By Jens Bastian*

Moody’s sovereign credit rating downgrade of Greece from Ba1 to B1 dropped like a bombshell in Athens on Clean Monday. The three-notch downgrade to a status of “highly speculative” placed Greece deep in junk territory, alongside Belarus and Bolivia. The rating agency last downgraded Greek government debt by a staggering four notches in June 2010. Moody’s now has the lowest rating for Greece of the three main international credit rating agencies and is the first to classify Greek sovereign debt as B1. Moody’s compounded its action two days later by downgrading six Greek commercial banks, making their refinancing options ever more difficult and expensive.

The three-notch downgrade was too large and -- as has been the case in the recent past with Greece -- premature. One notch together with a negative outlook would have made sense and reflected legitimate concerns about Greece’s fiscal challenges, mounting public debt problems and the deepening economic recession. Equally, in terms of timing, one would have preferred to wait until the end of March, by which time we will know more about the EU summit decisions intended to deal with the sovereign debt crisis in the eurozone.

Following Moody’s downgrade, the Greek Debt Management Agency (PDMA) proceeded with a monthly auction of six-month T-bills. The results were satisfactory as far as the bid-to-cover ratio was concerned, reaching a healthy 3.59 on the back of total volume of 1.625 billion euros. Given the ramifications of Moody’s downgrade, the yield increased from 4.64 percent (February 2011 auction) to 4.75 percent. Foreign investors bought roughly a third of the T-bills on offer, a considerable decline compared to the February auction when 80 percent of the buyers came from abroad.

For the time being, the T-bill auction signals a slight deterioration at the short end. However, the long bond market weakened dramatically during the week. This is where pricing in the risk of a Greek unilateral default or forced restructuring really shows up. More specifically, the yield on Greek 10-year government bonds jumped to 12.82 percent on March 8. This is the highest level registered since May 7 last year. Moreover, the cost of insuring against a Greek sovereign debt default has now reached levels that are comparable with insuring against the same event in Venezuela or Pakistan. According to the Financial Times (March 9, 2011) capital markets are now pricing in a 58 percent chance of a Greek bond default.

The reactions against Moody’s rating assessment were swift and hard. No surprise that Athens was livid. The European Commission in Brussels and the International Monetary Fund in Washington were not amused either. More important are the consequences of such a downgrade on the very dynamics that the rating agency is seeking to address.

Moody’s believes that “the likelihood of a default… has risen since its last downgrade.” The agency argues in its outlook that 20 percent of B1-rated sovereigns default within a five-year period. The credit rating outlook for Greece remained negative, meaning the country is more likely to be downgraded further in the medium term.

It is only a matter of time before Moody’s two other major competitors -- Standard & Poor’s and Fitch -- follow suit and administer a further coup de grace to Greece. Such spillover effects risk accelerating a self-fulfilling prophecy regarding a Greek default or restructuring. Standard & Poor’s announced in late February that it was considering cutting Greece’s sovereign rating, depending on the outcome of the EU’s summit at the end of March. In January this year, Fitch became the third rating agency to cut Greek debt to “junk status.”

It is worth remembering that since late 2009 the rating action by Moody’s in particular comes on the back of a sustained period of looking sideways when assessing Greece’s sovereign credit rating. The manner in which all three rating agencies have downgraded Greece since December 2009 suggests that they are trying to rectify their previous complacency with ever more aggressive and fast-track actions.

But both strategies are fundamentally flawed. It is neither an intelligent nor convincing way of regaining market credibility by switching from exellent ratings for Greece up until late 2009 to assessments that further push the country toward the abyss. If this “gang of three” with oligopolistic market influence were operating in any other business, the consequences of their previous and misleading ratings would have put them out of business. As the Financial Crisis Inquiry Commission in the US dryly observed in its final report from February 2011, the big three rating services were “essential cogs in the wheel of financial destruction.” It now appears that Moody’s is determined to rectify this assessment by driving Greece to the wall.

* Jens Bastian is visiting fellow for Southeast Europe at St Antony’s College in Oxford, UK, and senior economic research fellow at the Hellenic Foundation for European & Foreign Policy (ELIAMEP) in Athens, Greece.