When people lend money, they want to be sure they get it back with interest regardless of whether they are lending to a company or a state. Rating agencies assess how likely it is that a debtor will meet its obligations.

The Standard & Poor's analysts who downgraded Greece's credit rating have examined, among other things, the current budgetary situation, the political circumstances and economic growth prospects in Greece. "We believe that the government's scope for political maneuvers is getting narrower," the agency wrote.

Despite Greek leaders' reform pledges, the rating agency sees a "confidence crisis" because observers are uncertain whether the government is really in a position to implement the reforms quickly enough. Also, analysts doubt Greece has the political will to pursue the tough austerity measures "over a period of many years."

Exaggerated response?

However, Martin Huefner, chief economist at the Munich-based financial services provider Assenagon, views the Greek downgrade as a negative exaggeration by rating agencies eager to distance themselves from the overly positive assessments they issued before the financial crisis.

"I think the rating agencies are now trying to eliminate the mistakes made by Lehman Brothers by overdoing things a little now," he said.

Huefner also expects the other large agencies, Moody's and Fitch, to downgrade their evaluations of Greece. He believes the ratings have far-reaching consequences.

"The economic significance is that a string of investors - pension funds, insurance companies, etc. - will now no longer be allowed to invest in Greek bonds," he explained.

"Of course there are speculators (willing to accept high levels of risk), but the bulk of Greek bonds are held by pension and insurance funds," Huefner said.

Evasive credit

As a result, Greece now has little chance of obtaining the money it needs to pay off old debts.

"In the next three years, Greece needs over 100 billion euros in follow-up funding," said Wolfgang Gerke, president of the Bavarian Finance Centre, a Munich-based think tank

The crisis of confidence has been further exacerbated by the rating downgrading. Already last week, investors were demanding higher risk surcharges on an almost a daily basis when they lent money to the Greek state.

Whereas Germany can borrow money for less than three percent, the return on Greek government bonds reaching maturity in 10 years' time is over 10 per annum. In other words, for every euro that Greece borrows now, it will have to repay two euros. Clearly, this cannot go on for long.

Pressure to act

Share markets and the euro currency have been jolted by the demotion of Greek debt, as well as the slashing of Portugal's credit rating and the downgrading of Spain's.

The unrest in the markets is forcing Europe's politicians to act quickly. According to sources at the EU Council Presidency, billions of euros in aid to Greece could be released at a special summit on May 10 – a day after the election in Germany's most populous state, North Rhine-Westphalia. Observers say Chancellor Angela Merkel has been trying to delay approving the aid package - which is hugely unpopular in Germany - until after the election.

On Wednesday, Merkel and US President Barack Obama called for "resolute action" by Athens to control spending. The White House said after telephone talks between the two leaders that they "discussed the importance of resolute action by Greece and timely support from the IMF and Europe to address Greece's economic difficulties."

After balking at pressure to lead Europe's rescue effort, Merkel has signaled that Germany will now get behind the massive operation.

Merkel eases stance

"It is perfectly clear that the negotiations with the Greek government, the European Commission and the IMF need to be accelerated," Merkel told reporters in Berlin. "We hope they can be wrapped up in the coming days and on the basis of this, Germany will make its decisions," added.

Merkel apparently eased her stance after talks with International Monetary Fund chief Dominique Strauss-Kahn and European Central Bank president Jean-Claude Trichet. The IMF head warned that confidence across the entire 16-nation euro zone was now "at stake."

Merkel is set to hold an emergency cabinet meeting on the Greek and euro zone debt crisis next Monday amid warnings about the impact on the stability of the euro.

Politicians share blame

Economist Martin Huefner says politicians are partly to blame for the extent of the crisis. He says the constant vacillation by the federal government and the discussion about restructuring Greek debt has exacerbated the situation.

"The crisis management is very bad," Huefner said, adding that the "yes, but" debate in Germany has helped cut Greece off from private investors.

"Four weeks ago, we could still assume that there would be a co-financing – one part to be contributed by the private sector, one part by governments. Now only the governments are to lend money. That means things have become much more expensive," he added.

Author: Andreas Becker (rb/AFP)

Editor: Sam Edmonds