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1-A | January 24, 2012 The Implications of the Downgraded Credit Rating of France on the Euro Debt Crisis I. Introduction Standard & Poors (S&P), one of the Big Three Credit Rating Agencies, announced last January 13, 2012 that it has downgraded Frances credit rating by a notch from AAA status to AA+ (Bloomberg, 2012) making France lose its top-rating status. Furthermore, S&P warns France and other Eurozone member countries that they face the risk of further reductions in their credit ratings (Bloomberg, 2012). The downgrade by S&P is a blow to Pres. Nicolas Sarkozys insistence on protecting Frances creditworthiness through tax increases and spending cuts (Bloomberg, 2012). France downplays the credit rating downgrade as the French Finance Minister Francois Baroin comments that France now has the same credit rating as the United States (Bloomberg, 2012). The credit rating downgrade came as no surprise. In December 2011, S&P has already placed Eurozone members on credit watch (BBC, 2011). The agency's decision is uncontroversial, says the BBC's Robert Peston, because eurozone banks have been struggling to borrow, a number of eurozone economies are buckling under the burden of big government and household debts, and there is a significant risk of recession (BBC, 2012). S&P released Frances credit rating together with the credit ratings of other Eurozone member states. S&P has maintained Germanys AAA credit rating together with Finland, the Netherlands and Luxembourg (Bloomberg, 2012). However, the latter three countries are placed on negative watch by S&P (Bloomberg, 2012). The credit rating agency has also downgraded 9 other Eurozone member states (Bloomberg, 2012). The downgrade of Frances credit rating makes Germany the only key actor in the Euro Debt Crisis having AAA credit rating (The Guardian, 2012). S&P warns the EU that current measures to solve the debt crisis were not enough and they cannot continue on relying on austerity measures. According to S&P austerity was only heightening the financial crisis (The Guardian, 2012). Furthermore, S&P justifies its credit ratings of the Eurozone members as "primarily driven by insufficient policy measures by EU leaders to fully address systemic stresses" (The Guardian, 2012). Prior to S&Ps announcement of the downgrade, borrowing costs had fell (The Guardian, 2012), economies were seemingly starting to re-stabilize as German and French businesses were re-gaining investor confidence (Bloomberg, 2012), and the European Central Bank (ECB) has announced that it has averted credit shortage at banks (The Guardian, 2012 & Bloomberg, 2012). The downgrade of credit ratings of Eurozone countries, especially France, could possibly upset the positive developments of the debt crisis (The Guardian, 2012). Furthermore, the downgrade increases the risk of a sovereign default as the EU has already been struggling to fix the crisis and convince investors to put in money in their economies even before the credit rating downgrade (The Guardian, 2012).

Analysts predict that some European banks will be downgraded as a result of contagion. National banks are now seen to be riskier therefore it is possible that the downgrade of European banks would follow (The Guardian, 2012). The downgrade will also affect the ability of the European Financial Stability Facility (EFSF) to raise funds for the bailout of Greece, Ireland, and Portugal (The Guardian, 2012). II. Credit Rating Agencies and Why Credit Ratings Matter? Credit rating agencies are private-sector financial firms which assess the creditworthiness of companies or countries (BBC, 2012). In other words, they assess the ability of an entity to pay its debts. Credit ratings agencies also help assess fair price to charge for debt (The Guardian, 2012).They are private-sector firms because, in theory, this presupposes that they are impartial in their assessments of credit ratings. Their assessments are called credit ratings. Credit rating is a marking system designed to inform interested parties (BBC, 2012). It is given to large-scale borrowers, whether companies or governments, and tell the buyers of this debt how likely they are to be able to get it back. The score card also affects the amount that should be charged by way of return on that borrowing (BBC, 2012). A high score from a credit rating agency means cheaper borrowing - a low mark carries a heavy price (BBC, 2012). In the case of the Euro, a credit rating downgrade would mean higher cost for a country to borrow money. A downgrade of an issuers' rating pushes down the value of a bond and raises its interest rate. It can mean regulated funds must now sell these bonds (BBC, 2012). A change to the score means a change to the amount a borrower must pay its debt-holders, something that can make it more expensive to borrow as investors demand a higher rate of return for taking on more risky debt (BBC, 2012). o Why do Credit Rating Agencies and Credit Ratings Matter? The Eurozone is now starting to become anxious of the power of credit rating agencies as their credit ratings have a strong influence on the economies of countries. The European Commission has a set of proposals designed to rein them in, including requiring them to be more transparent about their ratings and to be held accountable for their mistakes. It also views them as hostile because the leading agencies are US-based. It would like to see a European agency of equal status (BBC, 2012). The credit rating that these credit rating agencies release affect the interest rates that countries offer to attract investors and lenders. Higher credit ratings mean that there is higher confidence that the debt is safe. This attracts more lenders. Lower credit ratings would mean higher risks, making it more difficult to raise funds for a country. Countries with lower credit ratings are usually the ones who are more in need of the funds. The AAA grade by the three ratings agencies Standard & Poor's, Fitch, and Moody's is considered the gold standard (The Guardian, 2012).

III. The Major Effect of the Credit Downgrade: Raising Bailout Funds Will Become More Challenging The downgrade of the French credit rating would have a significant effect on the European Financial Stability Facility (EFSF). The EFSF is Europes bailout rescue mechanism for Greece, Ireland and Portugal (Bloomberg, 2012). Most of the the funding for the mechanism mostly comes from the Eurozones strongest economies, France and Germany. Currently, the EFSF has a AAA credit rating. This reflects the credit rating of the EU member-states which funds it Germany, France, The Netherlands, Austria, Finland, and Luxembourg. Given that France and Austria were downgraded, it is likely for the mechanism to follow being downgraded as well. S&P hinted as much last October, when it stated that: In general, we expect the outlook on EFSF's issuer credit to reflect the outlook on the sovereign rating of its weakest 'AAA' guarantors. And if the EFSF loses its AAA, then its own cost of borrowing would probably increase, (Bloomberg, 2012). Furthermore, according to John Chambers, Managing Director of Sovereign Ratings at S&P, the rating of the EFSF depends on its guarantors, especially its AAA guarantors (BBC, 2012). IV. Conclusion The downgrade of the credit rating of Eurozone members can be seen as a setback in the positive developments of the Euro Debt Crisis. The focus is mainly on France since it is a key actor in providing solutions for the crisis. At the same time, it is also a major economy which has the capability to bailout the troubled Eurozone members. A downgrade in their credit rating would mean that it would be more difficult for them to obtain the necessary funds since they are creditors. So far, only S&P has downgraded its credit rating of France. However, this has already caused negative developments for the Eurozone. The Euro further depreciated against the US Dollar, investors are preferring US dollars over the Euro as their haven, and stocks generally went down. Also, Fitch and Moodys are also starting to reconsider and re-assess their credit ratings of the Eurozone members (The Wall Street Journal, 2012). This would have further impact on the state of the Euro. Credit ratings have a huge impact on trade and investment in a region. This not only affects the lending and borrowing between entities but is also sets the tone for trade (The Wall Street Journal, 2012). In the case of the Eurozone members, the best outcome would be that countries emerge with stable outlooks (The Wall Street Journal, 2012) However with the admitted uncertainty of the future of the Euro, this seems difficult to achieve. Continued downgrades would weigh heavily on the business that is coming in the Eurozone. Finally, it is not to be forgotten that credit ratings are opinions and rests on speculation (The Wall Street Journal, 2012). Credit ratings may reflect the reality of what is happening with the Euro but it does not determine it. The credit rating downgrade may be seen as a setback that can pose a challenge for the Euro.

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