Sarah Carlson, Vice President-Senior Analyst in Moody's Sovereign Risk Group and lead analyst for Greece. “Nevertheless, the macroeconomic and implementation risks associated with the programme are substantial and more consistent with a Ba1 rating.”

Moody's believes that the Eurozone/IMF support package has sheltered the Greek government from the markets while it enacts the very ambitious fiscal austerity measures and structural economic reforms stipulated by the package. These have the potential to restore market confidence, depending on the effectiveness of the government's execution, and place the country on a more stable debt trajectory. The rating agency's base-case scenario envisions Greece implementing the policy changes it needs to stabilise its debt-to-GDP ratio at around 150% by 2013, and reduce its debt burden, defined as the interest payment/revenues ratio, gradually thereafter (expected at 20% in 2014).

Should the economy respond positively to the competitiveness-enhancing structural reforms, debt stabilisation could be achieved earlier. “There is considerable uncertainty surrounding the timing and impact of these measures on the country's economic growth, particularly in a less supportive global economic environment,” says Ms Carlson. “This uncertainty represents a risk that leads Moody's to believe that Greece's creditworthiness is now consistent with a Ba1 rating, a rating which incorporates a greater, albeit, low risk of default.” Moody's outlook on Greece's ratings is stable, reflecting the substantial probability that the rating will not change over the next 12 to 18 months.

The key factors that will influence the rating agency's view will be the performance of the Greek economy, especially that of GDP and tax revenues. Information on these developments will take some time to accumulate and may prove to be either credit positive or negative. For further information, please see Moody's Special Comment “Key Drivers of Greece's Downgrade to Ba1″ available on www.moodys.com. Moody's previous rating action on Greece was implemented on 22 April 2010, when the rating agency downgraded Greece's rating to A3 and placed it under review for further downgrade.

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