DBRS Commentary: Policy Announcements Positive but Euro Area Debt Sustainability Still a Concern

DBRS Inc. (DBRS) has today released a commentary entitled “Policy Announcements Positive but Euro Area Debt Sustainability Still a Concern.” The commentary discusses a recent announcement by the European Council which will result in cheaper loans to Greece, Portugal and Ireland and make one of its lending facilities more flexible. Greater European financial support is welcome and may succeed in stabilising financial markets. However, the new measures raise almost as many questions as they provide solutions. Greater clarity is needed to buttress financial stability and investor confidence.

On 21 July 2011, the European Council announced better lending terms to Greece, Portugal and Ireland, required private investor involvement in a Greek restructuring, and gave the European financial stability facility (EFSF) greater flexibility to extend loans to governments and financial institutions. These measures will lower Greece’s debt burden, give Greece, Portugal and Ireland more breathing room to adjust public finances, and could improve financing conditions for Euro area governments and financial institutions.

However, Greece’s debt burden will remain high; if losses are imposed on private bondholders it could set a dangerous precedent and perpetuate uncertainty; and the EFSF might be insufficient to restore investor confidence.

Taken together, DBRS considers these measures as marginally positive for Portugal and Ireland, since the new loans lower their interest costs. However, the balance of risks is clearly to the downside for both sovereigns. DBRS continues to monitor these countries’ fiscal adjustments and growth outlooks as they strive to stabilise their debt ratios. Downside risks could also increase for both Spain and Italy if investor sentiment continues to deteriorate.

DBRS believes that greater clarity on timing, implementation and the extent of private sector involvement in the Greek program are needed to restore investor confidence, without which debt sustainability, financial stability and a return to higher growth in several member countries may be delayed, putting downward pressure on DBRS’s sovereign ratings.

Notes:
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.