Greek 50% Haircut Would Keep Sovereign's Rating Low

An EU invitation to private investors in Greek government debt to exchange their bonds for new debt with a 50% lower notional value would likely result in a post-default rating in the 'B' category or lower depending on private creditor participation.
Greece would still have a large amount of debt outstanding, its growth prospects are weak and its willingness to implement structural reforms may dissipate. That would restrict the potential for economic transformation and could undermine future public debt sustainability.
The exact amount of public debt Greece would have after a voluntary bond exchange will depend on the details of the debt exchange, creditors' participation rate and any contingent liabilities in both the Greek financial and non-financial public sector.
Yesterday's EU communique states that an ambitious reform programme coupled with deeper private-sector involvement should secure a reduction in Greece's public debt/GDP ratio to 120% by 2020. Based on a preliminary analysis, we believe that this reduction in Greek public debt implies a participation rate of about 85% on an estimated EUR210bn of private holdings of Greek government bonds (GGB).
There are a number of reasons why a 50% write down of GGBs will not translate into a comparable reduction in the overall public debt stock. Official creditors - other euro area member states (EAMS), the IMF and the ECB - currently hold over one-third of Greek public debt and are not expected to participate in the debt exchange. The EU communique makes no mention of how ECB holdings of GGBs will be treated. However, we think these are excluded from eurozone estimates of the impact of a 50% write down of GGBs.
Offsetting the benefits of debt reduction would be the escalation in potential contingent liabilities for the government: Greek bank and non-bank institutions are heavily exposed to the sovereign (EUR84bn) and would sustain substantial losses on a 50% debt write down. The IMF's Fourth Review of the Greek adjustment programme in July factored in additional funding needs of EUR30bn (13% of GDP) in 2011 to cover the costs of bank recapitalisation and other stock-flow adjustments.
Fitch estimates that after the debt exchange, Greece's public debt/GDP ratio would peak at 142% of GDP in 2013, still by far the highest in the eurozone, before declining to 120% by 2020. The EU communique makes reference to the potential contribution of privatisation receipts: these could deliver a material reduction in the debt/GDP ratio, providing that the programme was fully implemented. However, Fitch views with some caution the apparent commitment to increase the Greek privatisation programme by an additional EUR15bn, given the already ambitious nature of the existing EUR50bn programme.
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