Downgrade drama: S&P lowers France, Italy, Spain, 6 others

By Jamey Keaten, Associated Press Updated 4m ago

PARIS Ratings agency Standard & Poor's has downgraded the government debt of France, Austria, Italy and Spain, but maintained Germany's at the coveted "AAA" level.

The cuts, which eliminated France and Austria's triple-A status, deal a heavy blow to the currency union's ability to fight off a worsening debt crisis. In total, S&P cut its ratings on nine eurozone countries.

France and Austria both dropped one notch to AA+. Italy was lowered by two notches to BBB+ from A, and Spain fell to A from AA-. Portugal and Cyprus also dropped two notches. The agency also cut ratings on Malta, Slovakia and Slovenia.

MORE: Greek debt talks break down
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The downgrades come as crucial talks on cutting Greece's massive debt pile appeared close to collapse Friday.

Speaking on France-2 television, Finance Minister Francois Baroin confirmed that France had been lowered by one notch. That would mean a rating of AA+, the same rating the United States has had since S&P downgraded it last August.

In the euro zone
Countries that use the euro currency: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain
Baroin said France had received a change to its rating "like most of the eurozone," referring to the 17 European nations that use the euro currency.

A credit downgrade escalates the threats to Europe's fragile financial system. It increases the costs at which the affected countries some of which are already struggling with heavy debt loads and low growth borrow money.

Baroin said the downgrade was "bad news" but not "a catastrophe."

"You have to be relative, you have keep your cool," he said. "It's necessary not to frighten the French people about it."

S&P had warned 15 European nations in December that they were at risk for a credit downgrade.

Earlier Friday, as rumors of a looming downgrade swirled around the financial markets, the euro hit its lowest level in more than a year and borrowing costs for European nations rose. Stock markets in Europe and the U.S. fell.

The fears of a downgrade brought a sour end to a mildly encouraging week for Europe's heavily indebted nations and were a stark reminder that the 17-country eurozone's debt crisis is far from over.

Earlier Friday, Italy had capped a strong week for government debt auctions, seeing its borrowing costs drop for a second day in a row as it successfully raised as much as 4.75 billion ($6.05 billion).

Spain and Italy completed successful bond auctions on Thursday, and European Central Bank president Mario Draghi noted "tentative signs of stabilization" in the region's economy.

Credit downgrades will drive up the cost of European government debt as investors demand more compensation for holding bonds now deemed to be riskier. Higher borrowing costs puts more financial pressure on countries already contending with heavy debt burdens.

In Greece, negotiations Friday to get investors to take a voluntary cut on their Greek bond holdings appeared close to collapse, raising the specter of a potentially disastrous default by the country that kicked off Europe's financial troubles more than two years ago.

The deal, known as the Private Sector Involvement, aims to reduce Greece's debt by 100 billion ($127.8 billion) by swapping private creditors' bonds with new ones of a lower value, and is a key part of a 130 billion ($166 billion) international bailout. Without it, the country could suffer a catastrophic bankruptcy that would send shock waves through the global economy.

Prime Minister Lucas Papademos and Finance Minister Evangelos Venizelos met Thursday and Friday with representatives of the Institute of International Finance, a global body representing the private bondholders. Finance ministry officials from the eurozone also met in Brussels Thursday night.

"Unfortunately, despite the efforts of Greece's leadership, the proposal put forward which involves an unprecedented 50% nominal reduction of Greece's sovereign bonds in private investors' hands and up to 100 billion of debt forgiveness has not produced a constructive consolidated response by all parties, consistent with a voluntary exchange of Greek sovereign debt," the IIF said in a statement.

"Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach," it said.

Friday's Italian auction saw investors demanding an interest rate of 4.83% to lend Italy three-year money, down from an average rate of 5.62% in the previous auction and far lower than the 7.89% in November, when the country's financial crisis was most acute.

While Italy paid a slightly higher rate for bonds maturing in 2018, which were also sold in Friday's auction, demand was between 1.2% and 2.2% higher than what was on offer.

The results were not as strong as those of bond auctions the previous day, when Italy raised 12 billion ($15 billion) and Spain saw huge demand for its own debt sale.

"Overall, it underscores that while all the auctions in the eurozone have been battle victories, the war is a long way from being resolved (either way)," said Marc Ostwald, strategist at Monument Securities. "These euro area auctions will continue to present themselves as market risk events for a very protracted period."

Italy's 1.9 trillion ($2.42 trillion) in government debt and heavy borrowing needs this year have made it a focal point of the European debt crisis.

Italy has passed austerity measures and is on a structural reform course that Premier Mario Monti claims should bring down Italy's high bond yields, which he says are no longer warranted.

Analysts have said the successful recent bond auctions were at least in part the work of the ECB, which has inundated banks with cheap loans, giving them ready cash that at least some appear to be using to buy higher-yielding short-term government bonds.

Some 523 banks took 489 billion in credit for up to three years at a current interest cost of 1%

Downgrade drama: S&P lowers France, Italy, Spain, 6 others