Greece’s risk of default was raised to 50 percent by Moody’s Investors Service as European officials rushed to put together the second bailout plan in two years to stave off renewed financial turmoil in the region.
Moody’s downgraded Greece to Caa1 from B1, putting it on a par with Cuba, according to a report published late yesterday. The move came after policy makers considered asking investors to reinvest in new Greek debt when existing bonds mature.
Twelve years after the currency was started, European leaders are trying to prevent the euro area’s first sovereign default. A 110 billion-euro ($158 billion) rescue in 2010 failed to prevent an investor exodus from Greece, and the country now faces a funding gap of 30 billion euros of bonds next year with its 10-year borrowing cost above 16 percent.
“Taken together, these risks imply at least an even chance of default over the rating horizon,” Moody’s said in a statement. “Over five-year investment horizons, around 50 percent of Caa1-rated sovereigns, non-financial corporate and financial institutions have consistently met their debt-service requirements. Around 50 percent have defaulted.”
Vincent Truglia, managing director of global economic research for Granite Springs Asset Management LLC in New York, says the Caa1 rating “causes problems for certain investors” that are not allowed to hold such low-rated debt. Truglia, a former head of Moody’s sovereign risk unit, said the ratings move could affect the way investors view large European banks that hold Greek debt.
“We’re talking about an extraordinarily low rating,” he said in a telephone interview.
Greek 10-year government bonds fell, pushing the yield up 12 basis points to 16.27 percent. Irish and Spanish bonds also declined. The Greek five-year swaps imply a 72 percent probability it will default within that time, according to a standard pricing model used by traders. The calculation assumes investors would recover 40 percent on the underlying bonds if there were a default.
European stocks fell, with the Stoxx Europe 600 Index slipping 0.7 percent to 276.48 as of 11:01 a.m. in London.
The Moody’s announcement comes as policy makers try to hammer out a solution for Greece’s woes before a summit of European Union leaders on June 23-24. The country’s additional needs may be known as early as today, as European and International Monetary Fund officials complete work on an assessment of its public accounts. Euro-region finance ministers may meet as early as next week.
Greece said the Moody’s downgrade “overlooks” its commitment to meeting its 2011 fiscal target as well as an “accelerated” state asset-sales program. Greece has already achieved “significant fiscal targets” and will submit to parliament its mid-term fiscal plan in the next few days, the government said in an e-mailed statement.
Win Thin, global head of emerging markets currency strategy for Brown Brothers Harriman & Co. in New York, played down the impact of Moody’s ratings change. “I don’t think people really care about the rating that much now,” he said. “I don’t want to make too much out of it.”
‘Down the Road’
Thin said the EU and IMF would “do everything they can to keep Greece from doing one of two things: default or leave the euro zone.” He said he expects an eventual restructuring of Greek debt, but only “down the road” when the European banks are better able to withstand any losses.
European policy makers have in recent days narrowed in on bond rollovers as a pillar of any new aid package. The step would be favored by the European Central Bank, according to two officials familiar with the situation, because it would skirt the risk of any agreement being classified as a default. Investors may be given preferred status, higher coupon payments or collateral, said two other EU officials familiar with the situation.
“The ECB is saying that they would eventually favor a Greek rollover plan, which by that they mean that they will ask banks to keep the exposure to the country’s banks constant,” said Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London. “It would give some breathing space.”
For months, a maturity extension was taboo, as Europe counted on a mix of budget cuts and official loans to put the country’s finances on track and stop the debt crisis at its source.
Greece has since given up plans to go back to bond markets, offering deeper deficit cuts and the sale of state assets in exchange for follow-up loans to prevent a default.
Greece’s fate hinges on the stance taken by Chancellor Angela Merkel of Germany, the country that designed the euro in its image. As Europe’s largest economy, Germany is the biggest underwriter of bailouts.
“Moody’s does not believe that a restructuring of Greece’s debt is inevitable,” the company said. A default “would very likely be highly destabilizing. These factors represent an incentive for Greece’s supporters to continue to support the country, at least for a few more years.”
Moody’s said that Greece may nevertheless find it difficult to impose further austerity measures upon voters. European calls for cuts have sparked political warfare, with opposition parties rejecting Prime Minister George Papandreou’s proposals on May 27. The biggest opposition party, New Democracy, objects to the “policy mix” and not to the principle of saving money, said Notis Mitarachi, the party’s alternate head of economic policy.
“Greece is running out of options,” Moody’s said, and “heightened implementation risk inherent in any new program also increases the probability of a default event.” Further cuts are also likely to hurt growth, it said.
Greece’s debt is likely to mushroom to 157.7 percent of gross domestic product in 2011, the highest in euro history, the European Commission said May 13. It predicted a 3.5 percent economic contraction, shedding doubts on whether Greece will generate the tax revenue to pay off its debts.
Europe’s financial leaders need to hammer out a revised Greek package by the end of June, in time to persuade the IMF to pay out its share of the next tranche of loans.
The Washington-based lender provided 30 billion euros of Greece’s original loans, along with a third of the loans since granted to Ireland and Portugal as the spreading crisis threatened the integrity of the euro.
European financial officials are also considering so-called negative incentives such as cutting off old Greek bonds from eligibility for use as collateral with the ECB while granting that privilege to new bonds, the people familiar with the situation said.
Policy makers’ efforts echo 2009’s so-called Vienna Initiative that encourage western European banks to continue funding their units in eastern Europe, the people said.
Greek sovereign debt has been the world’s most expensive to insure since April, when it surpassed Venezuela. Credit-default swaps on Greece now cost 1,471 basis points, exceeding Venezuela’s by about 300 basis points and leading Pakistan, the next most expensive, by almost 600.
Credit swaps on Portugal and Ireland, which rose to records today, now round out the five most expensive sovereigns after overtaking Argentina in April. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
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