Something is floating down the river- and this is not a poop on Thames.
FRANKFURT (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings
Services today completed its review of its ratings on 16 eurozone sovereigns,
resulting in downgrades for nine eurozone sovereigns and affirmations of the
ratings on seven others.
We have lowered the long-term ratings on Cyprus, Italy, Portugal, and Spain by
two notches; lowered the long-term ratings on Austria, France, Malta, the
Slovak Republic, and Slovenia, by one notch; and affirmed the long-term
ratings on Belgium, Estonia, Finland, Germany, Ireland, Luxembourg, and the
Netherlands. All ratings on the 16 sovereigns have been removed from
CreditWatch where they were placed with negative implications on Dec. 5, 2011
(except for Cyprus, which was first placed on CreditWatch on Aug. 12, 2011).
The outlooks on our long-term ratings on all but two of the 16 eurozone
sovereigns are negative; the outlooks on the long-term ratings on Germany and
Slovakia are stable. See "Standard & Poor's Takes Various Rating Actions On 16
Eurozone Sovereign Governments," published today for full details.
This report addresses questions that we anticipate market participants might
ask in connection with our rating actions today.
WHAT HAS PROMPTED THE DOWNGRADES?
Today's rating actions are primarily driven by our assessment that the policy
initiatives that have been taken by European policymakers in recent weeks may
be insufficient to fully address ongoing systemic stresses in the eurozone. In
our view, these stresses include: (1) tightening credit conditions, (2) an
increase in risk premiums for a widening group of eurozone issuers, (3) a
simultaneous attempt to delever by governments and households, (4) weakening
economic growth prospects, and (5) an open and prolonged dispute among
European policymakers over the proper approach to address challenges.
The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements
from policymakers lead us to believe that the agreement reached has not
produced a breakthrough of sufficient size and scope to fully address the
eurozone's financial problems. In our opinion, the political agreement does
not supply sufficient additional resources or operational flexibility to
bolster European rescue operations, or extend enough support for those
eurozone sovereigns subjected to heightened market pressures.
We also believe that the agreement is predicated on only a partial recognition
of the source of the crisis: that the current financial turmoil stems
primarily from fiscal profligacy at the periphery of the eurozone. In our
view, however, the financial problems facing the eurozone are as much a
consequence of rising external imbalances and divergences in competitiveness
between the EMU's core and the so-called "periphery". As such, we believe that
a reform process based on a pillar of fiscal austerity alone risks becoming
self-defeating, as domestic demand falls in line with consumers' rising
concerns about job security and disposable incomes, eroding national tax
revenues.
Accordingly, in line with our published sovereign criteria, we have adjusted
downward our political scores (one of the five key factors in our criteria)
for those eurozone sovereigns we had previously scored in our two highest
categories. This reflects our view that the effectiveness, stability, and
predictability of European policymaking and political institutions have not
been as strong as we believe are called for by the severity of a broadening
and deepening financial crisis in the eurozone.
In addition to our assessment of the policy response to the crisis, downgrades
in some countries have also been triggered by external risks. In our view, it
is increasingly likely that refinancing costs for certain countries may remain
elevated, that credit availability and economic growth may further decelerate,
and that pressure on financing conditions may persist. Accordingly, for those
sovereigns we consider most at risk of an economic downturn and deteriorating
funding conditions, for example due to their large cross-border financing
needs, we have adjusted our external score downward.
WHY WERE SOME EUROZONE SOVEREIGNS DOWNGRADED BY TWO NOTCHES AND OTHERS BY ONE
NOTCH?
We believe that not all sovereigns are equally vulnerable to the possible
extension and intensification of the financial crisis. Those we consider most
at risk of an economic downturn and deteriorating funding conditions, for
example due to the large cross-border financing needs of its governments or
financial sectors, have been downgraded by two notches, as we lowered the
political score and/or the external score reflecting our view of the risk of a
marked deterioration in the country's external financing.
