17/01/2012 04:16 GMT

Eurozone Crisis: Standard And Poors Downgrades Euro Bailout Fund

The eurozone's bailout fund, the European Financial Stability Facility (EFSF) has been downgraded by the rating agency, Standard & Poors (S&P). The move was inevitable following Friday's mass downgrade of nine sovereigns in the single currency area, and serves to highlight the waning confidence in European leaders' plans to end their debt crisis.

On Friday, S&P cut the ratings of nine European countries, including France and Austria, which lost their AAA-grades, and Italy, which fell two notches from A to BBB+. The EFSF was subsequently cut from AAA to AA+.

The fund was designed to borrow from the capital markets at relatively cheap rates, based on its AAA-rating, which gives investors confidence in being paid back. That money would then be passed on at cheap rates of interest to sovereign countries, such as Greece and Italy, which are struggling with unmanageable debt and high costs of borrowing.

The other two leading rating agencies, Fitch and Standard & Poors, have so far maintained their top ratings, although losing a top rating from S&P makes it more difficult to raise this capital.

In a statement on Monday, Klaus Regling, the EFSF's CEO, said that the downgrade would not prevent the fund from using its €440bn in existing capacity, before its successor fund, the European Stability Mechanism, begins to function in the summer of 2012.

“The downgrade to 'AA+' by only one credit agency will not reduce EFSF’s lending capacity of €440 billion. EFSF has sufficient means to fulfil its commitments under current and potential future adjustment programmes until the ESM becomes operational in July 2012,” Regling said.

The reason for the downgrades on Friday was principally the failure of European sovereigns to balance the need for austerity - which has been called for by markets and politicians in equal measure - and the need for economic growth. The former without the latter will not lead to any meaningful reduction in debt.

The eurozone is widely predicted to slide back into recession in 2012.

"This is yet another milestone on the Eurozone's descend into a downward economic spiral," Sony Kapoor, managing director of the Re-Define think tank, said in an email. "Things are likely to continue to get worse as the Euro area enters what may turn out to be a deep recession."

"This is more a reputational blow for the EU that had so prided itself on being a 'AAA' entity than anything with much economic significance. Unless the EU reverses course and shifts the focus to growth and away from its single minded obsession with austerity, the wave of downgrades will continue."

The mass downgrades added a layer of complexity to an already worrying situation in Southern Europe. The Greek government is locked in critical talks with its private sector creditors to arrange a write-down on its debt.

In October 2011, Greece had agreed on a 50% "haircut" on its debt, but that figure is no longer considered sufficient to bring the country back towards solvency. The Institute of International Finance (IIF), which has been negotiating on behalf of Greece's private sector creditors, is back in negotiations, after announcing a "pause for reflection" on Friday.

Greece has a €14.4bn bond maturing on March 20, and, without many options for financing remaining - absent an intervention by the European Central Bank (ECB) - it may well be facing a default before the end of the first quarter.