DBRS Ratings GmbH (Morningstar DBRS) changed the trends on the Hellenic Republic’s (Greece) Long-Term Foreign and Local Currency – Issuer Ratings to Positive from Stable and confirmed the ratings at BBB (low). At the same time, Morningstar DBRS changed the trends on Greece’s Short-Term Foreign and Local Currency – Issuer Ratings to Positive from Stable and confirmed the ratings at R-2 (middle).
KEY CREDIT RATING CONSIDERATIONS
The trend changes reflect Morningstar DBRS’ expectations of further improvement in the banking system fundamentals. The banking sector is likely to continue maintaining good profitability, reducing nonperforming loans (NPLs), and lowering deferred tax credits. Legacies related to a strong nexus with the government have also receded as a result of the government decision to sell a large amount of stakes in systemic banks. Moreover, healthy and rising primary surpluses, in tandem with sound nominal growth, will facilitate further significant reduction in the public debt-to-GDP, which is expected to fall to below 140% by 2027 from 161.9% in 2023. In addition, the implementation of structural reforms remains on good track, which, along with higher investments supported by European Union (EU) resources, should raise GDP potential and make the country’s growth more self-sustained. Since 2021, Greece has been outperforming euro area average growth, and this is likely to continue over the next two years. GDP is expected to expand by more than 2.0% in both 2024 and 2025.
Greece’s BBB (low) credit ratings are underpinned by its EU and euro area membership and by the implementation of past institutional and economic reforms that have enhanced the resilience of the economy. The country continues to make progress on the execution of its Recovery and Resilience Plan (RRP or Greece 2.0), which is expected to improve the country’s business environment, boost productivity and help narrow the investment gap with its euro area peers. Significant EU resources provide incentives for the implementation of growth-enhancing reforms, while supporting investment with funds also channeled through the strengthened banking system. Moreover, there is strong political commitment to maintain a prudent fiscal strategy, reflected in the rapid improvement in the primary surplus despite the multiple shocks the economy has faced since 2020. The credit ratings are constrained by the still high public debt ratio, the small size of the economy, and the persistent current account deficit.
CREDIT RATING DRIVERS
Morningstar DBRS could upgrade the credit ratings if one or a combination of the following occur: (1) further improvement in the condition of the banking system; (2) continuation of sound fiscal performance, supported by sustained primary surpluses and a material reduction in the public debt ratio; or (3) continued implementation of reforms that boost investment, thereby improving longer-term growth prospects.
Morningstar DBRS could change the trends on the credit ratings back to Stable if the banking sector fails to reduce its vulnerabilities, the projected reduction in the public debt ratio materially underperforms, or if the improvement in growth prospects underwhelms. Potential triggers for a downgrade include one or a combination of the following: (1) a prolonged weakening of fiscal discipline that puts the public debt ratio on a sustained upward trend; (2) a reversal in structural reforms.
CREDIT RATING RATIONALE
Further Declines in NPLs and Lower Nexus with the Sovereign Reduce Legacy Vulnerabilities
Significant effort has been made to strengthen Greece’s banking sector, which, thanks to an improvement in credit quality, is now more resilient than in the past. Banks are better capitalized, more liquid, and have increased their profitability, with the support of a rise in net interest margin. Moreover, an improvement in operating efficiency after a deep restructuring process, and a reduction in credit costs consistent with the improvement in their risk profile, further reinforced the Greek banks. Recent shocks, including the energy crisis and high interest costs, have not prevented the aggregate gross NPL ratio to continue to decline. It was at 7.5% as of Q1 2024, down more than 40 percentage points since its peak in June 2017. This reduction was primarily driven by sales and securitizations of loans under the Hercules Asset Protection Scheme (HAPS), which has benefitted from a public guarantee. The upcoming merger between Attica Bank and Pancreta Bank, although resulting in a public recapitalisation of around EUR 500 million, will likely help the NPL ratio of the banking system to further fall towards the euro area average.
