The euro crisis - can politicians catch up with the avalanche?

Transcription

1 The euro crisis - can politicians catch up with the avalanche? Senior Economist Frank Øland Hansen franh@danskebank.dk Senior Analyst Lars Tranberg Rasmussen laras@danskebank.dk Chief Analyst Allan von Mehren alvo@danskebank.dk

2 Agenda How bad is the fiscal situation in PIIGS? Recent events in Greece Bond market issues issuance, ECB collateral, whos buying? The danger of contagion Lessons from the Asian crisis Could it spread to the rest of the world? What to watch Stability programmes - PIIGS 2

3 How bad is the fiscal situation Large deterioration in fiscal situation in PIIGS Deficits it are dangerously high... h...and ddebt btis rising i fast 10,0 Budget deficit, % of GDP 10,0 50 5,0 0,0-5,0-10,0 Ireland Portugal Spain Italy 50 5,0 0,0-5,0-10,0-15,0 Greece ,0 Source: European Commission Source: European Commission 3

4 How bad is the fiscal situation Households experienced sharp financial deepening 4

5 How bad is the fiscal situation Greece to miss the European recovery We expect a moderate recovery in core eurozone PMI manufacturing in... Germany during 2010, supported by exports, inventory France adjustments and a gradual recovery in final demand Germany, especially, will benefit from being a very open and highly competitive economy Greece is neither open nor competitive Greece is not expected to show positive real growth before Nominal GDP growth is likely to stay around 0% in the coming years Exports in % of GDP Ireland Germany Portugal Italy Spain Greece Italy Spain Greece Real effective exchange rate, index = 100, Jan 2002 Ireland Greece Spain Italy Germany Portugal Source: Reuters Ecowin Source: Reuters Ecowin 5

6 How bad is the fiscal situation A lot of structural imbalances hampering growth outlook 10.0 C/A deficit among the highest in EMU 7.5 % of GDP, moving annual totals zone, is gradually declining Inflation has outpaced German price Italy growth by an accumulated 18% over the Spain last decade C/A in REER appreciation has been strong too Germany France Greece Greece HICP relatively to Germany, Index = 100, Ireland Spain Portugal Italy Source: Reuters Ecowin Source: Reuters Ecowin 6

7 How bad is the fiscal situation 1) In the long run we expect an increase in the age-related expenditure as well 2) limited savings in some of the PIIGS Increase in age-related expenditure by Source: Danske Markets calculations

8 How bad is the fiscal situation IMF WEO April 2010 Greece and Portugal face little growth Source: IMF 8

9 How bad is the fiscal situation Debt-to-GDP ratios will explode if nothing is done Greece Ireland Portugal Spain France Italy Germany Source: European Commission, IMF, Reuters Ecowin 9

10 How bad is the fiscal situation The mathematics of government debt ratios The increase in a country s debt ratio is given by: Snowball effect where D is the total debt level, Y is nominal GDP, PD is the primary deficit, i is the average (nominal) interest paid on government debt, y is the nominal GDP growth rate and SF is the stock-flow adjustment.

11 How bad is the fiscal situation Interest rates and growth matters Higher nominal rates and/or lower nominal growth can speed up the snowball effect A1%-point decrease in average funding costs from 2010 results in a 5-17%-point lower debt-to-gdp to ratio in 2020 Impact of a 1%-point increase in average funding costs from 2010 on debt in Source: Danske Markets calculation

12 How bad is the fiscal situation The risk of a self-fulfilling panic Greece and Portuguese interest costs too high to reduce budgets Ireland and Spain not critical yet but no room for higher yields Assumed avg interest cost over next 4 years in budget plans Current yield level (5y) Greece Portugal Ireland Spain Source: European Commission, Reuters Ecowin 12

13 Recent events Recent events 16 March ECOFIN approves Greek austerity measures and announces that ta rescue package is in place - no details on size, instruments or conditions 25 March EU leaders reach agreement on a combination of EU loans and IMF loans in the event that Greece is not able to get market financing 9 April Fitch lowers Greek rating to BBB- from BBB+ 11 April Details on the loans: EUR30bn from euro area member states and EUR15bn from IMF in first year 15 April Greece requests discussions on programme with the EC, ECB and IMF 21 April EU/IMF discussions in Athens begins 23 April Greece asks for the rescue package to be activated 27 April S&P downgrades Greece to junk status (BB+/B)

