Ratings agency Moody's Investors Services has revised its outlook for the top-notch ratings of Germany, the Netherlands and Luxembourg on the basis of potentially increased costs for supporting Spain, whose state of economic crisis deteriorated yesterday.
Ratings agency Moody’s Investors Services has revised its outlook for the top-notch ratings of Germany, the Netherlands and Luxembourg on the basis of potentially increased costs for supporting Spain, whose state of economic crisis deteriorated yesterday.
Moody’s cut from stable to negative its outlook on the three core European countries’ Aaa sovereign ratings, as all are affected by “the rising uncertainty regarding the outcome of the euro area debt crisis given the current policy framework, and the increased susceptibility to event risk stemming from the increased likelihood of Greece’s exit from the euro area, including the broader impact that such an event would have on euro area members, particularly Spain and Italy.”
These nations each banned short selling of various financial instruments temporarily yesterday as yields on their long-term debt exceeded 6%.
Spain’s debt yield reached 7.4% yesterday, ahead of further plans to test the market by raising more debt in Madrid today.
Moody’s said: “The continued deterioration in Spain and Italy’s macroeconomic and funding environment has increased the risk that they will require some kind of external support. The scale of these contingent liabilities is of a materially larger order of magnitude for these countries due to their size and their debt burdens; for example, the size of Spain’s economy and government bond market is around double the combined size of those of Greece, Portugal and Ireland. “
Of Germany it noted: “The material risk of a Greek exit from the euro area exposes core countries such as Germany to a risk of shock that is not commensurate with a stable outlook on their Aaa rating. The elevated event risk in turn increases the probability that the contingent liabilities will eventually crystallise, with Germany bearing a significant share of the overall liabilities.
Moody’s said even if core Europe does not suffer a Greek exit with contagious effects on other peripheral nations, “there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required.
“Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form”.
Germany’s contingent liabilities stem from bilateral loans, the EFSF, the European Central Bank via the holdings in the Securities Market Programme and the Target 2 balances, and, once established, the European Stability Mechanism.
Moody’s also pointed to the German banking system’s “vulnerability to the risk of a worsening of the euro area debt crisis” as another reason for its ratings action.
“German banks have sizable exposures to the most stressed euro area countries, particularly to Italy and Spain. Moody’s cautions that the risks emanating from the euro area crisis go far beyond the banks’ direct exposures, as they also include much larger indirect effects on other counterparties, the regional economy and the wider financial system.
“The German banks’ limited loss-absorption capacity and structurally weak earnings make them vulnerable to a further deepening of the crisis.”
The agency noted similar reasons for the Netherlands, adding in the country’s “own domestic vulnerabilities, specifically the weak growth outlook, high household indebtedness, and falling house prices, whose impact is amplified by this heightened event risk.”
For Luxembourg it also noted “concerns about the country’s economic resilience in view of its significant reliance on financial services industry for employment, national income, and tax revenue”.The agency kept the outlook for Finland – another country it assessed in today’s announcement – stable due to its “unique credit profile”:
Moody’s does not believe Greece will exit the euro, but it admitted today “the risk of an exit by Greece from the euro area has increased relative to the rating agency’s expectations earlier this year”
An exit would “pose a material threat to the euro” and even though a strong policy response would be expected, ‘it would still set off a chain of financial-sector shocks and associated liquidity pressures for sovereigns and banks that policymakers could only contain at a very high cost. Should they fail to do so, the result would be a gradual unwinding of the currency union, which Moody’s continues to believe would be profoundly negative for all euro area members.”