With the health of the banking system improving, the Hellenic Financial Stability Fund has carried out important divestments in systemic banks. This has attracted private investors enabling the government to sold a large amount of stakes in systemic banks, which help reducing the nexus with the banks. Morningstar DBRS expects further improvement in the quality of capital with continued reduction in the deferred tax credit, which, as of YE2023, accounted for 44% of total prudential own funds, down by 8 percentage points compared with 2022. House prices have increased substantially over the past few years, reversing the decade-long downtrend but rising living costs and interest rates have worsened households affordability matrices. However, there are no signs of excess lending and leverage and Morningstar DBRS views risks to financial stability as contained at the moment. New macroprudential measures, including a cap on the loan-to-value ratio, to be effective as of first of January 2025 will help maintain sound lending standards.
Over the last decade, loan growth has been subdued but recently is improving, particularly for non-financial corporations. Morningstar DBRS notes that banks’ effective management and allocation of RRF funds, together with the substantial reduction in NPLs that has taken place, position banks well to further provide credit to Greek corporates, thereby supporting economic growth. Under the RRF, Greece will draw loans amounting to EUR 17.7 billion, of which EUR 16.7 billion will be channeled through Greek banks. So far, only EUR 1.9 billion has been disbursed to firms but an acceleration is likely going forward. The resolution of private non-performing exposures (NPEs) that were transferred from the banks’ balance sheets to the real economy and are now managed by credit servicing firms (CSFs) remains a vulnerability. However, Morningstar DBRS expects a gradual reduction of these NPEs over time.
Public Debt-to-GDP Ratio Remains the Highest in the Euro Area, but It is on Steep Downward Trajectory: Favourable Structure and Proactive Debt Management Mitigate Risks
The Greek public debt ratio is expected to continue to fall, benefitting from rising primary surpluses, moderate interest rates, and sound, although decelerating, nominal growth. Greece’s debt-to-GDP ratio peaked at 207.0% in 2020 before falling to 161.9% in 2023, the lowest level since 2010; further declines are likely to occur in the medium term. The government envisages the public debt ratio continuing to fall to 152.7% of GDP this year, implying a drop of around 54 percentage points in only four years, one of the steepest declines in modern times.
In Morningstar DBRS’ view, risks to public debt sustainability are mitigated by several factors. First, Greece’s debt structure is very favourable with 100% of debt at fixed rates after swaps. Secondly, the weighted-average maturity is very high, expected to stand at 19 years in 2024, and around 70% of the debt is held by the official sector, which makes the debt less susceptible to market volatility. Finally, the Greek Public Debt Management Agency (PDMA) has been able to temporarily overhedge its debt portfolio, mitigating the impact of the rise in interest costs. In 2024, the average effective interest rate on medium- to long-term debt is expected to stand at 1.3%. These factors bode well for investor confidence and government bond yields continue to benefit from favourable demand, with the 10-year spread over German Bunds slightly above 100 basis points.
Greece’s public debt benefits also from a proactive debt management strategy with early repayments that have reduced short-term debt and smoothed the redemption profile. For example, PDMA fully repaid its international Monetary Fund (IMF) loans and prepaid EUR 2.6 billion and EUR 5.3 billion of the Greek Loan Facility (GLF loans) in 2022 and in 2023, respectively. The PDMA, which aims to continue to reduce the stock of net public debt, will likely early repay an additional of around EUR 8 billion of GLF loans in 2024, corresponding to three years of GLF redemptions. This should help reduce financing needs and contain the funding costs taking advantage of the positive mark-to-market position on derivatives.
The sizeable cash reserves of around EUR 34 billion (15% of GDP or three years of gross funding needs) in mid-2024 continue to serve as a liquidity buffer and enhance confidence among market participants by reducing refinancing and interest rate risk. These reserve buffers, combined with the pro-active debt management strategy to achieve the lowest possible interest rate costs, thereby significantly reducing repayment risks, underpin the positive qualitative adjustment in the Debt and Liquidity building block assessment. However, despite the favourable debt profile, Morningstar DBRS notes that Greece’s debt sustainability relies primarily on its ability to sustain primary surpluses and on solid nominal GDP growth rates, as, in the long run, official sector debt will be replaced with market financed debt that will expose Greece to increased market volatility.