On the other hand, we affirmed the ratings of sovereigns which we believe are
likely to be more resilient at their current rating level in light of their
relatively strong external positions and less leveraged public and private
sectors. These credit strengths remain robust enough, in our opinion, to
neutralize the potential ratings impact from the lowering of our political
score.
In this context, we would note that the ratings on the eurozone sovereigns
remain at comparatively high levels, with only three below investment grade
(Portugal, Cyprus, and Greece). Historically, investment-grade rated
sovereigns have experienced very low default rates. From 1975 to 2010, the
15-year cumulative default rate for sovereigns rated in investment grades was
1.02%, and 0.00% for sovereigns rated in the 'A' category or higher.
WHY DO THE RATINGS ON MOST OF THESE SOVEREIGNS HAVE NEGATIVE OUTLOOKS?
For those sovereigns with negative outlooks, we believe that downside risks
persist and that a more adverse economic and financial environment could erode
their relative strengths within the next year or two to a degree that in our
view could warrant a further downward revision of their long-term ratings. We
believe that the main downside risks that could affect eurozone sovereigns to
various degrees are related to the possibility of further significant fiscal
deterioration as a consequence of a more recessionary macroeconomic
environment and/or vulnerabilities to further intensification and broadening
of risk aversion among investors, jeopardizing funding access at sustainable
rates. A more severe financial and economic downturn than we currently
envisage (see "Sovereign Risk Indicators," published Dec. 28, 2011) could also
lead to rising stress levels in the European banking system, potentially
leading to additional fiscal costs for the sovereigns through various bank
workout or recapitalization programs. Furthermore, we believe that there is a
risk that reform fatigue could be mounting, especially in those countries that
have experienced deep recessions and where growth prospects remain bleak,
which could eventually lead to lower levels of predictability of policy
orientation, potentially leading to another downward adjustment of the
political score, which might lead to lower ratings.
We believe that important risks related to potential near-term deterioration
of credit conditions remain for a number of sovereigns. This belief is based
on what we see as the sovereigns' very substantial financing needs in early
2012, the risk of further downward revisions of economic growth expectations,
and the challenge to maintain political support for unpopular and possibly
more severe austerity measures, as fiscal targets are endangered by
macroeconomic headwinds. Governments are also aiming to put greater focus on
growth-enhancing structural measures. While these may contribute positively to
a lasting solution of the current crisis, we believe they could also run
counter to powerful national interest groups, whose resistance could
potentially jeopardize the reform momentum and impede the recovery of market
confidence. In our view, it also remains to be seen whether European banks
will indeed use the ample term funding provided by the ECB (see below) to
purchase newly issued sovereign bonds of governments under financial stress.
We believe that as long as uncertainty about the bond buyers at primary
auctions remains, the risk of a deepening of the crisis remains a real one.
These risks could be exacerbated should renewed policy disagreements among
European policymakers emerge or the Greek debt restructuring lead to an
outcome that further discourages financial investors to add to their positions
in peripheral sovereign securities.
For two sovereigns, Germany and Slovakia, we concluded that downside scenarios
that could lead to a lowering of the relevant credit scores and the sovereign
ratings carry a likelihood of less than one-in-three during 2012 or 2013.
Accordingly we have assigned a stable outlook.
HOW DO WE INTERPRET THE CONCLUSIONS OF THE DECEMBER EUROPEAN SUMMIT?
We have previously stated our belief that an effective strategy that would
buoy confidence and lower the currently elevated borrowing costs for European
sovereigns could include, for example, a greater pooling of fiscal resources
and obligations as well as enhanced mutual budgetary oversight. We have also
stated that we believe that a reform process based on a pillar of fiscal
austerity alone would risk becoming self-defeating, as domestic demand falls
in line with consumer's rising concerns about job security and disposable
incomes, eroding national tax revenues.
