Next up: Greece begins criminal proceedings against the rating agency for character defamantion and libel (or is that slander?). Also, Belgium is next. Yet most importantly, there is no mention in the downgrade if the "Vienna plan" currently contemplated, or the latest zany "debt rolling" proposal constitutes an Event Of Default, meaning the market will have even more uncertaintly to grapple with.
Moody's downgrades Greece to Caa1 from B1, negative outlook
Moody's Investors Service has today downgraded Greece's local and foreign currency bond ratings to Caa1 from B1, and assigned a negative outlook to the ratings. The rating action concludes the review for possible downgrade that the rating agency initiated on 9 May 2011.
The main triggers for today's downgrade are as follows:
1. The increased risk that Greece will fail to stabilise its debt position, without a debt restructuring, in light of (1) the ever-increasing scale of the implementation challenges facing the government, (2) the country's highly uncertain growth prospects and (3) a track record of underperformance against budget consolidation targets.
2. The increased likelihood that Greece's supporters (the IMF, ECB and the EU Commission, together known as the "Troika") will, at some point in the future, require the participation of private creditors in a debt restructuring as a precondition for funding support.
Taken together, these risks imply at least an even chance of default over the rating horizon. Moody's points out that, over five-year investment horizons, around 50% of Caa1-rated sovereigns, non-financial corporate and financial institutions have consistently met their debt service requirements on a timely basis, while around 50% have defaulted.
Greece's Caa1 rating incorporates Moody's assumption that current negotiations between the Greek government and the Troika will result in further official support for the Greek government and the announcement of additional austerity and structural reform measures.
The negative outlook on the Caa1 rating reflects Moody's view that the country's very large debt burden, the significant implementation risks in its structural reform package, and the country's ongoing need for external support skew risks of future rating actions to the downside.
The first trigger for today's downgrade is Moody's view that Greece is increasingly likely to fail to stabilize its debt ratios within the timeframe set by previously announced fiscal consolidation plans. The Greek government failed to achieve a number of the fiscal consolidation targets in 2010 as a result of fiscal shortfalls (both spending cuts and revenue collections) at the general government level and persistent weaknesses in tax collection. It has also become readily apparent that, under current policies, Greece is unlikely to meet its previously announced budget targets for 2011. These shortfalls have occurred in part because GDP growth has been weak -- in fact, the recession was deeper than was expected in 2010, and 2011 growth forecasts have been revised downwards. Moreover, in the coming weeks, Moody's expects the announcement of further fiscal austerity measures, which are likely to depress growth in 2011. This may in turn further weaken the political consensus within Greece to endure all the adjustments mandated by the reform package.
The expectation of a repeated failure to meet targets carries two implications. First, Greece is unlikely to return to the credit markets in 2012 for funding, and will require additional financial assistance from the Troika in order to avoid a default. The quid pro quo for such assistance will inevitably be further fiscal austerity and economic reform measures that will be necessary to address the shortcomings of the programme to date. Second, Moody's believes that raising the austerity bar still higher will further increase implementation risk for the Greek programme.
Heightened implementation risk in turn underpins the other key driver of today's downgrade to Caa1. Namely that the increased likelihood that the Troika will make the provision of financial assistance to Greece over the medium term conditional on a debt restructuring, in which private sector creditors would absorb some economic losses. Moody's believes that the public discussion about current policy options -- including the possibility that financial assistance to Greece may be delayed or suspended -- indicates that officials' cost-benefit analysis of a Greek restructuring is shifting.
HEIGHTENED IMPLEMENTATION RISK OF PROGRAMME INCREASES DEFAULT RISK
In light of recent comments by EU and IMF officials, Moody's believes that Greece is running out of options, and that heightened implementation risk inherent in any new programme also increases the probability of a default event. This view is supported by the following observations:
- Greece's large debt burden means that, even under the most positive scenarios, the country's debt sustainability will remain vulnerable to adverse macroeconomic developments, shocks to the Greek financial system or shifts in market sentiment for years to come. This will be true even if additional liquidity support is given to the government and if the full EUR50 billion privatisation programme is implemented on schedule.
Regardless of how strong the incentives to prevent Greece from defaulting, the longer the reform programme takes to be seen to be having its desired effect on debt sustainability and the longer that Greece needs to rely on support from the Troika, the more likely a default becomes.
- Further fiscal austerity is likely to deepen and prolong the recession and further undermine domestic political support for the reform programme. A failure to secure broad political support for the country's fiscal and economic reform package would threaten the programme and increase policy instability.
Nevertheless, Moody's does not believe that a restructuring of Greece's debt is inevitable. This is because a default in the short term would very likely be highly destabilising, and the full impact on Europe's capital markets would be hard to predict and harder still to control. The fallout would have implications for the creditworthiness of issuers across Europe. These factors represent an incentive for Greece's supporters to continue to support the country, at least for a few more years.
Further funding does not make it easier for the government to comply with the fiscal and structural reform programmes, but it does buy the government time to implement these plans and allow positive domestic dynamics to build. While it is not Moody's base case assumption, the large volume of structural economic reform in the Memorandum of Understanding (MoU) has the potential to reinvigorate the economy and generate substantially higher economic growth over the medium term.
Moreover, the Greek state has substantial assets in excess of the EUR50 billion privatisation target that could in principle be mobilised to reduce debt. Of course, this would require the Greek government to be willing to sell these assets and willing buyers to be found for them.
WHAT COULD CHANGE THE RATING UP/DOWN
Greece's Caa1 rating incorporates Moody's assumption that further official support will be available to the Greek government over the short term, and that additional austerity and structural reform measures will be announced over the next month.
Moody's would downgrade Greece's rating further if it transpired that the Greek government's compliance with the conditions stipulated in the MoU is materially weakening, and that, as a result, there is a rising risk that additional funding will not be forthcoming. Any announcement of a programme that includes conditions that satisfy Moody's definition of default would also lead to further downgrades.
Moody's would upgrade Greece's rating if the pace of fiscal consolidation and/or structural reform implementation were to proceed much more rapidly than Moody's currently expects. An upgrade could also follow if key drivers of the debt dynamics -- such as economic growth, interest rates, privatisation revenues or the ability to generate large primary surpluses
-- were seen to be evolving in a way that would significantly accelerate the pace of debt reduction.