A brave new world without AAAs
Citi's Global Economics Team warns of further sovereign downgrades, with France thought to be the next G7 country at risk of losing its AAA rating.With the US's sovereign rating being downgraded by Standard & Poor's, many are asking who will be next? The focus is shifting to other G7 countries, namely France, which although it has played an integral role in the bail outs of other eurozone countries, now faces speculation about its own debt problems.
According to data provided by Citi's Global Economic Team, France's 2010 deficit currently stands at 7% of GDP, which is lower than the UK's at more than 10%, but higher than other eurozone countries such as Germany, and the 17 euro area countries.
"We expect that France, with its high public debt and deficit, and popular resistance to cutbacks in its, even by euro area standards, extremely large welfare state, is now likely to be the G7 country at the highest risk of losing its AAA rating," writes Citi's economists. "The markets appear to share this sentiment with French 10-year spreads over German Bunds reaching 16-years highs of 90.7bps on Friday, 5 August 2011, at levels not seen since the last of the major ERM crises in December 1994."
According to Citi's Global Economics team, in the wake of the US sovereign downgrade, other AAA-rated sovereigns in the G7 are also at risk. "In the emerging Brave New World without AAA G7 sovereigns, relative safety guides portfolio allocation decisions. Absolutely safe assets no longer exist," writes Citi's economists.
They also warn that the UK could lose its AAA status if growth further falters. In early August, Mervyn King, the Governor of the Bank of England announced a second downward revision for UK 2011 economic growth, with the economy now forecast to grow by 1.4% instead of 1.8%, but he cautioned that figure may need to be revisited in light of the anaemic growth in both Europe and the US. According to Citi's economists, "The clearest risk to
the UK’s AAA rating would come from an abandonment of its fiscal austerity policy," yet some say it is this very policy, which is hampering growth.
Citi also warns that Germany needs to "look over its shoulder" as its government gross debt ratio is 80% of annual GDP. France and Germany's insistence that the Maastricht criteria for full EMU membership, which called for public debt levels to be no more than 3% of GDP, be relaxed in their case, could come back to haunt them.
So what does a world without AAA-rated G7 sovereigns look like? According to Citi's economists, for a country's currency to be considered a safe haven by investors, a AAA rating is not necessary. "It is sufficient that the sovereign is viewed as at least as safe as the next best alternative," it states. In that respect, it adds that the US is unlikely to relinquish its safe haven status, despite the downgrade.
Citi highlights that some of America's leading companies are likely to remain AAA-rated and could "trade through" the sovereign. "Some AAA-rated corporates are therefore likely to join the highest rated sovereigns as safe havens when the markets go into risk-off mode. This could then tempt some of these corporates to issue too much debt, following down the road trod by their sovereigns."
Pic provided by Dan.