THIS year could be a watershed for the Eurozone. There is now a real chance the region can overcome the market volatility and fragmentation of the past few years, and that countries like Greece could actively return to capital markets.
European leaders have laid much of the groundwork towards restoring credibility to Eurozone policy. But improving creditworthiness now depends on their response to the Eurozone’s economic, political, and social risks. They have a challenging but achievable agenda, though implementation risks loom large. These risks are the main reason that most of our outlooks on Eurozone sovereign credit ratings are still negative.
First, the effectiveness of “outright monetary transactions”, announced by the European Central Bank (ECB) last September, depends on the willingness of governments to follow through with measures that will likely be politically and socially contentious. The risk to the credibility of the ECB could be significant if the conditions attached to its assistance are breached due to lack of domestic political resolve. The key to a lasting solution lies with national politicians, not with the ECB. Without sustained reform progress, the ECB can only achieve temporary respites.
Another risk is complacency arising from improving market conditions. This could lead to fragile policy agreements unravelling if policymakers believe that previously-agreed actions can be shelved or watered down. It is too early to say that complacency has taken hold, but the consensus may be more brittle than many appreciate.
Investor confidence will also only return if member states continue to make progress in rebalancing their economies, by structurally stabilising public debt and further reducing external deficits. This process has some way to go and will seriously challenge political leaders.
The economic and social costs of rebalancing, however, may be more easily contained if the burden was shared more evenly between the Eurozone’s core and the peripheral deficit countries. Safeguards to the social contract may also be necessary in countries suffering from high unemployment, excessive private leverage, and stagnating or falling living standards.
And with the key to successful resolution in the hands of governments, the electoral calendar remains a vital factor. Votes in the Netherlands, Greece, and France last year resulted in governments that took a constructive view of crisis resolution. We believe that the most important elections in 2013 – in Italy, Germany and Austria – will also lead to a continuation of the current policy path.
Challenges in the Eurozone remain formidable. But we expect 2013 to be a critical year in determining whether the downward trajectory of sovereign ratings in the Eurozone, which began in 2004 with the downgrades of Greece and Italy, will finally end. If we see disciplined policy implementation, progress towards economic and fiscal rebalancing, and social cohesion, it would be realistic to say that Eurozone sovereign creditworthiness had “bottomed out”.
Moritz Kraemer is head of Europe, Middle East and Africa sovereign ratings at Standard & Poor’s Rating Services.