by Win Thin
Here are some more thoughts on S&P moving its outlook on Belgium’s AA+ rating to negative from stable. S&P noted that it may cut the rating by one notch within the next six months if the major political parties do not form a government soon, and added that a cut could still be seen over the next two years if the next government fails to stabilize public debt and improve political cohesion. S&P analyst noted that the current caretaker government may be “ill-equipped” to respond to any shocks to the public finances. In our view, Belgium and France are the weakest credits in the core as our sovereign ratings model still puts France as a borderline AA+/Aa1/AA+ credit compared to actual ratings of AAA/Aaa/AAA. While Belgium does have weak fundamentals, our model shows it to be correctly rated at AA+/Aa1/AA+. However, we acknowledge that contagion remains strong in the euro zone and we cannot rule out a downgrade for Belgium since the rating agencies remain on the warpath. As we saw during the Asian crisis, the agencies tend to overcompensate on the downside in times of crisis as they try to regain lost credibility.
The budget and debt ratios for Belgium have always been high, but we note that the rest of the core has in a sense caught up with Belgium during this crisis. In 1999, there was a gap between the debt/GDP ratios of Belgium and France of 55 percentage points. In 2010, that gap was only 16 percentage points. The market is now viewing Belgium as twice as risky as France, as its 5-year CDSs are trading at 204 bp vs. 101 bp for France. Indeed, this puts Belgium right around Italy (208 bp) and shows that the distinction between core and periphery is getting harder and harder to make. After France and Belgium, we view the next weakest core country as Austria, and note that its CDSs are trading at 93 bp today. CDS prices for Belgium, France, and Austria have all moved significantly higher over the past month and reflect growing contagion risk for the entire euro zone.
So while our model does not show Belgium as being out of line with current ratings of AA+/Aa1/AA+, the fact that it has been under a caretaker since the government collapsed in April is clearly playing a big role in S&P’s decision. Indeed, the Belgian situation is a stark reminder that politics are likely to play a greater role in the evolution of the euro zone crisis in 2011, as governments in Ireland, Greece, Spain, and others are struggling (and sometimes failing) to stay in power even as they try institute tough austerity measures. We were quite surprised that the IMF was willing to grant an aid program to Ireland even though it is a virtual certainty that a new government will be in place next year whose commitment to austerity is still unknown. During EM crises of the past, the IMF often waited until the government changeover had taken place first before starting negotiations. Either way, the mix of political uncertainty, slow growth, and high unemployment is likely to provide a very volatile (and negative) backdrop for the euro zone in 2011.
