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S&P Downgrades Eurozone Countries As Investors Avoid Eurozone Government Debt

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Standard & Poor's Ratings Services slashed the credit ratings of nine eurozone countries on Friday, marking a deterioration in confidence in the troubled eurozone.

S&P stripped France and Austria of their gold-plated AAA ratings, downgrading them to AA+, and downgraded Italy and Spain two notches to BBB+ and A, respectively. It also downgraded Portugal and Cyprus to junk, or non-investment grade, ratings: BB and BB+ respectively. Slovenia was downgraded to A+ from AA-, Slovakia was downgraded to A from A+ and Malta was downgraded to A- from A.

"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," S&P said in a statement on Friday.

Some Northern eurozone countries avoided a downgrade, such as AAA-rated Germany, the AAA-rated Netherlands and AA-rated Belgium. Ireland's BBB+ rating also did not take a further hit, though its outlook is negative.

S&P emphasized that more downgrades were likely. It has placed 14 eurozone countries on negative outlook, including France -- the second-largest economy in Europe -- Belgium, Italy, Spain and even the AAA-rated Netherlands and Finland. Just Slovakia and Germany -- Europe's largest economy and the leader in the eurozone debt crisis talks -- escaped from a negative outlook.

Unlike during S&P's downgrade of the U.S.'s credit rating, which investors largely ignored as they continued to buy U.S. debt, European investors this time have preempted the rating cuts by already pulling investments out of the eurozone.

Though the news had been expected for weeks, American and European stocks fell on Friday. The S&P fell 0.49 percent, the DAX in Germany fell 0.58 percent and the FTSE 100 in Britain fell 0.46 percent. The euro plunged 1 percent to $1.2684, near a 16-month low, according to Bloomberg. Investors also sold off Italian and Spanish government bonds, driving up the interest rate on 10-year Italian government debt to 6.74 percent as of 4:40 p.m. EST, according to The Financial Times.

Investors and economists told The Huffington Post that European leaders simply are not focused on the essentials for investor confidence -- such as economic growth and a credible backstop for European governments -- as the European Central Bank maintains its hardline stance against buying much government debt and the eurozone plunges into recession.

Maurice Obstfeld, international economics professor at the University of California at Berkeley, said that the credit rating downgrades will exacerbate the European debt crisis by making it more expensive for eurozone countries to borrow. He said that since eurozone countries do not print their own money, they have a more serious risk of defaulting on their debts.

According to Obstfeld, the intensification of the crisis in Europe will both hurt American exports and also increase the likelihood of a financial crisis spreading to the United States.

If France and Italy, two of the eurozone's three largest economies, come under more funding pressure, "the problems are very dire indeed," Obstfeld said.

The real issue is that eurozone countries are being cut off from market funding and may yet suffer from a prolonged recession, said Jonathan Lemco, principal and senior analyst at Vanguard, an investment company.

"In the absence of clarity, why get involved?" Lemco said. He said plenty of safer government debt is being issued elsewhere, and as long as the European Central Bank does not provide backstop funding for governments and economic growth does not appear likely, investors will continue to avoid eurozone countries.

On the other hand, Nicholas Economides, economics professor at New York University's Stern School of Business, told The Huffington Post on Friday that it is a positive development that S&P is issuing credit ratings that are "more reflective of reality." He said the move will place more pressure on European politicians to do what is necessary to avoid a financial crisis potentially worse than the one in 2008.

"This is good for the European Union, and it is also good for the rest of the world," Economides said. "The United States would like the Europeans to take more seriously their own crisis and deal with it."

Bart van Ark, chief economist at the Conference Board, said that investors are concerned that leaders of Germany -- the leading eurozone economy -- are pursuing priorities in the wrong order. He said that first, the European Stability Mechanism should triple in size to 1.5 trillion euros, or $1.9 trillion, as a backstop for troubled governments, then the eurozone should become fiscally integrated. But instead, Germany is trying to implement tougher penalties for countries that exceed deficit limits. When someone is drowning, a lifeguard should not insist that the drowning person learn to swim before saving him, he said.

"The timing of what they want to do is wrong," van Ark said.

Valentijn van Nieuwenhuijzen, head of macroeconomic strategy at ING Investment Management, said that three preconditions are essential for investors to be confident enough to invest in the government debt of countries such as Italy, Spain, Portugal and Ireland.

Van Nieuwenhuijzen said that first, the ECB needs to act as a lender of last resort for governments, even if through another institution such as the International Monetary Fund. Second, the eurozone needs to be set on a path toward economic growth, ideally driven by a two-year stimulus in Northern European countries led by Germany, which would boost exports from Southern Europe to Northern Europe and support economic growth throughout the eurozone. Third, the eurozone needs to become more fiscally integrated and commit to implementing more economic reforms that would make Europe more competitive.

"What is misperceived by a lot of policymakers and commentators is that investors only want fiscal reform," van Nieuwenhuijzen said. "It's still a very popular political ploy along with this fantasy that fiscal austerity will generate expansion in the real economy.... There is no global support of this theory in academia, but still it's very popular."

Germany still seems far from pursuing a stimulus plan. Jens Weidmann, head of the German central bank, recently said that he wants Germany to do no new borrowing, even though investors now are paying Germany for some government bonds.

Weidmann recently told the Tagesspiegel newspaper in Germany, ''We must quickly achieve a structurally balanced budget.''

This story has been updated from its original version to reflect S&P's official announcement Friday of its downgrades and outlook for eurozone countries.

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