European auto manufacturers will struggle to maintain credit ratings despite expected long-term global growth in demand, due to a glut of capacity, Moody's Investors Service warned on Monday.

Moody's believes global demand for passenger cars and light vehicles should grow by 2-3 percent per annum in the long term, Falk Frey, a Moody's senior vice president, said in a report. However, the challenges for European manufacturers to participate in this trend are immense.

The credit ratings agency said the main driver of the credit quality of European automakers in the short-to-medium term will be their dependency on Western European markets where demand is set to remain flat, leading to a continued battle for market share. French and Italian producers in particular are highly exposed to Western Europe, it said.

The problem of over-capacity in the industry is also increasing, with competition from plants in Eastern Europe a threat, Moody's said.

Other challenges come in the form of increases in raw material prices, the strength of the euro and higher costs related to environmental and safety requirements.

The agency said earnings at France's Renault were expected to rebound by 2008, but warned that any visible signs of deviation from this expectation would put the current rating under pressure. Moody's rates Renault at Baa1, the eighth-highest investment-grade rating.

Although Renault has cut costs in recent years, Moody's said the company suffers from low capacity utilisation and it warned that further cost cutting might not be enough to boost profitability in the face of stiff European competition.

With the launch of several new models, national rival PSA Peugeot Citroen is expected to be able, at a minimum, to prevent market share erosion, the agency said.

Together with cuts in Peugeot's workforce and plant capacity in Western Europe, its financial profile should strengthen in 2008 and 2009 to fit more comfortably in the Baa1 category.

Moody's said the ratings of DaimlerChrysler, currently Baa1, would be mainly driven by the sale of 80.1 percent of its struggling Chrysler U.S. unit to Cerberus Capital Management.

Fiat SpA saw a strong rebound in 2006, Moody's said, but sustained growth in sales and market share was needed to lift its rating to investment grade from the current level of Ba2.