Chancellor Angela Merkel said euro-area downgrades by Standard & Poor’s reinforce Germany’s stance that European leaders must redouble their efforts to resolve the debt crisis as governments prepare to sell more debt this week.
“The decision confirms my conviction that we have a long way ahead of us before investor confidence returns,” Merkel told reporters yesterday in Kiel. Resolving the crisis is a “longer process” that will take more than a few months, Merkel said in comments broadcast today by Deutschlandfunk radio.
Germany was left with the euro-area’s only stable AAA rating as S&P stripped France and Austria of their top credit grades, citing “insufficient” policy steps to combat the debt crisis. The decision to include France among the nine sovereign downgrades was “disappointing” even if expected, French Prime Minister Francois Fillon said, noting that the market response in advance of the announcement late on Jan. 13 “was muted.”
The S&P verdict on France shouldn’t be “dramatized” or “politicized,” Fillon said at a news conference in Paris yesterday. “The rating agencies won’t decide our policies.”
France sells as much as 8.7 billion euros ($11 billion) in bills tomorrow, offering the first gauge of the decision’s impact. History suggests the reaction may be limited. Ten-year yields for the nine sovereign borrowers that lost their AAA ratings between 1998 and the U.S.’s downgrade in August rose an average of two basis points in the following week, according to JPMorgan Chase & Co.
“I think we will still have to fight for a while with the fact that investors haven’t regained full confidence in the euro,” Merkel said in the radio interview today. Debt-cutting steps being taken by the new Italian and Spanish governments will “convince markets in the medium term,” she said.
Merkel said yesterday in Kiel that the S&P downgrades won’t “torpedo” efforts to provide financing to indebted member states by weakening the current bailout fund, the European Financial Stability Facility. The EFSF could provide firepower even if its creditworthiness sinks below AAA status, she said.
“I was never of the opinion that the EFSF necessarily has to be AAA,” Merkel said. “AA+ is also not a bad rating,” Merkel said, citing a remark made by French Finance Minister Francois Baroin.
Germany and France are pushing for stricter budget rules as the bedrock of European governments’ response to the debt crisis that emerged in Greece in late 2009 and is now buffeting Spain and Italy. Merkel and French President Nicolas Sarkozy will meet with Italian Prime Minister Mario Monti in Rome on Jan. 20 to prepare for a European summit 10 days later.
Greek Debt-Swap Talks
Threatening to overshadow the Rome meeting are Greek debt swap talks that stalled two days ago and may resume Jan. 18.
Merkel today in her radio interview urged the Greek government to make good on debt-cutting commitments and banks to uphold their pledges of a debt writedown made in October.
There is the “expectation that Greece implements the measures it has accepted,” Merkel told Deutschlandfunk. At the same time, she said she expects the International Institute of Finance, the negotiator for the banking industry, “keep to its commitments,” including a 50 percent writedown of Greek debt.
Greece aside, S&P acted at the end of a week in which signs grew that Europe’s woes may be cresting as borrowing costs fell, evidence of economic resilience emerged and the European Central Bank said it had quelled a credit crunch at banks.
S&P cited the propensity of European leaders to be behind the curve in their response to the crisis as one reason for the decision.
“The policy response at the European level has not kept up with the rising challenges in the euro zone,” Frankfurt-based Moritz Kraemer, S&P’s managing director of European sovereign ratings, said in a conference call yesterday.
While policy makers have engaged in an “open and prolonged dispute” over the appropriate course of action, the ECB has been “using its flexibility” through its decisions to lower interest rates, aid banks and step up sovereign bond purchases, he said. “For the time being they have had a constructive role.”
Investors ignored S&P last year when it cut the U.S. to AA+ in August as the company argued that the failure up to then of Democrats and Republicans to agree on budget cuts made the U.S. less creditworthy. Seven weeks after the downgrade, the yield on the benchmark U.S. government bond fell to a record 1.6714 percent.
Contrast With U.S.
One difference is that the U.S., unlike France, is prepared to print money, making it easier for the world’s largest economy to pay its debts.
“The U.S. is still rightly seen as a safe haven,” Fredrik Erixon, director of the European Centre for International Political Economy in Brussels, said by phone. “The U.S. is a big liquid economy with a strong tradition of honoring its debts in modern time and a central bank pledged to taking action if needed. It’s different with France in the sense that they cannot rely on strong central bank policies.”
Germany has aligned itself with ECB in warning fellow member states not to weaken the tougher debt rules outlined in the so-called fiscal pact being drafted for the Jan. 30 summit.
ECB Executive Board member Joerg Asmussen said in a letter to negotiators last week that euro-area governments are diluting the pact. From the ECB’s perspective, recent changes in a text aimed at translating the agreement into an international treaty “imply a substantial watering-down of the earlier draft proposal,” he said.
“These revisions in my view clearly run against the spirit of the initial general agreement on an ambitious fiscal compact,” Asmussen said in the letter.
Spanish Prime Minister Mariano Rajoy, responding to Spain’s downgrade in a speech in Malaga yesterday, pledged spending cuts and a banking-system cleanup, as well as a “clear, firm and forceful” commitment to the euro’s future.
Merkel, who convened with leaders of her Christian Democratic Union for a strategy meeting, said the S&P decision won’t unduly force Germany to increase financing for the bailout package. European leaders must now quickly set up the permanent fund, the European Stability Mechanism, which is due to replace the EFSF this year, a year ahead of schedule.
German Foreign Minister Guido Westerwelle called the S&P announcement an “artificially produced” setback that emerged just as leaders’ efforts were beginning to bear fruit. In an e-mailed statement, he said he’ll step up efforts with euro-member states to create a European ratings company.
Michael Fuchs, the CDU’s ranking floor member for economic issues, said the downgrades were “arbitrary Anglo-Saxon politics that don’t square with the efforts of countries including France” to take aim at state spending.
“At the same time, the rating moves show we daren’t weaken the terms of the fiscal pact,” Fuchs said in an interview in Kiel. “The days of writing in escape clauses for fiscal austerity must be over; the stakes are too high.”