Credibility cut turns up heat on European leaders

BRUSSELS - Agence France-Presse

French President Nicolas Sarkozy addresses his New Year speech to the justice representatives at the Elysee Palace in Paris on Jan 13 only hours before S&P’s credibility downgrade on eurozone’s second biggest economy. AFP photo

Two weeks before a new summit, European leaders are under pressure to deliver a credible solution to the debt crisis after Standard & Poor’s punished their policies with stinging credit downgrades.

Eurozone governments face an uphill battle as they scramble to avoid a messy debt default in Greece, boost a bailout fund considered too small to save bigger countries and seal a fiscal pact aimed at tightening budget discipline.

After a relatively calm start to the year, the crisis returned with a vengeance on Jan. 13 as negotiations between Greece and bank creditors on a huge debt writedown hit a snag and Standard and Poor’s downgraded nine eurozone nations.

The credit ratings agency justified its action saying that EU policies in recent weeks “may be insufficient to fully address ongoing systemic stresses in the eurozone.”

And with recession looming, Standard and Poor’s warned that the focus on all-out austerity could backfire against the economy.

More than two years into the crisis, bailouts of Greece, Portugal and Ireland, the creation of an emergency fund and a slew of continent-wide austerity measures have once again failed to calm fears of a eurozone breakup.

“This is more a downgrade of the eurozone’s management of the crisis,” said Sony Kapoor, head of Re-Define economic think tank.

“Standard and Poor’s had given EU leaders fair warning but they have wasted the month they have had to change course and come up with a credible crisis resolution strategy,” he said.

European leaders, all except Britain, agreed last month to seal a “new fiscal compact” by March to tighten budget discipline and deepen integration in order to convince markets that there will be no repeat of the crisis.

But Standard and Poor’s, in addition to kicking France and Austria out of the exclusive club of AAA-rated nations, warned that “a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating.”

EU leaders plan to discuss how to spur growth and jobs at their January 30 summit, but the new fiscal treaty will also figure high on the agenda.

After years of toothless fiscal oversight in the EU, the pact would require governments to enshrine balanced budgets in their constitutions and threaten more automatic sanctions against countries that run excessive deficits.

German Chancellor Angela Merkel, who has championed stricter budget rules, said on Jan. 14 that the downgrade means Europe must quickly implement the new treaty, “and not try again to soften it.”
“The (Standard and Poor’s) decision confirms my conviction that we in Europe still have a long road ahead of us until investor confidence is again restored,” Merkel said.

The ratings agency’s move has also fueled doubts about the eurozone’s ability to boost its bailout fund, the European Financial Stability Facility (EFSF).

Originally endowed with guarantees totalling 440 billion euros, the EFSF only has 250 billion euros left after bailing out Portugal and Ireland -- insufficient for Italy or Spain if the eurozone’s third and fourth biggest economies need help.

EU leaders agreed last year to leverage the fund to one trillion euros, but they have failed to attract much interest among private investors and foreign governments.

The downgrades could hurt the EFSF.

S&P warned in December that any downgrade of one of the six triple-A nations could affect the EFSF’s own top rating.

Luxembourg Prime Minister Jean-Claude Juncker, head of eurozone finance ministers, said governments would “explore the options for maintaining the EFSF’s AAA rating.”

Backed by guarantees from eurozone states, the fund borrows from investors at cheap rates and then lends that money to nations that have been shut out of the private markets.

A drop in the fund’s credit rating may therefore lead investors to impose higher lending rates.

A new permanent fund, the European Stability Mechanism, is due to be activated in July with its own capital base of 500 billion euros. Governments are divided over whether to increase its size, with some wary of tapping on taxpayers.

For analysts, the rate cut is a stark reminder that the crisis is far from over.

“The downgrade does not reflect the fact that the efforts of the eurozone to escape the crisis had shown some promising positive results,” said Janis Emmanouilidis, analyst at the European Policy Centre.

“At the same time, the downgrade shows that more needs to be done to manage and eventually overcome the crisis.”