14 Recent events This is getting contagious Source: Reuters Ecowin 14

15 Bond market issues ECB has said they will extend temporary collateral rules into 2011 hence, Greek govt will remain eligible as long as the rating remains above BBB- ECB's rating floor Greece (Moody's) Greece (S&P) Greece (Fitch) Greece have some room left on the rating and ECB has announced that the rating floor of BBB- will be extended into 2011 However, if a Eurozone country cannot use its bonds as collateral then they have de facto left the euro The minimum credit threshold for marketable and nonmarketable assets in the Euro system collateral framework will be kept at BBB-/Baa3 beyond the end of 2010, except in the case of asset-backed securities Aaa Aa+ Aa Aa- A+ A A- BBB+ BBB BBB- A schedule of graduated valuation haircuts to the assets rated in the BBB+ to BBB- range (or equivalent) will replace the uniform haircut add-on of 5% that is currently applied to these assets. No changes will be made to the current haircut schedule foreseen for central government debt instruments and possible debt instruments issued by central banks that are Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 rated in the above-mentioned range, i.e. Greek government bonds can be used as collateral with the same rules as today Source: S&P, Moody s, Fitch, ECB Current FC LT rating of Greece: S&P: BB+, Fitch: BBB-, Moodys: A2

16 Bond market issues So who is buying Greek debt at the moment? Greek banks The recent 10Y syndicated auction Geographic investor base Type of Investor Greece 23% Fund managers 39% UK 20% Banks 25% Germany 14% Pension funds 24% Asia 8% Central banks 7% Nordics 8% France 7.5% Benelux 4.5% The recent 7Y syndicated auction Geographic investor base Type of Investor Greece 43% Fund managers 32% UK 15% Banks 42% Germany 5% Pension funds 18% Asia 5% Central banks 8% Nordics 6% France 8% Benelux 5% Italy 4% Italy 3% The investor base in Greek government bonds is primarily foreign somewhere between 65%-80% is the estimate, but this is changing At the recent 10Y and 7Y auctions, domestic investors on the other hand took almost 25% and 43% of the issue. This was much higher compared to the 5Y auction in December However, in the recent 7Y auction banks took 42% of the deal, while real money accounts + central banks took more than 70% of the 10Y deal

17 Bond market issues Expected issuance 2010 Expected issuance (mn) Expected gross bond issuance 2010 Official estimate Danske Markets Gross issuance 2010 YtD Bonds matured 2010 YtD Net issuance 2010 YtD Expected net issuance 2010 % issued YtD of expected gross issuance Official estimate Danske Markets Germany 207, ,000 77,000 52,250 24,750 73,500 37% 37% France 188, ,000 84,329 18,626 65,703 94,081 45% 42% Italy 240, ,000 77,532 44,165 33,367 68,314 0% 32% Spain 97, ,000 34,908 17,212 17,696 66,605 36% 35% Portugal 24,000 24,000 8, ,002 18,092 0% 33% Greece 54,000 55,000 18,390 8,216 10,174 38,322 0% 33% Belgium 32,750 32,750 17, ,507 8,058 53% 53% Netherlands 50,000 50,000 26,280 12,636 13,644 26,686 53% 53% Austria 23,000 22,000 9,829 8,811 1,018 13,189 43% 45% Finland 16,000 16,000 6, ,501 10,620 41% 41% Ireland 21,080 21,080 11,825 6,657 5,168 20,284 56% 56% Total - EUR 952, , , , , ,751 39% 38% Denmark 66,900 66,900 53, ,110 12,620 79% 79% Sweden 73,000 73,000 25, ,725 73,000 35% 35% Norway 27,000 27,000 3, ,000 27,000 0% 11% Source: Government programmes, Danske Markets calculations

18 The danger of contagion Lessons from the Asian crisis July1997 Summer 1998 Worse case of contagion Started in Thailand (2 July 1997) Ultimately contributed to Russian default (Aug 1998), LTCM (Sep 1998) and Brazil crisis (late 1998/early 1999) Run up to crisis in Asia Massive capital inflows Current account deficits Real estate bubbles Rapid credit expansion, short-term USD funding Trigger for crisis: Strengthening USD CNY devaluation Slow down in exports -> sudden stop in capital flows Source: Reuters Ecowin 18

19 The danger of contagion Asian crisis is scary example of how contagion can develop 2 July 1997 Thailand devalues Malaysia, Phillipines and Indonesia follow shortly after Three months later Korea goes was a big surprise for policymakers because Korea looked much better on fundamentals Western money fleeing Asia this time the opposite could be the case Source: Reuters Ecowin 19

20 The danger of contagion The contagion to Western countries Equity markets in US only hit modestly to begin with but Russia/LTCM hits Commodity prices fall hurting commodity exports (Russia, Brazil) 1500 Index Equity indices Index Asia >> << US OECD growth hit directly through trade links with Asia but recovers 100 after 6-9 months % m/6m, AR %m/6m, AR 8 Asia industrial production >> << OECD industrial production Source: Reuters Ecowin 20

21 The danger of contagion How did the Asian crisis stop? Massive show of financial force: largest IMF programme to date in Korea (USD55bn) Implementation of harsh measures to prove commitment -> Eventually leads to return of investor confidence and capital coming back [currencies stabilising, equities] 21

