The big news out of Europe over the weekend was the downgrading of Belgium by Moody’s (h/t a63 who called it):
Belgium’s credit rating was cut two steps by Moody’s Investors Service, which said rising borrowing costs, slowing growth and liabilities from Dexia SA’s breakup (DEXB) threaten to inflate the euro area’s fifth-highest debt load.
Moody’s lowered Belgium’s debt rating to Aa3, the fourth- highest investment grade, from Aa1, with a negative outlook, the ratings company said yesterday. The action follows Standard & Poor’s one-step downgrade of Belgium to AA on Nov. 25.
We also saw some action from Fitch with a rating review of Europe in which they took a swipe at nearly half of the Eurozone:
France’s credit outlook was lowered by Fitch Ratings, which also put the grades of nations including Spain and Italy on review for a downgrade, citing Europe’s failure to find a “comprehensive solution” to the debt crisis.
Fitch affirmed France’s AAA rating and placed Spain, Italy, Belgium, Slovenia, Ireland and Cyprus on a “Rating Watch Negative” review, which it expects to complete by the end of January
An interesting sideshow to the rating agencies work has been the politicking between Paris and London. It was obvious from the latest summit that there was tension between the two cities and it wouldn’t be long before it started to deteriorate. It began after the head of the French central bank made comments that the rating agencies were making decisions based on politics not economics and that UK should be the place to start downgrades:
“A downgrade doesn’t strike me as justified based on economic fundamentals,” Bank of France Governor Christian Noyer told Le Telegramme, a newspaper based in Brittany. “Or if it is, they should start by downgrading the U.K., which has a bigger deficit, as much debt, more inflation, weaker growth and where bank lending is collapsing.”
Obviously it is completely ludicrous for a central banker to claim that rating agencies should separate political risk from economics in credit ratings. France, a country without monetary sovereignty, is now looking to enter into an agreement to significantly reduced its fiscal sovereignty. This comes with significant credit risk because the national government could become authoritatively detached from the nation’s treasury along with the central bank. We have already seen the issues with the detachment of nations from their monetary sovereignty within Europe and this new move adds an additional layer of risk. I don’t deny that the UK has its own economic problems but the fact that its national government is able to apply counter-cyclical monetary and fiscal policy in times of an economic downturn makes them far less of a credit risk than nations who have given up that right.
Mr Noyer’s statements were followed up with some more comments by the French PM in which he seemed to once again claim that rating agencies should downgrade the UK first:
French Prime Minister Francois Fillon on Thursday questioned why credit ratings firms haven’t taken a closer look at their scores for the U.K., which he said is in a worse position than some of its neighbors.
The euro zone faces “a challenge with relation to the European currency first and foremost because we’re very indebted,” Fillon said at an here at the start of a trip to Brazil.
“But we’re not the only ones. Our British friends have a higher deficit and more debt, and I would say that the ratings agencies have not yet noted that,” Fillon said.
This was followed by a barrage of back and forth comments from various French and English politicians leading to a phone conversation between the French PM and the UK Deputy PM in an attempt to patch up relations:
Fillon made clear it had not been his intention to call into question the UK’s rating but to highlight that ratings agencies appeared more focused on economic governance than deficit levels.
The Deputy Prime Minister accepted his explanation but made the point that recent remarks from members of the French Government about the UK economy were simply unacceptable and that steps should be taken to calm the rhetoric.
Hopefully that is the end of it, but I am doubtful.
Late last week, Reuters got hold of the most recent version of the new fiscal compact. The most important part was:
There is also a stipulation that countries should aim to keep their primary deficits — which exclude the cost of debt financing — below 0.5 percent of GDP over the economic cycle, an objective that has been called ‘the golden rule’.
Participating countries that fail to meet the targets can be taken to the EU’s highest court, the European Court of Justice — an effort to enforce much stricter and more automatic sanctions on those that breach rules that have all too often been violated in the past, including by France and Germany.
“Any contracting party which considers that another contracting party has failed to comply… may bring the matter before the Court of Justice of the European Union,” article 8 of the 14 article draft agreement states.
“The judgment of the Court of Justice of the European Union shall be binding on the parties in the procedure, which shall take the necessary measures to comply with the judgment within a period to be decided by said court.”
That rule raises the possibility of Germany or another participating member state dragging another before the ECJ if there is a feeling that they have not done enough to transpose the stricter budget rules into national law.
The proposal also says that the fiscal compact would come into effect across the Eurozone once nine members have ratified it. Members could then agree to join on a per-country basis:
Once nine euro zone countries have ratified the deal, it will come into force and it will be binding on each subsequent country that ratifies it — that means that Greece, for example, may not have to ratify it for months or even years, even if the pact has already come into force for the rest of the euro zone.
I seriously cannot believe that Europe would make such a decision without requiring a referendum, but I have stated before I am surprised by the lack of democracy in modern Europe. Everyone involved needs to think long and hard about making such a decision. Ireland is a net exporter and is therefore already competitive in the euro, but not even it seems to be able to drag itself forward under the weight of austerity and the country’s outlook continues to be poor:
The government doesn’t have any room to manoeuvre in terms of spending the bailout money if it wants to hit its bailout programme targets (which are based on overly optimistic GDP figures, so will be more difficult to hit than the government expects). All the bailout money is going towards financing the deficit and debt.
Noonan said yesterday that the plan is for Ireland to issue a lot of debt in the markets in 2012 (it has to issue a little in the markets next year but then a lot in 2013 according to the bailout programme, so significant issuance next year would reduce the huge funding hump in 2013). Irish bond yields have decoupled from the other bailout countries’ and have come down, but still exceed 8%, which is completely unsustainable.
With unemployment soaring, domestic demand plummeting and Ireland’s 3 biggest export markets – the UK, the US and the eurozone – either going into stall speed or recession, I don’t think there’s any chance Ireland can return to the markets for long-term debt next year.
Ireland will therefore either need another bailout in the same fashion as Greece next year to cover its funding costs, or it will face a bail-in (debt restructuring). Considering that Greece is likely to default and exit the eurozone towards the end of next year, Ireland may choose to default rather than accept the conditionality of another bailout. If other weaker eurozone countries aren’t making their creditors whole, the Irish may wonder why they are going through such a painful structural adjustment to do so
In other news, Monti got his austerity package through the Italian parliament and we all have another Eurozone fin-min teleconference to look forward to tonight.