ARC Ratings On The Greece Tragedy

Includes: FXE, GREK
by: Joan Feldbaum-Vidra


Grexit risk has increased.

Capital controls risks have increased.

Existential Eurozone risks are contained.

The Greek Tragedy: Plot Driven Drama Devoid of a New Theme

We are currently witnessing a new act in the play, The Greek Tragedy. ARC Ratings continues its watch over developments in Greece as that country's six-year long financial crisis continues to unfold. The swearing in of a Syriza‑led government will, in our view, likely be met with only modest concessions from the Troika and official creditors. As such, Alexis Tsipras, head of the new Syriza-led government, will not satisfy his campaign pledges to cut Greece's debt in half. A period of acute uncertainty will persist over the near term on how Tsipras will manage this reality. Existential questions about the broader integrity of the Eurozone, as we know it, will not take center stage, even as risks of a Grexit increase.


- Modest fiscal expansion and relaxation of debt repayments terms will be on the table.

- QE and crisis management infrastructure insulates Eurozone from existential risks.

- Grexit risk has increased, especially because Syriza lacks experience governing the country, even though 75% of Greeks want to keep the Euro.

- Capital controls may be instituted to stabilize the country if deposit flight accelerates and a new Troika agreement looks unlikely.

- Greece will need to tap the markets in the next few years, even assuming Troika relations are regularized. Sustaining investor confidence in Euro membership will be essential. Amortizations falling due according to the present debt repayments schedule total EUR 24 billion in 2015-16.

Why are We Here?

Greece was catapulted into this current period of policy quagmire because of the standstill over the installation of a new Greek President in December. The outgoing New Democracy-led government of Antonis Samaris failed to secure enough votes to install its candidate, Stavros Dimas, to the position. According to the Greek Constitution, after the three failed rounds of votes in the Greek parliament, snap elections were in order. National elections were held last Sunday, 25 January. Syriza took 36.6% of the vote, affording it 149 out of the 151 seats needed for a majority government, and formed a coalition with Independent Greeks. Both parties are united by their opposition to the Troika bailout program austerity that has contributed to the full-throttle depression in Greece, a collapse of GDP by 25% in real terms, the worst any country has experienced in global history.

Syriza's popularity and populist platform have been a threat to Greek policymaking for several years, since the start of the Troika-led austerity program. The risks that Syriza would win this vote were high. In addition to the economic collapse, it has become increasingly clear to Greece, and indeed all onlookers, that Greece's debts of 175% of GDP are unmanageable and that the economy is still suffering under them.

Indeed, the initial projections for Greece's macro adjustment look unrealistic, compared to what Greece has experienced. A GDP contraction of just around 4-6% was built into the initial program, not the 25% collapse that has been endured. Moreover, the rebound in growth expected in the program design is simply not going to occur. Greece does not have a tradition of vibrant export-led growth and most of Greece's exports are destined to countries within the beleaguered Eurozone bloc. Moreover, the macro-impact of Greece's adjustment has been so profoundly severe, in terms of both income levels and employment, it is hard to see domestic demand rebounding meaningfully anytime soon. All these factors have contributed to the attractiveness of Syriza's anti-austerity platform (as well as the growth of more radical parties, such as Golden Dawn). Syriza's popularity has also been underpinned by the inequities in Greece's severe adjustment, with certain sectors in the economy - namely tax payers - being hurt most.

Dream vs. Reality: Greece needs the Troika, but does the Troika need Greece?

Greece's fate very much depends upon negotiating a new Troika package once the current one expires in February. The cold, hard facts are that in spite of Greece's fiscal primary surplus - an increasingly elusive 5% of GDP programmed for the current year - it is still very much on life support. Three out of its four top banks have failed the ECB's stress tests and are in need of more capital. Deposits are fleeing the banks since the failed Presidential vote in December, and the public coffers are not in a position to make any sort of rescue to stabilize the system.

Neither of Tsipras' election pledges are acceptable to the European community of policymakers. Tsipras' election platform has been that he will both cut Greece's debts in half and ramp up government spending to spur growth. The Troika group of creditors - The European Commission, the IMF, and the ECB - state that they will not support a haircut, and a fiscal expansion will create new debt which Greece cannot afford.

The upcoming election season in Europe is not conducive to caving in to Greek demands. Estonia, Finland, Portugal and Spain all have upcoming legislative elections. Italy has a vote for President coming up. These countries have weathered the crisis and austerity, even if not as severe as Greece's. Giving into Tsipras' demand could heighten such demands in these countries for similar treatment. The specter of debt relief would rekindle existential questions about the integrity of the Eurozone - such questions that have been put on the back burner thanks to the coordinated EU fiscal policy efforts and the ECB's lender of last resort pledge. European policymakers cannot cede to Tsipras while expecting other afflicted countries to continue to tow the line on structural reform and debt regularity, especially as these countries are paying for Greece's mess.

