A plan by France and Germany to increase fiscal integration in Europe is promising and could help avoid a mass debt downgrade of euro zone countries by Standard & Poor's, a director with the ratings agency said on Tuesday.
Frank Gil, senior director of European sovereign ratings at S&P, said Friday's crucial EU summit could be considered successful if leaders came up with some indication they have a strategy to spur economic growth and share fiscal and financial risks.
There could be, at least what we heard already from the French and the Germans looks potentially promising: a shift toward some sort of fiscal transfer, some sort of fiscal sharing, he said in an interview with Reuters Insider.
John Chambers, chairman of S&P's sovereign ratings committee, also said greater fiscal union in the euro area would be supportive of ratings.
It would put finances of the union on a better footing, and would better align the monetary policy with the fiscal policy, Chalmers said in a separate interview with Reuters Insider.
To watch Gil's interview: http://tinyurl.com/7944gsc
To watch Chambers' interview: http://tinyurl.com/887wxqv
S&P on Monday issued an unprecedented warning that it could downgrade nearly all euro zone members, including top-rated countries such as Germany and France, if leaders fail to reach an agreement on how to solve the region's debt crisis.
S&P's move increased pressure on policymakers to act quickly. It could also give a boost to the plan agreed on Monday by French President Nicholas Sarkozy and German Chancellor Angela Merkel to impose mandatory penalties on countries that exceed deficit targets.
S&P issued its ratings warning just days before the EU summit to warn investors of the possibility of imminent downgrades in the euro zone, Chambers said.
If things go bad in the summit we'll have to lower some ratings, and to signal that possibility we use the credit watch, he said.
S&P's concerns are not that EU leaders are unable to identify the issues plaguing the euro zone, but that they might not act in a timely manner, Gil said.
It's clear that so far the policy responses to the pressures on sovereigns and commercial banks in Europe simply haven't gone far enough, he said.
Some of the initial efforts to improve confidence have backfired, he added, citing the fact that a bailout fund created to backstop troubled euro zone countries hasn't been fully implemented yet.
S&P also warned on Tuesday that it could downgrade its AAA rating on the bailout fund, the European Financial Stability Facility, if the countries that guarantee its financial obligations are downgraded.
FINANCIAL SECTOR RISKS
How to save troubled European banks without jeopardizing the finances of specific countries also must be addressed by EU leaders, Gil said.
In the past we've also pointed out the need to partly delink sovereign from financial sector risk by creating a mechanism which could recapitalize European banks independently of their underlying sovereigns, he said.
Gil cited the Netherlands as an example of a competitive economy with low government debt that could get hurt by its banks' exposure to other euro-zone countries.
Their banking system is roughly four times the Dutch GDP, and if you look at their external asset exposure, you can see how exposed they are through the financial sector to other euro zone countries and economies, he said.
Such interdependence, Gil said, has caused competitive economies such as those of Germany and the Netherlands to contract more than the Spanish economy did in 2009, when the global financial crisis threw most countries into recession.
The fact that even German, whose economy is considered one of the strongest in the euro zone, had its rating placed on watch negative by S&P simply means that everybody is in the same boat, Chambers said.
It's true that Germany is an external creditor, but if there are problems among the external debtors within the euro zone, that is going to have a big impact on German banks and there are going to be fiscal consequences to that, he said.
(Editing by Dan Grebler, Neil Stempleman, Leslie Adler)