Full text: Fitch upgrades Greek law bonds to B- Stable from restricted default

The following explanation of the recent Greek ratings action was posted at Fitch Ratings website.

Fitch Ratings-London-13 March 2012: Fitch Ratings has upgraded Greece’s Long-term foreign and local currency Issuer Default Ratings (IDRs) to ‘B-‘ with Stable Outlooks from ‘Restricted Default’ (RD). The Short-term foreign currency IDR has been upgraded to ‘B’ from ‘C’ and the Country Ceiling affirmed at ‘AAA’.

Fitch has withdrawn the ratings on the bonds issued by the Republic and governed by Greek law and assigned ‘B-‘ ratings to Greece’s new government bonds created as a result of the private sector involvement (PSI) debt exchange, The issue ratings on foreign-law bonds will remain ‘C’ pending settlement on 11 April, while the issue ratings of securities not eligible for the bond exchange remain unchanged.

The rating actions follow the official confirmation of a 96% participation in the distressed debt exchange (DDE) and the initial exchange of EUR177bn of Greek-law bonds for new securities. In accordance with Fitch’s statement on 6 June 2011 (see ‘Fitch Outlines Rating Approach to a Sovereign Debt Exchange’) and the agency’s distressed debt exchange (DDE) criteria (12 August 2011), the completion of the exchange has cured the rating default event.

Fitch says the DDE and the losses imposed on bondholders have significantly improved Greece’s debt service profile and reduced the risk of a recurrence of near-term repayment difficulties on the new Greek government securities. The agency considers that significant and material default risk remains in light of the still very high level of indebtedness post-PSI and the profound economic challenges faced by Greece, as reflected in the low speculative grade rating of ‘B-‘. However, in Fitch’s view, there is a limited margin of safety for debt service on the new securities over a 12 to 24 month horizon, reflected in the Stable Outlook.

Post-default, debt service should be moderate. The effective interest rate on public debt is estimated to have fallen to less than 4% from 5.5%, while substantive amortisation payments have been pushed out to 2020 and beyond. Nonetheless, the capacity for continued payment remains vulnerable to deterioration in the political and economic environment.

Fitch expects the new EU-IMF programme will be fully funded (ie. not reliant on Greece regaining access to term finance from the market), in contrast to the first Greek Loan Facility, providing a limited margin of safety for bondholders. Moreover, as a result of the significant writedowns to face value, Fitch estimates that private bondholders now account for barely 30% of the stock of public debt (compared to 64% pre-PSI), while the interest rate on the new PSI bonds will be just 2% in 2013-15, rising to 3% in 2016-20. In Fitch’s opinion, these considerations limit the potential gain that could be derived from any future restructuring of private sector bond holdings and underline the burden that could fall on official creditors.

Lower interest payments, allied with further fiscal consolidation, are projected to bring down the fiscal deficit from around 9.5% of GDP in 2011 to 4.5% in 2012. Further reductions thereafter will depend upon the political willingness and ability to sustain and implement structural and fiscal reforms under the auspices of an EU-IMF programme, as well as on the highly uncertain evolution of the Greek economy. In any event, the public debt/GDP ratio will rise initially towards 170%, as the government assumes new liabilities to fund the DDE and recapitalise the banking system, while further adjustments of prices and wages will lead to a continued decline in nominal GDP until 2014.

Fitch notes that while it is possible to discern a downward trajectory of the public debt/GDP ratio to around 120% by 2020 as targeted by the EU/IMF, this outcome is very sensitive to assumptions regarding the implementation of fiscal austerity and economic growth. The current government has completed a long list of ‘prior actions’. However, their implementation is likely to prove very challenging for any administration, while Greece’s ability to sustain primary surpluses of 4.5% of GDP from 2014 onwards is untested. Moreover, in the near term, the prospect of a general election and uncertainty over the composition and commitment of a new government to the EU-IMF programme also poses a significant risk. Nonetheless, the sustainability of the public finances and ultimately Greece’s membership of the eurozone depends upon the implementation and effectiveness of structural and fiscal reforms in laying a foundation for a sustained economic recovery.

Future rating actions will be driven by Greece’s performance against the parameters of the new EU-IMF programme and the sovereign’s capacity and willingness to honour its restructured debt obligations. A broadly successful programme, including the maintenance of substantial fiscal surpluses, concerted structural reforms and demonstrable economic recovery would put upward pressure on the ratings. Conversely, EU-IMF programme failure, reflecting potential political and economic shocks, and/or renewed debt service difficulties would be likely to lead to a downgrade of Greece’s sovereign ratings.

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