Sunday, January 26, 2003

German Debt to Lose AAA Status?

It seems Germany's status as the benchmark in the eurozone debt market is under threat because of growing concerns about their ability to hold on to their triple A credit ratings. Arguably investors are already begining to price in the risk of a German downgrade as the fiscal position continues to worsen. Standard & Poor's this week affirmed Germany's triple A rating with a stable outlook, but pointed to growing debt and fiscal deterioration as an indication that Germany "has begun to fall behind its triple A rated peers in terms of fiscal and economic indicators". Because of its benchmark status - the result of Germany's historically strong finances - Berlin has been able to borrow more cheaply than other eurozone governments, this position could now be in the process of changing, making the debt more costly to maintain and thus in principle increasing the deficit.

David Riley, head of sovereign ratings at Fitch, said: "Germany's triple A rating can no longer be taken for granted." Fitch plans to review Germany's rating in the first quarter of next year. "We are going to Germany because we are concerned about the structural issues and I would not rule out a negative action," Mr Riley said. Moody's is also planning to visit the country next year but it said that its main concerns focused on long-term structural issues, such as the state pension system, rather than on the shorter-term fiscal position. A downgrade or even a change of outlook on Germany by any of the three large rating agencies could affect its benchmark status. While German 10-year yields are still the eurozone's lowest, some analysts now expect France, its closest rival since the euro came in, to achieve benchmark status next year in terms of the price of its debt.
Source: Financial Times

Meantime Italy, with a current debt GDP ration of around 109.8%, plans to use a piece of 'coupon-clipping' to reduce the outstanding stock of debt to around 108.5% by swapping €39 billion of 1% government bonds held by the Bank of Italy in its own portfolio with comparable issues carrying higher coupons (say in the 4-5% range). Since an increase in the coupon would reduce the nominal value of the debt this move would help the debt/GDP ratio, the stream of future budget deficits, in contrast, would go up by around one-tenth of a percentage point a year in paying the higher interest. The real problem, however, is that a country with a stock of debt larger than its GDP keeps living beyond its means and borrowing from the future, and no amount of financial jiggery-pockery is going to change that reality.

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