Sunday, 15 January 2012

France downgraded to AA+ and what it means for the rest of EU

In a move that only confirms what the rest of the world already knew, financial ratings agency Standard and Poor`s downgraded Friday 9 of the Eurozone countries: Cyprus, Italy, Spain and Portugal by two notches and Austria, France, Malta, the Slovak Republic and Slovenia by one notch. By far the biggest implications are for the downgrade of France from its triple A status to AA+ because it will consequently mean that its EFSF guarantees will not be as high rated as before and threaten to bring down the AAA status of this special investment vehicle.

S&P - thank you Captain Obvious...

It is common knowledge that the ratings agencies have only shadowed financial developments, in the sense that they reacted only long after the influential factor worked its way into reality. This means that ratings offered by such financial institutions serve more as a description of the current status rather than a means to forecast the future developments. Nevertheless, a hat down for Standard and Poor`s for being the first to acknowledge the budgetary and fiscal imbalances in the United States by downgrading US debt to AA+ in August 2011 and now for being the first to downgrade France for its financial system filled with toxic peripheral-country debt and doing nothing to address it. 

In a Journey to Alpha  October article entitled "Is EFSF going to save Greece" some questions remained unanswered:

Some of the countries that provide financial guarantees are going to be the direct beneficiaries of this facility ? How can this be ? What happens if one of these countries, or worse, more of these countries go into selective or total default? Who is going to pay the bill ?

These answers are still tricky to  address: in the case of a selective default of one of the countries, say Greece, are the core European countries going to step in and reimburse the creditors? Under the current form of EFSF, most probably no, under a different form called ESM, possibly yes. But in order for this to work, the European Central Bank needs to step in and conduct a major bond purchase program, in the form of quantitative easing. It also needs to bypass the liquidity window provided to banks, which seems to have little effect on the evolution of bond yields.

S&P analysis

Even though the research only states what is already obvious to most of us, it also present one of the clearest, uncluttered pictures on the current European Debt crisis. From S&P analysis:

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 our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.
We believe that as long as uncertainty about the bond buyers at primary auctions remains, the risk of a deepening of the crisis remains a real one. These risks could be exacerbated should renewed policy disagreements among European policymakers emerge or the Greek debt restructuring lead to an outcome that further discourages financial investors to add to their positions in peripheral sovereign securities. 
The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures. Instead, it focuses on what we consider to be a one-sided approach by emphasizing fiscal austerity without a strong and consistent program to raise the growth potential of the economies in the eurozone.

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