As the price tag to clean up the euro zone debt crisis soars, new warnings are being sounded about the potential risks to the financial and economic health of the stronger members.
France could lose its coveted triple-A credit rating if its already strained finances deteriorate further as a result of the costs of bank recapitalizations and its share of the euro bloc's rescue fund, Moody's said in its annual assessment of the country's fiscal health. The bond-rating agency also downgraded Spain, one of the weaker members of the euro club, again citing the risk to its shaky finances stemming from the debt crisis.
The rescue fund could total as much as €2-trillion ($2,8-trillion), following an agreement between France and Germany, the Guardian newspaper reported Tuesday. Foreign officials, including Bank of Canada Governor Mark Carney, have said the Europeans need to at least double the fund from its current size of €440-billion. And some economists have argued it will take €2-trillion or more to restore confidence and stabilize markets.
The expanded fund will be presented at a crucial European summit meeting Sunday as part of a "comprehensive plan" to resolve the festering crisis, the newspaper said, citing European Union diplomats.
German Chancellor Angela Merkel said people should not be expecting a breakthrough at the summit: "These sovereign debts have built up over decades, so they won't be ended with one summit," Ms. Merkel said. Fixing the problem "will require tough, long-term work."
The latest twists and turns in the long-running debt saga are occurring against a backdrop of growing market impatience, increased pressure from exasperated world leaders and fresh fears that it may already be too late to contain the damage to the most fiscally challenged euro zone members.
Moody's assessment makes it clear that France, a core euro country, faces worsening fiscal and economic conditions that could be exacerbated by its key financial role in efforts to resolve the region's debt crisis. Moody's said it might change the country's outlook to negative from stable if the costs of bank recapitalization and the euro bloc's debt rescue package put too much strain on its already stretched finances.
"The deterioration in debt metrics and the potential for further contingent liabilities to emerge are exerting pressure on the stable outlook of the government's [triple-A]debt rating," Moody's said. This opens a new front in the debt battle, as France has long been regarded as one of the sounder members of the 17-country single currency bloc.
The warning underlined the increasingly precarious state of even the stronger core members of the euro zone as they grapple with the spreading sovereign debt crisis that has crippled Greece, forced Ireland and Portugal to seek bailouts, and hovers menacingly over the larger economies of Spain, Italy and Belgium.
France is now caught in a vicious circle. If the debt crisis continues unabated, France's fiscal and economic situation will deteriorate further. If it meets its financial obligations to backstop a much larger rescue, that in turn will further damage France's own finances and make the French vulnerable to a credit downgrade. Such a rating cut would increase its costs of financing its share of the rescue.
Market reaction to the Moody's report was swift and followed the same script that has become all too familiar to the weaker euro bloc countries. Bond investors demanded higher risk premiums to hold French government bonds, widening the gap between French 10-year benchmark debt and comparable German bonds, regarded as the safest in Europe, to 1.14 percentage points. That is the widest yield differential between the two core euro zone countries in nearly 20 years.
French Finance Minister François Baroin insisted in a TV interview that the country has room for more belt-tightening and that its triple-A rating is in no danger. But he acknowledged that the official growth target for next year of 1.75 per cent is probably too high, based on weakening economic conditions.
"Obviously, the French growth outlook has deteriorated appreciably," said Howard Archer, chief European economist with IHS Global Insight in London. The research firm has reduced its growth forecast to 0.4 per cent in 2012, which means a virtually stagnant economy. Its target for the whole euro zone is only 0.3 per cent, underscoring the damage wrought by the debt crisis.
The dimmer outlook and weakening fiscal position put considerable pressure on the French "to take additional measures to make sure they hit their fiscal targets," Mr. Archer said.
But despite Mr. Baroin's assurance that he has some fiscal manoeuvring room, the coming presidential election next spring will dampen any government enthusiasm for new austerity measures at a time when the economy is grinding to a standstill.
"It's a difficult balancing act between trying to achieve their fiscal goals but not killing off growth even more," Mr. Archer said.