IHS Global Insight Perspective | |
Significance | IHS Global Insight has downgraded Greece's long-term Sovereign Risk Rating two notches from 25 to 35 (equivalent to BBB on the generic scale) and Portugal's rating from 15 to 25 (equivalent to A-). Both ratings have a Negative outlook. |
Implications | Standard & Poor's (S&P) yesterday also downgraded its credit rating for Greek debt from BBB+ to BB+, a triple-notch reduction. This effectively means "junk" status for Greek debt, the first time this has happened to a member of the Eurozone. Furthermore, S&P downgraded its credit rating for Portugal by two notches from A+ to A- as fears mount that it too will struggle to service its debt, given very weak economic activity. |
Outlook | A worse-than-expected performance by the Greek or Portuguese economy, any signs of the countries falling behind their fiscal targets, increasing pressure from the markets, or rising social tensions would all be likely to trigger a further downgrade of our ratings in the future. |
Risk Ratings | For Greece, our rating is less favourable than that given by Moody's—which last week downgraded its assessment from A2 to A3 (25 on the IHS Global Insight scale that runs from 0 to 100)—but it sits above the Fitch rating (BBB-, equivalent to 40). Meanwhile, Moody's currently rates Portugal as Aa2 (equivalent to 5), while Fitch's rating is AA- (equivalent to 10). |
IHS Global Insight has downgraded Greece's long-term Sovereign Risk Rating two notches from 25 to 35 (equivalent to BBB on the generic scale) with a Negative outlook. We had cut our rating from 20 to 25 in November 2009 following the announcement that the fiscal deficit in 2008 was significantly higher than originally estimated, and we revised the outlook from Stable to Negative the following month. Our rating is less favourable than that given by Moody's—which last week downgraded its assessment from A2 to A3 (25 on the IHS Global Insight scale that runs from 0 to 100) (see Greece: 23 April 2010: Further Sovereign Downgrade Puts More Pressure on Greece)—but it sits above the Fitch rating (BBB-, equivalent to 40).
At the same time, IHS Global Insight has also downgraded Portugal's long-term Sovereign Risk Rating from 15 to 25, equivalent to A- on the generic scale. This follows a change in outlook from Stable to Negative during the first week of March. Moody's currently rates Portugal as Aa2 (equivalent to 5), while Fitch's current rating is AA- (equivalent to 10).
Standard & Poor's (S&P) yesterday also downgraded its credit rating for Greek debt from BBB+ to BB+, a triple-notch reduction. This effectively means "junk" status for Greek debt, the first time this has happened to a member of the Eurozone. Furthermore, S&P downgraded its credit rating for Portugal by two notches from A+ to A- as fears mount that it too will struggle to service its debt, given very weak economic activity.
Greece: Dire Economic Situation Makes Fiscal Consolidation Extremely Difficult
Following a fall of 2.0% in 2009, Greek GDP is expected to contract again in 2010 and the imbalances present in the economy mean that growth is likely to be extremely weak over the medium term. Higher unemployment, a significantly tighter fiscal policy, reduced availability of credit, and larger spare capacity levels mean that domestic demand—which had been the engine of growth during the past decade—will struggle for a considerable time. Moreover, a low savings rate, the relative lack of openness of the economy, and its very weak external competitiveness mean that the adjustment will be lengthy. Although the recent softness of the euro is a welcome development for Greek exporters, the only way to improve the external competitiveness of the economy in the short run is by reducing costs—for example, wages—as Greece does not have control over its exchange rate.
Additionally, there are concerns that the strong adjustment and structural measures needed to put the economy back on track may trigger social tensions. The public still seems to support the government on the whole, but this support has been eroded significantly following the implementation of tough austerity measures and is in danger of being diluted even further if the crisis continues to intensify. If that were to happen, the main worry is that the important reforms the country so badly needs to ensure sustainable growth and the health of the public finances—such as pension reforms—may be watered down.
Although the 45-billion-euro (US$59-billion) Eurozone/International Monetary Fund (IMF) bailout programme deals with the short-term liquidity problems (see Eurozone - Greece: 12 April 2010: Following New Sovereign Downgrade, Eurozone Details Greek Rescue Package), we have always maintained that the economy's problems are long term and the bailout does not change our outlook.
