UPDATE: Fitch Upgrades Greece to B-; Outlook Stable

Fitch Ratings has upgraded Greece's Long-term foreign and local currency IDRs to 'B-' from 'CCC'. The Short-term foreign currency IDR has also been upgraded to 'B' from 'C' and the Country Ceiling upgraded to 'B' from 'B-'. The Outlook on the Long-term IDRs is Stable. KEY RATING DRIVERS The upgrade of Greece's sovereign ratings by one notch to 'B-' reflects the following factors: The Greek economy is rebalancing: clear progress has been made towards eliminating twin fiscal and current account deficits and 'internal devaluation' has at last begun to take hold. The price has been high in terms of lost output and rising unemployment and the capacity for recovery is still in doubt. Nonetheless, sovereign debt relief and an easing of fiscal targets have lifted Central Bank measures of economic sentiment to a three-year high and the risk of eurozone exit has receded. The Economic Adjustment Programme (EAP) is on track amid a semblance of political and social stability. The current administration has displayed much greater ownership of the EU-IMF funded EAP than its predecessors, committing to further upfront fiscal consolidation and a renewed push on structural reforms. Still, tangible economic recovery remains elusive, while resistance to reform is high, underlining the continuing risks to implementation. Greek primary fiscal adjustment of over 9% of GDP in 2009-12 (excluding one-off support to the financial sector), and around 16% in cyclically adjusted terms, ranks as the most ambitious instance of fiscal consolidation among advanced economies in recent times. The current account deficit has also shrunk from 10% of GDP in 2011 to 3% in 2012. The revised EU-IMF programme gives Greece two additional years (2015-16) to attain a primary surplus of 4.5% of GDP. This relaxation is reflected in Fitch's expectation of a milder economic contraction of around 4.3% in 2013 (-6.4% in 2012) and a weak recovery in 2014. Structural reforms are progressing. The financial system has stabilised: EUR16bn-EUR17bn of time deposits have returned to the system since mid-2012 and bank recapitalisation is well advanced. Meanwhile, a small, but significant milestone was passed earlier this month with the completion of the first major privatisation since the EAP began. Considerable progress has also been made with labour market reforms and 80% of the earlier loss of competitiveness has been clawed back. However, product market reform remains a major challenge: progress in this area will be important to support a sustainable recovery and for the success of the EAP. Extensive private and public sovereign debt restructuring has put programme funding on a more secure footing and should moderate the rise in the peak public debt/GDP ratio to around 180% in 2013-14. Notwithstanding this still extremely high headline public debt ratio, the significantly reduced interest cost and maturity extension provided by the debt restructuring and EAP financing means that sovereign debt service now appears more secure than the size of the debt stock would otherwise imply. Even so, public debt sustainability is still far from assured and will be dependent on economic recovery and a sustained primary fiscal surplus. The degree of default risk for private creditors, encapsulated in the previous 'CCC' rating, has subsided. In Fitch's view, sovereign debt restructuring and debt buy-backs have reduced private creditors' share of general government debt to the point (15%, excluding T-bills), where there would be little to be gained financially from any further restructuring. Barring Greek exit from the euro, Fitch could envisage official creditors bearing the brunt of any future default, albeit the political considerations of any such move may not be straightforward. Greece's sovereign ratings are underpinned by its still high income per capita, which far exceeds 'B' and 'BB' medians, its superior measures of governance on most counts and membership of the eurozone, which shields it from balance of payments and exchange rate risks and has facilitated access to unprecedented financial assistance. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are more broadly balanced than in the recent past. Nonetheless, the following risk factors individually, or collectively, could trigger a rating action: Sustained economic recovery founded on solid implementation of the EU-IMF programme, including broad structural reforms, would be grounds for an upgrade. Conversely, failure of the economy to recover, leading to the re-emergence of renewed funding gaps could trigger a negative rating action. Likewise, renewed political and social instability, leading to an unravelling of the EU-IMF programme, would intensify the risks of Greek exit from the euro zone and widespread default - sovereign and private sector - leading to a downgrade. Macroeconomic imbalances have generated high public and external debt and left Greece acutely vulnerable to domestic and external shocks, such as developments in Cyprus. Fitch does not interpret the Troika's (EU/IMF/ECB) treatment of Cyprus as implying any diminution of support for Greece. However, the agency considers that developments in Cyprus could have a knock-on effect to Greece, were the EAP to go off track again, leading to speculation among Greek businesses and depositors about how larger financing gaps might be filled. KEY ASSUMPTIONS The ratings and Outlooks are sensitive to a number of assumptions: - Political and social stability are maintained and the current administration remains in place. - Continued broad adherence to the EU-IMF EAP. The sustainability of Greece's public finances and its continued membership of the eurozone depend upon the implementation of structural and fiscal reforms and their effectiveness in laying the foundations for a sustained economic recovery. Outright rejection of the EAP, or material slippage against targets, would trigger a downgrade. - Fitch assumes that the EUR50bn allocated to recapitalisation of Greek banks is sufficient and that the financial sector makes no further material demands on the sovereign balance sheet. - Public debt outcomes are sensitive to assumptions about growth, the primary balance and interest rates. - Greece remains a member of the eurozone and does not seek to impose capital controls in the face of renewed strains on sovereign creditworthiness. In the event of a Greek exit from EMU, Fitch would treat the forcible redenomination of sovereign and private sector debt as a default event in line with its Distressed Debt Exchange rating criteria. - The eurozone remains intact and that there is no materialisation of severe tail risks to global financial stability and investor confidence.