Sunday, 5 February 2012

14th January - 'Au revoir' AAA

On the 14th January, France finally - and officially - lost its AAA credit rating. Had Sarkozy not made such a fuss about the importance of retaining it last year, it might not have been such a big deal. As it is, reports speak of Eurozone doom and little else. In total, nine countries in the Eurozone were downgraded; Italy, Spain, Cyprus and Portugal were cut two notches, with the latter two given "junk" ratings. Austria, Slovakia, Slovenia and Malta were the other countries downgraded. Germany kept its AAA rating.

But what do the downgrades mean? The sovereign debt rating is an instrument designed to gauge the likelihood of a state being able to repay its debts. There are several considerations that come into play here, discussed in another post. But here's where France and the UK differ - if the UK runs into problems repaying debts, the Bank of England can print more money and off we all go. The government has shown that it is not afraid to turn to quantitative easing, and this is an important reason why the UK - even with current debt levels - is much less likely to default that France, regardless of the devaluation that occurs. Germany has repeatedly blocked moves to allow the European Central Bank to print Euros, so France only has a finite supply. Considering Germany's experience with hyper-inflation in the 1920s, this is understandable, but leaves the Eurozone in a difficult situation.

Moreover, considering France was one of the main backers of the EFSF, the loss of a French AAA rating clearly had implications for the future of the fund. Two days later Standard & Poor's downgraded the EFSF from AAA to AA+. The loss of AAA ratings effectively reduced the fund's AAA rated guarantees from €440 billion to €260 billion. Approximately €40 billion of this will go to bailing out the Irish Republic and Greece, while €100 billion had been ear-marked for a second Greek bailout. Due mainly to procrastination and posturing on the part of Eurozone leaders, this latter has now risen to an expected €145 billion, however Greece is currently under huge pressure to implement further austerity reforms before this second bailout will be agreed.

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