A lower S&P rating will not reduce effectiveness of package, say officials

LONDON - European officials said the euro region's temporary bailout vehicle - the European Financial Stability Facility (EFSF) - has enough funds to deal with the sovereign debt crisis after losing its top credit rating at Standard & Poor's (S&P).

"The EFSF has sufficient means to fulfil its commitments under current and potential future adjustment programs," said Klaus Regling, the facility's chief executive officer, in an e-mail. S&P cut its rating on the EFSF to AA+ from AAA.

The EFSF, designed to fund rescue packages for Greece, Ireland and Portugal partially through bond sales, owed its AAA rating to guarantees from its sponsoring nations. On Jan 13, two of those sovereigns, France and Austria, were cut to AA+ from AAA by S&P, which also downgraded seven other euro countries.

"The EFSF's obligations are no longer fully supported either by guarantees from EFSF members rated AAA by S&P, or by AAA-rated securities," S&P said. "Credit enhancements sufficient to offset what we view as the reduced creditworthiness of guarantors are currently not in place."

Investor reaction

Investors have nevertheless taken the S&P downgrades in their stride in an echo of the rally in Treasuries that followed the company's downgrade of the US last year. French borrowing costs fell at a sale of one-year notes on Monday and the yield on the country's 10-year government bond has slipped 5 basis points to 3.017 percent since the downgrades.

Regling underscored the fact that the EFSF - which has a capacity of 440 billion euros ($557 billion) - will be replaced by a permanent fund in July. The European Stability Mechanism will be capitalized by governments.

"EFSF has the funds necessary to succeed," said French Budget Minister Valerie Pecresse in an interview.

Luxembourg's Prime Minister Jean-Claude Juncker, who leads euro area finance ministers, said the EFSF "will continue to be backed by unconditional and irrevocable guarantees by euro area member states".

European leaders may struggle to deliver their new fiscal rules and cut Greece's debt burden as their efforts come increasingly under fire. Greek officials will reconvene with creditors on Wednesday after discussions stalled last week, while governments in Europe are preparing for a Jan 30 summit.

The policy response to the crisis "has not kept up" with the risks, which remain "firmly tilted to the downside", Moritz Kraemer, S&P's managing director of European sovereign ratings, said on a conference call on Jan 14.

Changing outlook

On Monday, S&P said that governments "may currently be exploring credit-enhancement options" and that if the EFSF adopts enhancements "sufficient to offset its now-reduced creditworthiness", it "would likely raise" the rating to AAA.

Still, it said that if such enhancements are "not likely to be forthcoming", it would change the outlook to negative to "mirror the negative outlooks of France and Austria".

The German Finance Minister Wolfgang Schaeuble indicated the government won't increase its guarantee on the facility, saying the nation's liability of 211 billion euros is sufficient to ensure the EFSF's ability to lend.

"The guarantee sum that we have is sufficient by far for what the EFSF has to do in coming months," he said in an interview on Deutschlandfunk radio. Chancellor Angela Merkel said on Jan 14 that she was "always of the opinion that the EFSF doesn't necessarily need a AAA rating".

Fiscal progress

On Monday, the European Commission said that the S&P downgrades ignored Europe's progress in fiscal consolidation. Commission forecasts show the euro area's aggregate deficit will fall to 3.4 percent of gross domestic product in 2012 from 4.1 percent in 2011, according to spokesman Olivier Bailly.

Kraemer said in an interview that while there has been progress on fiscal discipline, "little has been done to address the core underlying problems" of competitiveness and imbalances.

Merkel said the rating company's criticism of "insufficient" policy steps reinforced her view that leaders must redouble efforts to resolve the crisis.

Germany, France, the Netherlands, Finland, Austria and Luxembourg were the top-rated nations backing the fund, and Germany is now the only one of 17 euro nations with a stable AAA rating.

Bloomberg News