22 The danger of contagion Lessons 1. Expect the unexpected 2. Shared story determines vulnerability 3. There are panics and there are panics Multiple equilibria 4. Unpleasant revelations are poison for confidence 5. It takes substantial effort to turn confidence once it slides Demand curve starts sloping the wrong way; falling price -> falling demand 6. Expect policymakers globally to get involved 22

23 The danger of contagion Vulnerability PIIGS share the same story The most vulnerable countries of contagion are countries that share the same story Or as Krugman puts it, linked in the mind of investors Ireland Budget deficit, % of GDP The story about Greece concerns - poor public finances, current account deficit and poor structural growth prospects Greece Portugal Spain Italy Current account deficit, % of GDP Italy Ireland Spain Portugal Greece Source: Reuters Ecowin 23

24 The danger of contagion Could it spread to US and UK? Spain just got downgraded by S&P to AA with negative outlook (still AAA at Moodys and Fitch) Budget deficit similar to UK and US but debt is smaller Growth prospects probably worse, though Source: Reuters Ecowin 24

25 The danger of contagion Whats needed: Restoration of investor confidence is key Strong political will to reform with financial force behind it from IMF/EU Policymakers need to get ahead of the curve not sure it will happen Risk it will get worse before it gets better as policymakers keep reacting rather than preventing 25

26 What to watch What to watch for contagion see new Monitor out today Rating actions Auction performance of Portugal, Spain (tap of EUR4bn 5y Thursday next week) and Italy Performance of risky assets CDS on banks in Southern Europe Contagion to CEE German election 9 May in Nordrein-Westphalen (largest state, t 18 million people) 26

27 What to watch Tentative road map for Greece 2 May Talks with IMF and European Commission to be concluded 5M May Strikes planned 6-7 May Greek Parliament could vote on a 3-year savings programme 7 May German law on aid for Greece to be approved by Parliament 9 May Local elections in Nordrhein-Westfalen (Germany) 10 May Special emergency Eurogroup summit on Greece 15 May Greece should provide detailed information on the state of implementation of these measures and on the measures to be taken in order to reach budget targets in 2011 and May EUR8.5bn Greek government bond matures

28 STABILITY PROGRAMMES - PIIGS 28

29 The Greek stability programme % Budget deficit Change Debt Change GDP %, assumed Interest expenditure, % Ave financing cost, % ,7 113,4-1,2 5,0 4, ,7 4,0 120,4 7,0-0,3 5,2 4, ,6 3,1 120,6 0,2 1,5 5,4 4, ,8 28 2,8 117, ,9 1,9 54 5,4 46 4, ,0 0,8 113,4-4,3 2,5 5,2 4,6 Source: Greek Finance Ministry Debt level to peak at 120% if programme is followed Risk of longer recession due to fiscal tightening g negative spiral Greece need to get bond yields down to meet own assumption 29

30 Portugal - stability programme % Budget deficit Change Debt Change GDP %, assumed Interest expenditure, % A ve financing cost, % Source: Portuguese Finance Ministry EU Commission expressed fcst based on too optimistic assumptions Current 5y yield is 5.6%! Already much above assumed costs 30

31 Spain stability programme % Budget deficit Change Debt Change GDP %, assumed Interest expenditure, % Ave financing cost, % ,4 55,2-3,6 1,9 3, ,8 1,6 65,9 10,7-0,3 2,2 3, ,5 2,3 71,9 6,0 1,8 2,6 3, ,3 22 2,2 74,3 24 2,4 29 2,9 29 2,9 39 3, ,0 2,3 74,1-0,2 3,1 3,1 4,2 Source: Spanish Finance Ministry Current 5y yield is 3.3%! Still ok 31

32 Ireland stability programme % Budget deficit Change Debt Change GDP %, assumed Interest expenditure, % Ave financing cost, % ,7 64,5-7,5 2,1 3, ,6 0,1 77,9 13,4-1,3 2,9 3, ,6 82,9 5,0 3,3 3,4 4, ,2 2,8 83,9 1 4,5 3,8 4, ,9 2,3 83,3-0,6 4,3 3,9 4,7 Source: Irish Finance Ministry Current 10y yield is 5.3%! 32

33 Italy stability programme % Budget deficit Change Debt Change GDP %, assumed Source: Italian Finance Ministry 33

34 The problem of self-reinforcing debt accumulation Lower nominal growth and higher yields result in a stronger snowball effect than before the crisis 10% 8% 6% 4% 2% 0% Nominal GDP growth IMF Forecast Yield on 10-year benchmark government bond Austria Belgium Finland France Germany Greece e Ireland Italy Ne etherlands Portugal l Spain

35 Tightening needed to stabilise debt by 2020 Government debt, % of GDP Annual tightening of primary deficit needed from 2011 to 2015, % of GDP 140 Austria Belgium Finland France Germany Greece Ireland Italy Netherlan ds

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