A number of euro countries, including Italy, could see their credit ratings downgraded by the end of this month as they struggle to cope with too much debt and slowing economic growth, Fitch ratings agency said today.
Though the agency remains confident that the euro zone will not break up over the next year, it is concerned about the weak economic outlook and is urging the European Central Bank to step up its involvement in solving the crisis, notably by buying more government bonds in the markets.
Fitch's head of sovereign ratings David Riley said the agency will give its verdict on several euro countries by the end of January. Fitch currently has Italy, Spain, Belgium, Ireland, Slovenia and Cyprus on so-called "ratings watch negative" and Riley said the reductions could be up to two notches.
Much interest in the markets centres on Italy, the third-largest euro zone economy and considered too expensive to bail out. Riley says it is the "front line" of Europe's debt crisis especially as it has to tap bond market investors heavily this year.
"The future of the euro will be decided at the gates of Rome," he said at a conference in London today. Though Italy has a relatively low budget deficit in comparison to its economy, the country is saddled with massive amounts of debt and will have to raise up to €360 billion, according to Fitch.
Italy has found itself in financial trouble in recent months, with investors demanding increasingly high interest rates to lend it more money. Its long-standing prime minister, Silvio Berlusconi, was forced to resign late last year as the economic backdrop darkened, making room for a caretaker government under well-respected economist Mario Monti.
Riley said the challenge of Monti's government is to convince investors it has a proper strategy to keep a lid on spending but also that it has a strategy for economic growth. An expanding economy helps keep a country's debt to GDP ratio under control.
Many economists think that the euro zone as a whole will fall into recession this year as the debt crisis has ravaged economic confidence and prompted banks keep a lid on their lending.
For Riley, getting growth going again is crucial if Europe is to finally emerge from a two-year crisis. "Until we see broad-based economic recovery, only then will we be able to say the crisis is over," Riley said.
With Italy's economy stagnating at best, investors remain unconvinced about the country's prospects - the yield on the country's ten-year bonds, an indication of the rate it would pay to raise 10-year money, hovered around the 7% mark today. That is widely considered unsustainable in the long-run.
Italy has a debt burden of around €1.9 trillion, way more than the backstop the euro zone has so far provided and more than the debt levels Greece, Ireland and Portugal. Those three countries eventually had to be bailed out by their partners in the euro zone and the International Monetary Fund.
Fitch said France, the euro zone's second-largest economy, is also facing difficulties because of its debt burden, which is over 80% of GDP, though its cherished triple A-rating is not one of those facing an imminent cut by Fitch.
The escalating debt crisis has been partly fueled by downgrades by the ratings agencies. Overall, Riley said the crisis is likely to be prolonged and punctuated by episodes of extreme volatility and that without greater involvement by the European Central Bank through the purchase of government bonds in the markets, the euro zone's current firewall, the EFSF, is "not credible."
He warned that political instability, fueled by discontent over the impact of austerity measures, could trigger problems in resolving the two-year debt crisis.
Riley also said that Greece will remain at the heart of the crisis over the coming months as it seeks to negotiate a deal with private creditors on reducing the value of their holdings of Greek debt. He said even that deal would fail to materially lighten Greece's debt load, though he was confident Greece would still be a member of the euro zone this time next year.
