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European debt crisis

Competitive divide key to Europe's woes, S&P says Add to ...

A day after Standard & Poor’s unveiled its mass European downgrade, German Chancellor Angela Merkel went back on the warpath, urging European leaders to redouble their efforts to fight the debt crisis before rising borrowing costs cripple the weakest countries and send Greece into default.

But the centrepiece of Ms. Merkel’s plan for countries to tackle the debt crisis, with deep austerity measures that cut budget deficits and lighten national debt loads, is as much a part of the problem as the solution, S&P said in explaining its move to downgrade France’s and eight other nations’ credit ratings Friday.

The real problem, the ratings agency said, is current account imbalances and “divergences in competitiveness” between the strong northern economies and the weak southern ones, such as Spain, Italy and Greece. Greece’s imbalances and anemic competitiveness are so dire that many economists expect it to default on its debt this year.

S&P said Athens is at “risk of imminent default” and that a disorderly default cannot be ruled out unless an agreement with private bondholders to take substantial losses on their holdings is reached by March 20, when the Greek treasury must redeem €14.5-billion ($18.8-billion) of bonds. Greece’s financial health continues to deteriorate, in spite of a bailout and efforts to increase tax collection and reduce government spending.

While Europe’s political leaders scramble to rein in the continent’s fiscal crisis, some analysts worry the competitive divide of European nations, along with crushing debt loads carried by various nations, may ultimately lead to the eventual breaking up of the euro zone.

Friday’s downgrades by S&P saw France and Austria lose their prized triple-A long-term sovereign debt ratings. The ratings of Italy, Spain and Portugal were cut by two notches. Portugal’s debt was downgraded to non-investment grade, or “junk,” status. Germany kept its triple-A rating and the rating of Ireland, which received a bailout from the EU and the International Monetary Fund in 2010, was left intact. Adding to concerns, the S&P also said the outlook for 14 European nations is “negative.”

On Saturday, in response, Ms. Merkel urged the euro zone countries to stick with their debt-cutting pledges and ramp up the efforts, announced at the Dec. 9 European Union summit, to build a fiscal union, one that would allow oversight of national budgets and impose penalties on EU countries that exceed their deficit and debt limits. (Britain, an EU member but not part of the euro zone, opted out of the agreement.)

In a radio interview on Saturday in Germany, Ms. Merkel said debt-reduction steps by the new Italian and Spanish governments will “convince the markets in the medium term,” adding that “I think we will still have to fight for a while with the fact that investors haven’t regained full confidence in the euro.”

The authors of Friday’s S&P’s euro zone downgrade report, led by Moritz Kraemer, senior sovereign credit analyst in Frankfurt, were critical of the austerity-led approach to tackling the crisis, which began more than two years ago, when Athens admitted that the national deficit and debt figures had been underplayed for years.

S&P said “we believe that a reform process based on a pillar of fiscal austerity alone would risk becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.”

The agency said it believed that the common interpretation, that the crisis is largely the result of fiscal recklessness, is wrong. “In our view, however, the financial problems facing the euro zone are as much a consequence of rising external imbalances and divergences in competitiveness between the [European monetary union’s]core and the so-called ‘periphery,’ ” it said.

Germany’s current account surplus is enormous (the current account is the difference between a country’s exports of goods, services and interest and dividend income, and its total imports of them). Greece, Spain, Portugal and Italy are running negative current account balances. Economists say the crisis will not end unless their imbalance extremes are eliminated. Germany will have to consume more; the weak countries will have to become more competitive so they can export more.

S&P said the Dec. 9 EU summit, billed as a make-or-break event for the survivability of the euro, did not produce the “breakthrough of sufficient size and scope to fully address the euro zone’s financial problems.”

The so-far unsuccessful effort to reach agreement on losses for holders of Greek debt is adding to tensions.

In a note published Sunday, the French bank Société Générale said “the sheer inability to reach agreement is now threatening new turmoil.”

The bank said it believed a compromise will be reached with the bondholders by the end of the month, but that there is a 10-per-cent chance of a “disorderly default,” one that could unleash economic and social havoc in Greece and throughout Europe.

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