International ratings agencies are warning the United States and several European governments that they face credit downgrades if they don't soon come up with clear plans to get their deteriorating fiscal houses in order.
Moody's Investors Service said Tuesday the weakening public finances in the U.S. and Britain may “test the Aaa [triple-A] boundaries” for their ratings.
While analysts say there is no immediate risk of a cut in the ratings of major developed economies, the less stable fringe players are already feeling the heat.
In Europe, Ireland, Portugal and even France are under pressure to rein in rising budget deficits. And deeply troubled Greece has become the first euro-currency country to be whacked.
Athens' debt was downgraded a notch Tuesday to triple-B plus by Fitch Ratings. That's only three levels above junk status and means Greece will have to pay investors more to buy its bonds.
Another rating agency, Standard & Poor's, put the country on its watch list for a possible downgrade.
Spreads were already widening dramatically on Greek bonds as a result of a rapidly worsening fiscal crisis, its lack of credibility after steep revisions of economic performance and previous deficit projections, as well as growing fears over its unfunded social spending commitments.
The downgrade reflects Athens' announcement Tuesday that the fiscal deficit for this year is likely to hit 12.5 per cent of GDP, far above its official projection of 3.7 per cent last January.
Relying on government numbers and taking into account obvious economic difficulties, Fitch had previously expected a much more modest jump to 6 per cent.
“It's an issue of credibility and a lack of track record,” said Paul Rawkins, a senior director with Fitch Ratings' sovereign team in London.
The ratings agency now expects government debt to total 115 per cent of GDP by year end and probably 120 per cent by the end of next year.
Market reaction was quick, as the euro fell and investors fled Greek bonds and equities.
“Markets are quite sensitive at the moment, especially with what happened to Dubai during the last couple of weeks,” said Diego Iscaro, a senior economist with IHS Global Insight in London. “Sovereign [debt] has been in the spotlight.”
Although the fear that a hard-pressed government will delay repayments or even default on its obligations hangs over the market, analysts said such an outcome is unlikely in the case of Greece or other European governments facing spiralling debt costs as a result of last year's financial meltdown and the prolonged recession.
Indeed, demand for Greek bonds at recent auctions was strong, thanks to its higher yield relative to other euro-bond issuers, and the view that its fellow euro-zone members would ride to the rescue, if only to protect their shared currency.
“In the short-term, the risk [of default] is not significant,” Mr. Iscaro said. “They have raised most of their funding requirements for next year.”
Fitch followed its downgrade of Greece's debt by cutting the rates of five Greek banks. This is normal procedure, as corporate borrowers typically fall below their national governments on the ratings scale. Also, Greek banks own large amounts of their government's bonds.
Meanwhile, any risks to the bigger industrial countries appear minimal, thanks to their capacity to raise taxes and their access to deep capital pools.
“The risks of a credit downgrade for the U.S. and U.K. are pretty low,” said Geoffrey Somes, senior economist with State Street Global Advisors.
“Yes, the current fiscal situations are pretty poor, with budget deficits over 10 per cent of GDP and debt levels over 50 per cent of GDP and rising fast. But these imbalances developed during what was for both countries one of the worst economic downturns in the post-WWII period.”
Even a “moderate pace of recovery” would brighten their fiscal prospects considerably, Mr. Somes said.
