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Ratings agency Standard & Poor’s has affirmed ‘B+/B’ sovereign credit ratings on Greece and projects an economy grow by 2.8% on average over 2019-2022. Furthermore, the agency said that “Greece has one of the most advantageous debt profiles of all our rated sovereigns in terms of maturity and average interest costs, despite the large government debt.”
Rating Action
On April 26, 2019, S&P Global Ratings affirmed its ‘B+/B’ foreign and local currency long- and short-term sovereign credit ratings on Greece. The outlook remains positive.
Outlook
The positive outlook signifies that we could raise our ratings on Greece within the next 12 months if the economic recovery strengthens.
This could result from additional certainty as regards the direction of the economic policy implemented by the government via further economic reforms boosting Greece’s economic growth potential and alleviating outstanding socioeconomic challenges. Another potential trigger for an upgrade would be a marked reduction in nonperforming exposures (NPE) in Greece’s impaired banking system, as well as the elimination of all remaining capital controls. Mitigation of fiscal risks related to pending court decisions regarding the past public wage bill and pension system measures could also trigger an upgrade.
We could revise the outlook to stable if, contrary to our expectations, there are reversals of previously implemented reforms, or if growth outcomes are significantly weaker than we expect, restricting Greece’s ability to continue fiscal consolidation, debt reduction, and financial sector restructuring.
Rationale
Our ratings on Greece reflect the improving economic outlook, accompanied by strong budgetary performance and a very favorable government debt structure. These are balanced against the country’s high external and public debt burdens, a difficult situation in the banking system, characterized by a large stock of NPE, a challenged monetary transmission mechanism, and remaining capital controls.
In terms of maturity and average interest costs, Greece has one of the most advantageous debt profiles of all our rated sovereigns. Our rating pertains to the commercial portion of Greece’s central government debt, which is less than 20% of total Greek debt, or less than 40% of GDP. The final disbursement from the European Stability Mechanism (ESM) program provided Greece with a sizable cash buffer, which we estimate will meet central government debt-servicing into 2023. We project that Greece’s general government gross debt-to-GDP ratio will decline from 2019, aided by a recovery in nominal GDP growth, while the government’s net debt-to-GDP trajectory will depend on the budgetary implications of potentially adverse court decisions on past pension reforms, as well as on the success of the strategy to support the reduction of NPE in the banking sector.
Institutional and Economic Profile: Greece’s economic growth prospects are improving
- Greece graduated from its ESM program in August 2018, having secured further debt relief and a sizable cash buffer.
- We project that the economy will grow by 2.8% on average over 2019-2022 as domestic demand strengthens and solid export performance continues, although the latter will likely be limited by the ongoing slowdown in the rest of the eurozone, Greece’s main trading partner.
- The pace of further economic reforms may slow during 2019, an election year.
Following real GDP growth of 1.9% in 2018, we expect the economy will expand by about 2.3% in 2019, before the pace gradually strengthens over 2020-2022. Employment growth continues to be solid: We forecast growth above 2% annually through 2022, although the recent increase in the minimum wage could lead to a slowdown in hiring. Moreover, the economy would benefit from a higher share of permanent jobs, given that in 2018, and so far in 2019, slightly more than one-half of new employees were hired on temporary contracts.
Over the next three years, we expect Greece’s economic growth will surpass the eurozone average, including in real GDP per capita terms, reflecting a steady recovery following a deep and protracted economic and financial crisis. We also expect economic performance to remain balanced, with domestic demand and exports continuing as the key drivers of growth. In this context, we expect slowly rising private consumption on the back of improved employment prospects, as well as the recent government decision to increase the monthly minimum wage by almost 11% to €650. Moreover, if the recovery becomes well entrenched, we believe that consumption would likely see a boost from the pent-up demand by households, held back during the past protracted recessionary period. A key constraint on the economic outlook remains authorities’ decision to subordinate public investment spending (including on education) to current expenditure, particularly on social transfers, although the government is committed to improving the absorption capacity and thus addressing the under execution of public investment, which together with an accelerated use of EU funds should support economic growth over our forecast horizon.
