Downgrades add to euro woes

Eurozone should encourage support of other countries by removing their artificial trade barriers and increasing access

Amid protracted political infighting among the eurozone countries on how to overcome their debt crisis, Standard & Poor's (S&P) recently cut the credit ratings of nine eurozone members, including France and Austria, which had long enjoyed the top AAA credit rating.

The downgrades have irked eurozone leaders, as they come at a time when debt-laden EU countries have been struggling to find solutions to their financial distress. S&P defended its action on Saturday, saying the region's leaders have not done enough to solve their debt crisis and that France and Germany should make greater efforts to reduce the growing risk of debt defaults in the region. It is a reminder of the warnings issued by Robert Zoellick, president of the World Bank and Christine Lagarde, head of the International Monetary Fund (IMF) that the world economy is entering a new danger zone and that all countries should make combined efforts to promote economic growth and stability.

Eurozone governments, including France and Germany, have acknowledged the severity of the sovereign debt crisis in Europe, and launched the European Financial Stability Facility (EFSF) in a bid to ensure the stability of the euro and prevent the crisis from escalating. The EFSF is essentially guaranteed and low-cost bailouts by the eurozone nations that enjoy a triple-A credit rating to members with lower ratings or those that lack an independent financing capability.

However, following the S&P downgrades, the EFSF's funds are expected to decline from the original 440 billion euros ($560 billion) to 260 billion euros. The credit rating downgrades have undermined the EFSF's ability to build confidence, increased the financing costs for debt-laden EU countries and sparked panicked asset reorganizations by European banks. Following the move, regional banks are likely to reduce their holdings of the government debts of France and Austria, and increase the demand on the US dollar and Japanese yen, which will possibly result in new fluctuations in the global capital market. It is believed that once the risk of debt defaults bites Italy and other major regional economies, the magnitude of the eurozone debt crisis will exceed that of the 1997 financial crisis in East Asia, which will be a severe drag on the still sluggish global economic recovery.

The ongoing fiscal austerity efforts made by eurozone countries and their declining public investment and job creation capabilities have undercut the possibility for the IMF and overseas agencies to offer assistance to the badly battered eurozone nations. To forestall a fluidity crisis, the European Central Bank (ECB) should unwaveringly inject more fluidity into the region's financial agencies. Such a practice will help avoid a fluidity crisis and the selling of assets by financial agencies, a move that would expedite a financial collapse and the eruption of a full-blown crisis.

Eurozone countries should also accelerate the launch of the European Stability Mechanism, a permanent rescue-funding program. The establishment of a roughly 500 billion euros-worth funding pool under the program, together with the EFSF, funds raised by non-governmental organizations and the IMF bailouts, will come to the aid of the debt-laden eurozone nations and help prevent a possible collapse.

Besides, eurozone countries should also open investment access to other countries and lower their market admission thresholds in a bid to acquire more trade trust and funding support from countries outside the continent. At a time when they are bogged down in the quagmire of a lingering debt crisis, EU countries' artificial trade barriers are hindering efforts by other countries to help them solve crises.

Given that the EU remains the largest trade partner of China, the eruption of a fluidity crisis in the eurozone would have a negative impact on China in its endeavor to adjust its foreign reserve structure and promote the marketization of the yuan's exchange rate. It would also be unfavorable to China's ongoing integration into the global economic system. A fluidity crisis in eurozone nations would affect the "go global" strategy adopted by China's enterprises and its domestic financial stability. But if no fluidity crisis occurs in eurozone nations, China should unwaveringly strengthen trade and investment exchanges with the EU, and work more closely with the bloc to push for the establishment of a better international financial and monetary regime.

The author is vice-dean of the School of Economics at Fudan University.

(China Daily 01/18/2012 page8)