Moody's cut Greece's credit rating further into junk territory on Monday and said it was almost certain to slap a default tag on its debt as a result of a new EU rescue package.
It was the second rating agency to warn of a default after euro zone leaders and banks agreed last week that the private sector would shoulder part of the burden of a rescue deal that offers Greece more cash and easier loan terms to keep it afloat and avoid further contagion.
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"The announced EU programme along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent," Moody's said in a statement.
Bank lobby IIF, which led private sector negotiations, aims to attract 90 percent investor participation in the bond exchange plan which comes on top of the EU's new 109 billion euro bailout.
Moody's cut Greece's rating by three notches to Ca, just one notch above default, to reflect the expected loss implied by the proposed debt exchanges.
Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would review Greece's rating after the debt swap is completed.
"Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings," it said.
However, whereas Fitch pledged to quickly give Greece a higher, "low speculative grade" after its bonds had been exchanged, Moody's said it could not forecast when the rating would change or how.
"It all depends how quickly the debt exchange takes place," said Alastair Wilson, Moody's Managing Director for EMEA Credit Policy. "Once we have greater visibility over that, we will reassess the credit profile quite quickly. Whether the rating will change, that's a different question," he told Reuters.
A senior EU official said on Saturday that the aim was to start a voluntary swap of privately-held Greek bonds for longer in late August and conclude it in early September.
Greek bank shares and the broader stock market were unfazed by Moody's action, trading flat. Analysts said the downgrade and the default warning were priced in and less worrying following assurances provided by the EU deal.
"The EU Council last week effectively secured Greek banks' continued access to ECB liquidity, even in the case that PSI (private sector involvement) triggers a selective default," said Platon Monokroussos, an economist at EFG Eurobank.
CONTAGION CONTAINED ... FOR NOW
Moody's said it would take into account the possibility of a second default while reassessing Greece's rating.
"Our experience is that relatively small restructurings have often been followed by deeper defaults," Wilson said, adding that he could not say if this would be the case for Greece.
The rescue package for Greece benefits other euro zone countries by containing near-term contagion risks but it was not necessarily positive in the longer run as it set a precedent for private sector involvement in rescue deals, Moody's said.
"The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral," it said.
The cost of insuring most peripheral euro zone government debt against default rose on Monday on market doubts that the fresh aid package for Greece agreed last week will protect bigger economies from contagion.
Standard & Poor's and Fitch rate Greece CCC, broadly in line with Moody's rating. S&P has not yet said how the EU summit deal will affect Greece's rating. (Additional reporting by Cecile Lefort in Sydney; Writing by Ingrid Melander, editing by Mike Peacock)