The outlook for private investment is also improving, given the gradual increase in net foreign direct investment (FDI). However, in our opinion, the key to a faster economic recovery is a substantial reduction in the banking sector’s NPE, which would significantly enhance credit activity in the private sector and as a consequence crystalize the benefits of the substantial structural reforms Greece has undergone since 2010. We believe that the positive impact of the reforms, for example in product and services markets, are unlikely to be displayed in the recessionary or low economic growth mode that Greece has known over the last decade. Without access to working capital, the broader small and midsize enterprise sector–the economy’s largest employer–remains in varying degrees of distress. Private sector default is widespread, including on tax debt. Moreover, the economy’s ability to attract foreign investment to finance growth remains weak.
Absent the materialization of external risks, such as from mounting global protectionism and a faster-than-forecast slowdown in eurozone economic growth, Greece’s export sector is well positioned to benefit from its reinforced competitiveness. In this context, Greece’s labor cost competitiveness has improved to its level before 2000 and, together with the reorientation of domestic businesses from domestic to external demand, has resulted in almost a doubling of the share of exports of goods and services (excluding shipping services) in GDP terms, from 19% in 2009. Greece’s market shares in global trade have increased correspondingly and we expect further gains over the forecast period through 2022.
Since 2015, policy uncertainty has receded, and in August 2018, the Syriza-led government exited the country’s third consecutive lending program, having overseen large fiscal and external adjustments. Nevertheless, we believe that a faster economic recovery could result from further improvements in business environment, including an acceleration of the privatization process and government arrears clearance, as well as the above-mentioned improvements in the banking sector with respect to its capacity to fund the economy.
Although Greece’s labor cost competitiveness has been restored, we believe that its competitiveness in other areas remains weak. Greece still compares poorly with its peers, due to its many impediments to competition in its product and professional services markets, alongside relatively weak property rights, complex bankruptcy procedures, an inefficient judiciary, and the low predictability of the enforcement of contracts. As a consequence, while net FDI inflows have recently improved, they may not be sufficient to fund a more powerful economic recovery. At the same time, a recent reversal of labor reform, which could reintroduce collective wage negotiations at the national level, might weaken the ongoing recovery in the job market by reducing companies’ flexibility to navigate a tough economic situation. Over the long term, however, in the absence of reforms to the business environment, we think that GDP growth is unlikely to exceed 3% on a sustained basis, constrained by administrative burdens and anticompetitive behavior across the economy–particularly concentrated in the services sector. Complacency and fatigue in addressing structural problems may not adversely affect macroeconomic outcomes or sovereign debt-servicing ability in the medium term, but would likely cap Greece’s growth prospects in the long term.
Following the successful termination of the ESM program, Greece is subject to quarterly reviews by the European Commission under the “enhanced surveillance framework.” Ongoing debt relief and the return of so-called ANFA/SMP profits on Greek bonds held by the European Central Bank (ECB) and the eurozone’s national central banks (ESCB) will be subject to ongoing compliance with the program’s objectives. Use of the cash buffer for purposes other than debt-servicing will have to be agreed with the European institutions. We therefore believe that the Greek authorities will have strong incentives to avoid backtracking markedly on most previously legislated reforms. In this context, despite a delay, the authorities have complied with the commitments made regarding a series of post-program actions which led to a decision by the Eurogroup on disbursement of profits on ESCB holdings of Greek government bonds earlier this month.
The next general election is to be held by October 2019 at the latest, although early elections, e.g., after the May local and European elections and before the parliamentary summer break, cannot be excluded. The government’s stability was weakened earlier this year, following the departure of a junior coalition partner, due to an agreement regarding Greece’s long-standing conflict about the name issue with its northern neighbor, recognized as North Macedonia as of Feb. 12, 2019. We believe that the agreement is positive for economic relations and growth prospects of both countries. Given that 2019 will also see local and European elections, it is very likely that the polarization of the political landscape will escalate in the coming months. In our view, this represents a risk that areas such as privatization, increasing the efficiency of the judicial system, and further improvements in the business environment will face delays.
