(Repeat for additional subscribers)
May 6 (The following statement was released by the rating agency)
Fitch Ratings says some recovery in eurozone periphery
sovereign ratings is possible in a benign scenario of economic recovery and
declining debt ratios. Nevertheless, the agency is generally cautious about the
medium-term outlook for the eurozone as many countries face a long period of
convalescence and the risk of relapse.
Fitch has taken several positive rating actions on sovereigns in the eurozone
periphery as the intensity of the crisis has eased and countries have started to
repair damage to their creditworthiness. These include upgrades for Greece (May
2013) and Spain (April 2014); and positive changes in Outlooks (including
Negative to Stable) for Ireland (November 2012), Cyprus, Italy and Portugal (all
April 2014) and Slovenia (May 2014), as well as Belgium (January 2013).
Positive rating actions reflect an end to recessions, a move into current
account surpluses, a narrowing in budget deficits, enhanced financing
flexibility and market access, reduced tail risk of eurozone exits, structural
reforms and gains in competitiveness, an easing in banking sector risks and
reforms at the eurozone level.
Spreads on eurozone periphery government bonds have narrowed sharply since
summer 2012. However, market spreads have been more volatile than our ratings
through the crisis and, having 'overshot', had more ground to make up. For
example, spreads on ten-year sovereign bonds peaked at over 1100bp for Ireland
(the lowest Fitch rating was 'BBB+') and over 550bp for Spain (lowest 'BBB'),
Italy ('BBB+') and Slovenia ('BBB+').
To the extent that Fitch has a different view on credit fundamentals from the
market, as it has done at various stages of the eurozone crisis, it remains to
be seen whether ratings are 'too low' or investors are not being adequately
compensated for credit risk. Fitch's ratings are purely a measure of the
relative rank ordering of credit risk, while current low bond yields may also
reflect weak growth prospects, low inflation, anticipated monetary policy
easing, strong market liquidity and a search for yield in a low interest rate
Cutting budget deficits and stabilising then reducing public debt ratios would
be a key driver of rating upgrades. Our new report today highlights that even
with favourable economic conditions and strong fiscal policy discipline this
will be challenging. It explains other potential triggers including: sustained
and balance economic recovery, structural reforms, a track record of secure
market access, reducing net external and private debt ratios, lowering
unemployment, strengthening banking systems, continuing eurozone level
institutional reforms and avoiding political shocks.
Further upgrades of eurozone periphery sovereigns are possible in a scenario in
which these triggers are met. However, ratings could stagnate or even decline if
growth is weak and debt ratios flat-line or keep rising.
Fitch believes that Ireland, Portugal and Spain have the greatest medium-term
potential, in a favourable scenario, for multi-notch rating recoveries as their
ratings fell further in the crisis (7-8 notches) than Italy and Slovenia (4-5
notches) and they have suffered less severe damage and are less exposed to
downside risks than Cyprus and Greece (which defaulted and are still in EU/IMF
programmes). We do not envisage any sovereigns in the eurozone periphery
recapturing pre-crisis rating levels in the foreseeable future. This reflects
not only the long and difficult adjustment path ahead, but also the legacy of
Some lessons can be drawn from the eurozone crisis. Pre-crisis credit
fundamentals were not as robust as they originally appeared. Rates of GDP growth
were unsustainably fuelled by credit growth and high capital inflows, budget
balances were flattered by cyclical upswings, banking sectors were more risky
than they appeared, access to market financing was more fragile, and there were
design flaws in European Economic and Monetary Union. Moreover, Greece
misreported its public finance figures.
Finally, our report also looks at historical precedents of how quickly countries
recovered rating notches lost in crises. We looked at 10 Fitch-rated sovereigns
countries ranging from Korea (1997) to Iceland (2007) that experienced
downgrades of three or more notches within two years, followed by a recovery in
ratings above the 'B' range. These countries saw an average downgrade of 5.9
notches, and recovered an average of 4.1 of those lost notches within five years
of the start of the crisis (as measured by the year of the first downgrade) and
5.3 of them within ten years.
However, we also looked at how challenging it is for developed countries to
achieve large sustained reductions in government debt ratios. Since 1970, there
were only nine episodes of reductions in government debt/GDP ratios of at least
20pp over an eight year period. And these were in environments of stronger GDP
growth than is likely in the eurozone today.
The report entitled 'Eurozone Periphery: Rating Recovery Potential' is available
Link to Fitch Ratings' Report: Eurozone Periphery: Rating Recovery Potential