Countries' Debt Woes Pose Risk to Upturn

By JOANNA SLATER, BRIAN BLACKSTONE and MARCUS WALKER Worries over finances of some of the world's governments rippled through financial markets Tuesday, as a series of negative credit-rating actions served as a reminder of the fragility of the global recovery. Fitch Ratings cut Greece's credit rating a notch to the lowest level in the 16-nation euro zone, raising concerns that Athens could be sparking the biggest fiscal crunch the European monetary union has faced in its 10 years. Moody's Investors Service sliced ratings even more on Dubai government-controlled companies, renewing worries about the Arab emirate. Moody's also said the U.K.'s rating would be at risk if it didn't lower its budget deficit. Email Alerts For WSJ.com subscribers only Europe Alerts: Click here to sign up All email settings Even as a fledgling recovery takes hold, the deterioration of some government balance sheets represents a continuing risk. For certain countries, like Greece, the financial issues largely predated the crisis; for others, like the U.S. and U.K., the problems are an outgrowth of initiatives to fight the economic downturn. Greece's case could present the European Central Bank and the European Union with a dilemma: whether to bail out the country or possibly see a euro-zone member face a debt crisis. The first course could reduce the pressure for fiscal discipline, while the second could damage the credibility of Europe's great single-currency experiment. In an interview at The Wall Street Journal's Future of Finance Initiative conference in London, David Cameron, leader of Britain's opposition Conservative Party, said that tackling the U.K.'s massive deficit is "vital" but that moving too quickly to slash spending could jeopardize a fragile recovery. Investors reacted to Tuesday's debt worries by retreating from riskier assets, punishing currencies like the euro and the British pound. Bonds of riskier countries dropped. The Dow Jones Industrial Average declined 104.14 points to 10285.97, the sharpest fall since Nov. 27, after Dubai said it would delay payments on a government-owned concern's debt. Russia's finance minister added to the chorus of concerns Tuesday. He said Russia is "still a weak link" in the global economy and would be vulnerable in case of a reversal of the tide of money now flowing in, partly because of higher oil prices. In coming months, Russia is seeking to borrow in foreign currency for the first time since it defaulted on sovereign debt in 1998, triggering a financial convulsion. The euro is the centerpiece of Europe's drive toward closer political union, but skeptics have long warned that a monetary union isn't sustainable without more powerful pan-European political institutions. Greece's struggles threaten the first real fractures in the European currency union since its inception in 1999. The union has a single currency and monetary policy, but each of its 16 members has its own fiscal policy. The European Commission projects Greece's 2009 budget deficit at almost 13% of gross domestic product, versus an EU average of just under 7%. Greek government debt, currently about 112% of GDP, probably will balloon to 130% before stabilizing, Fitch said. Fitch cut Greece's rating a notch to BBB+, still within investment grade, citing its lack of decisive action to rein in the deficit. High debt and a sluggish economy are shared by Portugal, Ireland and Spain, creating a risk of contagion if investors flee Greek assets. "This raises question marks over the long-term viability of the euro's current membership," said Simon Tilford, chief economist at the Center for European Reform, a London think tank. "On current trends," he added, "we'll end up with economic stagnation and mounting political tensions in the euro zone, and, at worst, fiscal crises and a loss of political support for continued membership." Investors sold the euro in the wake of Greece's downgrade. Late Tuesday in New York, one euro bought $1.4704, down from $1.4813 a day earlier, continuing a slide that started Friday when the U.S. reported upbeat jobs data. Stock markets in the U.S. and Europe declined, with Greek shares down more than 6%. Seeking safety, investors drove up the prices of U.S. and German government bonds. In a sign investors want to park cash in secure places through year-end, the U.S. Treasury sold four-week bills with a zero-percent yield. The premium investors demand for holding 10-year Greek government bonds compared with the safer German government bonds hit its highest point since April. The premium, or spread, rose to as much as nearly 2.3 percentage points Tuesday, making it more expensive for Greece to refinance its debt. Yet the fact that financial markets "are punishing the bad and rewarding the good is a positive development," said David Woo, head of global currency strategy at Barclays Capital in London. He said that what Greece is facing now -- a very public reprimand and higher borrowing costs -- is "a form of policy discipline for the Greek government to do the right thing." Greek Finance Minister George Papaconstantinou pledged steps to restore fiscal credibility, doing "whatever is needed to meet our medium-term goals." But Greece's newly elected socialist government so far has failed to persuade EU officials or investors it will take the painful measures, especially spending cuts, that analysts say are needed to avoid a debt crisis. But Ireland is expected Wednesday to announce cuts in spending, including on public services. Greece's problems underscore longstanding concerns the European monetary union lacks the tools to make sure members' debts don't spiral out of control. The European Commission can impose fines on Athens, but such a step could make Greece's financial problems even worse. Investors are also focused on the highest-rated borrowers. The U.S. and U.K. are among those with a triple-A rating, but Moody's cautioned Tuesday that without action to curb deficits, both could drift toward a possible downgrade. Write to Joanna Slater at joanna.slater@wsj.com, Brian Blackstone at brian.blackstone@dowjones.com and Marcus Walker at marcus.walker@wsj.com