The euro zone’s worst-case scenario of recession and default is looming larger after a mass debt downgrade of France and several other countries, and stalled Greek debt restructuring talks.
Standard & Poor’s stripped France of its prized triple-A rating and slashed the ratings of Italy, Spain and six other European countries Friday, continuing a disturbing pattern of the feared becoming reality in Europe’s smouldering debt crisis.
The move Friday crushed nascent hope that the region’s debt woes might finally be easing after successful bond auctions by Spain and Italy earlier in the week.
The most immediate problem for the euro zone is that France – its second largest economy – will now face significantly higher borrowing costs just as the region slides into recession.
Equally important, the downgrade makes it more expensive for the European Financial Stability Fund to raise cash because France is the fund’s No. 2 backer behind Germany. The EFSF, set up in 2010, is due to raise money in the markets on Tuesday.
S&P said its decision was prompted by the failure of European leaders to adequately deal with “ongoing systemic stresses in the euro zone” at their December summit. Those challenges include tightening credit conditions, rising risk premiums, the slowing economy and an “open and prolonged” dispute among European policy makers on how to tackle their problems, the agency said in a statement.
“The agreement reached has not produced a breakthrough of sufficient size and scope to fully address the euro zone's financial problems,” S&P said.
Also downgraded Friday were Austria, Portugal, Slovakia, Slovenia, Cyprus and Malta. Only Germany, the Netherlands, Finland and Luxembourg retain triple-A ratings among the euro zone’s 17 member countries.
S&P also warned of “reform fatigue” in some European countries, which could stall efforts to improve finances as the continent slips back into recession.
In Greece, negotiations aimed at getting investors to take a voluntary cut on their Greek bond holdings appeared near collapse, raising the probability that the country could soon face a full-scale debt default.
French officials played down the significance of S&P’s decision to cut the country’s debt rating by a notch to double-A-plus – the same rating as the United States after its own downgrade last summer. Finance Minister François Baroin said it’s bad news, but far from devastating.
“It’s a reduction of one level, it’s the same level as the U.S. It’s not a catastrophe,” Mr. Baroin told France-2 television.
Eurogroup president Jean-Claude Juncker of Luxembourg defended the actions of euro zone leaders in the face of economic crisis, pointing out that recent moves alleviated tensions in bond and lending markets.
Losing the triple-A rating is also a political problem for French President Nicolas Sarkozy, who is already trailing his main rival, Socialist Party candidate François Hollande in the lead-up to the coming presidential election.
As rumours of a possible downgrade circulated Thursday, Mr. Sarkozy urged the French people not to dwell on what the markets and rating agencies are doing.
“Markets and rating agencies exasperate our citizens,” he said. “We must take back control of our destiny.”
German Finance Minister Wolfgang Schaeuble likewise said people shouldn’t “overrate the assessments of rating agencies.” And he suggested that successful bond auctions this week by Spain and Italy are more important harbingers.
But ratings are more than symbolic. Euro zone countries have borrowed hundreds of billions of dollars to finance their debts – much of it overseas. Lower ratings are an indicator of greater risk, prompting investors to demand higher interest rates to hold those bonds.
S&P put 15 European nations on notice in December of possible downgrades.
The yield on France's 10-year government bond rose to 3.1 per cent Friday from 3 per cent earlier in the day. The comparable rate for Italy is 6.6 per cent.
Germany, regarded as the best credit risk in Europe, pays just 1.76 per cent. The yield on U.S. 10-year Treasuries was 1.85 per cent Friday, down 0.08 percentage points.
The euro hit its lowest level in more than a year, while stock markets in Europe, Canada and the U.S. retreated.
Some analysts have speculated that Europe’s fiscal woes, if not fixed quickly, could lead to an eventual breakup of the euro zone, triggered by a cascading series of defaults, starting in Greece, and then afflicting other heavily indebted countries.