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Lower credit rating in the Euro zone was expected – and can give both negative and positive effects
17-01-2012 14:26
Standard and Poor’s downgrading of the credit rating of nine Euro zone countries did not come as a surprise. For France and Austria, having the highest credit rating is no longer something they can boast about. The question is more about the consequences this downgrading will result in and if it really is as unfair as the Euro politicians claim.
It is entirely reasonable for the Euro zone to no longer have the highest credit rating. Recession, credit restrictions and political difficulties in reaching agreement on future institutions and playing rules in the Euro zone weigh heavily on the negative side of the scales. There was certainly movement in the right direction on the positive side of the scales when the European Central Bank, ECB, increased liquidity and government bond rates fell slightly in the crisis countries. However, the underlying problems remain, and these concern an inadequate institutional structure to deal with crises in the Euro zone, incorrect fiscal policy for many years and a far too meagre growth policy. These will not be resolved by a few summit meetings, it will take more than that to right the ship. This process has probably already been started – but it will take time and the course will be anything but straight ahead.
The downgrading of the credit rating could have applied to all the Euro countries, because at the end of the day, it is the rescue fund, the European Financial Stability Facility, EFSF, that has been negatively affected as this too is moving in the direction of a lower credit rating. There will probably be a slight heightening of tension between France and Germany also. At the same time, in economic terms, the effects need not be that great, more a case perhaps of the political and psychological effects coming into play.
First, the USA's credit rating has also been downgraded, but without any major economic effects. On the contrary, the financial markets continue to view the US as a safe haven as the economic statistics continue to improve and the Euro crisis has worsened. If France and Austria get to grips with both fiscal policy and growth policy (even though it is concerns about growth that S & P has been focusing on) one could imagine that the effects on interest rates need not be great.
Second, the EFSF will probably be replaced by a new fund, the European Stability Mechanism, ESM, in the summer, a more stable facility where funds are deposited in advance and not guaranteed in on-loans as with the EFSF. The downgrading of the credit rating that will probably also hit the EFSF can hasten a decision on whether or not the ESM genuinely needs to be brought forward. In the meantime, the EFSF may perhaps not need to have the highest credit rating, something that Germany has directly opened up to. The AAA rating stigma can start to be toned down.
Third, the political effects can come to the fore. France is entering a waiting period and naturally enough, during the presidential election campaign, all opposition parties will use the downgrading as proof that France is on the wrong path. Even more important political effects will be whether or not the credit rating hastens reform efforts in the Euro zone – in terms of both fiscal policy and growth policy. The ECB has stated that the proposals from the summit of 9 December can be diluted. Which is something the Euro zone cannot afford. Partly because the ECB's scope to support growth would then disappear, and partly because Germany and the other countries approved by S & P would not be able to steer the ship by themselves.
Fourth, the psychological effects look like being greater than could be expected of a decision that everyone had already expected. The focus lies on the EFSF. Even on what confirmation of the decision means for the scale of the Euro crisis. It is also a slightly sensitive time point as growth has started to become more positive than in the autumn. However, there is no point in the Euro politicians fighting it and bad mouthing the credit rating agency – setting up an agency owned by the Euro countries would hardly instill greater confidence.
The negative news is that it will be a messy spring politically speaking (the Euro zone negotiations, national political changes in association with democratic elections), economically, financially and psychologically speaking, (the controlling power of the EFSF, the role of the ECB, banks' credit ratings that can now become even lower when the country ratings have been downgraded and the consequences this will have on the financial markets). The positive news is that the effects need not be so great if the political decisions are speeded up, and that the downgrading itself, helps hasten the process and keep things on course. There is a great deal at stake – for the Euro zone it is all about avoiding running aground.
Cecilia Hermansson
