Fitch downgrades Italy, Spain

Compiled by Ben Woodhead

Fitch Ratings has downgraded the credit ratings of five eurozone nations, including Spain and Italy, and said they remained vulnerable to further cuts in the next two years.

The latest set of downgrades, not unexpected, come as Greek government officials and private creditors seek to negotiate an accord on the issue of new debt on terms that EU finance ministers will approve.

• Geithner presses Europe to increase crisis firewall
• Greece expects debt swap deal in days
• Consensus builds for IMF funds boosts
• UK sets terms for IMF pledge

In its action on Friday, Fitch downgraded Belgium, Cyprus, Ireland, Italy, Slovenia and Spain. “All the ratings have been removed from (ratings watch negative), with the negative outlook on all six countries indicating a slightly greater than 50 per cent chance of a downgrade over a two-year time horizon.”

Fitch said new rating levels “capture financing flexibility in its assessment of the credit profiles of eurozone sovereigns that have large fiscal financing needs and significant financial/economic imbalances.

“Moreover, rising “home bias” in the allocation of capital, the divergence in monetary and credit conditions across the eurozone, and near-term economic outlook highlight the greater vulnerability to monetary as well as financing shocks faced by these sovereign governments.

“Consequently, these sovereigns do not, in Fitch’s view, accrue the full benefits of the euro’s reserve currency status. The net impact of this revision under Fitch’s sovereign rating methodology is to lower the long-term ratings of the affected sovereigns by one notch.

Fitch said it “recognises the significant commitments made at the 9-10 December and previous EU summits to enhance economic policy coordination so as to prevent a recurrence of the severe macro-financial imbalances that arose in the euro’s first decade, as well as efforts to create a long-term framework for fiscal stability over the medium to long term.

The ratings agency also said it anticipated that European leaders would make good on their commitments in the forthcoming January 30 summit.

In Fitch’s opinion, “the eurozone crisis will only be resolved as and when there is broad economic recovery. It is evident that further substantial reforms of the governance of the eurozone will be required to secure economic and financial stability, including greater fiscal integration.”

“A deeper and more prolonged economic recession than currently anticipated would undermine political support for, and public acceptance of, fiscal austerity and structural reform,” Fitch said. “It would also have the potential to weaken the commitment of the economically and fiscally strongest eurozone countries, and the ECB, to providing necessary support to eurozone peers.”

GEITHNER PRESSES EUROPE TO INCREASE CRISIS FIREWALL

The downgrades to Italy and Spain came as US Treasury Secretary Timothy Geithner pressed Europe to boost its bailout fund resources, citing the eurozone debt crisis and oil prices as the two main factors influencing the pace of the US’ economic upturn.

Two bankers who attended meetings with Geithner at the World Economic Forum in Davos said the US was looking for eurozone countries to roughly double the size of its financial firewall to 1.5 trillion euros. There was no immediate comment from the U.S. Treasury on the report.

The US economy is growing at an annual rate of around 2-3 per cent, Geithner told the annual conference in the Swiss Alps, adding that it still faces big challenges to repair damage wrought by the financial crisis.

Earlier on Friday, eurozone finance officials voiced optimism that key building blocks of a solution to Europe’s sovereign debt crisis were gradually slotting into place.

Geithner acknowledged progress in fiscal discipline, eurozone governance and structural economic reforms in Europe.

But he said: “Our view is that the only way Europe is going to be successful in holding this together is for them to bring a stronger firewall and that is going to demand a bigger commitment.”

Howard Lutnick, chief executive of broker Cantor Fitzgerald, who attended the first session: “If the European participants to the euro set aside 1.5 trillion euros to buy their debt as a backstop, they don’t need anyone else to buy their debt.

“They become very Japan-like and (the) European sovereign debt crisis ends. Because there is no crisis - we will buy the bonds. End of story.”

Piet Moerland, chairman of Rabobank of the Netherlands, who attended Friday’s meeting with Geithner, said the United States and other players were saying Europe had to raise its contribution to the rescue fund before the IMF could move.

“What they say is you have to move first and then we have the conviction that you are successfully managing the crisis, we will support that,” Moerland told Reuters.

GREECE EXPECTS DEBT SWAP DEAL IN DAYS

Greece, which sits at the heart of the firewall debate, expects to conclude difficult debt talks with private creditors within days and negotiations with the EU and the IMF on a new bailout deal by the middle of next week, Prime Minister Lucas Papademos told Reuters on Friday.

Speaking at his neo-classical office shortly before resuming talks with bankers on a bond swap deal that is key to saving the eurozone member from bankruptcy, Papademos said: “Greece will not default.”

“We made significant progress over the last few weeks and in the last few days in particular. We are trying to conclude the discussions as quickly as possible. I am quite optimistic an agreement will be reached in the coming days,” Papademos said.

The prime minister, who leads an emergency coalition government tasked with steering Greece out of its worst economic crisis in decades, spoke to Reuters minutes before bankers’ chief negotiator Charles Dallara swept up to his mansion in his limousine for a new round of talks.

Papademos was also upbeat about parallel negotiations with the so-called troika of the European Union, International Monetary Fund and European Central Bank, saying agreement was expected soon on the reforms they are demanding in exchange for a new 130-billion euro aid package Greece needs to stay afloat.

“The aim is to complete the discussion with the troika by the middle of next week at the latest. I hope sooner rather than later,” he said.

The former central banker said Greece had made progress on both fiscal and structural reforms with results already emerging.

