Greece: Positive Rating Outlook Yet Material Challenges Remain

Scope rates Greece BB+, one notch below investment grade but we raised our Outlook from Stable to Positive in December 2022. The assignment of a Positive Outlook was underpinned by a series of factors, notwithstanding significant economic challenges still remain.

While significant progress has been made, a series of challenges remain: moderate medium-run growth of about 1%, above-EU-average unemployment at 11.6%, limited economic diversification, a rigid labour market, external-sector vulnerabilities, and still-elevated non-performing loans in the banking sector. Parliamentary elections by July raise political uncertainties as well, as any post-election pivot of economic policies could raise financial risks.

We Assume Economic Slowdown But No Recession In The Greek Economy

As for economic fundamentals, we see growth slowing to 1.3% this year before rebounding to an above-potential 2.0% next year and averaging 1.4% over 2025-27. Scope does not expect a recession this year. The current economic slowdown follows strong recovery since the pandemic crisis: 8.4% growth in 2021 and an estimated 4.9% last year, outperforming euro-area averages (Figure 1).

Figure 1. Real economic growth (%), 2020-24F

HICP inflation is expected to gradually ease from an exceptionally elevated 9.3% YoY last year to 3.9% in 2023 and 2.8% next year. An anticipated pause in ECB rate hikes at a terminal (deposit) rate of at least 3% by the summer of this year will deliver much-needed relief for regional markets and economies.

But even as short-end policy rates continue rising over coming months, 10-year bond yields have eased – to 4.3%, representing a spread to Bunds of 182bp. This represents a sizeable discount from peaks of 5.1% and 295bp as of last autumn.

Strengthened European Support Supports Ratings if Sustained After the Elections

Significantly strengthened European institutional support for Greece since the Covid-19 crisis, which underpinned originally Scope’s upgrade to BB+, will be credit positive if it is maintained beyond this year’s elections. European monetary and fiscal policy tools strengthen debt sustainability of especially vulnerable borrowers such as Greece via central-bank asset purchases and the re-investment of redemptions, relaxed collateral requirements and NextGeneration EU disbursements.

The ECB’s enhanced policy framework since the Covid-19 crisis and waivers granting Greece access to Eurosystem facilities anchor a degree of further convergence of the credit-risk profile of the sovereign with that of other euro-area Member States. As long as Greece stays compliant with EU rules, we assume the ECB will deliver a backstop for Greek sovereign bonds, demonstrating its continued support for Greece even as Covid-19 crisis conditions fade.

EU fiscal programmes have strengthened. The Recovery and Resilience Facility represents a meaningful step in the direction of greater fiscal integration, disproportionately aiding the most-indebted EU borrowers like Greece. A strong emphasis in Scope’s credit ratings on European institutional support reflects a core difference of its sovereign-rating approach against that of other rating agencies.

A Steady Decline in Public Debt in Progress

Our positive rating outlook for Greece is further driven by a decline in public debt. A baseline debt-sustainability analysis envisions debt-to-GDP falling from 171% in 2022 to 164.5% in 2023 and 150.5% by 2027. This comes after peaks of 206.3% in 2020. High inflation contributes to reduced debt ratios but inflation might also prove a primary obstacle to Greece’s path to investment grade if borrowing rates were to rise again.

Figure 2. General government debt and interest payments

Higher Borrowing Rates and a Weakening Profile of Government Debt Are Credit Constraints

Because of higher borrowing rates, net interest payments as a proportion of general government revenues are set to increase from 5% of general government revenue in 2021 to 8.9% by 2027 even as Greece’s debt ratio drops (Figure 2). This is a constraint for further upside to Greece’s ratings. Even as long-run debt sustainability is aided by a declining debt ratio, short to medium-run debt sustainability weakens as outstanding concessional loans from its European official-sector lenders – mostly the European Stability Mechanism and European Financial Stability Facility – are gradually replaced by more expensive market financing.

The ECB’s transition to quantitative tightening will shift debt held by the Eurosystem back to private-sector balance sheets. As sovereign ratings are assigned on a sovereign’s privately-held debt, quantitative tightening is credit negative by expanding the stock of rateable privately-held securities.

We expect primary budget surpluses of 1% of GDP from 2024-2027, slightly more conservative than the government’s 2% assumption. Maintaining prudent primary surpluses after conclusion of the Enhanced Surveillance programme and after 2023 elections is crucial for Greece regaining an investment-grade status.

Scope Ratings has two scheduled calendar review dates of Greece’s sovereign ratings this year – 3 March and 4 August 2023.

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Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Keith Mullin, Senior Editor at Scope, contributed to writing this commentary.