Sisyphus Rock and Roll

Warnings Feed Europe Debt Fears

Germany's Finance Minister Says Crisis Isn't Over; Credit Ratings on Cyprus and Greece Downgraded

By GEOFFREY T. SMITH and TERENCE ROTH

Sober warnings that the European debt crisis didn't end with last week's summit of European Union leaders reignited concerns of contagion risks on Wednesday, boosting borrowing costs for high-debt governments and pressuring the euro.

 

German Finance Minister Wolfgang Schäuble said Wednesday in an open letter to lawmakers belonging to his Christian Democratic Party that the euro-zone debt crisis isn't over and that more discipline is needed.

Also Wednesday, Moody's Investors Service downgraded Cyprus and warned it may cut the country's rating further, citing its weak fiscal position, fractious political climate and the exposure of its banks to Greece. The island's economic troubles have been compounded by rolling blackouts after an explosion destroyed the country's largest power station this month. A government spokesman said President Dimitris Christofias will push ahead with a cabinet shuffle planned for Thursday.

And Standard & Poor's Ratings Services cut its ratings on Greece further into deep junk territory, after the ratings company concluded a proposed restructuring by the nation's government would amount to a selective default. Moody's had cut Greece's rating Monday, warning that the bond exchange that is planned would constitute a default, and Fitch issued a similar warning on Friday.

Mr. Schäuble said in his letter that Germany wouldn't write "blank checks" for the European Financial Stability Facility, the EU's bailout fund for distressed governments—again registering German opposition to calls to increase the fund's lending volumes to reassure markets that default risk was being minimized. He also cautioned against putting Spain and Italy in the same boat as Greece, which he described as being at the root of the crisis. "The financial situation in some countries that are now in [the market's] focus, is in itself no cause for serious concern," he wrote.

Late Wednesday, Spanish Finance Minister Elena Salgado reached an agreement with the finance chiefs of Spain's powerful regions on budget targets and spending controls, despite escalating tensions in recent weeks over measures needed to slash one of the European Union's largest budget deficits.

Still, the suggestion of more tests to come and of limits on German support for future safety nets put investors on edge, shaking the comparative calm that followed the EU's decision last week on a second bailout package for Greece totaling €109 billion ($158.17 billion), augmented by debt concessions by creditor banks.

Other news Wednesday contributed to the unease. The International Monetary Fund, concerned about its enormous long-term exposure to the euro zone, may contribute a smaller share of official financing in the new Greek aid package than it did for the Portuguese and Irish rescue programs, people familiar with the situation said.

IMF financing of a new Greek package "is not a done deal," said Paulo Nogueira Batista, Brazil's representative on the IMF executive board. There are legitimate questions about whether the package is sufficient to lower Greece's debt profile enough to make the country's debt sustainable, he said. Mr. Batista also criticized Europe for assuming IMF funding. "It's inappropriate...they come close to treating the IMF as part of their own structure," he said.

The IMF has already pledged to lend €78.5 billion to Greece, Ireland and Portugal through 2014. That is many times the IMF shareholding of these three countries, a growing source of worry to fund officials.

Greece's debt sustainability is still a concern for fund officials despite the new aid package.

Given the high risk of contagion and the systemic nature of the crisis, however, the fund is widely expected to approve new cash for Greece.

David Beers, Standard & Poor's Corp.'s global head of sovereign ratings, said on CNBC television that Greece faces new ratings downgrades and probably will have to restructure its debt for a second time within the next two years.

Italy had to pay a yield of 4.07% on its new 10-year bond on auction Wednesday, up sharply from 2.51% at the previous sale. The two auctions aren't directly comparable because Tuesday's was an inflation-linked bond. The higher yield was caused largely by the recent increase in the inflation rate.

The wave of news contributed to a revival of caution, as investors again backed away from the high-debt countries on the euro-zone's periphery.

The euro fell to $1.4365 in New York afternoon trading, although the deadlock on the U.S. debt ceiling continued to drag on the dollar.

Spanish and Italian bonds fell, but didn't break out of their recent trading ranges.

The cost of insuring debt issued by highly leveraged governments against default jumped from Tuesday's levels, although later Wednesday it settled from intraday highs.

The cost of insuring European bank debt rose Wednesday, more in response to government debt burdens than to less-than-impressive bank earnings. "If you look at a bank's CDS, and then at the sovereign, they're moving in virtually one line," said Philip Gisdakis, head of credit strategy at UniCredit SpA.