The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements
from policymakers, lead us to believe that the agreement reached has not
produced a breakthrough of sufficient size and scope to fully address the
eurozone's financial problems. In our opinion, the political agreement does
not supply sufficient additional resources or operational flexibility to
bolster European rescue operations, or extend enough support for those
eurozone sovereigns subjected to heightened market pressures. Instead, it
focuses on what we consider to be a one-sided approach by emphasizing fiscal
austerity without a strong and consistent program to raise the growth
potential of the economies in the eurozone. While some member states have
implemented measures on the national level to deregulate internal labor
markets, and improve the flexibility of domestic services sectors, these
reforms do not appear to us to be coordinated at the supra-national level; as
evidence, we would note large and widening discrepancies in activity and
unemployment levels among the 17 eurozone member states.
Regarding additional resources, the main enhancement we see has been to bring
forward to mid-2012 the start date of the European Stability Mechanism (ESM),
the successor vehicle to the European Financial Stability Fund (EFSF). This
will marginally increase these official sources' lending capacity from
currently €440bn to €500bn. As we noted previously, we expect eurozone
policymakers will accord ESM de-facto preferred creditor status in the event
of a eurozone sovereign default. We believe that the prospect of subordination
to a large creditor, which would have a key role in any future debt
rescheduling, would make a lasting contribution to the rise in long-term
government bond yields of lower-rated eurozone sovereigns and may reduce their
future market access.
We also believe that the agreement is predicated on only a partial recognition
of the source of the crisis: that the current financial turmoil stems
primarily from fiscal profligacy at the periphery of the eurozone. In our
view, however, the financial problems facing the eurozone are as much a
consequence of rising external imbalances and divergences in competitiveness
between the EMU's core and the so-called "periphery." In our opinion, the
eurozone periphery has only been able to bear its underperformance on
competitiveness (manifest in sizeable external deficits) because of funding by
the banking systems of the more competitive northern eurozone economies.
According to our assessment, the political agreement reached at the summit did
not contain significant new initiatives to address the near-term funding
challenges that have engulfed the eurozone.
The summit focused primarily on a long-term plan to reverse fiscal imbalances.
It proposed to enshrine into national legislation requirements for
structurally balanced budgets. Certain institutional enhancements have been
introduced to strengthen the enforceability of the fiscal rules compared to
the Stability and Growth Pact, such as reverse qualified majority voting
required to overturn sanctions proposed by the European Commission in case of
violations of the broadly balanced budget rules. Notwithstanding this
progress, we believe that the enforcement of these measures is far from
certain, even if all member states eventually passed respective legislation by
parliaments (and by referendum, where this is required). Our assessment is
based on several factors, including:
The difficulty of forecasting reliably and precisely structural deficits,
which we expect will likely be at the center of any decision on whether
to impose sanctions;
The ability of individual member states' elected governments to extricate
themselves from the external control of the European Commission by
withdrawing from the intergovernmental agreement, which will not be part
of an EU-wide Treaty; and
The possibility that the appropriateness of these fiscal rules may come
under scrutiny when a recession may, in the eyes of policymakers, call
for fiscal stimulus in order to stabilize demand, which could be
precluded by the need to adhere to the requirement to balance budgets.
Details on the exact content and operational procedures of the rules are still
to emerge and -- depending on the stringency of the rules -- the process of
passing national legislation may run into opposition in some signatory states,
which in turn could lower the confidence of investors and the credibility of
the agreed policies.
More fundamentally, we believe that the proposed measures do not directly
address the core underlying factors that have contributed to the market
stress. It is our view that the currently experienced financial stress does
not in the first instance result from fiscal mismanagement. This to us is
supported by the examples of Spain and Ireland, which ran an average fiscal
deficit of 0.4% of GDP and a surplus of 1.6% of GDP, respectively, during the
period 1999-2007 (versus a deficit of 2.3% of GDP in the case of Germany),
while reducing significantly their public debt ratio during that period. The
policies and rules agreed at the summit would not have indicated that the
boom-time developments in those countries contained the seeds of the current
market turmoil.
