Merkel Wants Higher Taxes, Deeper Cuts, Faster Reforms; S&P Says Eurozone Policies Fall Short , France at Risk of Further Downgrades

In the wake of S&P debt downgrades, Merkel vows faster eurozone reforms.

European leaders promised on Saturday to speed up plans to strengthen spending rules and get a permanent bailout fund up and running as soon as possible, a day after U.S. agency S&P cut the ratings of several euro zone countries' creditworthiness.

It also warned that France, which suffered a downgrade to AA+ from the top-notch AAA, was at risk of further cuts if a recession further inflates its debt and budget deficit.

Leaders including Merkel have urged countries to tighten their belts with higher taxes and deep spending cuts to rein in massive budget deficits. But that has heightened market concern about their ability to grow their way back to health, pushing borrowing costs even higher for heavily indebted governments.

S&P said it was not working on the assumption of a euro zone break up, although it blamed its leaders for focusing too much on cutting debts and not sufficiently on competititveness.

"We think that the diagnosis of policymakers regarding the crisis is only partially recognising the origin of the crisis," said Kraemer, mentioning the focus on budget austerity.

"The proper diagnosis would have to give more weight to the rising imbalances in the euro zone in terms of the external funding positions, current account positions, much of it is based in diverging trends of competitiveness," he said.

The ratings decision hit some countries harder than others, with France, Austria, Malta, Slovakia and Slovenia suffering single-notch downgrades, but Italy, Portugal, Spain and Cyprus falling two notches. Portugal's debt is now rated junk.

ECB policymaker Ewald Nowotny, an Austrian, said Italy in particular would now face problems given large refinancing needs this year in that country and its banks.

Asked in an interview broadcast by Austrian radio if Italy - now rated at the same BBB+ level as Kazakhstan - was "problem child number one," Nowotny agreed.

"In a certain sense, yes, because we know this year Italy has a very significant refinancing need. Italian banks also need refinancing," he said.

European leaders are set to meet at a summit on January 30 to discuss how to boost growth and jobs, and Merkel's words on Saturday suggest she will also be looking for faster progress on tighter common fiscal rules.

But now, policymakers at the meeting may have bigger fish to fry. The downgrades threaten the top rating of Europe's current bailout fund -- the European Financial Stability Facility -- as contributors France and Austria are no longer rated AAA.

A downgrade of the EFSF could increase its borrowing costs, reducing its ability to protect the currency bloc's weaker members. S&P said it would deliver its view on the impact to the EFSF from the sovereign downgrades "shortly."

S&P Says Eurozone Policies Fall Short , France at Risk of Further Downgrades

MarketWatch reports Euro-zone policies have fallen short

Standard & Poor’s credit analysts said Saturday that Euro-zone policy makers have failed to address the “broadening and deepening” financial crisis the region now faces, leading the agency to issue long-term downgrades on nine countries, including Cyprus, Italy, Portugal, Spain, Austria, France, Malta, Slovakia and Slovenia.

Perhaps most notably among the cuts late Friday, S&P downgraded France and Austria to AA+ from AAA, leaving only Germany, Netherlands, Finland and Luxembourg left as AAA-rated countries in the currency group. Portugal and Cyprus were downgraded to junk-bond status.

During a conference call Saturday morning, S&P credit analyst Moritz Kraemer said policymakers have yet to come up with solutions to the “systemic stresses” that plague Euro-zone nations during its debt crisis.

Among these problems, he said, are tightening credit conditions; weakening prospects for economic growth in the region; and continued disagreement among government officials over how the situation should be addressed.

Instead of concentrating on work rules and reforms, leaders in France, Germany, and Spain have called for higher taxes. Greece has had higher taxes imposed.

Even without tax hikes, the European recession would be deep and lengthy. Higher taxes will make the situation much worse.

Expect budget deficits to widen as unemployment soars and revenues collapse.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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