Spain has become the latest country to have their credit rating downgraded. Next in line could be Portugal and Ireland. As a country, having ones credit downgraded is a huge blow to the economy. Most countries today rely heavily on borrowing to keep their economies moving along, and when credit ratings fall, borrowing costs go up, sometimes dramatically. For Americans this might seem like a European problem, and nothing for us to worry about, but with each new bailout, and with every trillion added to the deficit, the potential for the U.S. to have their credit rating downgraded is increased. That is still an afterthought at this point, but if it were to happen the results would be catastrophic. Kathy Lien takes a closer look at the latest credit rating downgrades in her blog post below, and attempts to answer the question: "What does it mean to have your credit rating downgraded?"
This morning, Standard and Poors downgraded the sovereign debt rating of Spain from AAA to AA+. With Greece’s rating downgraded last week and Ireland and Portugal on credit watch negative, this could be the beginning of more downgrades.
Therefore it is important to consider what it means for a country to have their credit rating downgraded:
To have your credit rating downgraded means higher costs of borrowing. The Euro is slipping as we are seeing an exodus out of Spanish bonds because some global funds are mandated to invest only in AAA debt. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt.
On a local level, we expect investors to shift their money out of Spanish debt and into countries with a higher credit rating such as Germany or even outside of the Eurozone. Spanish Bond prices have dropped significantly since the beginning of the year, driving yields higher. The gap between the interest rates on German and Spanish bonds have hit the highest level in 10 years, reflecting the sharp divergence in economic performance. Talk of Spain leaving the Eurozone is irrelevant because their cost of borrowing would skyrocket if they chose to do so. I think that there is a greater chance the countries being downgraded will be kicked out of the Eurozone.
This post can also be viewed at kathylien.com.