Another Blow to Europe:-

As has been pretty much the European story since the crisis strengthened, with Europe’s leaders content to just kick the can down the road, it takes a few weeks after a ‘crisis’ summit/meet for the next crisis to erupt. So barely a month after the ‘last-chance’ summit where, at Angela Merkel’s insistence, Europe continued down the wrong path by plumping for fiscal austerity even in the face of a recession, the next crisis is here. US credit rating firm S&P has downgraded not just France, but 8 other countries as well. Expectedly, France has lost its AAA tag, Italy and Spain have been further downgraded (Italy now has the same status as Kazakhstan), and Portugal is now junk status. Apart from raising the cost of the ¤200 billion that France needs to refinance during the year, this could hurt both Sarkozy’s re-election chances as well as the prospects of necessary French reforms. Again, expectedly, the Greek restructuring talks have broken down and a full-scale default looks likely—most likely this will be in March when it has to redeem ¤14.4 billion in maturing debt. In other words, the possibility of a two-speed Europe once again looks likely, though it still remains unclear as to how countries are to leave the euro, and what happens to them when they do so.

With the downgrade of France and the others (Germany continues with the AAA tag), the real fallout will be on the European Financial Stability Facility as one of its principal sponsors isno longer AAA rated. Which means that either the EFSF will lose its AAA rating or the others like Germany will have to increase their contribution—given the problem got exacerbated by Merkel not wanting to give an unlimited German backstop to weaker European nations, this looks unlikely. How all of this will pan out is uncertain, though the IMF’s January 24 projections will help put a perspective on things. For India, apart from the impact that a recession in Europe will mean for exports—Europe is one of the main reasons for why Infosys lowered its next quarter earnings forecast—the larger issue remains of the funding needs of European banks and the money they have invested in India ($148 billion). It is no one’s case that all of this will go back, but certainly significant sums will be demanded back by European banks. How significant will decide the future trajectory of the rupee.

As appeared in the Editorial of Financial Express