S&P's ratings downgrade: How it affects the eurozone

It wasn’t entirely unexpected but it shocked global investors, nevertheless.

Late on Friday, after European markets closed, ratings agency Standard and Poor’s (S&P) downgraded the credit ratings of nine European nations, including France and Austria, which lost their precious triple-A ratings.

A ratings downgrade, in theory signifies higher borrowing costs for a nation. However, reality shows that’s not always the case.

[caption id=“attachment_183125” align=“alignleft” width=“450” caption=“Widely expected, but the ratings cuts have serious implications. Reuters”] [/caption]

In the past, both the US and Japan have suffered similar downgrades but their cost of borrowings has not risen dramatically - so it can be argued that the eurozone downgrades, in one sense, don’t really matter.

However, it’s important to note the eurozone is different from the US and Japan in one important respect - the countries forming the eurozone don’t have the liberty to print their own currencies to pay off their debts. So, their risk of default has to be viewed differently from the prospects of a US or Japanese ratings downgrade.

So, what happens next to the eurozone, and the single currency? Here are five implications of the ratings cut:

**Weaker euro:**It will make a shaky euro even shakier. Most experts believe the 17-nation single currency will stay under pressure in the medium term. In fact, some experts believe the worst is not over for the euro, despite the currency hitting a 16-month low in recent weeks.

Indeed, Europe’s common currency has slipped in each of the past six weeks and was the worst performer in 2011. In the short term, expect the yen and the dollar to keep gaining against the euro.

Louder austerity calls: The calls for fiscal austerity through harsh government spending cuts and curbs on public debt are likely to get louder. Indeed, expect Germany to take a much tougher stance on the subject, especially since it was among the countries that escaped a ratings cut on Friday. As a Royal Bank of Scotland note, quoted by The New York Times, said, “Germany comes out a clear winner and will have its position at the negotiating table strengthened even further.”

Indeed, Chancellor Angela Merkel has already said efforts towards a planned fiscal pact.“We are now called upon to implement the fiscal pact even faster …to implement it decisively and not try to dilute it… Instead, we should accept the challenge to guarantee solid finances in future,” she said, according to The Wall Street Journal. Of course, tough spending cuts at a time of low or no growth will not necessarily work to the advantage of many of Europe’s economically floundering nations.

**Weaker bailout fund:**The European Financial Stability Fund (EFSF) could lose its triple-A rating, which would limit its ability to raise funds at low cost from the financial markets. The EFSF, launched in May 2010, is a 440 billion euro facility that depends on guarantees from eurozone members, mainly those rated triple-A. Germany and France were the top two backers of the fund.

With France losing its top rating, the fund’s rating is now in danger. However,John Chambers, chairman of S&P’s rating committee, told Reuters that the fund could retain its top rating if there was additional funding from Germany and other countries still holding on to their triple-A rating, according to this report. Will that happen? At the moment, seems very unlikely.

Keeps the euro crisis simmering: Anyone who thought 2012 would be the year in which the eurozone crisis would be resolved will be sorely disappointed. The major impact of the ratings downgrade, of course, will be felt by the weakest countries, which will see further erosion in their credit worthiness and face rising funding costs.

Overall, it just adds to the problems of the region, which shows no sign of resolving the eurozone crisis.In another worrying sign, on Friday, a previously-agreed deal between Greece and private bond holders seemed to reveal some major cracks.A failure to adhere to the terms of the deal will prompt international lenders to back away from lending to Greece.Without aid, Greece is set to default in March when it has to redeem bonds worth 14.5 billion euros.

Economically, the region is tottering on the brink of a recession and with austerity calls growing louder, growth could remain subdued for a very, very long time.

**More downgrades in store:**S&P is just the first shocker, expect other ratings agencies to follow.“Following Friday’s sovereign downgrades, in the coming days we expect a litany of other rating downgrades of related entities,” Laurent Fransolet, analyst at Barclays Capital told_Reuters_. “Given the propensity of rating firms to announce things after one another, we would expect some further headlines on this in the coming weeks. Indeed, Fitch had already announced that it aimed to conclude its ‘watch negative’ reviews before the end of the month,” Fransolet added.