Fitch Ratings has upgraded Greece's Long-term foreign and local currency Issuer Default Ratings (IDRs) by one notch to 'CCC' from 'CC'. The issue ratings on Greece's senior unsecured foreign and local currency bonds have also been upgraded to 'CCC' from 'CC'. The Short-term foreign currency IDR has been affirmed at 'C'. The Country Ceiling has been raised by one notch to 'B-' from 'CCC'.
Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch's sovereign rating on Greece is 13 November 2015, but Fitch believes that developments in Greece warrant such a deviation from the calendar and our rationale for this is laid out below.
KEY RATING DRIVERS
The upgrade of Greece's IDRs reflects the following key rating drivers and their relative weights:
The 14 August agreement reached between Greece and the European Institutions on the framework for a third official bailout programme has reduced the risk of Greece defaulting on its private sector debt obligations. An initial disbursement of about EUR23bn is expected this week and will ease the acute liquidity strain of recent months, covering the repayment of EUR3.2bn of bonds held by the Eurosystem maturing on 20 August as well as a European Financial Stabilisation Mechanism bridging loan maturing in September.
The programme is intended to facilitate an eventual return to market funding. However, the risks to the programme's success remain high. It will take some time for trust to be restored between Greece and its creditors, which increases the risk of delayed programme reviews. Meanwhile, the political situation in Greece remains unpredictable.
Last week's deal was reached relatively quickly and without the brinkmanship seen in the run-up to previous deadlines. This suggests that relations with the creditors have improved, as implied by the public statements from key players, although they remain delicate. The ruling Syriza party can rely on the support of centrist parties to carry key votes in parliament but the party itself is at risk of splitting, and has suffered large rebellions over key reform votes. The prospect of snap elections before the end of the year is likely, which raises uncertainty over the future direction of relations with the creditors.
The agreement sets out the broad conditionality that Greece will be expected to implement under a European Stability Mechanism (ESM; AAA/Stable) programme. This covers a wide range of structural reforms, notably to pensions and the labour and product markets. A long-term privatisation fund targeting EUR50bn in receipts is also stipulated. The track record of privatisation since 2010 suggests this figure is unlikely to be met.
Targets for the government's primary balance have also been stipulated and imply a further fiscal drag in the near term. The targets are ambitious and pose a risk to Greece's economic performance. The latter is already likely to be extremely weak in 2H15 due to the banking system shutdown that followed the expiry of the previous bailout programme.
The overall funding envelope for the ESM programme is expected to be "up to" EUR86bn. The role of the IMF is more uncertain than in previous programmes. The Fund states that it expects to remain involved in the programme but only if "significant" debt relief is forthcoming. Discussions on debt relief are slated for the first programme review (October) although there may yet be disagreements between the IMF and Europe as to the ambition of the debt relief on offer. Fitch does not expect principal haircuts on the official debt stock given the political sensitivities around this issue.
Part of the ESM programme consists of a package of up to EUR25bn for bank recapitalisation, with EUR10bn forming part of this week's disbursement. Fitch believes that EUR25bn should be sufficient. However, capital needs could also exceed this amount, especially if deferred tax assets are not given full equity credit. The ECB is providing sufficient ELA liquidity to the Greek banks although capital controls are likely to persist at least until next year.
The breakdown in relations between Greece and its creditors in January-July culminated in the explicit threat of a Greek exit from the eurozone being made by key creditor countries. It is reasonable to assume that if such a situation was reached again, the risk of 'Grexit' would be high.
The ratings are sensitive to the following key assumptions:
Fitch assumes that the first disbursement under the ESM programme will take place before the 20 August bond payment to the Eurosystem (EUR3.2bn).
Fitch assumes that any debt relief given to Greece under the ESM programme will apply to official-sector debt only, and would not therefore constitute an event of default under the agency's criteria.