Moody's Investors Service cut Greece's debt rating on Tuesday but partially reassured financial markets by saying the country remained far from a crisis, igniting a rally in Greek bonds and bank stocks.
In a sign of stiff opposition to the government's efforts to bring state finances under control, a union representing over half a million public sector workers and pensioners announced a 24-hour strike to protest against wage and pension reforms.
Moody's downgraded Greece to A2 from A1, citing the country's swelling budget deficit. It was Greece's third downgrade by a major credit rating agency this month; Fitch took action early this month, followed by Standard & Poor's.
Government steps announced in the last few weeks to curb the deficit are likely to prove only partially effective, Moody's said, keeping its outlook for Greece negative, meaning the country risks a further downgrade.
But Moody's also made clear that it saw little chance of a near-term financing crisis in Greece and that instead, the risks were long-term. Its downgrade was smaller than the two-notch cut which the markets had feared, and its new rating for Greece was still two notches above the BBB+ assigned by Fitch and S&P.
"Greece's repositioned rating of A2 balances the Greek government's very limited short-term liquidity risks on the one hand, and its medium- to long-term solvency risks on the other," said Sarah Carlson, Moody's lead sovereign analyst for Greece.
That was a relief to investors, who have been worrying that Greece's debt problems could ultimately prevent it from borrowing in the bond market. The European Union might then be forced into a costly bailout of the country, denting confidence in the value of the euro and European assets in general.
Greek bank stocks, which had tumbled more than 35 percent since mid-October, were up over 6 percent on Tuesday afternoon.
The premium which investors demand to hold 10-year Greek government bonds rather than benchmark German Bunds narrowed dramatically to 246 basis points from 280 — though it remained very high compared to most euro zone nations, which are below 100 bps.
Justin Knight, a market strategist at UBS, said there was room for Greek spreads to narrow further as investors realized their worst-case scenarios for Greece were probably excessive.
But he added that austerity steps revealed by Greek Prime Minister George Papandreou this month were not enough to allay markets' concerns fully. Papandreou announced a halt of most public sector hiring in 2010 and a freeze on wage hikes for high-level civil servants, but his plans include pay rises above inflation for poorer civil servants.
"The country is sticking to a budget that the markets do not find entirely credible. Until the budget moves to a more structural approach to reduce the deficit, and that involves cost-cutting, we will not really see volatility go down by much," Knight said.
Greece is set to become the euro zone's most indebted nation next year with public debt projected at 121 percent of gross domestic product. The budget deficit rose to 12.7 percent of GDP in 2009; the government aims to cut it to 8.7 percent next year.
Such a cut will be politically difficult without the cooperation of labor unions. The umbrella civil servants union ADEDY said on Tuesday that it planned a 24-hour strike in late January or early February to protest against budget reforms that it claimed were being forced by markets.
"We will not accept that the cost of the crisis will be borne by our shoulders," ADEDY's head, Spyros Papaspyros, told Reuters. "Specific forces from the markets are attacking us; it is to them that we will answer."
Greece's main private sector union, the General Confederation of Greek Workers (GSEE), which represents some 2 million workers, said it would decide by mid-January whether to join ADEDY's strike.
"We are also thinking of moving to a strike, but it depends on how negotiations over pay rises and the social security system go," said GSEE spokesman Stathis Anestis.
Carlson, the Moody's analyst, said a further Greek rating cut was "more likely than not" over the next 12 to 18 months and that the government's ability to implement reforms would be key to the outlook for its rating.
"We'll also be looking at the public acceptance of whatever measures the government wants to put into place, because that's really key for their success or failure," Carlson said.
"There's clearly not much of a history of public acceptance, so we can't take that for granted."
Markets have been fretting that Greek banks could lose some of their access to European Central Bank funds at the end of next year if Moody's downgrades Greece further.
The ECB plans to tighten its collateral rules at the end of 2010, so if the ratings of all three major agencies are no higher than BBB+ then, banks could become unable to exchange Greek government debt for cash in ECB refinancing operations.
However, Moody's said on Tuesday that it saw very little risk of this.
"Moody's believes that Greece is extremely unlikely to face short-term liquidity/refinancing problems unless the European Central Bank decides to take the unusual step of making the sovereign debt of a member state ineligible as collateral for bank repurchase operations — a risk that we consider very remote," says Arnaud Mares, senior vice president in Moody's Sovereign Risk Group.
ECB officials have so far insisted publicly they will not change their planned collateral rules to accommodate Greece. But many analysts expect the central bank to ease its rules in the end if that is necessary to avert a crisis.
Greek officials said the smaller-than-feared Moody's downgrade was an initial sign that Greece, which aims to resume borrowing from the international bond market in January, was starting to regain investors' trust.
"I believe Moody's rating better reflects the prospects of the Greek economy, given the Greek government's commitment to take the necessary measures to restore fiscal health and improve competitiveness," Spyros Papanicolaou, head of Greece's Public Debt Management Agency, told Reuters.
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