The Economy Will Remain Supported by Investment; Successful Implementation of RRP Key to Sustained Growth
The Greek economy expanded by 2.0% in 2023 on the back of strong private consumption, export and investment growth. In 2024, the country’s economic activity will likely continue outperforming the euro area average benefitting from the easing of financing conditions, the anticipated improvement in the external environment, and the flow of EU funds. Real GDP growth is projected to come in at 2.2% this year and 2.5% in 2025, according to estimates by the Bank of Greece. The labour market remains resilient with the unemployment rate falling below 10% in June 2024 for the first time since August 2009, although it is still above the EU average. Similar to other small economies, Greece is exposed to geopolitical risks that could negatively affect tourism and shipping industries or lead to a rise in commodity prices and put upward pressures on prices. The country also remains vulnerable to extreme climate events.
Greece aims to improve its growth prospects by using both the grant and the loan component of the NGEU. The RRF could help Greece close the investment gap with its euro area peers as a result of a higher share of spending (as a share of GDP) relative to other countries, which stood at 14.1% of GDP at the end of 2023 from 10.7% in 2019. Moreover, capital stock, which had been declining since 2009, turned positive in 2022, and it is expected to continue increasing.
Greece continues to deliver on its RRP. Thus far, the country is among the top performers in the EU for the share of funds disbursed. It has completed 23% of its milestones and targets and has received EUR 7.59 billion of grants and EUR 9.62 billion of loans, close to 50% of the total envelope of almost EUR 36 billion (16% of GDP). Although there are some delays regarding the implementations related to the grant component, the country is absorbing a huge amount of resources. The successful implementation of the RRP will help Greece improve its growth prospects and warrants a positive qualitative adjustment to the Economic Structure and Performance building block assessment.
Commitment to Fiscal Responsibility Remains, With Primary Surplus Target Set at 2.1% in 2024; Medium-Term Fiscal Plan Expected to Be Prudent
Greece’s fiscal accounts, after deteriorating because of the measures implemented to mitigate the impact of the COVID-19 pandemic and of the energy crisis, are improving rapidly. Following the peak at 9.8% of GDP in 2020, the deficit fell to 1.6% in 2023 with further improvements expected this year and in 2025. Stronger-than-anticipated tax revenues, as well as lower primary expenditures, led the primary surplus to rise to 1.9% of GDP, largely exceeding the 1.1% target last year. On the back of sound economic growth and stronger fiscal revenues, primary surplus will likely continue to increase. While the government set a GDP target of 2.1% in its stability programme in April, higher-than-anticipated fiscal revenues, helped by digitalization and tax compliance measures, will likely lead to an overperformance in the primary surplus this year. The latest data on tax revenues are encouraging, with the general government primary surplus in the first half of the year, around EUR 1 billion higher than in the corresponding period last year. In this context, the deficit is set to drop to 1.2% and 0.9% of GDP in 2024 and 2025, respectively.
In the upcoming days, the government will present its medium-term fiscal plan to the European authorities for a time horizon of four years, and Morningstar DBRS does not anticipate a derailment in fiscal prudence. Net primary expenditures targets will likely be in line with the new EU fiscal rules reflecting the Greek government strong commitment to a conservative budgetary strategy. Morningstar DBRS expects the government maintaining a primary surplus of 2.0% of GDP or above for a prolonged period of time to be a challenge, but the Greek authorities have a sound track record in rapidly repairing fiscal accounts, despite multiple shocks over recent years.
Risks to the fiscal outlook remain and are related to slower growth that could lead to weaker fiscal revenues, renewed energy and food price pressure that would require additional support measures, extreme climate-related events, and the impact on contingent liabilities. On the other hand, persistent improvement in fiscal revenues thanks to government measures to increase tax compliance might deliver better-than-expected fiscal results. According to the IMF, the share of informal economy has declined significantly to 16% in 2021 from around 30% in 2013, and further declines are possible. This would bode well for fiscal capacity going forward.