While we see a lack of fiscal prudence as having been a major contributing
factor to high public debt levels in some countries, such as Greece, we
believe that the key underlying issue for the eurozone as a whole is one of a
growing divergence in competitiveness between the core and the so-called
"periphery." Exacerbated by the rapid expansion of European banks' balance
sheets, this has led to large and growing external imbalances, evident in the
size of financial sector claims of net capital-exporting banking systems on
net importing countries. When the financial markets deteriorated and risk
aversion increased, the financing needs of both the public and financial
sectors in the "periphery" had to be covered to varying degrees by official
funding, including European Central Bank (ECB) liquidity as well as
intergovernmental, EFSF, and IMF loans.
HOW HAS THE EUROPEAN POLICY RESPONSE AFFECTED THE RATINGS?
We have generally adjusted downward our political scores (one of the five key
factors in our published sovereign ratings criteria) for those eurozone
sovereigns we had previously scored in our two highest categories. This score
change has been a contributing factor to the rating actions on the relevant
sovereigns cited above. Under the political score, we assess how a
government's institutions and policymaking affect a sovereign's credit
fundamentals by delivering sustainable public finances, promoting balanced
growth, and responding to economic or political shocks. Our political score
also captures the potential effect of external organizations on policy
settings.
It is our view that the limitations on monetary flexibility imposed by
membership in the eurozone are not adequately counterbalanced by other
eurozone economic policies to avoid the negative impact on creditworthiness
that the eurozone members are in opinion view currently facing. Financial
solidarity among member states appears to us to be insufficient to prevent
prolonged funding uncertainties. Specifically, we believe that the current
crisis management tools may not be adequate to restore lasting confidence in
the creditworthiness of large eurozone members such as Italy and Spain. Nor do
we think they are likely to instill sufficient confidence in these sovereigns'
ability to address potential financial system stresses in their jurisdiction.
In such a setting, the prospects of effectively intervening in the feedback
loop between sovereign and financial sector risk are in our opinion weak.
HOW DO YOU EXPECT MACROECONOMIC DEVELOPMENTS WILL AFFECT THE REFORM AGENDA?
We believe that the elusiveness of an effective policy response is likely to
add to caution among households and investors alike, weighing on the growth
outlook for all eurozone members. Our base case still assumes that the
eurozone will record moderate growth in 2012 and 2013, i.e. 0.2% and 1%,
respectively -- down from 0.4% and 1.2% according to our early December
forecast, with a relatively mild recession in the first half of 2012.
Nevertheless, we estimate a 40% probability that a deeper and more prolonged
recession could hit the eurozone, with a likely reduction of economic activity
of 1.5% in 2012. Furthermore, we believe an even deeper and more prolonged
slump cannot be entirely excluded. We expect this weak macroeconomic outlook
if realized would complicate the implementation of budget plans, with
slippages to be expected, which would likely further dampen confidence and
potentially deepen the recession, as funding and credit is curtailed and the
private sector increases precautionary savings.
WHAT IS YOUR VIEW OF THE LATEST DEVELOPMENTS IN GREECE AND WHAT IMPACT DO THEY
HAVE YOUR ANALYSIS?
We did not change the rating on Greece, which had been downgraded to 'CC' in
July 2011, indicating our view of the risk of imminent default. Negotiations
with bondholders have taken longer than originally anticipated and we believe
may now run close to a large redemption of €14.5 billion on March 20, 2012,
raising the specter of a disorderly default. Such an event would in our view
further complicate the restoration of affordable market access for other
sovereigns experiencing market stress. We understand that the main unresolved
issues are related to the treatment of holdouts, the participation of official
creditors, and the coupon of the new bonds that will be offered (which partly
determine the effective recovery, which we continue to expect to lie between
30% and 50%). We do not believe that private-sector involvement will
necessarily be a one-off event in the case of the Greek restructuring and
would not be sought in possible future bail-out packages in a future case of
sovereign insolvency or prolonged loss of market access. All the more so as
official lenders are less likely to bear any future losses as their lending
will be channeled through the ESM, a privileged creditor that is expected to
be senior to bondholders in any future restructuring.
