Monday, 13 February 2012
S&P expects Eurozone to stay together as growth returns
Standard & Poor's (S&P) does not expect the Eurozone to break up, adding that it should gradually climb out of its current mild recession in the second half of this year and into 2013. The rating agency projects flat GDP growth for the Eurozone as a whole in 2012 and 1% growth in 2013, although it has currently assigned a 60% probability to its forecast.
Last month S&P lowered nine Eurozone country ratings including France. According to S&P, 15 out of the 17 Eurozone ratings have a negative outlook, with only the Slovak Republic and Germany having stable outlooks. S&P has also downgraded the EU bailout fund, The European Financial Stability Facility, to AA+ from AAA.
In a briefing, Frank Gill, Senior Director, European Sovereign Ratings at S&P, said that one of the triggers for the downgrades was domestic policy making. In particular whether policies, such as deregulating the labour market and professional services, are implemented to restore competitive-ness in countries such as Spain, Italy and Portugal.
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Another trigger was fiscal policies, he said, ‘in those countries that don’t have any remaining fiscal space, which have high levels of public debt and that have to meet consolidation targets, including Italy and Portugal.’
“Despite the extraordinary response by the European Central Bank (ECB) through the LTROs (Long Term Repo Operation), which we think buys time for policymakers but doesn’t replace the necessary structural surgery, we still see credit conditions deteriorating in places like Italy and France that will weaken domestic demand. That makes it very difficult to project what the fiscal outcome will be this year in those countries,” he added.
Mr Gill said that S&P’s expects an orderly default in Greece, that there will be a debt restructuring, that the March 20th debt repayment will be paid on time, and in full, and that there will be a haircut imposed on private sector holders of Greek debt.
However, he pointed out that it is only a small sub-component of the outstanding commercial debt. The question is, he said, whether debt levels after this will really be reduced to sustainable levels in Greece.
Mr Gill added that a Greek exit form the Eurozone would bankrupt financial sector and force the economy to adjust even more rapidly than it is currently doing because it would not have access to the lender of last resort, the ECB. “So our baseline expectation is that Greece remains in the Eurozone,” he said.
But what about the possible effect on Germany? Germany is rated AAA with a stable outlook and general government debt is around 80% of GDP. “To weaken Germany’s debt score would require not a contingent liability but an explicit liability, i.e. an increase in general government debt of 20% of GDP,” said Mr Gill.
The impact of an exit by a single member of the Eurozone would depend, for example, on Germany’s contingent liability to the European Stability Mechanism, and how much they would explicitly have to take on in additional debt, he said.
“But potentially you could see pressure on even Germany’s rating. But we don’t see that as likely in 2012 or 2013, or at least what we are saying is there is a less than one in three possibility of an explicit liability of that size for Germany,” said Mr Gill. However, he stressed that in making its ratings S&P’s underlying assumption is that the Eurozone will not break up.
Asked about the difference in ratings between Italy and France he explained that although Italy ran a primary fiscal surplus last year, general government debt is about 120% of GDP and GDP itself has been stagnating for nearly a decade. In France, general government debt is roughly 80% of GDP, and S&P’s view is that there will be GDP growth this year of roughly 0.5%. However, Mr Gill added that S&P believes there is a 40% probability of a recession across the Eurozone in 2012, which would mean a contraction in France.
On the issue of the UK’s rating, he explained that the country has a medium term fiscal consolidation plan, and has benefitted from having a floating exchange rate, as well as borrowing in the currency that it prints. “We feel it is a very flexible economy,” he said.
“If you look at some of the labour reforms that have yet to be implemented in some Eurozone countries, these were implemented quite a long time ago in the UK and you are seeing an adjustment in the current account deficit which is now trending below 2.5% of GDP. And most of this is being funded by foreign direct investment inflows.”
He added, however, that ‘this is not to say there aren’t clear questions about growth prospects in the UK and about what the Eurozone crisis means for growth and the ability to meet the ambitious fiscal consolidation plans.
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