The credit rating agency of Standard and Poor’s has added to the negative news coming out of the Euro-zone by downgrading Italy, the Euro-zone’s 3rd largest economy, to A/A-.
“We believe the reduced pace of Italy’s economic activity to date will make the government’s revised fiscal targets difficult to achieve.” – Standard and Poor’s credit rating agency
Judging that Italy is less creditworthy than Slovakia and on par with Malta, S&P’s cut has increased the strain for reform and action in the Euro-zone. Following an inconclusive meeting of European finance ministers in Poland last Friday, the news has illustrated the continuing difficulty of achieving quick action from countries bound by a single currency but divided by domestic policies. The finance ministers’ meeting on Friday did include the unprecedented attendance of US Secretary of Treasury, Timothy Geithner. Geithner warned the assembly that Europe needed to unite and show collective will in trying to resolve the debt crisis. Despite the US’ lack of a strong position to criticize any country’s handling of an economic crisis, Geithner recommended that the 17 members of the Euro-zone significantly expand the capacity of their joint bailout fund, the EFSF.
“I found it peculiar that even though the Americans have significantly worse fundamental data than the Euro-zone, that they tell us what we should do, and when we make a suggestion…that they say no straight away.” – Maria Fekter, Austrian Finance Minister
There is much popular sentiment in Germany, Austria, the Netherlands and Finland to use financial transaction tax to increase the EFSF; rather than using taxpayer money, advocated by the US. The EU, as a supranational entity expanded by Charles de Gaulle to combat trans-Atlantic ties in Europe, has criticized the recommendation by Geithner. The European countries are founded on a much more socialist liberalism than that of the US and they aim at removing as much fiscal pressure as possible from the people. Meanwhile, the US taxes its lower and middle class heavily in times of need. Clearly, the disparity between the two continents did not provide subtle ground for negotiation or any desire to adhere to the warning from one another.
Nevertheless, the ministers remain unable to agree among themselves on some of the details concerning a second bailout package for Greece, a country that is desperately awaiting the release of about $11 billion in loans, which will only allow the government to function until mid-October. Yet, this bailout package, which was supposed to be released by late-September, has been delayed until the beginning of October because of Member State dissent. Country’s like Finland have raised concerns over the package and have insisted on collecting collateral from Greece on its share of any emergency loans, which could delay, or even scarp, approval for the bailout.
Furthermore, the latest signs of stress on the banking system has come from the Bank of China, which has stopped foreign exchange forwards and swaps rating with the top 3 French banks and Switzerland’s UBS. So saying, the trust in the French banking sector is crumbling, as seen in Germany’s industrial conglomerate Siemens withdrawing 500 million Euros from France and depositing the funds into the European Central Bank. Of all European banks, French lenders have some of the highest exposure to Greek sovereign debt. BNP PAribas and Credit Agricole also have large holding of Italian sovereign debt.
“Orderly or not, we have no idea what the effect of a default would be on other countries, especially Italy. If there is just a 5% chance that this will affect Italy, then you don’t want to do it.” -Peter Bofinger, German Finance Ministry adviser
Besides the growing concerns in Italy and France, the source of the fiscal plague, Greece, remains the key factor to the Euro-zone. Total Greek public debt is about 370 billion Euros, around $500 billion. By comparison, when Argentine defaulted in 2001, its debt was only $83 billion. Russia defaulted in 1998 and its debt was only $79 billion. While these countries have defaulted on their debt, they did not cause systemic contagion, but analysts weighing the numbers on Greece note that its debt is far higher, so the ripple effects could be more serious. A Greek finance ministry official said that Athens was close to a deal with European and IMF inspectors on extra austerity measures to secure the release of an 8 billion Euro loan, which will be vital to pay state salaries and pensions next month. Essentially, Greece is scrambling to ensure a semi-functional government, demonstrating the ledge of anarchy that could easily spill over Greece.
Despite the slipper slope of anarchic news being reported across international media, European stocks have advanced on news from Greece and its talk with the IMF and EU. SAP AG gained 2.1%, EON AG and RWE AG both climbed more than 3%, Stoxx Europe 600 Index rose 1.3% and the DAX has gone up 1.68%.
“The S&P move on Italy was expected and European shared have been under priced versus US stocks. Investors may be beginning to pick up equities ahead of a possible catch-up with S&P 500.” – Henrik Henriksen, chief investment strategist at PFA Pension A/S