Portugal: Contagion Risks Have Increased Sharply
Revisions to the public finances data revealed that the Portuguese fiscal deficit stood at 9.4% of GDP in 2009, much higher than previously thought. Unfortunately, a challenging economic outlook will make fiscal consolidation all the more difficult. Domestic demand will be under intense pressure from significantly tighter fiscal policy, while the weak external competitiveness of the economy means that it will be very difficult for Portugal to "export" its way out of the recession. As a member of the Eurozone, Portugal cannot devalue its currency to improve its external competitiveness in the short term and the reforms needed to improve the external performance of the economy are unlikely to be implemented in the short run.
Although the stock of public debt compares favourably with that of other countries within the Eurozone, the economy's competitiveness problems, combined with the large fiscal deficit and the high debt levels in the private sector, make it susceptible to becoming the next victim of short sellers, which would have a dampening impact on demand for long-term debt. Indeed, government bond yields have risen sharply, and spreads between Portuguese and German 10-year government bonds currently sit at their highest levels since Portugal entered the Eurozone. We are concerned that the absence of a Eurozone safety net for Portugal—in contrast to the 30-billion-euro programme already in place for Greece—could make it extremely vulnerable in bond markets, driving up yields and eroding the government's ability to bring down the fiscal deficit. Worryingly, the sluggishness of the Eurozone in coming up with a detailed bailout plan—and the apparent differences between Germany and most of the other Eurozone members—has increased fears about the availability of help should Portugal require support in the future.
Outlook and Implications
The markets' pressure on the weakest Eurozone economies does not show any sign of easing. On the contrary, the situation is deteriorating at a worrying pace.
Yesterday's downgrades had a devastating impact on bond markets. Spreads between Greek and German 10-year government bonds have reached a record high of 780 basis points today, more than 100 basis points above yesterday's level, while the general index of the Athens Stock Exchange has plunged by 7.4%. Greece's five-year credit default swaps (CDS) have jumped to more than 900 basis points, higher than any other sovereign. Meanwhile, Portugal's bond spreads, which had reached a record 278 basis points, started high but actually remained relatively stable following the announcement of the S&P downgrade. The euro has also been hit, falling to a one-year low of 1 euro:1.317 against the U.S. dollar, while bourses across Europe have suffered badly as investors worry about the outlook for the region.
It is imperative that the Eurozone now reaches a decision on when the first tranche of the bailout funds will be available for Greece. The funds are expected to be ready before 19 May, when 8.5 billion euro is due to be refinanced, but nothing has been officially announced. The Greek government must not only achieve the planned reduction in the fiscal shortfall this year—from 13.6% to 8.7% of GDP—but it must also announce how the deficit will be brought down in 2011 and 2012 and implement reforms to improve the long-term sustainability of the public finances if it is to have any chance of succeeding. A better-than-expected performance by the economy, which we expect to contract sharply again in 2010, would also help the government's case, but this is, in our opinion, a very unlikely scenario. On the other hand, a worse-than-expected performance, any sign that the government is behind in its efforts to achieve its fiscal target, or increasing social tensions would be likely to trigger a further downgrade of our rating.
Portugal is also in a difficult situation. Although the deficit and debt levels are lower in Portugal than in Greece and the Portuguese government has much more fiscal credibility than its Greek counterpart, the underlying problems are very similar; these are two very uncompetitive economies within a common currency area. It is clear that the markets do not believe that the fiscal measures implemented by the government to deal with the deteriorating public finances are enough, and we expect the administration to implement further austerity measures over the coming months. One major concern is that there are doubts about how the Eurozone will respond if Portugal becomes the next victim of bond short-sellers. Germany's government has made it clear that the safety net in place for Greece is a one-off and there are questions about its political willingness to continue helping economies in distress.
Indeed, one of the main problems is that the Eurozone does not have a clear or quick mechanism in place to deal with this type of crisis at a time when many of the less competitive economies are running large fiscal deficits. In fact, it could be argued that Spain presents the most serious long-term risk to the Eurozone, given that it accounts for some 11.5% of the region's real total GDP, as opposed to Greece's share of 2.6% and Portugal's 1.8%. Although Spain's immediate public finance problems are not as bad as Greece's, there are serious concerns over its longer-term economic outlook. The risk of contagion from the Greek crisis spreading across the Eurozone is growing by the day. The next couple of months will be vital and much will depend not only on how the Greek situation unfolds, but also on how the highly indebted economies inside the Eurozone perform. A sovereign crisis is not unavoidable but, worryingly, all the right elements are in place for one to occur.