Moreover, a more resolute approach toward the reduction of NPE in the banking sector may see little further progress before the electoral challenges play out. However, we expect Greece’s economic and budgetary policies will comply with commitments it made at the time of the termination of the ESM program.
Importantly, we view positively the constitutional amendments regarding the disentangling of the presidential elections away from the government mandate. While the details of the presidential election according to the new arrangement remain to be specified, the risk of government instability due to a potentially unsuccessful appointment of the president of the republic by the parliament appears to be eliminated. The previous arrangement has led in the past to a vote of confidence in the government and potentially, to new general elections, instilling instability in the length of the government’s mandate and policy predictability. As a result, the next government will be able to face a more stable mandate, without being distracted by the presidential elections and related political maneuvering undermining the predictability of economic and budgetary policies.
Flexibility and Performance Profile: Strong budgetary performance to continue, while banks are on the mend
- We project general government debt will decline during 2019-2022.
- The creation of cash buffers via the final ESM program disbursement limits risks to debt repayment through 2023.
- If implemented, proposals for an accelerated reduction in NPE in the banking sector could unlock credit activity and contribute to faster restoration of investment.
Following a large budgetary adjustment since the start of the economic and financial crisis, Greece has established a track record of exceeding budgetary targets via rigid expenditure controls and improved revenue performance. In 2018, the primary balance reached 4.4% of GDP, significantly outperforming the target agreed with the creditors of 3.5% of GDP, and above the government’s own target of 4.0% of GDP. The overperformance against the government’s own target occurred despite a delayed payment to the government for the concession of Athens International Airport that occurred earlier this year.
As a result of the better-than-planned budgetary performance, contingent deficit-reducing measures, such as pension spending cuts, did not need to be implemented. The 2018 performance was characterized by higher government revenue, in particular from higher indirect taxes, which appears to have nevertheless been lower than the government’s own plans. In addition, primary expenditure was lower than budgeted (government expenditure without interest payments), reflecting compliance with the spending restraints in place, including in health care and the public sector wage bill. While headline consolidation progress has been dramatic, it is notable that key components of spending on human capital, particularly on education and health, have been cut sharply to below European averages since the beginning of the crisis in 2009.
The 2019 budget includes a series of measures aimed at improving hiring incentives, including focusing on reducing the temporary character of the current employment structure. For example, in the education sector, 4,500 teachers and specialized staff will be hired on a permanent basis for positions currently occupied by temporary teachers, without an impact on the overall headcount in the public sector. The budget also includes a reduction of social security contributions for independent professionals, the self-employed, and farmers, as well as a subsidy to social security contributions for the young. Finally, the government aims to reduce the tax burden on the economy by reducing tax rates on corporate income, dividends, and basic property, as well as the existing stock of arrears at approximately €2.1 billion at the end of 2018.
The execution of the 2019 budget could be negatively affected by pending court rulings on past government decisions on public sector wages, as well as on the 2012, 2015, and 2016 pension system reforms. In our view, this would make compliance with the 2019 primary balance target somewhat more difficult. Moreover, given the upcoming elections, political maneuvering of the government, for example a higher increase in public sector workforce than planned, could lead to lower compliance with its expenditure ceiling.
If these risks do not materialize, we project that in 2019-2022 Greece will report general government primary surpluses above the 3.5% of GDP target agreed with official creditors, which should see gross general government debt decrease to just below 150% of GDP in 2022 from slightly above 181% in 2018. Even in nominal terms, we forecast gross general government debt will decline from 2019, in line with the central government amortization schedule and our expectation of headline fiscal surpluses. Net of cash buffers, we project that net general government debt will decline below 140% of GDP in 2022. Nevertheless, the government net debt-to-GDP trajectory over the coming years will depend on the budgetary implications of potential adverse court decisions on past public wage bill and pension system reforms, as well as of the government’s strategy to support the reduction in the NPE of the banking sector.
