Euro empire totters on rating shock; France loses AAA status

The empires of Europe are crumbling faster than you can say “sovereign debt crisis”.

On Friday the 13th (how’s that for a prophetic symbol !), rating agency Standard & Poor’s delivered on its long-pending threat to downgrade eurozone countries’ sovereign ratings if they didn’t get their act together.

France, Europe’s second largest economy, and Austria were stripped of their top-notch AAA sovereign rating; seven other countries, including Italy, Spain and Portugal, saw their ratings downgraded.

[caption id=“attachment_181835” align=“alignright” width=“380” caption=“France loses its AAA badge. Reuters”]  [/caption]

Fourteen other countries, including France, were put on a negative outlook for a further downgrade.

Germany, the powerhouse of the European economy and the moneybags of Europe, emerged as the only major country not to suffer a downgrade.

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But in every other way, these developments, and a feared imminent default by Greece, leaves the euro empire, which has been on infirm ground for much of the past year, tottering on the brink of collapse.

S&P’s explained its broad-sweep action by saying in a statement that “today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the Eurozone.”

 In other words, nothing that the European leaders have done in recent weeks can prevent a collapse of the eurozone under the weight of the debt burden.

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And with the risk of further downgrades, the downside risks to the eurozone and to the global economy have become significantly higher.

Although S&P’s action was known to be coming - it had given notice of it more than a month ago - it caused mild panic in the financial markets.

In the short term, markets around the world, including in India, will suffer from a flight from risk. But as Firstpost has argued earlier, from an Indian perspective, this news is not an unmitigated disaster.

When the short-term risk aversion fades, fund managers and moneybags will have to turn to the emerging markets, which are still logging relatively higher growth rates, for returns. And that, if India gets its act together, is good news for Indian investors.

Reuters adds:

Negotiations on a debt swap by private creditors seen as crucial to avert a Greek default that would rock Europe and the world economy broke up without agreement in Athens, although officials said more talks are likely next week.

If Greece cannot persuade banks and insurers to accept voluntary losses on their bond holdings, a second international rescue package for the eurozone’s most heavily indebted state will unravel, raising the prospect of bankruptcy in late March.

French Finance Minister Francois Baroin, speaking after an emergency meeting with President Nicolas Sarkozy, played down the impact of Europe’s second biggest economy being downgraded to AA+ for the first time since 1975.

“This is not a catastrophe. It’s an excellent rating. But it’s not good news,” Baroin told France 2 television, saying the government would not respond with further austerity measures.

The euro fell by more than a cent to $1.2650 on the news. European stocks, which had been up on the day, turned negative but reaction to the widely anticipated news was moderate. Safe-haven German 10-year bond futures rose to a new record high while the risk premium investors charge on French, Spanish, Italian and Belgian debt widened.

Eurozone finance ministers responded jointly by saying in a statement they had taken “far-reaching measures” in response to the sovereign debt crisis and were accelerating reforms towards stronger economic union.

Greek negotiators who have repeatedly voiced confidence in a deal in which private creditors would accept writedowns of 50 percent of the face value of their bond holdings said they were now less hopeful, warning of “catastrophic consequences” for Greece and Europe if they failed.

The Institute for International Finance, negotiating on behalf of banks, said: “Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach.

The two sides are divided principally over the interest rate Greece will end up paying, which determines how much of a hit banks take. While both appear to be engaged in brinkmanship, there are also doubts about the take-up rate of any voluntary deal, since some hedge funds have bought up Greek debt and want to be paid out in full or trigger default insurance.

The double blow of the S&P news and the stalling of the Greek debt talks came after a brighter start to the year with Spain and Italy beginning their marathon debt rollover at lower borrowing costs this week.

The European Central Bank’s move last month to flood banks with cheap three-year liquidity helped ease a worsening credit crunch and provided funds which governments hope some will use to buy sovereign bonds.

Rescue fund weakened

S&P said the eurozone faced stresses including tightening credit conditions, rising risk premiums for a growing number of sovereigns, simultaneous deleveraging by governments and households and weakening economic growth prospects.

It also cited political obstacles to a solution to the crisis due to “an open and prolonged dispute among European policymakers over the proper approach to address challenges.”

Austerity and budget discipline alone were not sufficient to fight the debt crisis and risked becoming self-defeating, the ratings agency said.

German Finance Minister Wolfgang Schaeuble played down the news, saying: “In the past months, we’ve come to agree that the ratings agencies’ judgments should not be overvalued.”

France and Austria were at risk because of their banks’ exposure to the debt of peripheral eurozone countries and Hungary respectively, as well as the weakening economic outlook for Europe. Italy and Spain face historically high borrowing costs.

The cut in France’s rating is a serious setback for the centre-right Sarkozy’s chances of re-election in May and could weaken the eurozone’s rescue fund, reducing its ability to help countries in difficulty.

France is the second largest guarantor of the European Financial Stability Facility, which has a AAA rating. Preserving that status would require members to increase their guarantees, which could prove politically unpopular.

In their statement, the euro zone finance ministers said they would do all they could to ensure the rescue fund keeps its top rating.

After vowing for months to do everything to preserve Paris’ top-notch standing, Sarkozy appeared to prepare voters last month for the loss of the prized status before the election.

His political opponents pounced on the S&P decision as a verdict on the failure of his policies. “This is in reality a double downgrade. It is a downgrade of our sovereign rating that will affect the country’s reputation, with heavy consequences, and it is also a downgrade compared to our main neighbour, Germany, with which we had equal status up to now,” centrist candidate Francois Bayrou said.

Socialist party leader Martine Aubry said: “Mr Sarkozy will be remembered as the president who downgraded France.”

It is not clear how far the downgrade will increase France’s borrowing costs, since markets have already anticipated the prospect by raising the French risk premium over German Bunds.

“One notch is priced in but not more. The Franco-German spread can widen. It is about 130 basis points for the 10-year bond. The maximum level reached was 180 to 190 basis points and it can go back to this level,” said Alessandro Giansanti, senior rates strategist at ING in Amsterdam.