Downgrades give Germany upper hand to avert euro crash

By Catherine Field

The credit-rating downgrades that struck Europe at the weekend may have few immediate financial consequences but will have a resounding impact on political efforts to haul the continent out of crisis, say analysts.

The downgrade mostly affects southern members of the 17-economy eurozone. As a result, northern countries, led by Germany, will gain the upper hand in crucial talks to avert the single currency's crash, they say.

The US agency Standard and Poor's cut France and Austria's AAA rating by one notch to AA+, scaled back its long-term ratings on Cyprus, Italy, Portugal and Spain by two notches and its ratings for Malta, Slovakia and Slovenia by one notch.

Credit ratings help determine a country's ability to borrow at affordable rates. A lower rating means the country is considered a relatively riskier prospect, and so the interest rates rise accordingly.

This lesson was painfully learned by Greece, Spain and Italy last year. After gorging for years on easy debt, they suddenly became viewed by markets as risky bets.

Their cost of borrowing flared, adding to a chronic debt burden and driving their governments into unpopular austerity programmes. Greece, and then Italy, moved closer to default, and with it the prospect that the world's second biggest currency would collapse.

S&P's downgrades are an official acknowledgement of last year's market sentiment, the Wall Street Journal said in a commentary.

"They reflect a reality that the market has been dealing with for months: the eurozone crisis is deep, difficult and here to stay. A downgrade adds a little to the challenge but doesn't change the big picture."

On the political front the big loser is French President Nicolas Sarkozy. He refused to introduce austerity when the global financial crisis broke in 2008 and instead went on a borrowing spree to buoy growth.

As the debt burden surged, he unwisely declared France's triple-A, which the country has held since 1975, as a line in the sand. When the markets fought back, Sarkozy had to introduce two rounds of belt-tightening, both of them very modest but widely disliked.

With the loss of the triple-A, Sarkozy's future looks bleak. Elections loom in April, and he is already way behind Socialist challenger Francois Hollande in the opinion polls and facing an emerging threat on the right from Marine Le Pen, daughter of extremist leader Jean-Marie Le Pen.

Sarkozy's fumble means he has also lost ground at a critical point in Europe in the negotiations to frame a "fiscal pact" aimed at stopping the single currency from unravelling.

Conceived hastily at an EU summit in December, the "pact" would stop countries from running up unsustainable debts that imperil other economies sharing the currency.

Its broad lines were conceived by Sarkozy in alliance with German Chancellor Angela Merkel. But their relationship has been fractious. To Merkel's anger, Sarkozy argued against too much European control over national budgets and against German plans for the European Court of Justice to punish deficit junkies.

He also pleaded for the European Central Bank to become a lender of last resort to distressed economies. S&P's downgrade is thus an emphatic victory for Merkel's philosophy of stern and disciplined housekeeping, a doctrine shared by Finland, Luxembourg and the Netherlands - which like Germany have kept their AAA - and by Austria.

Even so, the outcome remains unclear, the Royal Bank of Scotland said in an analysis for clients.

"Germany comes out as a clear winner and will have its position at the negotiating table strengthened even further. Likewise, France's position at the European negotiating table is likely to be weakened vis-a-vis Germany," it said. "This might render future negotiations surrounding fiscal integration even more difficult."

Finance ministers meet in Brussels on January 24, to be followed by an EU summit on January 30. The aim is to sign the pact by March. If the northern countries push their approach too far, a split could happen.

Storm clouds are gathering anew over Italy because of the downgrade - and failure to forge a deal with creditor banks means Greece is moving back to the cliff edge of default.

Overall, the picture points to a monetary union that will gather only northern European countries, says Frits Bolkestein, a former EU commissioner.

The Dutchman has already thought of a new designation: the "neurozone".

- NZ Herald

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