Standard & Poor’s rationale for latest sovereign ratings cuts

Ratings agency Standard & Poor’s has sought to justify lowering the long-term ratings on nine European nations. We print below excerpts of the arguments it made for Friday’s downgrades.

It cut ratings on Cyprus, Italy, Portugal, and Spain by two notches, and of Austria, France, Malta, Slovakia, and Slovenia, by one notch.

It said there was at least a 33% chance ratings on Austria, Belgium, Cyprus, Estonia, Finland, France, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, and Spain would be cut this year or 2013.

“Today’s rating actions are primarily driven by our assessment that 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. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt 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.

“The outcomes from the EU summit on 9 December 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone’s financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

“A reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

“On the other hand, we believe that eurozone monetary authorities have been instrumental in averting a collapse of market confidence. We see that the European Central Bank has successfully eased collateral requirements, allowing an ever expanding pool of assets to be used as collateral for its funding operations, and has lowered the fixed rate to 1% on its main refinancing operation, an all-time low. Most importantly in our view, it has engaged in unprecedented repurchase operations for financial institutions, greatly relieving the near-term funding pressures for banks.”

“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 at sustainable rates.

“There is a risk 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 us to the view that lower levels of predictability exist in policy orientation, and thus to a further downward adjustment of our political score.

“The ratings on the eurozone sovereigns remain at comparatively high levels, with only three below investment grade – Portugal, Cyprus, and Greece. Historically, investment-grade-rated sovereigns have experienced very low default rates. From 1975 to 2010, the 15-year cumulative default rate for sovereigns rated in investment grade was 1.02%, and 0% for sovereigns rated in the ‘A’ category or higher. During this period, 97.78% of sovereigns rated ‘AAA’ at the beginning of the year retained their rating at the end of the year.”

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