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Q&A: Why is a AAA credit rating the gold standard?

Europe has been plunged into a fresh crisis after France admitted it had been stripped of its coveted AAA rating

Why does a credit rating matter?

The interest rate nation states are forced to offer to attract sufficient lenders when taking out multi-billion euro loans depends, in part, on their credit rating. France, Germany, the Netherlands, Luxembourg, Finland and Austria have enjoyed the highest rating throughout the crisis, keeping their borrowing costs low. The AAA grade by the two ratings agencies Standard & Poor’s and Fitch and Moody’s is considered the gold standard.

Can France and the others brush off a downgrade?

They will try, but eurozone countries have borrowed hundreds of billions from overseas lenders, many of them banks and hedge funds; these lenders want to judge the risk of losing their money and pay close attention to ratings given by the two agencies.

How do lenders react to a downgrade?

Interest rates go up, and states find it more expensive to service debts. When rates hit 7% it becomes difficult to find lenders at all – Greece, Portugal and Ireland had instead to ask Brussels for loans; Italy and Spain are close to needing a bailout.

Why would France be downgraded?

Nicolas Sarkozy has battled hard to maintain France’s AAA status, but his determination to keep the eurozone together has lumped more costs on France; meanwhile, its exports have faltered, and the government cannot generate enough income to meet its long-term welfare commitments, let alone give extra support for other debt-laden countries.

Does this apply to all the eurozone?

Each state has its own story. In Austria, ratings agencies see its banks vulnerable to a slowdown in eastern Europe, where they have lent billions. Slovenia has relied on a flow of Italian and German investment that has now dried up.

Why does the UK escape a downgrade?

On most measures it would rank alongside France and be vulnerable to a downgrade: George Osborne has admitted missing debt reduction targets, and our banks have huge loans in Ireland and Spain. But our independent central bank has spent £275bn propping up the UK’s financial system, and the pound’s flexible exchange rate has effectively cut 25% off our debt to foreign investors.

Weren’t the same agencies wrong in the boom?

Yes. They agreed with major banks that derivatives sold to other banks deserved a AAA rating, when they were full of US mortgage debt and highly toxic. Now they argue that their sovereign ratings [for nation states] are done in separate departments, and continue to be an independent service. © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds