The world's ninth largest economy is now joining the first largest in the unhappy doghouse of Standard & Poor's downgrades. Just as the U.S. was busted down from AAA (S&P's highest rating) to AA+, so, too will France see its "credit score" fall.
A downgrade by S&P signals that the latest pledges by European leaders to clamp down on deficits and step up cooperation won’t be enough to end the region’s debt crisis and curtail the rise in France’s borrowing costs. The country’s benchmark 10-year bonds now yield 130 basis points more than debt of AAA rated Germany.
A downgrade of France may further complicate Europe’s efforts to stem the crisis by threatening the rating of the region’s bailout fund. The European Financial Stability Facility, which is funding rescue packages for Greece, Ireland and Portugal partially with bond sales, owes its AAA rating to guarantees from the euro region top-rated nations. A French downgrade may prompt investors to demand higher rates on the fund’s debt.
When the U.S. was downgraded after the debt-ceiling debate debacle last year, the ultimate impact was negligible. Yields on 10-year Treasury bonds actually dipped to historic lows, falling below 2 percent at times (Like now!), as money rushed into U.S. debt as a safe haven from global volatility.
France might not have such good fortune. The yield on its 10-year bond is above 3 percent. But the worrisome thing, as Bloomberg notes, is that the spread between France's bond yields and the world's fifth largest economy, Germany's, could widen. The whole point of the single euro currency was to prevent this — to level borrowing costs for all member of the eurozone.
Now what the 17 eurozone countries — including France, Germany, Italy, Spain, and of course basket-case Greece — need is the ability to basically refinance all euro debt, through the actions of the European Central Bank, the EFSF, and member nations. For this to succeed, both France and Germany, the effective leaders of the eurozone, need to be able to work together to avert a slow-motion crisis.
Low borrowing costs for one and rising borrowing costs for the other isn't exactly a formula for seamless cooperation. And let's not forget, French President Nicholas Sarkozy is facing a re-election challenge this year. A debt downgrade, while not unexpected, was the last thing he really needed.
Of course, let's not overreact. S&P didn't exactly cover itself in glory during the financial crisis. So it's easy to look at seemingly dramatic moves that the agency makes now and conclude that they they don't really mean much at all.