The declining public debt combined with the government’s commitment to fiscal stability and strengthening of the banking sector were the main reasons for Scope Ratings to recently upgrade Greece’s credit rating. But what can we expect from now on?
Dennis Shen, Chair of the Macroeconomic Council and primary sovereign analyst for Greece, explained what weighed mostly on the rating agency’s decision, but also warned that further upgrades will not be easy. The challenges are many – from persistent weaknesses, such as high current account deficits and low GDP per capita – to demographic challenges and climate change.
The full interview with Natasa Stasinou follows:
What was the main driver for Greece’s upgrade?
The upgrade of Greece’s sovereign rating to BBB reflected first an expectation of continued reductions in government debt. Here, we recognise stronger-than-expected primary budget surpluses in recent years and the narrowing of the headline budget deficit. Second, the strengthening of the banking system and reductions in outstanding sovereign-bank links. Finally, our expectation of sustained output growth as Greece transitions to the so-called Greece 2.0 and an associated modest upside revision of our estimate of trend growth at this stage.
On the first point, Greece’s general government debt ratio has continued moderating, from pandemic-crisis peaks of 212.6% of GDP as of 2020, reaching potentially an estimate of 155.3% by the end of this year, representing a meaningful 57pp reduction, having already declined to below pre-pandemic levels. This has been driven by favourable public-debt dynamics as anchored by a strengthened medium-run nominal-growth outlook, still-low average interest costs of the outstanding debt, and a government commitment to budgetary prudence. These factors we consider as being sustainable enough as to maintain continued debt declines even if at a gradually moderating pace.
We forecast that the government debt ratio will moderate to 145.0% of GDP by the end of next year, before possibly reaching 132.0% by end-2029. If so, the latter figure may represent the lowest debt ratio of the sovereign since the beginning of the Greek crisis in Q1 2010. Our debt projections have strengthened and are anchored by a slight upside revision of our medium-run primary-balance estimate to an average of 2.75% of GDP surpluses for 2024-27, the remainder of the Kyriakos Mitsotakis government. The continued concentration on budgetary prudence has given us this greater confidence in the ability of authorities to sustain elevated primary-surplus objectives ahead of the next general elections, barring unforeseen crises and even absent the same degree of straight-jackets from before.
The ongoing improvement of banking-system stability and reduced sovereign-bank links also supported the upgrade. This includes the decline in non-performing loans on bank balance sheets, the sale of government shares in the systemic banks, a gradual amortisation of significant deferred tax credits, expiration of the Hercules Asset Protection Scheme by the end of this month and moderately stronger capitalisation. These factors all support banking-system resilience and curtail contingent liabilities for the sovereign deriving from the financial system. Although banking-system risks are not fully resolved, the meaningful improvements achieved to date anchor a one-notch rating upgrade at this intermediate stage.
Finally, the progress Greece has made around the so-called Greece 2.0, seeking to book end the years of crises since 2009, anchors the upgrade. This is advanced by the fundamental reforms and investment of the recent years. Our conclusion of an enhanced stability and sustainability of the economy underscored the decision to moderately bolster an estimate of medium-run trend growth to 1.25% a year from a former estimate of 1.0%, although this trend-growth figure remains restrained by Greece’s modern economic history.
Here, each year that passes without a crisis is a further data point supporting the thesis of Greece 2.0 and may present further upside for our trend-growth estimate down the road.
What is now the main challenge Greece faces ahead. Could it expect further upgrades?
At this stage, Greece’s government debt is still among the highest of a universe of 40 sovereign states publicly rated by Scope, second only after Japan’s. This elevated stock of government debt exposes the sovereign to increases of financing rates during the recurrent market re-appraisals of risks associated with indebted sovereign borrowers.
As Greece increasingly relies on the capital markets and accelerates the early repayment of bailout loans, and as the ECB quantitatively tightens, the structure of Greek government debt is gradually weakening. Interest payments are increasing slowly, as Greek refinances via more expensive market issuance. The very-long weighted-average debt maturity of 18.9 years – the lengthiest of our sovereign universe – is declining as the government specifically targets an average maturity of 10 years in 10 years’ time. And as sovereign ratings are assigned only on debt due to be repaid to the private sector, the increasing share of Greek debt held on the private-sector balance sheet represents a credit concern.
Political and policy-related risks may increase in the longer run, such as after future general elections. With regard to longer-run economic potential, structural economic weaknesses and demographic challenges remain outstanding, such as net emigration, moderate GDP per capita and bottlenecks for longer-run economic potential. The external sector represents a longer-standing bottleneck given outstanding current-account deficits. Of relevance, environmental challenges also constrain the credit rating, presenting a risk for longer-run economic and budgetary outlooks given the increasing occurrence and intensity of wildfires and drought.
We rate the Greek sovereign with a Stable Outlook, signalling we do not currently foresee a more than one-in-three probability of a change in the long-term ratings over the next 12-18 months. Further upside from the BBB investment-grade level may be possible if: i) nominal economic growth and fiscal consolidation see further strong and sustained reductions of general government debt while the weakening of the government debt structure is managed; ii) there is further strengthening of the outlook for medium-run potential growth and macroeconomic sustainability; and/or iii) banking-sector and sovereign-bank risks are additionally trimmed.