HOW DOES STANDARD & POOR'S VIEW THE ECB's RESPONSE TO DATE?
In our view, the actions of the ECB have been instrumental in averting a
collapse of market confidence. We see that the ECB has eased its eligibility
criteria, allowing an ever-expanding pool of assets to be used as collateral
for its funding operations, and has lowered the fixed rate on its main
refinancing operation to 1%, an all-time low. Most importantly in our view, it
has engaged in unprecedented repurchase operations for financial institutions.
In December 2011, it lent financial institutions almost €500 billion over
three years and announced further unlimited long-term funding auctions for
early 2012. This has greatly relieved the funding pressure for banks, which
will have to redeem over €200 billion of bonded debt (excluding in some
jurisdictions sizeable private placements) in the first quarter alone. By
lowering the ECB deposit rate to 0.25%, we believe that the central bank has
implicitly tried to encourage financial institutions to engage in a carry
trade of borrowing up to three-year funds cheaply from the central bank and
purchasing high-yielding government bonds. Recent Italian and other primary
auctions suggest to us, however, that banks and other investors may still only
be willing to lend longer term to governments facing market pressure if they
are offered interest rates that, all other things being equal, will make
fiscal consolidation harder to achieve.
Reports indicate that many investors had hoped that a breakthrough at the
December summit would have enticed the ECB to step up its direct government
bond purchases in the secondary market through its Security Market Program
(SMP). However, these hopes were quickly deflated as it became clearer that
the ECB would prefer to provide banks with unlimited funding, partly with the
expectation that those liquid funds in banks' balance sheets would find their
way into primary sovereign bond auctions. This indirect way of supporting the
sovereign bond market may yet be successful, but we believe that banks may
remain cautious when being faced with primary sovereign offerings, as most
financial institutions have aimed at shrinking their balance sheets by running
down security portfolios in order to comply with higher capital requirements,
which become effective in 2012. We believe that the ECB has not entirely
closed the door to expanding its involvement in the sovereign bond market but
remains reluctant to do so except in more dramatic circumstances. In our view,
this reluctance is likely prompted by concerns about moral hazard, the ECB's
own credibility (particularly should losses mount), and potential inflation
pressures in the longer term. We think it may also be the case that the ECB
(as well as some eurozone governments) is concerned that governments' reform
efforts would falter prematurely if market pressure subsides.
We believe that the risk of a credit crunch remains real in a number of
countries as economic conditions weaken and banks continue to consolidate
their balance sheets in light of tighter capital requirements and poor market
conditions in which to raise additional equity. However, the monetary policy
actions described above may mitigate the risk of a more extreme tightening of
credit conditions, which, if it were to come to pass, could put further
pressure on economic activity and employment.
In summary, while the monetary policy reaction has not been as accommodating
as many investors may have anticipated or hoped for, we believe that it has
nevertheless provided significant breathing space during which progress on
policy reform can be made. Furthermore, the ECB may yet engage in additional
supporting steps should the sovereign and bank funding crises intensify
further. Therefore, we have not changed our monetary score on eurozone
sovereigns.
HOW DOES STANDARD & POOR'S ASSESS THE REFORM EFFORTS OF THE NEW GOVERNMENTS IN
ITALY AND SPAIN?
In our view, the governments of Mario Monti and Mariano Rajoy have stepped up
initiatives to modernize their economies and secure the sustainability of
public finances over the long term. We consider that the domestic political
management of the crisis has improved markedly in Italy. Therefore, we have
not changed our political risk score for Italy because we are of the opinion
that the weakening policy environment at the European level is to a sufficient
degree offset by Italy's stronger domestic capacity to formulate and implement
crisis-mitigating economic policies.