Despite the size of Greece’s debt, the average cost of servicing this debt, at 1.6% at the end of 2018, is significantly lower than the average cost of refinancing for the majority of sovereigns rated in the ‘B’ category. We anticipate that, even with increasing commercial debt issuance, the proportion of commercial debt will remain less than 20% of total general government debt through year-end 2021. We therefore expect a gradual reduction in interest costs relative to government revenues. Potential partial prepayment of the outstanding obligations to the International Monetary Fund (currently totaling €9.4 billion), as recently suggested by the authorities, would reduce the interest burden further without easing the post-program surveillance. We estimate the average remaining term of Greece’s debt at 18.2 years as of year-end 2018, although this is set to increase further with the implementation of the debt-relief measures granted in June 2018.
In 2018, Greek banks made further progress in reducing their NPE stocks, which at the end of December stood at €81.8 billion (excluding off-balance-sheet items) from the €107.2 billion peak in March 2016, a reduction by almost 25%. Initiatives to tackle the high stock of NPE are underway, including write-offs and implementation of out-of-court restructuring, the development of a secondary market, and electronic auctions. The recently adopted household insolvency law, agreed with the EU institutions, is likely to reduce the phenomenon of strategic defaults and accelerate the settlements with the borrowers, which will under certain conditions benefit from a state subsidy toward mortgage repayment installments.
Based on experience in other peers, like Spain, Ireland, Slovenia, and Cyprus, we believe that a faster decline in NPE may not be possible without a more resolute approach and involvement of additional government support. The current considerations by the authorities involve a proposal for an asset protection scheme, with the government extending sovereign guarantees to the senior tranches, and a scheme based on deferred tax credits, which would involve a transfer of a part of NPE to an asset management company, supported by a funding contribution by the government. In the context of our sovereign rating analysis, we would likely view positively the implementation of the above proposals, which appear complementary, since they would materially improve the likelihood of meeting the banks’ own NPE reduction targets to 20% or below. As a consequence, and given the experience of the sovereigns cited above, we believe that such measures would likely lead to faster economic recovery. Namely, despite steady increases in new credit in the corporate sector (1.6% year on year in February 2019), the overall credit activity (overall -0.4% year on year in February 2019) is still negative and does not contribute to a meaningful restoration of investment activity in the economy.
At the same time, the banking system’s liquidity has improved. Banks continue to reduce their reliance on official ECB financing and have in the first quarter of this year completely eliminated their reliance on more costly emergency liquidity assistance. An uptick in deposits has helped, as have repurchase transactions with international banks and sales of NPE. While deposits into the banking system have been growing–household and corporate deposits grew by about 6% in 2018–confidence has not returned to the extent that would enable a full dismantling of capital controls, although these have been eased in line with the Bank of Greece plan, most recently in October 2018. Over the past year, Greece’s systemically important banks have issued covered bonds. Like the sovereign, this was their first market foray since 2014. With Greece having graduated from the ESM program, its banks lost the waiver that allowed them to access regular ECB financing using Greek government bonds as collateral. However, despite the loss of the waiver, the banks’ funding was not disrupted.
Greece has had a significant adjustment in its external deficit. The current account deficit fell from nearly 14.5% of GDP in 2008 to the record low of 0.8% of GDP in 2015, mainly via significant import compression, before widening somewhat as the economy started to recover. In 2018, the solid export performance, including the substantial growth in the services surplus, was more than offset by a higher oil deficit and import growth. We project the current account deficit will decline slightly in 2019, but expansion of imports on the heels of consumption and expected solid investment recovery, as well as a slowdown in global economic trade, could lead to a wider current account deficit.
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