U.S. rating agency Standard & Poor's cut its credit rating of the euro zone's EFSF rescue fund on Monday, and Greece was under pressure to break a deadlock in debt swap talks if it is to avoid an unruly default.
French Finance Minister Francois Baroin said there was no need to shore up the European Financial Stability Facility after S&P downgraded it by one notch to AA+ from triple-A, echoing the view of Germany, the only major euro zone member to retain a top-notch credit rating.
S&P said in a statement the decision was all but inevitable following identical cuts three days earlier to the creditworthiness of France and Austria, two of the EFSF's guarantors.
We consider that credit enhancements that would offset what we view as the now-reduced creditworthiness of the EFSF's guarantors and securities backing the EFSF's issues are currently not in place, the agency said in a statement.
We have therefore lowered to AA+ the issuer credit rating of the EFSF, as well as the issue ratings on its long-term debt securities.
Financial markets, which had fallen after the mass downgrades of euro zone members on Friday, showed little reaction to the latest blow -- which had been expected -- and Japan, a major buyer of EFSF bonds, said they remained an attractive investment.
A growing number of experts, including a Standard & Poor's official, warned that a Greek default was on the cards, after Greece's talks with creditors broke down on Friday.
Greece was under growing pressure to secure a last-ditch agreement with its private creditors to accept voluntary losses on their holdings of Greek bonds.
Athens risks going bankrupt when 14.5 billion euros (12 billion pounds) of bond redemptions fall due in late March. Without a private sector bond swap involving a voluntary writedown, a 130 billion euro second international bailout for Greece could fall apart.
The talks with creditor banks broke down because of different views on what interest rate is acceptable, the head of the group leading private sector talks said.
Charles Dallara, managing director of the Institute of International Financial, said the banks were very surprised at the stance taken by some officials representing both governments and multilateral institutions, without naming them.
The EFSF was set up by the 17 governments that share the European single currency in May 2010 and has so far been used to provide emergency loans to Ireland and Portugal. It is also expected to contribute to a second bailout of Greece.
The fund has an effective lending capacity of 440 billion euros, which depends on guarantees, mainly from the euro zone's AAA countries, only four of which now remain: Germany, Luxembourg, Finland and the Netherlands.
LENDING CAPACITY UNAFFECTED
In a statement, the EFSF said the downgrade would not affect its lending capacity, and emphasised that its short-term rating remained at S&P's top level.
The downgrade to 'AA+' by only one credit agency will not reduce EFSF's lending capacity of 440 billion euros, said the fund's chief executive, Klaus Regling.
EFSF has sufficient means to fulfill its commitments under current and potential future adjustment programmes until the ESM becomes operational in July 2012, he added.
The ESM -- the European Stability Mechanism -- is a permanent rescue fund that is expected to have an effective capacity of 500 billion euros, based on paid-in capital of 80 billion euros and callable capital of 620 billion euros.
French Finance Minister Francois Baroin said there was no need to shore up the EFSF despite the S&P rating downgrade.
The EFSF has kept intact its ability to lend, with enough means and guarantees to fulfil the full range of its present and future commitments, he said in a statement. There is therefore no need to act on the EFSF at the moment.
German Chancellor Angela Merkel's spokesman, Steffen Seibert told reporters: The government has no reason to believe that the volume of guarantees that the EFSF has now should not be sufficient to fulfill its current obligations.
We should not forget that it has been decided to significantly move forward the ESM and to have it in place in mid-2012, one year earlier than planned.
There was also support from Japan, with Finance Minister Jun Azumi saying Tokyo's trust in EFSF bonds, in which it has so far invested 21 billion euros, had not been shaken.
Japan has bought them by certain amounts and our stance will not immediately change just because of the downgrade, Azumi told reporters after a cabinet meeting.
The euro hovered just above a 17-month trough against the dollar early in Asia on Tuesday, but reaction to the S&P downgrade was muted. Trading overnight was subdued as U.S. markets were shut for the Martin Luther King holiday.
The head of Austria's debt office told Reuters the loss of Vienna's AAA status had also been priced into the market already, and Austria was able to sell treasury bills on Monday at rates very close to zero.
French President Nicolas Sarkozy brushed off the historic loss of Paris' top credit rating for the first time since 1975, a blow to his campaign for re-election in May, saying France's policy would not be dictated by rating agencies.
Contrasting S&P's move with a statement by rival watchdog Moody's, which still has France on an Aaa rating, he said: My deep belief is that it changes nothing. We must reduce the deficit, we must reduce our spending and we must improve the competitiveness of our economy to return to a path of growth.
LOSERS TO PAY?
Italian Prime Minister Mario Monti, whose debt-laden country was downgraded by two notches along with Spain, called last week during a visit to Berlin for the EFSF to be increased to ward off attacks on his country's bonds.
But a senior politician in Merkel's conservative CDU party, Michael Meister, said it was the downgraded countries that should increase their guarantees for the fund.
Germany was not downgraded so our contribution should not be changed. Countries that were affected must contribute more to the guarantees, Meister told Reuters.
Sources familiar with Greece's talks with its private creditors said EU paymaster Germany was pressing for new bonds to be given to banks in the planned swap to carry a low coupon of less than four percent that would increase the banks' effective losses to 75 percent.
The IMF was also weighing on the talks by warning that the Greek economy and the euro zone's economic outlook have worsened since the bailout package was agreed in October, raising Athens' funding needs to make its debt sustainable by 2020, they said.
Greece put a brave face on the standoff. There is a little pause in these discussions, Greek Prime Minister Lucas Papademos told CNBC television. But I am confident they will continue and we will reach an agreement that is mutually acceptable in time.
(Additional reporting by Lefteris Papadimos in Athens, Steve Slater and Richard Hubbard in London, Jan Strupczewski in Brussels and Fiona Ortiz in Madrid; Writing by Paul Taylor; Editing by Tim Pearce and Alex Richardson)