Current Account Deficit Will Narrow Slowly but Remain High in the Medium Term
Greece’s lingering deficit in goods balance and elevated negative Net International Investment Position (NIIP) weigh on the country’s external position and on the credit ratings. Going forward, these vulnerabilities are likely to recede, although marginally, with the trade deficit gradually narrowing but remaining elevated while external debt as a share of GDP falling as a result of net repayments of government official debt and stronger nominal growth.
However, Morningstar DBRS views Greece’s external position as more resilient than in the past. The country has improved its external competitiveness, has become a more open economy, and exports of goods and services in terms of GDP were around 45% in 2023 from 22% in 2010. Moreover, the current account deficit, after temporarily widening in 2022 above 10.3% of GDP, declined to around 6.3% in 2023. The deficit has benefitted from normalising energy prices, and the strong rebound in tourism receipts, which were up 13% in 2023 over the 2019 level. Over the medium term, despite economic growth above the potential and high import of investment goods, the deficit in the current account could continue to narrow, with the IMF projecting the deficit to fall to slightly above 5% of GDP in 2025. In Morningstar DBRS’ view, future improvements in the current account balance will also depend on the structural rise in export capacity, as well as to replace energy imports with renewable energy production. Supportive inflows of FDI, which reached a two-decade high in 2022, and the NGEU funds should mitigate the funding risks stemming from elevated current account deficits.
Greece’s negative NIIP at around 139% of GDP as of Q1 2024, despite the fall of more than 40 percentage points since the peak in Q2 2021, remains very high. However, it is less of a concern in Morningstar DBRS’ view, since Greece benefits from a favourable debt structure reflecting a large share of liabilities in the hands of the official sector, with long maturity, mostly denominated in euro and at fixed rates. However, future significant declines are unlikely to occur soon because of the long-term horizon of foreign official-sector loans to the public sector.
Outright Majority Secures Policy Continuity to Take Advantage of the Strong Momentum on Reforms
The outright majority obtained by the New Democracy party, led by Kyriakos Mistotakis, in the latest parliamentary elections in 2023 bodes well for political continuity as well as for implementing the government agenda. This will help also government stability when Greece aims to fulfill the targets and milestones of its RRP, aiming to boost its resilience and economic prospects. Although EU elections in June, saw a narrower support for the ruling party, political opposition seems fragmented and weak. Therefore, the government is expected to serve the full legislative term.
The successful implementation of the Greece 2.0 economic programme, with several reforms and investments in the pipeline, remains a key priority for the government. Among others, the government plans to address weaknesses in the justice system, public administration, and strengthen the public health system, which along with improvements in education, will help Greece achieve longer-term benefits. The improvement in the political environment and the government’s commitment to address Greece’s long-standing challenges warrants a positive qualitative adjustment to the Political Environment building block assessment.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.
Environmental (E) Factors
There were no Environmental factors that had a significant or relevant effect on the credit analysis.
Social (S) Factors
The following Social factor had a significant effect on the credit analysis: Human Capital and Human Rights. Greece’s GDP per capita estimated by the IMF at USD 22,805 in 2023 was relatively low compared with its euro system peers. This factor has been taken into account in the Economic Structure and Performance building block.
Governance (G) Factors
The following Governance factor had a significant effect on the credit analysis: Institutional Strength, Governance, and Transparency. According to the World Bank Worldwide Governance Indicators, in 2022 Greece’s rank for both the Rule of Law (59.9 percentile) and for Government Effectiveness (66.5 percentile) were significantly lower than its euro area peers. The following Governance factor had a relevant effect on the credit analysis: Bribery, Corruption, and Political Risk. Greece underperforms the EU average in the “Control of Corruption” indicator (56.6 percentile rank); however, it has made good progress in recent years improving its score in the Corruption Perception Index score to 49 in 2023 from 36 in 2012. Morningstar DBRS notes Greece’s institutional strengths associated with euro membership and recent improvements in these areas. These factors have been taken into account in the Fiscal Management and Policy and Political Environment building blocks.