01/27/2012 04:05 EST | Updated 03/28/2012 05:12 EDT

Eurozone Downgrade: Fitch Lowers Credit Ratings For Italy, Spain, Belgium, Cyprus and Slovenia


FRANKFURT - Fitch Ratings downgraded the debt of Italy, Spain and three other countries that use the euro on Friday, a possible setback as European leaders work to contain the continent's debt crisis.

The lower government-debt ratings for Italy, Spain, Belgium, Cyprus and Slovenia could make it more expensive for these countries to borrow.

Fitch said its decision was based on the deteriorating economic outlook in Europe, a concern that Europe's bailout fund is not large enough and a belief that European leaders are not acting quickly or boldly enough to prevent the debt crisis from worsening.

The downgrade came after European financial markets had closed. The major stock indexes of Germany, France and Britain fell slightly on Friday, while the euro rose 0.83 per cent to $1.3189.

Government debt ratings can play a significant role in determining countries' borrowing costs. The higher the costs the greater the likelihood of default for a heavily indebted country.

Ireland, Greece and Portugal have been cut off from bond market borrowing because of investors' fears that they might default. They have had to take bailout loans from other eurozone governments and the International Monetary Fund.

Lower debt ratings do not guarantee higher borrowing costs, however.

Borrowing costs for many European countries have fallen in recent weeks despite Standard and Poor's decision on Jan. 13 to lower its ratings for nine countries that use the euro. This reflects growing investor confidence in those countries' economic policies and the impact of the European Central Bank's decision to loan hundreds of billions of euros to banks at very low rates. Some of that money has been used to buy government bonds, which are paying higher interest rates and enabling banks to earn a tidy profit.

The latest example was on Thursday, when Italy borrowed nearly $6.5 billion in two-year bonds at an interest rate of 3.76 per cent. It paid 4.85 per cent in a comparable bond auction in December.

Fitch lowered its ratings for the five countries by one notch and placed a negative outlook on all of them — meaning there is more than a 50 per cent chance of a further downgrade over the next two years.

Italy was lowered to a rating of A-, while Spain was downgraded to A. The rating of a sixth country, Ireland, was affirmed at BBB+, but it also received a negative outlook.

Fitch also issued a warning to Italy, a recent focus of the crisis because of its €1.9 trillion ($2.5 trillion) in debt and sluggish, bureaucracy-choked economy. The agency said the third-largest eurozone economy would face permanently higher borrowing costs that would make it harder to keep its debt under control. It resisted stronger ratings action because of the "strong commitment" of the new Italian government under Prime Minister Mario Monti to balance the country's budget and make Italy a better place to do business.

European leaders have been criticized for moving too slowly in tackling the crisis, which started in October 2009 when Greece admitted it was in deep financial trouble.

Led by Germany, the eurozone's largest member, governments have resisted sweeping solutions such as pooling their borrowing power in so-called eurobonds and have balked at increasing the financing of their bailout funds from €500 billion. Efforts have focused instead on making bailed-out countries try to cut spending and reduce their budget deficits. The 17 members have also agreed to come up with a treaty requiring national laws to limit deficits.

At the World Economic Forum gathering in Davos this week, leading European finance chiefs have sought to reassure anxious global business leaders that Europe is on track to solve its debt crisis.

But Fitch said that European leaders' "gradualist" approach to tackling the crisis meant that Europe will continue to face episodes of severe financial volatility that would erode government's ability to repay debt.

Fitch said the eurozone's difficulties would be compounded by a shrinking economy.

"The eurozone crisis will only be resolved as and when there is broad economic recovery," Fitch said. "It is evident that further substantial reforms of the governance of the eurozone will be required to secure economic and financial stability, including greater fiscal integration."

Greece is locked in talks to secure a crucial debt relief deal with private investors while also tackling demands from its European partners and the IMF for deeper economic reforms.

Failure on either front would force the recession-bound country to default on its debt in less than two months, pouring new fuel on the fires of Europe's debt crisis.