Back in January S&P downgraded most of Europe under the following statement:
Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.
The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements from policymakers lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone’s financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.
S&P went on to say that they were, in particular, watching both Spain and Italy because they felt that the current policies of Europe were inadequate to address growing weakness in their economies and that due to this weakness both countries would struggle to meet defined fiscal targets:
It is our view that the limitations on monetary flexibility imposed by membership in the eurozone are not adequately counterbalanced by other eurozone economic policies to avoid the negative impact on creditworthiness that the eurozone members are in opinion view currently facing. Financial solidarity among member states appears to us to be insufficient to prevent prolonged funding uncertainties.
Specifically, we believe that the current crisis management tools may not be adequate to restore lasting confidence in the creditworthiness of large eurozone members such as Italy and Spain. Nor do we think they are likely to instill sufficient confidence in these sovereigns’ ability to address potential financial system stresses in their jurisdiction .In such a setting, the prospects of effectively intervening in the feedback loop between sovereign and financial sector risk are in our opinion weak.
At the time of the assessment I said that I thought many people would interpret this action as an overzealous attempt by the S&P to gain back some creditability after the rating agencies failings pre-GFC which, in part , it could have been. However, that shouldn’t have taken away from the fact that this analysis was well-balance. In fact, given recent events, you could say it has been right on the money.
As I said then:
My long running assessment of the European financial crisis is that the competiveness imbalance between the core and periphery is the major issue and, although some of the current policies being implemented are stated to be aimed at addressing this, the reality is that they are actually making the problem worse. The latest Spanish employment figures are once again a reminder that austerity policy aimed at already deflating economies in order to make them more competitive are in fact counter-productive. What we have seen and continue to see from the periphery nations is a not growth at all, but a reduction in industrial production and a rise in employment, and therefore a renewed burden on the government sector meaning its attempts to deleverage fail while the private sector weakens further.
And this all comes back to the basis of what I have been talking about for a long period of time in relation to European financial policy. The fact that the “fiscal compact” and its predecessor are backwards. There is no doubt that European economies have developed imbalances, much of which have been worse via the single currency; I talked about this here. If Europe had credible macro-prudential oversight this never would have happened, but that is now in the past.
Today, after those imbalance led to a crisis followed by a huge loss of private sector wealth, attempting to make large fiscal adjustments in the government sector without first re-investing in the private sector to provide new mechanisms to regain that wealth is a recipe for further financial disaster.
I would hope, after the 2 years of continued failure with the existing policies , that Europe’s economic elite may have finally learnt this lesson. Hopefully recent talk of a “Growth compact” is just that, and not some new attempt to continue to enforce the existing programs under another name. As I have stated previously, I am still yet to be convinced on that point.
Today S&P revisited Spain and once again downgraded the country sighting much of what I have said above:
In our view, the strategy to manage the European sovereign debt crisis continues to lack effectiveness. We think credit conditions, and hence the economic outlook for Spain, could now deteriorate further than we anticipated earlier this year unless offsetting eurozone policy measures are implemented to support investor confidence and stabilize capital flows with the rest of the world. Such measures at the eurozone level could include a greater pooling of fiscal resources and obligations, possibly direct bank support mechanisms to weaken the sovereign-bank links, and a consolidation of banking supervision or a greater harmonization of labor and wage policies.
In light of the rapid rise in public debt since 2008, we expect the Spanish government to implement a sustained budgetary consolidation effort – including strengthening fiscal surveillance frameworks at the regional government level – aimed at gradually reducing the government’s net financing needs.
Balancing this commitment to stabilizing public finances with policymakers’ clear interest in preventing an acceleration of the economic downturn will be challenging in the absence of fiscal transfers from abroad, or private-sector credit creation at home. At the same time, we believe front-loaded fiscal austerity in Spain will likely exacerbate the numerous risks to growth over the medium term, highlighting the importance of offsetting stimulus through labor market and structural reforms.
That is, in S&P’s view, Spain is attempting to implement a program in order to re-adjust the economy away from inefficiency and re-focus on tradable goods and services away from consumption. However the fiscal drag of the government sector, the slowing of its trading partners under similar conditions and the lack of support from ‘core’ Europe in the absence of currency deflation has become counter-productive.
Let’s hope the Eurocrats actually listen this time or they’ll be back again.