The likelihood of a country other than Greece leaving the European Union’s single currency area remains very low, but has the potential to increase materially this year given the rise of anti-EU political parties in the region, Moody’s Investors Service said in a report today.
While it is unlikely that any of these parties will gain sufficient electoral support to seek a mandate for exit from the euro area in the
near future, they can still influence political agendas, potentially weakening support for euro area membership.
The report, “Euro Area Issuers – FAQ: Insights on How Euro Area Exit Risk is Reflected in Moody’s Ratings” addresses a range of investors’ questions about how Moody’s reflects euro area exit risk in its ratings, including the likelihood of a country leaving the euro area and how the rating agency would assess whether a departure followed by a currency redenomination constitutes a default.
“Aside from Greece, Moody’s believes that the likelihood of a country leaving the euro area remains very low,” said Colin Ellis, Moody’s Chief Credit Officer for EMEA and the report’s co-author. “However, this probability could increase over coming months, depending on the results of upcoming elections.”
Any exit from the European single currency would be an existential moment for the euro area: it would demonstrate conclusively that the currency union was not indivisible.
A country leaving the euro area and redenominating its currency would not necessarily automatically result in a default, however. In that
situation, Moody’s would in particular focus on any change in the financial value of debt obligations relative to the original contractual
Moody’s would only conclude that a default had occurred if redenomination resulted in investors being offered securities that were of diminished value relative to the original — euro-denominated — promise.
Exit risk is reflected both in Moody’s euro area bond ratings and euro area country ceilings, which capture risks affecting a given country that arise from political, institutional, financial and economic factors either within that country or externally.
In a currency union like the euro area, the main irreducible credit risk that Moody’s country ceilings reflect is the risk of the country exiting the euro area and redenominating all domestic debts into a new, weaker currency.
“Ultimately, the single currency is a political construct that relies on sustained popular support among member states,” said Mr Ellis. “Any evidence that such popular support was waning in key member states could weigh on popular support elsewhere in the euro area, increasing credit risks.”
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