S&P cuts Lithuania, Latvia, affirms Estonia ratings

NEW YORK Mon Oct 27, 2008 12:55pm EDT

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NEW YORK Oct 27 (Reuters) - Standard & Poor's said on Monday it lowered the credit ratings on Lithuania and Latvia, while affirming the ratings on Estonia.

The outlook on all three Baltic sovereign is negative.

S&P lowered its long- and short-term foreign and local currency ratings on Latvia to "BBB/A-3" from "BBB+/A-2", on expected fiscal deterioration and increased risks the government will have to support domestically owned banks under a worsening credit environment, S&P said in a statement.

"The uncertainty surrounding these banks' liquidity needs, refinancing capacity, and worsening credit quality increases the external vulnerabilities of the Latvian economy." S&P's credit analyst Eileen Zhang said.

The negative outlook reflects the prospect of a downgrade if the government takes on substantial debt to support one or more banks operating in Latvia, or if a large outflow of funds triggers a balance of payment crisis.

The ratings could be lowered further if pressure on the exchange rate intensifies or the economy contracts faster than expected, S&P said.

The outlook on the City of Riga was revised to negative from stable, and the 'BBB' long-term ratings were affirmed.

LITHUANIA DOWNGRADED

Lithuania's long-term foreign and local currency ratings were lowered to "BBB+" from "A-" as the new government, which faces its first probable recession since its independence, has few policy options but to increase fiscal deficits and raise its debt burden.

"Projected fiscal deficits of above 3 percent of GDP challenge the credibility of Lithuania's currency board regime and increase the economy's external vulnerability," Zhang said.

The negative outlook reflects the increasing risk of a hard landing for the Lithuanian economy--specifically a sharp economic slowdown that is substantial enough to reduce employment, increase private sector insolvencies, and significantly worsen the public sector balance sheet in a short period of time, S&P said.

The ratings could be lowered further if pressure on the exchange rate increased or the economy contracts faster than expected.

The short-term ratings were affirmed at "A-2". S&P lowered its transfer and convertibility assessment "A+" from "AA-".

ESTONIA AFFIRMED

S&P affirmed Estonia's "A" long-term and "A-1" short-term sovereign credit ratings on the country's strong public sector balance sheet and narrowing external imbalances.

The outlook is negative.

"Our decision to affirm the ratings reflects the comfort provided by Estonia's accumulated fiscal reserve of around 10 percent of GDP. In the face of a sharp economic slowdown, this fiscal buffer should allow the government to maintain a net asset position despite expected moderate deficits," Zhang said.

The negative outlook reflects the persistent risk of a hard landing for the Estonian economy--specifically a sharp economic contraction that leads to job losses substantial enough to reduce households' ability to meet financial obligations.

In the event of a sharp deterioration in banks' asset quality, the contingent liability from the financial system could significantly worsen the government balance sheet in a short period of time, S&P said.

"We expect foreign participation in the banking system to maintain external funding, but this is dependent on the willingness and ability of the two big Swedish banks to maintain their investment in Estonia and allow its external imbalances to unwind in an orderly manner," Zhang said.

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