Monday, September 26, 2011

Larger Europe bailout fund could weigh on ratings-S&P

WASHINGTON: Europe's efforts to ramp up its fight against the euro zone debt crisis could potentially trigger credit rating downgrades in the region, a top Standard & Poor's official warned on Sunday, Sept 25.

David Beers, the head of S&P's sovereign rating group, said it is still too soon to know how European policymakers will boost the European Financial Stability Facility, how effective that will be and its possible credit implications.

But he said the various alternatives could have "potential credit implications in different ways," including for leading euro zone countries such as France and Germany.

European officials, seeking more resources to protect the euro zone against fallout from its debt crisis, are considering ways to increase the impact of the 440 billion-euro fund by leveraging, although it remains unclear exactly how.

Beers said it was evident, however, that policymakers cannot leverage the EFSF without limits.

"There is some recognition in the euro zone that there is no cheap, risk-free leveraging options for the EFSF any more," Beers told Reuters.

Some analysts say at least 2 trillion euros would be needed to safeguard Italy and Spain if the Greek crisis spreads.

"We're getting to a point where the guarantee approach of the sort that the EFSF highlights is running out of road." Beers said in an interview late on Saturday.

Euro zone member states provide guarantees to the EFSF, which makes loans to struggling member countries such as Greece. But countries such as Germany have signaled they will not commit to making more of their own money available.

Beers said that reluctance is why policymakers are now discussing options such as leveraging the fund via the European Central Bank or via markets, or even the possibility of deeper fiscal integration in the euro zone.

Beers declined to comment on implications of each of the scenarios for boosting the EFSF.

However, one option could involve backing up the fund with money from the European Central Bank, eliminating the need for politically unpopular cash injections from hard-up European governments.

That solution, although potentially reducing the impact on sovereign ratings, would probably increase liabilities in the ECB's balance sheet and possibly leave euro zone countries on the hook for restoring the bank's capital in the event of losses caused by an euro zone default.

Leveraging the EFSF could also result in a downgrade of its own AAA credit rating.

A deeper fiscal union between members of the euro zone, on the other hand, would increase borrowing costs for core European countries such as France and Germany, while providing relief to the more debt-heavy peripheral countries.

S&P's warning echoes concerns expressed by some European policy-makers at semiannual meetings this weekend at the International Monetary Fund and World Bank in Washington .

"We should not think of leveraging a public pot of funds as a free lunch," ECB Governing Council member Patrick Honohan told reporters.

S&P, which cut Greece's credit rating deeper into junk territory in July, believes European policymakers are also finally realizing that Greece's debt restructuring will take place with significant haircuts.

"Therefore, there are going to be some banks that might require additional capital," Beers said.

S&P believes, however, that banks can still raise money in the market rather than relying only on government support.

"The banks have to go out and talk with potential investors. There have been interesting developments this year, certainly banks in Europe have been raising capital," Beers said in the interview.

RECESSION RISK

On the economic outlook, S&P sees rising risks of recession in the United States and parts of Europe as their economies struggle to recover at the same time that major emerging market countries such as China and India tighten monetary policies.

The implications of a double-dip recession for ratings of developed countries would depend on how governments respond to the crisis of confidence that is at the root of the economic weakness, Beers said.

That response, he added, needs to go beyond lowering fiscal deficits and should include addressing market concerns about bank capital cushions and focusing on the structural drivers of the fiscal deficits, typically health care and state pensions.

"If governments are unable to focus on the long-standing impediments to growth, then austerity alone is not going to give you growth," Beers said, citing the case of Italy.

He also had a warning for Germany. Many economists, he said, had initially overestimated the country's growth performance for this year and are finally realizing that its fate is "inexorably linked to that of all its neighbors."

"The idea that they could somehow decouple is now mostly discredited in terms of both its growth performance and, to some degree, their fiscal performance."

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