Debt downgrade underscores Europe's woes

Standard & Poor’s downgraded the credit ratings of France, Italy and seven other European countries on Friday, a move that may have more symbolic than fundamental financial impact but served as a reminder that Europe’s economic woes were far from over.

This underscore that even as Europe’s debt turmoil enters its third year, no clear solutions are yet in sight, despite recent signs that a new lending programme by the European Central Bank might be easing financial market pressures.

To some extent, the prospect of rating downgrades has already been priced into recent bond auctions by Italy, Spain and other countries. But the downgrades may now add to the borrowing costs of the nations affected. Some commercial banks that are required to hold only the highest-rated government securities will have to replace French bonds with other assets, like bonds of Germany. And the downgrades cannot help but add to the gloom pervading Europe’s economic climate.

“Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone,” S&P said.

French Finance Minister Francois Baroin of France said Friday that the loss of his country’s pristine AAA rating, cut a notch to AA+, was “not good news” but was “not a catastrophe.” But the downgrades pose fresh challenges for Europe’s political leaders, particularly French President Nicolas Sarkozy, who is expected to run for re-election this spring and had long cited his country’s AAA credit rating as a badge of honor.

After Friday, the only euro zone nations retaining their top AAA ratings are Germany, the Netherlands, Finland and Luxembourg. Italy and Spain, which are considered the two big euro-zone economies most vulnerable to an escalation of debt problems, both were downgraded two notches, Italy to BBB+ and Spain to A.

Just as significant as the ratings downgrades may be the suspension on Friday of the creditor talks in Greece, whose debt S&P long ago gave junk status. In October, the European Union pledged to write off 100 billion euros ($127.8 billion) of Greece’s debt if bondholders would agree to voluntarily accept 50 percent losses on their Greek holdings.

Such an arrangement, known as private-sector involvement, or PSI, has been pushed by Chancellor Angela Merkel of Germany as a way of forcing banks, not only European taxpayers, to foot the bill for bailing out Greece. But talks broke down on Friday between Greece and the commercial banks. If Greece defaults, it could set off the activation of credit default swaps, a type of financial insurance. If the issuers of that insurance have to start paying up, many analysts fear the same sort of falling dominoes of i.o.u.’s that cascaded through the financial industry after the subprime mortgage market collapsed in the United States in 2007 and 2008.

The Greek uncertainties only add to the regional doubt that helped set off the S&P downgrades. Europe’s economy, having barely clawed its way out of a recession three years ago, is again tipping into a new one. Even mighty Germany, with most of its neighbors in a downturn, is also expected to slip into a shallow recession this year.

On Friday, S&P kept Germany’s ratings untouched, but it said it could lower rating if its debt, now 80 per cent of gross domestic product, reached 100 per cent.