Despite these encouraging developments on domestic policy, we downgraded both
sovereigns by two notches. This is due to our opinion that Italy and Spain are
particularly prone to the risk of a sudden deterioration in market conditions.
Thus, we believe that, as far as sovereign creditworthiness is concerned, the
deepening of the crisis and the risks of further market dislocation that could
accompany an inconclusive European crisis management strategy more than offset
our view of the enhanced national policy orientation.
WHY WAS IRELAND THE ONLY SOVEREIGN AMONG THE SO-CALLED "PERIPHERY" NOT
DOWNGRADED?
We have not adjusted our political score backing the rating on Ireland. This
reflects our view that the Irish government's response to the significant
deterioration in its public finances and the recent crisis in the Irish
financial sector has been proactive and substantive. This offsets our view
that the effectiveness, stability, and predictability of European policymaking
as a whole remains insufficient in addressing the deepening financial crisis
in the eurozone. Excluding government-funded banking sector recapitalization
payments, the authorities have adjusted Ireland's budget by almost 13% of
estimated 2012 GDP since 2008 and plan additional fiscal savings of close to
8% of GDP for 2012-2015. All other things being equal, we view the
government's fiscal consolidation plan as sufficient to achieve a general
government deficit of about 3% of GDP in 2015. In our view, there is currently
a strong political consensus behind the fiscal consolidation program and
policy implementation so far has been extremely strong.
In our view, Ireland has the most flexible and open economy among the
"periphery" sovereigns. We believe that Ireland's economic adjustment process
is further advanced than in the other sovereigns currently experiencing market
pressures. This is illustrated by the 25% depreciation in the trade-weighted
exchange rate since May 2008 and Irish exports growth contributed positively
to the muted Irish economic recovery in 2011. However, in our view this also
leaves the Irish economy and, ultimately, the Irish government's fiscal
consolidation program susceptible to worsening external economic conditions,
which is reflected in our negative outlook on the rating.
WHAT ARE THE IMPLICATIONS FOR THE EFSF AND OTHER EUROPEAN MULTILATERAL LENDING
INSTITUTIONS?
Following our placement of the ratings on the eurozone sovereigns on
CreditWatch in December, we also placed a number of supranational entities on
CreditWatch with negative implications. These included, among others, the
European Financial Stability Fund (EFSF), the European Investment Bank (EIB),
and the European Union's own funding program. We are currently assessing the
credit implications of today's eurozone sovereign downgrades on those
institutions and will publish our updated credit view in the coming days.
RELATED CRITERIA
Sovereign Government Rating Methodology And Assumptions, June 30, 2011
Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009
Introduction Of Sovereign Recovery Ratings, June 14, 2007
RELATED RESEARCH
Standard & Poor's Takes Various Rating Actions On 16 Eurozone Sovereign
Governments, Jan. 13, 2012
Standard & Poor's Puts Ratings On Eurozone Sovereigns On CreditWatch With
Negative Implications, Dec. 5, 2011
Trade Imbalances In The Eurozone Distort Growth For Both Creditors And Debtors,
Dec. 1, 2011
European Economic Outlook: Back In Recession, published Dec. 1, 2011
Standard & Poor's RPM Measures The Eurozone's Great Rebalancing Act, Nov. 21,
2011
Who Will Solve The Debt Crisis?, Nov. 10, 2011
Ireland's Prospects Amidst The Eurozone Credit Crisis, Nov. 29, 2011
This unsolicited rating(s) was initiated by Standard & Poor's. It may be based
solely on publicly available information and may or may not involve the
participation of the issuer. Standard & Poor's has used information from
sources believed to be reliable based on standards established in our Credit
Ratings Information and Data Policy but does not guarantee the accuracy,
adequacy, or completeness of any information used.
Standard & Poor's, a part of The McGraw-Hill Companies (NYSE:MHP), is the
world's foremost provider of credit ratings. With offices in 23 countries,
Standard & Poor's is an important part of the world's financial infrastructure
and has played a leading role for 150 years in providing investors with
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