Greece Cut to Junk by Moody’s on ‘Substantial’ Risks

Greece’s credit rating was cut to non-investment grade by Moody’s Investors Service, threatening to further undermine demand for the nation’s assets as it struggles to rein in the euro region’s second-biggest deficit.

In making the four-step downgrade to Ba1 from A3, Moody’s cited “substantial” risks to economic growth from the austerity measures tied to a 110 billion-euro ($134.5 billion) aid package from the European Union and the International Monetary Fund. The lower rating “incorporates a greater, albeit, low risk of default,” Moody’s said in a statement yesterday in London. The outlook is stable, it said.

Greece has cut spending, raised taxes and trimmed wages to tackle the deficit, which swelled to 13.6 percent of gross domestic product last year, more than four times the EU limit. To secure the EU-IMF aid, the government pledged to trim the shortfall to 8.1 percent of GDP this year and bring it back under the 3 percent EU ceiling in 2014. The crisis has prompted investors to sell the bonds of Greece and other high-deficit nations and pushed the euro down 14 percent this year.

“We’ve got a lot of uncertainty around the growth outlook for Greece,” Sarah Carlson, vice president-senior analyst in Moody’s sovereign-risk group, said in a telephone interview yesterday. “It’s rare for a country to implement so much structural reform in a very short time.”

Recession Deepening

The government expects that the austerity measures will deepen the country’s recession and lead the economy to contract 4 percent this year, about twice the 2009 pace, and by 2.6 percent next year.

Moody’s warned on May 10 that it was considering cutting Greece’s credit rating to junk levels and Standard & Poor’s already cut Greece to below investment grade on April 27. As the EU bailout means that Greece doesn’t need to sell bonds for at least two years, the rating cut won’t immediately weigh on its borrowing costs.

“It’s going too far to say the crisis has deepened because of what’s Moody’s has done,” Stephen Gallo, head of market analysts at Schneider Foreign Exchange, said in a television interview today.

Yield Premiums

The yield on Greece’s 10-year bond rose 55 basis points to 8.89 percent. That’s still almost 4 percentage points below the 12.67 percent it reached on May 7. The yield premium investors demand to buy the Greek bond over comparable German debt increased 52 basis points to 622 basis points. Spreads on Spanish and Portuguese bonds also widened. The euro reversed early declines and rose to $1.2263 at 12:30 p.m. in London from $1.2221 yesterday.

The austerity measures agreed to last month by the government of Prime Minister George Papandreou will amount to almost 14 percent of GDP over four years. The program, which also includes sweeping reforms to the country’s pension and labor markets, has prompted street protests and strikes, including one in which three people died.

“We are frankly very disappointed,” Finance Minister George Papaconstantinou said in an interview. “We think that it doesn’t reflect the efforts nor the very real results we are getting on deficit reduction.” The deficit narrowed 38.8 percent to 8.97 billion euros in the first five months of the year, beating the 35 percent target in the country’s budget plan, the ministry said on June 10.

New Rating Company

European Union Economic and Monetary Affairs Commissioner Olli Rehn said today that Moody’s decision “raises issues relating to the role of credit-rating agencies in the financial system” and will be taken into consideration as the EU debates setting up its own rating company to compete with Moody’s.

While the EU-IMF package “effectively eliminates any near- term risk of a liquidity-driven default,” Moody’s said there remains “considerable uncertainty surrounding the timing and impact of these measures on the country’s economic growth, particularly in a less supportive global economic environment.”

“A junk status means it will fall out of some benchmark indices. People who use those benchmarks are likely to sell,” said Christoph Rieger, co-head of fixed-income strategy at Commerzbank AG in Frankfurt, Germany’s second-largest bank.

Dropped from Indexes

The bonds will be removed from Citigroup’s World Government Bond Index, the EMU Government Bond Index and the World Broad Investment-Grade Bond Index, the U.S. bank said in an e-mailed statement today. They will no longer be eligible for Barclays Capital’s Global Aggregate, Global Treasury, Euro Aggregate and Euro Treasury indexes from the end of June, Laurent Fransolet, head of European fixed-income strategy at the bank in London, wrote in an e-mailed response to questions today.

EU and IMF officials traveled to Athens yesterday as part of regular checks on the government’s budget plans. EU spokesman Amadeu Altafaj told reporters in Brussels that the 27-nation bloc is “optimistic” about Greece’s ability to implement the program.

Deutsche Bank AG Chief Executive Officer Josef Ackermann, reversing earlier remarks, said last week that he is “confident” Greece can repay its debt because of “the personal commitment given by the prime minister to implement the necessary reforms.”

S&P’s April 27 cut of Greece’s credit rating to non- investment grade was the first time a euro member lost its investment grade since the euro’s 1999 debut. S&P warned that bondholders could recover as little as 30 percent of their initial investment if the country restructures its debt.

Debt Rising

In its downgrade yesterday, Moody’s said its “base-case scenario envisions Greece implementing the policy changes it needs to stabilize its debt-to-GDP ratio at around 150 percent by 2013.” Debt will total 125 percent of GDP this year, according to European Commission forecasts.

“Should the economy respond positively to the competitiveness-enhancing structural reforms, debt stabilization could be achieved earlier,” Moody’s said.

Moody’s also downgraded its rating on the city of Athens to Ba1 from A3, citing “the uncertainties arising from current reforms on the city’s finances.” Athens and other Greek municipalities “are unlikely to have enough financial flexibility to permit their credit quality to be stronger than that of the sovereign itself,” it said.