/ 19 October 2011

Spain downgrade weighs down eurozone leaders

A double-notch downgrade of Spain’s credit rating has piled pressure on European leaders to make convincing progress on solving the region’s debt crisis at an October 23 summit.

The blow from Moody’s Investors Service came just a day after the agency warned France its triple-A rating could come under pressure and as Greeks began their biggest strike in years in protest at a painful austerity drive designed to avert default.

Markets are counting down to a summit of European Union (EU) leaders on Sunday which Paris has said will deliver a decisive outcome while Berlin has been more cautious.

The Spanish rating cut, which highlighted the threat of contagion from debt-stricken Greece, tempered a sharp rally in shares on Wall Street late on Tuesday.

Germany’s Chancellor Angela Merkel warned that leaders would not solve the debt crisis at a single meeting.

“These sovereign debts have been built up over decades and therefore one cannot resolve them with one summit but it will take difficult, long-term work. Nonetheless, I do think we will also be able to take relevant, important decisions,” she said.

It’s not so simple
A French government spokesperson said Merkel and France President Nicolas Sarkozy, the leaders of Europe’s two biggest economies, would talk later on Wednesday.

“It’s obvious that the contacts between Germany and France will be constant and permanent until October 23,” said Valerie Pecresse, who is also France’s budget minister.

The hope is that Sunday’s summit will agree new steps to reduce Greece’s debt, strengthen the capital of banks with exposure to troubled eurozone sovereigns and leverage the eurozone’s rescue fund to prevent contagion to bigger economies.

Scotching a media report that said a deal had been struck between Paris and Berlin to scale up the European Financial Stability Facility (EFSF) by around five times to more than €2-trillion, a senior EU official said: “It’s wrong.”

A second source said: “It’s naive to think you can make those calculations and come up with a nice round two-trillion figure. It’s not nearly as simple as that.”

The summit is likely to agree to leverage the bailout fund by allowing it to underwrite a portion of newly issued eurozone debt, officials have told Reuters. But the details are still being thrashed out.

“I think the models to make the EFSF more flexible need … significantly more preparation,” Austria Finance Minister Maria Fekter said.

Recapitalising banks
By guaranteeing the first 20% to 30% of any losses, the EFSF could stretch three to five times further. With about €300-billion of its €440-billion capacity still available, the fund could be expanded to more than €1-trillion, enough to support the refinancing needs of Spain and Italy for at least the next year or longer and ward off market attacks.

As well as trying to strengthen the rescue fund, eurozone leaders are racing to convince banks to accept “voluntary” writedowns of up to 50% on their Greek sovereign holdings and are trying to agree on a blueprint for recapitalising financial institutions at risk from the deepening crisis.

Greece remains mired in recession and its overall debt is forecast to climb to €357-billion ($489-billion) this year, or 162% of annual economic output — which few economists believe can be paid back.

Even the mighty German economy is not immune. Government sources said that Berlin would slash its 2012 growth forecast from 1.8% down to around 1%, with the debt crisis hitting German export markets and dampening consumer spending at home.

Spanish warning
Moody’s cut Spain’s bond rating to A1, from Aa2, the third of the major agencies to act in recent weeks and taking it a notch below the ratings of Standard & Poor’s and Fitch.

The agency’s reasoning may focus minds ahead of Sunday’s summit, highlighting the lack of resolution to the currency bloc’s crisis rather than particular Spanish policy shortcomings.

“Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area’s political cohesion and growth prospects to be fully restored,” the agency said.

In a statement, Spain’s Treasury said the downgrade reflected a short-term reaction to negative eurozone debt markets, rather than a change in medium and long term economic fundamentals, adding that the government remained committed to fiscal consolidation and reform.

While Europe’s leaders rush to stop a larger writedown of Greek debt infecting others in the eurozone, for ordinary Greeks, the cuts demanded of their country in return for help means facing up to years of pain.

Greek unions began a 48-hour general strike, the biggest protest in years, as Parliament prepares to vote on sweeping new austerity measures designed to stave off default.

The strike shut government departments, businesses, public services and even providers of everyday staples like shops and bakeries and will culminate in mass demonstrations outside Parliament.

The austerity package mixes deep cuts to public sector pay and pensions, tax hikes, a suspension of sectoral pay accords and an end to the constitutional taboo against laying off civil servants.

A first vote, on the government’s overall Bill, will be held on Wednesday night, with a second vote on specific articles expected some time on Thursday. It is expected to pass even though Greece has sunk deeper into crisis, despite repeated doses of austerity.

“None of my colleagues, who have been through a lot lately, will risk letting the country fall from our hands and break, go bankrupt,” Development Minister Mihalis Chrysohoidis said. — Reuters