DBRS Commentary: Euro Zone Clarity on Debt Resolution Key to Confidence

DBRS Inc. (DBRS) has today released a commentary entitled “Euro Zone Clarity on Debt Resolution Key to Confidence.” The commentary discusses a recent Euro zone proposal for a sovereign debt resolution (or restructuring) mechanism, to be introduced in June 2013. Unfortunately, in addition to preexisting concerns over liquidity and knock-on effects from the Middle East, the notion of debt restructuring has lowered investor confidence, since it implies existing bonds will be subordinate to new bonds issued in mid-2013.

In spite of the complexities of implementing CACs or an SDRM, particularly during a period of low investor confidence, it is reassuring that the Euro zone has the liquidity necessary to give countries time to stabilize their financial systems, implement fiscal austerity and return to growth. However, some market participants believe that the amount of EFSF loans currently available for member countries is insufficient, and risk aversion remains high.

In late-March, Euro zone countries plan to hold their first summit. Possible initiatives that may be introduced, and which may help to restore investor confidence, are an increase in the size of available EFSF loans, an extension in the maturities of existing emergency loans to distressed member states, and a reduction in interest rates on these loans. The introduction of longer-term measures to increase competitiveness might also help to restore confidence. However, DBRS believes that either greater clarity on what Euro zone policymakers intend by debt restructuring, or an indefinite postponement of the idea, is necessary to restore investor confidence. In the absence of either, premiums on sovereign bonds are likely to remain high, and DBRS’s ratings on the more distressed sovereigns in Europe could come under downward pressure.

The applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

A copy of this commentary is available by clicking on the link below or by contacting us at info@dbrs.com.