Greek Downgrade Spells Further Trouble

Greek stocks and government bonds tumbled on mounting concern the nation may struggle to meet its debt commitments as public finances deteriorate.

The benchmark Athens Stock Exchange General Index dropped as much as 6.1 percent, its biggest intraday decline since Nov. 26. The yield on the government two-year note rose the most since 1998. Fitch Ratings cut Greece one step to BBB+ today, the third-lowest investment grade. Standard & Poor's yesterday put Greece's A- rating on watch for a possible downgrade, signaling it may be reduced within two months.

"Greek bonds were already tanking on the S&P negative outlook and Fitch gave their fall a boost," said David Schnautz, a fixed-income strategist at Commerzbank AG in Frankfurt. "It's a long-term sustainability problem. Now the government has to tell the Greek public that something needs to be fixed." Greece, the lowest-rated country in the euro region, is struggling to shore up its finances amid a year-long recession. Gross domestic product shrank 1.7 percent in the third quarter from a year earlier, the National Statistics Office said Dec. 4.

The socialist government of Prime Minister George Papandreou, elected in October, plans to cut the budget deficit to 9.1 percent of gross domestic product next year, from 12.7 percent this year. The measures, including a partial freeze on public-sector pay, "are unlikely by themselves to alter Greece's medium-term fiscal dynamics," given the prospects of high deficits, debt and sluggish economic growth, S&P said yesterday.

Lack of CredibilityGreece is committed to a 'fair' fiscal consolidation and will submit a supplementary budget if needed, the country's Finance Minister George Papaconstantinou told reporters in Athens today. The downgrade reflects a lack of credibility, he said.

The decline in the ASE General Index brought its slump since Oct. 14 to 25 percent. It was the worst-performing index among 18 western European benchmarks today. National Bank of Greece SA (NBG), the nation's biggest lender, fell as much as 10 percent to its lowest level since July. EFG Eurobank Ergasias (EUROB:GA), the second-largest, sank as much as 7.8 percent. Piraeus Bank SA (BPIRY) slid as much as 9.2 percent.

"The news is alarming for the economy and the banking sector in specific," said Nikos Lianeris, an analyst at Athens- based Alpha Finance Investment Services SA. "The possibility of further rating downgrades increases pressure on the government to announce a set of decisive measures in order to bring the deficit down. Such a move would help restore confidence in the market."

2008 PrecedentThe yield on the two-year Greek note jumped 58 basis points to 2.66 percent, the highest level since April 23, as of 7:50 p.m. in Athens. It rose above 55 basis-points on Nov. 20 last year, when the Labor Department reported the highest number of jobless claims since 1992. The yield on the 10-year security climbed as much as 25 basis points to 5.39 percent today.

European Union officials are increasing pressure on the Greek government to take lasting measures to reduce the deficit, the largest this year in the 27-nation European Union. Greece is facing a "very difficult" situation and needs to take "courageous" decisions to counter the budget deficit, European Central Bank President Jean-Claude Trichet told the European Parliament in Brussels yesterday.

Yield SpreadToday's declines for Greek bonds drove the premium investors demand to hold 10-year government bonds over German bunds, Europe's benchmark securities, to as high as 225 basis points, or 2.25 percent points, the most since April 21. The comparable premium for Ireland was 171 basis points. Portugal's was 65 basis points and Spain's was 61 basis points.

The declines may offer investors a buying opportunity, according to Michiel de Bruin, head of European government bonds in Amsterdam at F&C Asset Management Plc, which manages $220 billion.

"The market seems to be over-reacting a bit," he said. "News flows from Greece haven't been very pretty over the past few weeks, but most of that is already in the price. Greece does have a fiscal problem, but they are not the only one in the region. I see the current spread as attractive."

The cost of protecting against losses on Greek government debt through credit-default swaps rose 20.5 basis points to 211, the highest level since March, according to CMA DataVision prices. That's higher than Turkey, Estonia and Russia, Bloomberg data showed.

'Exposed to Shocks'"The likely rise in public debt to more than 120 percent of GDP next year and further to 125 percent in 2011 would leave the public finances highly exposed to shocks," Fitch analysts Chris Pryce and Paul Rawkins in London wrote today in a report.

Fitch hasn't rated Greek debt BBB+ since March 2000, when it upgraded it from BBB.

An S&P downgrade for Greece before year-end would be the second in 2009. The company lowered the rating to A- from A on Jan. 14, Greece's lowest grade since November 1999, when it was raised from BBB, S&P's second-lowest investment grade. Moody's Investors Service lowered the outlook on Greece's A1 rating to "negative" on Oct. 29.

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