EXPLAINING THE DOWNGRADE OF CREDIT RATING

While Standard & Poors (S&P) is largely being blamed for the downgrade of credit rating, it may be useful to understand the basis of its assessment. After all Standard & Poors is only a messenger.

According to S&P the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address systemic stresses in the eurozone including (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issues, (3) a simultaneous attept to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.

Furthermore, S&P is of the opinion that the agreement from the EU summit on 9 December 2011 and subsequent statements from policymakers has not produced a breakthrough of sufficient size and scope to fully address the eurozone's financial problems such as supplying sufficient additional resources for operational flexibility to bolster European rescue operations or extending enough support for those eurozone sovereigns subjected to heightened market pressures.

From S&P's perspective the agreement among EU countries is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. However, in S&P's  view the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called "periphery" and therefore the reform process based on a pillar of fiscal austerity alone risks becoming self-deafeatng, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues.

Importantly, S&P believes that the effectiveness, stability and predictability of European policymaking and political institutions have not been as trong as it should be given the severity of a broadening and deepening financial crisis in the eurozone.

S&P sees that refinancing costs for certain countries may remain elevated, that credit availability and economic growth may further decelerate and that pressure on financing conditions may persist.

Also S&P believes that the main downside risks that could affect eurozone sovereigns to various degrees are related to the possibility of further significant fiscal deterioration as a consequence of a more recessionary macroeconomic environment and/or vulnerabilities to further intensification and broadening of risk aversion among investors, jeopardizing funding access ar sustainable rates. Also a more severe financial and economic downturn could also lead to rising stress levels in the European banking system, potentially leading to additional fiscal costsfor the sovereigns through various bank workout or recapitalization programmes. There is also a risk according to S&P that reform fatigue could be mounting, especially in those countries that have experienced deep recessions and where growth prospects remain bleak which could eventually lead to lower levels of predictability in policy orientation.

• France: Downgraded by one notch, from AAA to AA+ . Negative Outlook
• Austria: Downgraded by one notch, from AAA to AA+ . Negative Outlook
• Malta: Downgraded by one notch, from A to A- . Negative Outlook
• Slovenia: Downgraded by one notch, from AA-to A+ . Negative Outlook
• Cyprus: Downgraded by two notches, from BBB to BB+. Negative Outlook
• Italy: Downgraded by tow notches, from A to BBB+. Negative Outlook
• Portugal: Downgraded by two notches, from BBB- to BB. Negative Outlook
• Spain: Downgraded by two notches, from AA- to A. Negative Outlook
• Slovak Republic: Downgraded by one notch, from A+ to A. Stable Outlook
• Belgium: Unchanged at AA. Negative Outlook
• Finland: Unchanged at AAA. Negative Outlook
• Ireland: Unchanged at BBB+. Negative Outlook
• Luxembourg: Unchanged at AAA. Negative Outlook
• The Netherlands: Unchanged at AAA. Negative Outlook
• Germany. Unchanged at AAA. Stable Outlook