S&P downgrades European austerity
- 14 January 2012
- From the section Business
The S&P downgrades of France and other Eurozone governments were worse than many expected, but they were expected. What's most interesting, to me, is not the fact that S&P has done this, but the stated reason.
Why? Because, in essence, a major ratings agency has now joined the side of those who say fiscal austerity, as the central plank of the response to the eurozone crisis, is doing more harm than good.
The company's statements explaining its various decisions are worth reading in full.
Naturally, there are country-specific reasons why each country received the grade that it did.
But, running through the long list of press releases, it is striking that not one downgrade was due to the ratings agency thinking the government was not sufficiently committed to putting their fiscal house in order.
Quite the opposite.
In fact, "commitment to fiscal consolidation", in nearly every case, is given as a factor supporting the government's rating. (In Austria, they even think the deficit might come down faster than the government has promised.)
No, almost without exception, the key factors bringing down the ratings are: (a) fear of external contagion, and what that might do to national banking systems and/or the government's capacity to borrow; and (b) deep fears about economic growth, which in the case of the periphery could well make their fiscal targets impossible to achieve, and their national debt spiral out of control.
Naturally, S&P would like to have seen more European "solidarity" at last month's summit, and more money in the eurozone's rescue pot.
But the real problem, in the rating agency's mind, was that the agreements reached in early December were once again based "on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone".
"In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called 'periphery'.
"As such, we believe that 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."
That last bit might have been written by Ed Balls himself.
You might well ask, why do we care what any of these discredited ratings institutions has to say about anything? Didn't they get a lot of things badly wrong in the lead up to the financial crisis, and don't their decisions always lag far behind market reality?
Quite so. But - as Robert Peston and I have often explained - the systemic role of credit ratings gives them practical as well as symbolic significance, for government and (perhaps especially) banks.
Also, the fact that the ratings agencies are usually quite far behind the curve might make the comments about fiscal austerity that much more significant.
For some time now, eurozone bond markets have have been quietly shifting their attention, from a focus on budget cuts, to a focus on growth - and a worry that each will get in the way of the other.
A recent example was Spain, where the government responded to fears of an overshoot in the budget deficit by quickly announcing fresh spending cuts and tax rises, only to find the cost of borrowing in the market had risen even higher, because investors now thought the country would be even less likely to grow.
This is not new. But with large parts of the eurozone slipping back into recession it is becoming much more obvious - and may yet change the tenor of debate at the next European summit.
The IMF's own chief economist, Oliver Blanchard, suggested recently that "financial investors are schizophrenic about fiscal consolidation and growth".
"They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth—which it often does.
"Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds.
"To the extent that governments feel they have to respond to markets, they may be induced to consolidate too fast, even from the narrow point of view of debt sustainability."
Privately, many IMF officials have had doubts - from the very beginning - about the amount of fiscal austerity built into the early years of the adjustment programmes for Greece, Portugal and others. They have often let themselves be over-ruled by European officials, keen to show that countries were being forced to take tough medicine.
However, Mr Blanchard's comments suggest that the Fund's doubts about the pace of fiscal austerity in the eurozone, and lack of policies at the European level to offset it, might be about to come out into the open - just as S&P's have.
The short-term consequences of today's downgrades may well be less than feared. But the long-term consequences for the debate about fiscal austerity in the eurozone might be profound.