Europe is much better placed to manage Greece risks than it was a few years back. The Eurozone's crisis management infrastructure is much more developed than it was at the onset of the crisis - with the establishment of the European Stability Mechanism and the introduction of Quantitative Easing by the ECB last week. The institutions are in place to manage the resurgence of an existential crisis. Crisis management is also facilitated by the progress the afflicted periphery countries have made in stabilizing their finances over the past few years, as well as the cleaning up of the troubled banks in Europe.

Growth continues to be the main concern in the Eurozone, and indeed in Greece too. QE is hoped to spark that, principally through its role in depreciating the Euro, but also through creating more liquidity in the payments system. QE is a short-term fix that can only be productive if the underlying growth momentum exists. That is the worry for Greece.

The Reality of What Greece will Get: Renegotiated Terms but No Write‑Down/Modest Fiscal Expansion/New Troika Agreement by Expiry in February

Tspiras will get debt concessions, but not what he has promised. Many European officials are publicly stating that official creditors would contemplate extending the maturity of Greek debt repayments, and this relaxation of terms seems likely. Indeed, Greece's debt is too burdensome and there is no question it needs relief. Extending maturities beyond the current average maturity of 17 years will not help Greece much, but any more concessions are not politically feasible now. While this concession is a far cry from what Syriza has promised its supporters, it can deliver home that its fight has paid off.

Greece will be able to afford some fiscal expansion, but not much. Relaxing debt terms will free up some cash for other expenditures. Also, Greece might be able to tap the market so long and there is market confidence that there won't be another bail-in of private creditors, in the spirit of the Private Sector Initiative (PSI). The fact that Greece's debt is now overwhelming official-sector debt reduces the risk of another private creditor debt restructuring.

Signing a new Troika agreement would be part of this "smooth workout." A troika program is necessary for banks to continue to have ECB access, and to extend the government new credit. Greece has large debt payments due coming this summer, mostly to the ECB and IMF, but also to private creditors. The remaining EUR 7.2 billion installment under Troika program is key for Greece keeping current on its payments.

The Greek Saga Continues: The Threat of Grexit and Capital Controls

Clearly, the mismatch between what Greece needs - growth and massive debt relief - and what it will get suggests that the Greek saga will continue for some time.

The coming period is likely not to be a smooth one. Risks are high that the relaxation of terms that Greece gets will simply not be acceptable to the Greeks. There is a new risk that the new corps of policymakers in Greece will manage the situation recklessly, having no experience governing the country. 75% of Greek voters, including Syriza supporters, want to remain in the Euro. However, Syriza supporters may be forced to choose between their two competing goals.

Grounding Syriza supporters, somewhat, could be the fact that Greece will need to tap the financial markets in the next few years, and sustaining investor confidence is essential. Amortizations falling due, according to current repayment plans, alone stand at EUR 24 billion in 2015-16. The next tranche of the Troika loan disbursement of EUR 7.2 billion would only cover a fraction of this, and forecasted privatization receipts (EUR 5.6 billion), also do not provide sufficient coverage. Restructuring official debt repayments will help but only if generous.

The fact that Europe is more financially secure because of the crisis management infrastructure put in place, and the fact that the specter of default was confined to Greece, makes the Troika's intransigence on bending to Greece's demands ever more likely, in ARC's opinion.

All this means that the likelihood of a Grexit - a Greek exit from the Eurozone - has indeed risen. But it also suggests that at this juncture the rest of the Eurozone can quarantine itself from "existential risks" associated with a Grexit. Grexit would not be an inexpensive proposition for either side, including for European creditors to Greece. Grexit is no-one's preference.

The next few months will be very tenuous, with inexperienced and populist Syriza in the driver's seat paving the road ahead. Failure to try to achieve a middle ground with European policymakers could lead to events spiraling out of control. Should deposits continue to bleed the system, and panic ensue, the imposition of capital controls cannot be ruled out. Instituting capital controls would raise new questions about Greece's compatibility with the Euro, and could lead to a self-fulfilling prophesy.

ARC Ratings and Greece

ARC does not rate Greece yet, although we intend to do so soon as we broaden our coverage of Europe. In the sovereign space, ARC has assigned ratings to India and Malaysia. ARC will soon release ratings on partner countries of Portugal, South Africa, and Brazil, and then expand its coverage across Europe and the emerging markets space.

While ARC has not conducted a full due diligence on Greece, our rating of that sovereign would be deeply sub‑investment grade. Greece's outsized debt burden of 175% of GDP is unmanageable, and further debt restructurings are inevitable. Most of Greece's debts are to official creditors now, thanks to the EUR 240 billion Troika bailout program, and the PSI debt restructuring. Greece's debt has become more burdensome despite crisis-driven restructurings of its debts because the economy has collapsed - by about 25% - with prospects of vibrant growth elusive.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.