Greece has the lowest credit rating of all EU countries because it has made insufficient progress on reducing its public debt-to-GDP ratio, implementing pension reform and pushing through structural reforms. Yet, the probably unfavorable revision of the definition of public debt by Eurostat this summer, coupled with estimates that the proposed pension reform will raise the actuarial deficit of the system, cast doubts on the much-needed upgrade in the foreseeable future. The representatives of international credit agencies visiting Athens recently to take a look at the Greek economy left the government officials and bankers who met them with the impression that Greece should not expect an upgrade unless it reformed its pension system and took measures to reduce its public debt. Moody’s officials, visiting Athens a couple of weeks ago, also stressed the need for pension reform but put it in a more European context, saying that other EU countries, such as Germany – rated AAA and with better ratings than Greece – also faced similar problems, namely huge unfunded future pension liabilities, and it would be unfair to treat one country differently from the others solely on the basis of pension reform. They also admitted that the bankruptcy of a number of well-known corporations, such as Enron (rated higher than some sovereign states, such as Greece) had raised the issue of whether sovereigns were treated more harshly than corporates. Nevertheless, they gave the impression that progress in structural reforms was not sufficient for Greece to earn an upgrade. In a conference on «Greece within the Eurozone – a Rating Perspective» organized by Standard & Poor’s in Athens last week, officials of the credit agency also stressed the need for reform of the country’s pension system and acceleration of the pace of reduction of the debt-to-GDP ratio by implementing structural reforms, if there was to be a permanent effect on the ratio. They warned that the country’s public debt would rise to 280 percent of GDP in 2050 if the present pension system was not reformed, given the adverse demographic trends in place. Keeping Greece’s credit rating at A at a time most analysts expect government bond yields in the eurozone to go upwards means the state will not be able to lower its borrowing costs when old, high-yielding issues expire. The 10-year yield spread over German government bonds seems to reflect this reality by refusing to fall below the 30 basis points mark. On Friday, the yield spread was trading around 34 basis points. Moreover, Greece should be concerned about the possible introduction of new BIS (Bank of International Settlements) on bank capital adequacy, effective in 2005, which will make Greek government bonds less attractive if Greece has failed to be upgraded to AA- by then. Under current rules, the government bonds of OECD countries are assigned zero-risk weighting, meaning potential buyers (banks) should not put aside capital when they carry them on their books. In case Greece fails to repeat its previous feat, that is going from BBB- on November 1992 to A- in November 1999, in the next couple of years and a half, it will have to digest both the impact from the new BIS rules and the higher interest payments. The combination of the expected higher euro rates – more than 90 percent of Greece’s public debt is denominated in euros – and the loss of the zero-risk weighting advantage could be hard to bear for a country which has relied heavily on lower interest payments and faster GDP growth to turn its general government budget deficit into a surplus. Things could get even tougher if Eurostat revises, as expected, the definition of the general government debt in June-July to include the proceeds from securitization or convertible bonds. Government officials already are looking into ways to deal with the latter. The proposed pension reform appears to be crucial, both to the credit upgrade and the future of Greece’s fiscal consolidation efforts. Its critics claim the reform is bound to widen the actuarial deficit of the system because it raises the replacement ratio and reduces the retirement age for post-1992 workers, while its proponents argue it brings transparency and guarantees funding for the country’s main IKA pension fund until 2032. Although both sides seem to be right, the end-result will most likely be the widening of the actuarial deficit, which will hold back a credit upgrade. This ensures another attempt at reform from the next government, whether conservative or socialist. Still, the likelihood of an upgrade would not have been ruled out if the government had been successful in other areas such as privatizing state-controlled companies, limiting primary expenditure growth and showing tangible results from the deregulation and liberalization of certain markets. However, this has not been the case so far. Big items, namely the sale of Hellenic Shipyards, have been put off and the sale of the new Olympic Airways, which does not seem more certain now than it did in early 2002, seems to obscure the probable sale of a 49-percent stake in the Mont Parnes casino and the sale of lease contracts in prime marine docks, which seem to be on the right track. Moreover, the liberalization of the electricity market, initiated in February 2001, is on paper only while the benefits from the liberalization of the fixed-line telecoms market have just started to show. All in all, the chips are not in place for a credit upgrade by the two main international credit organizations in the near future. Given the municipal elections in the fall and the likelihood of a long general election period, usually associated with the pursuit of a looser fiscal policy, it is likely the next credit upgrade will have to wait until next year at best.