In a newly-published Special Report, Fitch Ratings sets out the broad sovereign rating implications of external financial support, including bond purchases by the European Central Bank (ECB) and/or the European Stability Mechanism (ESM)/EFSF. The rating implications of external financial support, including bond purchases, are assessed by Fitch on a case by case basis. The Special Report, whose main features are summarised below, sets out in detail the possible positive and negative implications of external financial support.
Sovereign bond purchases by the ECB in the secondary market and primary (or secondary) market purchases by the EFSF ('AAA') or ESM would likely be credit positive and ease downward pressure on sovereign ratings in the eurozone. The willingness and ability to conduct bond purchases in primary and secondary markets can allow the sovereign to retain affordable access to market funding, reduce the risk of self-fulfilling liquidity crises and by lowering sovereign credit spreads, ease domestic financial and credit conditions.
However, were bond buying by the official sector simply to substitute rather than support market access, the reliance on policy-conditional external financial support would not be consistent with a high investment-grade sovereign rating (single 'A' category and above). Prolonged reliance on official external support - whether directly lent or via bond purchases - with little prospect of a resumption of market access in the foreseeable future would place further downward pressure on sovereign ratings and lead to the likely loss of investment-grade status. In such a scenario, the political and financial incentives for official creditors to exercise their seniority over private creditor claims to impose a restructuring of privately held sovereign bonds would steadily rise.
The preferential treatment accorded to the ECB of Greek government bonds whereby they avoided the deep "haircut" imposed on private bondholders revealed that the ECB has de facto preferred creditor status. With the ESM also benefitting from explicit seniority over private creditors, junior only to the IMF, official sector support in the context of the eurozone crisis implies subordination of private creditors. Nevertheless, the sovereign debtor's lower debt service burden and reduced probability of default can be sufficient to more than offset the negative credit implications of subordination, underscoring that the rating implications of external financial support will continue to be assessed on a case-by-case basis.
The revealed seniority of the ECB will reduce the effectiveness of renewed bond purchases unless it is able to credibly address the "seniority issue". But even if the ECB is able to credibly pre-commit not to exercise its preferred creditor status in the event of default, its bond purchases are likely to be associated with EFSF/ESM bond purchases/lending, implying some subordination of private creditors. Nonetheless, subordination will not necessarily dominate the positive aspects of ECB/ESM bond purchases and financial support, especially in the context of a well-designed policy programme that enjoys domestic political support and is effectively implemented.