Early in September, DBRS Morningstar upgraded its rating on Greek credit from BB (high) to BBB (low), giving the country’s bonds access to the coveted “investment grade” status. DBRS Morningstar is one of four rating agencies that the European Central Bank officially recognizes, alongside S&P Global Ratings, Moody’s and Fitch Ratings.
The rate hike decision hinges on two key decision points, explains Nichola James, Managing Director of Sovereigns at DBRS Morningstar.
- First is Greece’s ability to spend a EUR 36 billion package in the coming years, “delivering reforms and investments that we expect will narrow the investment gap with euro area peers and raise economic growth prospects. Greece is unique in channeling the Recovery and Resilience Facility loan component to companies through its banking system,” James says, and
- Second is Greece’s willingness “to demonstrate fiscal responsibility and seeing further reductions in the public debt ratio.”
Greece’s Past Growth Was Bad Quality
It is surprising that a small country of 10 million could stir up so much financial anxiety, but the European Central Bank poured billions into the Greek economy in large part to avoid contagion to other larger countries which the financial crisis had made vulnerable, explains a Council on Foreign Relations timeline. Over the course of five years, three rescue packages amounting to EUR 326 billion were approved, and the country was strapped with drastic austerity measures that angered the population and lead to the overthrow of three government administrations.
Before the crisis erupted in 2010, Greece’s GDP growth “was quite strong, but it was growth of a bad quality, where the underground economy represented 25% of GDP, recalls Sébastien Mc Mahon, Vice-president of asset allocation, Chief Strategist and Senior Economist at IA Global Asset Management. And of course, the country’s debt represented 109% of GDP, the highest in the European Union.”
An example of the Greek government’s fiscal inefficiency, Mc Mahon notes, was that, as long as citizens had not completed the construction of their residence, they didn’t have to pay tax on it. As a result, one could see thousands of homes with scaffoldings rising up on some walls allowing people to claim that construction of their house was not finished, thereby avoiding payment of taxes year after year.
Greece’s Debt Is Higher Now Than Before the Crisis. So Why the Upgrade?
A surprising fact, at 160%, Greece’s debt-to-GDP ratio is significantly higher now than before the crisis. “Based on history, there was a consensus among economists that a ratio that surpassed 80% was a problem,” Mc Mahon points out.
There was an abundant amount of literature in the 2008-10 period, “but its conclusions proved incorrect, he continues. Economists agreed that the debt rubber band could be pulled further. Now, people consider that as long as the debt level is controlled and that governments have a firm intention to dial it down, it’s okay.”
Such considerations underpin DBRS Morningstar’s rating hike. “In its Stability Programme 2023, the government forecasts primary surpluses of over 2% of GDP from 2024 to 2026,” James says.
Another factor explaining the greater tolerance for high country indebtedness is that “there’s considerable need to hold sovereign debt in the Western world because of an aging population, Mc Mahon explains. If there really were problems with these debts, interest rates on them would be higher. But even before recent rate hikes by central banks, levels were at historical lows.”
As far as large debt portfolio managers are concerned, Greece is still not out of the woods. Other major rating agencies are still one notch away from hiking Greece’s debt to investment grade, Mc Mahon points out. Before managers fill up with Greek debt, “a more thorough analysis of the Greek situation will need to be done,” he says.
The Greek Economy is Resting on a Narrow Base
The Greek economy is not very powerful, resting mostly on the two legs of tourism and shipping. With the pandemic, tourism stalled, causing the country to record high deficits, a situation that has since been corrected. Other weaknesses, James adds, “include the economic legacies inherited from Greece’s prolonged financial crisis, namely, the very high public debt ratio, still sizeable levels of non-performing loans and the high unemployment rate.”
But strengths are present, notably “Greece’s membership in the European Union and the Euro Area, James says. In addition, the implementation of a vast number of economic reforms in the past years has enhanced resilience, and this was demonstrated in the recent (pandemic) crisis.”
Now, James adds, Greece has ownership of its fiscal performance and is issuing government bonds to a broadening investor base with narrower spreads to German bunds than higher credit-rated countries such as Italy.”
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