Moody's confirms Greece's government bond rating at Caa3; Outlook stable

Moody's Investors Service has today confirmed Greece's government bond rating at Caa3 and changed the outlook to stable. The short-term rating is unaffected by this rating action and remains at Not Prime (NP). Moody's government bond rating applies to debt issued on private sector terms only.

This rating action concludes the review for downgrade that commenced on 1 July 2015.

The key drivers behind the confirmation are the approval of the third bailout programme, and the emergence of a political configuration that is slightly more supportive than its predecessors for the implementation of reforms which the programme will require.

Notwithstanding the positive developments the Caa3 rating continues to incorporate a high level of implementation risk given Greece's weak institutions and past poor track-record of implementing conditions of financial support.

The stable outlook reflects Moody's view that the risks to creditors are now broadly balanced given that the recent election resulted, for the first time since 2010, in significant representation in parliament of parties that have broadly supported the third bailout package.

The local- and foreign-currency bond ceilings remain at Caa2. The local- and foreign-currency bank deposit ceilings remain at Caa3. In Moody's view, that level appropriately reflects losses expected on bank deposits given deposit withdrawal limitations and capital controls put in place in late June that Moody's expects will only be gradually removed. The short-term foreign-currency bond and deposit ceilings remain Not Prime (NP).

RATINGS RATIONALE

Greece's agreement to a EUR86 billion, three-year support programme funded by the European Stability Mechanism (ESM) (Aa1 stable) reduces the risk of default on private sector debt, if reforms that are a precondition for financial assistance are implemented. The agreement will also allow for the banking sector to be supported through a second recapitalisation by the end of this year if prior conditions are met. The Memorandum of Understanding (MoU) governing the programme is very detailed. Like previous programmes, it includes a number of reform measures that the Greek government must implement before the disbursement of any future tranches under the programme. The expected reforms span fiscal consolidation measures, such as improved tax collection, higher tax rates and reform of the pension and health system, as well as important structural measures including steps to de-regulate a number of product markets and reform the insolvency code.

Agreement on the third programme reduces the risk of default on private sector debt, so long as the reforms that are a precondition for financial assistance continue to be implemented, and fiscal and growth targets continue to be met. However, while Moody's believes that the macroeconomic and fiscal assumptions of the third programme are more realistic than previous programmes, they are unlikely to be met over the medium-term.

The third bailout programme envisages a slow return to growth -- with an economic contraction of 2.3% in 2015, 1.3% in 2016 -- which is broadly in line with Moody's own forecasts. But medium-term growth prospects for Greece still remain fragile and below the 2.7% assumed in the programme. The primary balance targets of a deficit of 0.25% of GDP this year, followed by small surplus of 0.5% in 2016, are feasible. But maintaining surpluses of 3.5% of GDP in the following years is unlikely to be achieved. Overall, the weak state of the economy, and the political and social tensions associated with ongoing fiscal austerity, will continue to contribute to the challenge of implementing the programme.

Given the optimistic nature of medium term forecasts, Greece's ability to continue to receive the funding it needs to meet its official and private sector debt obligations will ultimately depend on its official creditors' willingness to exercise flexibility from time to time. In particular, it will rest on their willingness to agree to some form of debt relief, which Greece needs to make its debt sustainable. Moody's expects a discussion on official-sector debt relief to take place once the first review of the programme has been successfully concluded. That is currently scheduled to take place in October, although it is likely to be delayed given the given that a new coalition government has only just been elected. Any discussions on debt relief will focus on re-profiling official sector debt by extending maturities and reducing interest rates. In Moody's view, the likelihood of the private sector being exposed to debt restructuring at this stage is relatively low given the wish of official creditors to re-establish market access for Greece. A further default on private sector debt would only delay this process.

To get to that point, the Greek government will first need to enact a series of legislative measures aimed at reforming the public administration and finances and enhancing competitiveness and financial stability.

Moody's expects the political environment following the elections on 20 September 2015 to be slightly more supportive of the implementation of reforms required under the programme than was the case under previous governments. For the first time since the economic crisis began in 2010, the current bailout package has the support of the two largest parties in parliament - Syriza (145 seats) and New Democracy (75 seats)- suggesting that the risk of legislative obstacles emerging to the implementation of the programme has fallen relative to the recent past. Notably, 267 out of 300 members of parliament ostensibly support the third bailout, including members of Pasok (17 seats), To Potami (11 seats) and the Union of Centrists (9 seats). Importantly, the splinter Syriza party, Popular Unity, that supported an exit from the euro area, failed to reach the 3% threshold and is not represented in parliament.

Looking further ahead, however, Moody's continues to believe that the programme will face high, ongoing implementation risks given the high level of political and social discontent, the country's weak institutions and its poor track-record of implementing the conditions of financial support to date. The weak voter turnout is reflective of the high level of ambivalence towards the financial support programme and the conditions it imposes on the population. Moreover, the execution capacity of the current coalition comprising of Syriza and Anel remains untested, which could lead to delays in implementing the reform of agenda agreed under the third bailout package.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook on the Caa3 rating reflects Moody's view that the combination of economic, financial and political risks in Greece is more finely balanced than in the recent past. The election outcome means that the risk of scenarios involving either an impasse being reached with official creditors and/or a deeper recession resulting from prolonged uncertainty has diminished somewhat.

WHAT COULD MOVE THE RATING UP/DOWN

Moody's would downgrade Greece's government bond rating should the conditions needed to provide ongoing assurance of the implementation of the third bailout package fails to materialize. This would most likely happen should the economic recovery be materially slower than expected, should the coalition government prove ineffective at reaching agreement on how to meet creditors' demands, or should wider political or social tensions emerge than undermine popular or legislative support for the third programme.

Although not likely over the near-term given the prevailing downside risks, Moody's would consider upgrading Greece's government bond rating in the event of (1) an increase in the pace of fiscal consolidation and structural reforms; (2) sustained economic growth and primary surpluses, which would support a continued decline in debt levels; and (3) more certainty and visibility on future external financial support and the political environment.

Prompted by the factors described above, the publication of this credit rating action occurs on a date that deviates from the previously scheduled release date in the sovereign release calendar, published on www.moodys.com.

GDP per capita (PPP basis, US$): 25,859 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 0.8% (2014 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -2.6% (2014 Actual)

Gen. Gov. Financial Balance/GDP: -3.5% (2014 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.9% (2014 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: Low level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 23 September 2015, a rating committee was called to discuss the rating of the Greece, Government of. The main points raised during the discussion were: The issuer's governance and/or management prospects have improved. The approval of the third bailout package makes the country somewhat less susceptible to event risks

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable.