Return to turbulent past of Greek politics could compromise path of progress

Greece has displayed strong recovery from this severe Covid-19 crisis, which hit the economy especially hard given economic dependence upon tourism and travel services. Sustaining a robust recovery rests, however, upon the government pursuing economic and banking sector reform in order to raise economic growth potential, without which an elevated stock of public debt could represent continued contingent risk during phases of global market stress.

We expect the Greek economy to grow around 8.9% in 2021 before slowing to 4.3% by 2022. Pent-up domestic demand after the forced savings accrued during crisis, the easing of pandemic-related restrictions in Greece and across Europe and associated return of foot traffic aiding services sectors, plus a continued highly accommodative monetary position of the ECB alongside significant budget stimulus already in the system support recovery. First inflows of EU funding are providing succor as well, with an inaugural tranche of €4 billion of Next Generation EU funding released in August and more significant funding due next year.

Medium run, we see the Greek economy expanding an above-potential rate of around 1.8% a year over 2023-26, anchored by EU- and nationally funded investment in the pipeline – which, on aggregate, easily exceeds cumulative Greek public investment of the previous five years. Here, we ought to recognize, moreover, the economy’s good track record of absorbing EU funds.

Greece ranked second in activation of EU cohesion funds over a 2014-20 multiannual budgetary period. Naturally, recovery of the tourism services sector and after a better-than-anticipated summer 2021 season, could certainly be of assistance in giving recovery a degree of impetus over coming years.

Nevertheless, Scope estimates longer-run growth potential of Greece of a considerably more modest 1% a year, restricted via an outstanding shrinking working-age population, the latter declining around 0.7% a year over 2021-26, while an overhang of elevated government debt remains a longer-standing economic bottleneck – reflecting the highest general government debt ratio after that of Japan among 36 nations whose debt Scope rates publicly.

Greece’s general government debt we see decreasing somewhat to 202% of GDP by end-2021, from a 206.3% all-time peak in 2020, supported by a sizeable 2021 economic rebound. Public debt ought to, thereafter, continue moderation, reaching 180.9% by 2026, near a 180.5% pre-crisis ratio from 2019.

A sustained economic recovery remains contingent upon Athens addressing residual structural economic bottlenecks. Greece’s long-run nominal growth potential rests as among the most modest of the euro area – a reflection of inadequate real growth as well as historical lowflation, with CPI having averaged -0.2% year-on-year over this past decade. 

Boosting tax compliance and curtailing elevated spending on pensions and public sector wages (above euro area averages) are further factors requiring attention, even though substantive efforts have already been made with respect to improving tax collections. 

The high stock of Greece’s debt naturally leaves the government vulnerable to a setback in international markets as the ECB scales back emergency support introduced over the crisis since 2020. On this basis, another key as regards recovery rests on forthcoming decisions of the central bank in transitioning quantitative easing policies for a post-Covid crisis phase. Should the ECB communicate continued flexibility of asset purchases, especially under periods in which markets are under duress, this could be rather crucial in ensuring sustainability of Greek debt.

[Greece has had] a hectic, seesaw ride after a sovereign debt crisis, the 2014-15 crisis and, most recently, Covid-19. How far Greece has come is similarly represented via our ratings history, under which we have led with upgrades of Greece from being rated B- to BB+ over a limited period since 2017, when our agency first started publishing sovereign credit ratings. Today, Greece rests one notch removed from a return to an investment-grade credit rating. Of course, there are outstanding risks to this constructive trajectory and one such uncertainty rests on the political side, and what might occur after 2023 elections. 

We have outlined factors that could support a positive credit rating action. Such factors reflect, firstly, were Eurosystem support of Greek debt instruments to be reinforced over coming years even as this crisis eases. Here, this starts with the ECB defining a post-crisis monetary policy framework and whether accommodations may be introduced in support of Greek debt even as PEPP and associated credit rating rule waivers are appropriately phased out.

We touched upon in our recent rating upgrade of Greece how an ECB innovation of flexible adjustment of parameters of PEPP – including adaptability of the program’s rules in introduction of specific waivers for credit ratings regulations to make feasible the purchases of Greek debt. We expect it to prove more durable than this single crisis alone with such targeted adjustments of asset purchase parameters likely to be available for reintroduction over future aggregate crises if required. 

Secondly, were fiscal consolidation and the economic recovery to result in a strong and sustained downward debt trajectory, this abets a ratings outlook. We are already observing such a downward debt trajectory; however, thus far, a 2021 decline of debt has been driven more by the scale of a post-crisis rebound in output rather than structural factors.

The question remains how significantly budget deficits might redress over coming years, how robust Greece’s fiscal policy framework might appear after the post-bailout surveillance concludes and whether a decline in government debt over coming years will prove substantive enough to make up for expected renewed increase of debt come future crises, similar to that experienced in 2020. Thirdly, if structural economic and external imbalances were curtailed, raising medium-term growth potential and strengthening macroeconomic sustainability, and, finally, if banking sector risks were trimmed, this would enhance credit provision to the private sector.

We highlight the significance of continued reduction of high nonperforming loans on domestic bank balance sheets, even whilst recognizing the significant progress that has been made recently. NPLs remain high – equivalent to 20.3% of total loans as of June this year – but are, importantly, down sharply as compared with 40% at end-2019. Nevertheless, an outstanding high level of NPLs weighs on banking system profitability and Greek lenders’ capacities to fund a robust recovery.

Piraeus, Alpha and the National Bank of Greece have taken important actions recently in improving capital ratios. However, for the sector as an entirety, common equity tier 1 capital ratios have edged down to 12.5% of risk-weighted assets as of Q2 2021 from 15% in December 2020, a reflection of poor profitability and asset quality. Under an adverse scenario of the European Banking Authority’s 2021 stress examination, core capital ratios of three of the four systemic banks of Greece declined to 8% or less – an indication of lingering financial system vulnerabilities.

A high share of deferred tax credits on bank balance sheets, banks’ increasing domestic government bond holdings, the state’s bank equity stakes as well as guarantees extended under the Hercules asset protection scheme also point to tightening of a sovereign banking nexus.