“Much more has been achieved than sometimes appears in public. There are some slippages in the implementation of the fiscal adjustment programme and the reforms. But internal devaluation is already taking place. We expect some modest growth to appear during 2013.”

Papademos said the budget deficit would be about 9.5 per cent of GDP in 2011, from 10.6 per cent in 2010. A worse than expected recession has made it hard for Greece to meet targets agreed with lenders, despite harsh salary cuts and tax hikes.

The troika has criticised the slow pace of Greek reforms and privatisations. Lenders have warned the second bailout will hinge on Greece’s proven commitment to the programme.

CONSENSUS BUILDS FOR IMF FUNDS BOOSTS

Elsewhere, Mexico’s central bank chief, Agustin Carstens, said on Friday he believed a consensus was building on boosting the International Monetary Fund’s resources to help European countries and others that might need aid from the global lender.

The IMF is seeking to more than double its war chest by raising $600 billion in new resources to help countries deal with the fallout of the eurozone debt crisis, but the plan faces roadblocks from the United States and other countries.

Mexico is working with the IMF and other countries “to see if we can get additional resources for the Fund,” Carstens said.

“Progress has been made and we have to build on that,” he told Reuters Insider television at the Davos Forum.

“I think slowly some consensus is building up,” he said when asked if any progress was being made to boost the IMF’s firepower to help the eurozone with its debt crisis.

“It’s a process where we need the collaboration of many different regions. I think there is clear understanding that the world economy needs additional resources not only to help Europe but to help other countries that might need IMF resources.”

Asked if Mexico and other emerging economies were prepared to increase their contributions to the IMF, Carstens replied: “Yes certainly, we have already said so. Not only Mexico, but other emerging markets would want to have additional participation in the Fund and I think it would be a move in the right direction.”

Turning to the Mexican economy, Carstens said the central bank was comfortable with its policy stance. Policymakers held interest rates at 4.5 per cent last week.

“Today we’re happy with the policy stance we have,” he said, adding that 3.5 per cent growth in Mexico this year was the best forecast he could make.

“I see balanced risks in both directions,” he said of the 3.5 per cent growth forecast.

“There is still the possibility of seeing slower growth in the world economy and of course that could effect us but then again we also could see higher domestic spending, more reactivation of our lending market - that also could give us stronger growth.”

Mexico’s peso has firmed to test the key 13 per dollar level this week, leading gains in Latin American currencies after the Federal Reserve said it would hold interest rates near zero until late 2014.

“Once you make assessments of the value of our currency, given our fundamentals, it’s not surprising we have seen a stronger peso,” Carstens said.

Asked if too much of an appreciation would be concerning, he replied: “Yes, but we are not there yet.”

UK SETS TERMS FOR IMF PLEDGE

Britain, meanwhile, will insist on seeing the “colour of Europe’s money” before it is willing to put UK taxpayers’ cash into a $US1 trillion International Monetary Fund war chest designed to help safeguard the future of the euro, the British finance minister (chancellor) George Osborne said.

The chancellor set four conditions for Britain’s willingness to provide a £16 billion guarantee that would allow the Washington-based fund to tackle financial problems in Europe and elsewhere.

Osborne said there could be no new special IMF funding vehicles, there would have to be full IMF “conditionality” - the tough terms debtor countries have to meet in return for loans - and Britain’s partners in the G20 group of developed and developing nations must participate.

“And crucially, IMF resources to support individual countries cannot be a substitute for further credible steps by the eurozone to support their currency,” he said. “In other words, the world needs to see the colour of their money before it contributes any more.”

The chancellor suggested a deal to provide more resources for the IMF was coming together, with the key remaining obstacle being Europe’s willingness to put up more money. “I think we can now see a way forward.”

Just before Osborne spoke at the World Economic Forum in Davos, Olli Rehn, Europe’s economic and monetary affairs commissioner, had told a session that Europe needed stronger firewalls. “I expect we can come to a positive solution. We need the support of our American and British friends. We need to increase the resources of the IMF,” Rehn said.

The US treasury secretary, Tim Geithner, appeared to indicate he would support extra funds, but that this would not be a “substitute” for changes in the eurozone.

Osborne acknowledged that eurozone countries had achieved much over the last 18 months, including pooling resources in a central fund, giving up sovereignty in a fiscal deal and tackling budget deficits and structural reforms in many countries.

“These are all difficult and courageous decisions, and they are having an impact. But while we should acknowledge these achievements, it would be a disservice to our own citizens to pretend that they are enough.”

Eurozone countries needed to convince financial markets that they could respond to any eventuality, Osborne said.

“The eurozone economy as a whole has sufficient resources to put the credibility of the firewall beyond doubt. All that is required is the political agreement to make those resources available on a credible timescale.” But while the onus was on Europe to help itself, the IMF should be ready to support individual countries that ran into trouble.

The managing director of the IMF, Christine Lagarde, wants the fund’s resources for tackling the financial crisis to double to $US1 trillion, with $US500 billion coming from the eurozone and $US500 billion from the rest of the world. Britain’s contribution would be about $US25 billion.

Addressing concerns over the UK’s economy, Osborne said: “A resolution of the eurozone crisis would provide the biggest single boost to the British economy in the short term. But we will not put our economy back on the path to prosperity unless we confront our domestic problems. And the biggest of those is captured by a single word: debt.”

Reuters, Guardian, AFP

The Australian Financial Review