Loss of France’s AAA-rating ‘would be more damaging’ than US downgrade

The loss of France’s AAA-rating would be a worse scenario for the global economy than the downgrade of the US, said Ignis chief economist Stuart Thomson.

The past few months have seen credit rating agencies Moody’s and Standard & Poor’s warning European sovereigns could face downgrades, but economists have been divided over whether these threats will become a reality.

Thomson expects France to lose its AAA-status in the next six months, while Italy, Spain  and Belgium are likely to face downgrades within a year, he said.

“France losing its AAA-status is more important than the US losing its AAA-status because of France’s role in the European Financial Stability Facility rescue fund, and a downgrade is inevitable based on its economic outlook,” said Thomson.

“A rapid deterioration in business confidence and credit availability in the French economy means that by spring next year, growth will be negative,” he said.

In regards to Italy, Spain, and Belgium, more importance is focussed on bank recapitalisations and the extent of haircuts to bondholders, according to Thomson.

“The level of required bank recapitalisation is more than Spain and Italy can afford at the moment so they are going to have to go to the EFSF to borrow. Whenever those countries show an inability to borrow then ratings agencies downgrade them,” he added.

Politicians have criticised ratings agencies, arguing they should not publicly downgrade stricken nations for fear of causing a market rout and making the situation for these countries worse. But Thomson said although the sell-offs associated with downgrades are unhelpful, ratings agencies are still a necessary tool.

“Investors will sell bonds if conditions deteriorate in any case. The sovereign credit ratings are completely unbiased and are as good as they can be, but obviously respond with a lag. They are necessary because the world is based around ratings and mandate and regulators stipulate ratings. The world does not work in an unstructured, unregulated way,” he said.

But according to Kevin Gardiner, MD and head of investment strategy for Europe at Barclays Wealth, a poor economic outlook alone will not prompt credit ratings agencies to downgrade a sovereign’s debt rating.

Gardiner does not see an actual downgrade of an AAA nation ahead, as long as
European politicians’ new accord on the debt crisis resolves the worst of the region’s problems.

“The long-term sovereign outlook is driven by fiscal balances, macroeconomic environment, political system, international position and other factors,” said Gardiner.

“For a AAA-sovereign, this capacity is highly unlikely to be adversely affected by foreseeable events such as recession, and should sustain through at least two business cycles.”

However, in the event of a failure to solve the eurozone crisis over the long term, and the deep recession and systemic risk which would inevitably follow, Gardiner said it should be easy to identify the likely candidates for a downgrade by looking at their debt to GDP ratio.