UBS: EMEA Economic Perspectives – Greece: is “peak macro performance” behind us?
Can Greece’s strong macro performance continue? 4 key investors debates
Greece had outstanding macro performance in 2021-2022 with 7.2% average growth, timely absorption of EU (RRF) funds, a tourism recovery, and a substantial reduction in public debt (-40ppt of GDP drop in public debt). However, current investor debates are more centered on whether this story has further legs, in particular regarding four aspects. First, downside risks to growth (in part) related to the recent natural catastrophes (wildfires, flooding). Second, exposure to any potential European growth headwinds. Third, the pace and significance of rating upgrades. Fourth, headwinds to banks’ re-rating from peaking NIMs and higher Bund yields. While the stellar 2021-22 performance cannot likely be repeated and macro gains are likely to be more gradual, we remain constructive on Greek macro given: a) resilient growth in part due to the availability and track record to absorb EU funds; b) subdued inflation; c) healthy trends in tourism; and d) the sustained fall in public debt.
Growth: revising growth lower for 2023-2024, but remaining above consensus
Greek GDP growth picked up in Q2 by 1.3% q/q and 2.7% y/y (seasonally adjusted), following 0% q/q in Q1. Resilient household consumption, growing fixed investments (buildings & structures) and inventories were driving GDP. After Q2 the growth carry- over into 2023 is 210bps. Initial indications for Q3 so far are mixed. On the one hand, business confidence jumped to 111.7 in August thanks to rising optimism in industry and the retail sector: this reading in the past was consistent with c5% y/y GDP growth. In the same tune, July industrial production exceeded Q2 average output by 1.4%. On the other hand, the economy-wide turnover data declined further to -7.2% y/y in July from -6% y/y in June, and vehicle registrations were also running a tad lower than in Q2. While it looks like that the July wildfires in Rhodes probably had limited negative growth implications (tourism remained strong, and Rhodes’ agricultural production was significantly reduced before), there is a clear concern about the damage caused by Storm Daniel (the worst since records began) and the subsequent floodings on the Thessaly plain. The affected area is very important for agriculture (see here and here) and thus can have both direct (lower contribution from agriculture) and indirect growth consequences (via higher inflation eroding real wages). The EU pledged EUR 250mn help for disaster relief (and there is a possibility for re-priotizing EUR 2bn from other RRF and cohesion funds) in addition to an additional budget of EUR 600mn from domestic sources. While we expect sequential growth to remain resilient in Q3 2023, we pencil in a more visible deterioration in momentum for Q4 2023. Overall, given the more challenging growth backdrop we mark down our 2023 and 2024 GDP projection to 3% for both years from 4.1% and 3.2% respectively. GDP should be mainly driven by household consumption (benefitting from a strong labour market and real wage gains) and investments (EU fund inflows, credit growth). We remain 120bps above consensus for 2023 and 150bps above consensus for 2024.
Could Greece decouple from potential European growth headwinds this time?
Greek GDP growth historically showed high sensitivity to Eurozone growth: a 1ppt drop in Eurozone activity generated 1.1-1.2ppt slower Greek economic growth. This would make sense given that 54% of Greek exports targeted European Union countries (ex oil products and ships the ratio was even higher at 64% in 2022), and c60-70% of tourists came from the European Union. However, we believe this time the sensitivity could be (much) lower due to three factors, implying more resilience in case of additional European growth headwinds. First, increased availability of EU funds, which provides a growth engine unrelated to the EU cycle. Greece is still eligible for around EUR 45bn worth of EU funds or 21% of GDP on top of the regular agriculture funds: EUR 2.6bn leftover from the 2014-20 MFF (available until-mid 2024), EUR 22bn RRF funds after the request to expand the RRF envelope to EUR 36bn (RFF grants: EUR 18.2bn, RFF loans: EUR 17.7bn – available until 2026), and EUR 22bn cohesion funds from the 2021-2027 MFF (available until 2030). So far Greece is very advanced in terms of absorption ratios in Europe (Greece received + requested c43% of the original RRF allocations versus the EU average of 21%). Second, the banking system is in a much better position to lend given the dramatically reduced NPL rates to 8.6% in Q2 2023 from the peak of 49.1% in 2017. Third, Greece has a more sustainable fiscal position: a primary budget surplus of 1% of GDP is planned for 2023 – and execution runs better -, and public debt is expected to fall by 16ppt to c150% of GDP by 2024. This implies that there is little need for very substantial fiscal adjustments, unlike in the previous decade.
Investment grade upgrade: clearly helpful, but scope for yields to fall might have initial limitations
Since the June elections, Greece’s sovereign credit rating was raised back to investment grade by DBRS, and two other agencies (Japanese rating agency Rating and Investment Information (R&I) and Scope). DBRS’s rating already enables the ECB to include Greek government bonds in asset purchase programs without a waiver and reduces the hair cut applied on Greek government bonds placed as collateral by Greek banks with the ECB for refinancing. Moody’s raised Greece’s credit rating to one notch below investment grade last Friday. Both S&P and Fitch are one notch below IG rating (S&P with positive outlook) and their reviews are scheduled for 20 October and 1 December respectively. If these two agencies were also to lift Greece’s ratings to IG, Greece would make significant headway for being able to receive investments from IG-rating constrained funds. While every fund is free to set its own investment criteria, the most frequently followed government bond benchmark index, the WGBI, has its inclusion criteria defined as: “To qualify for entry into the WGBI and WorldILSI, a market must have a minimum credit quality of A- by S&P and A3 by Moody’s” (so-called upper medium grade – i.e. higher than where Greece ratings would be in the first place of an IG upgrade). The WGBI index currently includes two Southern European countries: Spain and Italy. Given that Greek 10Y bond (GGB) yields have been trading inside Italian 10Y bonds (BTPs) since mid-May (latest spread: c-40bps), it looks that the market has already priced in the assumption of upgrade to IG. Despite this, Greek 10Y bond yields only dropped by 50bps year-to-date, as pressure from core yields (Bunds/UST) constrained the move. While 10Y GGB yields could fall further, given Spanish 10Y bond yields (higher credit rating and being a constituent of WGBI) trade “only” 40bps lower, this might limit the extent of initial spread compression. UBS expects 10Y Bund yields to fall to 0.9% by end-2024, which could trigger a substantial drop in GGB yields next year.
NIM-driven re-rating largely done for banks
In the banking sector, while corporate lending growth has been strong (driven by both RRF and non-RRF demand) and may remain resilient near term, net positive loan growth in the retail segment is still some way off. In Q2 23, the four systemic banks saw a y/y 60% increase in aggregate NII, driven by NIM widening. With rising deposit betas and the ECB policy rate outlook, we think NIMs are approaching the peak (likely reached in Q3) and pre-provision profit growth (depending on fee growth) may decelerate materially next year. We see the reinstatement of dividends and the potential reduction of the HFSF stakes in the banks as next catalysts. However, we note that although long term there may be substantial additional capital distribution potential in the sector based on double-digit RoTEs, (in some cases more than) adequate regulatory capital, and limited RWA growth, near-term dividend yields may be below the European average.