Europe s future New York, Oct 22 2015
Main messages Global outlook: moderate growth under an uncertain scenario in emerging economies. Eurozone: resilient domestic demand but subject to external, political and geopolitical risks. Spain: we expect growth of 3.2% in 2015,although with a downward bias and with risks related to political uncertainty. Banking Union has to be completed and further integration in Europe pursued. It will not be easy! Financial sector challenges: profitability, crisis legacy, deleveraging 2
1 Global 3
Prospects of modest growth World Economic growth (% of GDP) The current economic recovery is atypical and fragile World growth will not surpass the pre-crisis level The outlook is uncertain and continues to have downside risks (f) Economic growth Average 2000-2014 4
An uncertain scenario among the emerging economies Great uncertainty due to:? Doubts over China's economy The effects of low commodity prices The imminence of the Fed rate hike cycle? 5 The lack of credibility of certain economic policies
and yet, after the Great Recession, we are where we would have hoped to be (more or less) back then Growth switch from EM to DM GDP growth, YoY, (4Q MA) and debt switch from DM to EM Non Financial Private Sector, GDP % 200 4,0 2,0 2.5% 13,0 11,0 175 0,0-2,0 7% 9,0 7,0 150 125-4,0 Dec-02 Dec-05 Dec-08 Dec-11 Dec-14 US China, rhs 5,0 100 Dec-02 Dec-05 Dec-08 Dec-11 Dec-14 US China Source: BBVA Research Source: BBVA Research 6
What are the risks? Biased towards EM United States Pace of rate hikes that stifles growth Europe Greece Slow integration Political risks (refugees) China Sudden correction to activity Rising risk Risk remains the same Falling risk Emerging Economies Domestic problems in major economies Global geo-political Middle East Russia/Ukraine Source: BBVA Research 7
2 Europe 8
Europe: weak foreign demand but resilient domestic forces Economic growth (% of GDP) 2. 0 1. 5 1.. 0 0. 5 0. 0-0.5-1.0-0.3 Source: BBVA Research 0.9 1.9 1.5 2013 2014 2015 2016 (f) (f) Domestic demand is strengthening The external environment is more negative, except for the boost from the oil price slide which is lifting disposable income and feeding towards higher consumption 9
An overview of the drivers of growth in the eurozone Low oil prices Neutral fiscal policy QE until Sep 16 / OMT Global slowdown: China and emerging markets Solid domestic factors (confidence, labour market, credit) Positive impact of structural reforms in the periphery A lower than expected depreciation of the euro Resilience, despite recent events (elections, geopolitics, China s news) Greece lingering, and new domestic shocks (refugees, VW?) 10
Lower foreign demand, though main traders projected to remain resilient Europe s future World trade and EZ exports (% QoQ) and NEER 7 6 5 4 3 2 1 0-1 -2-3 -4-5 -6-7 1.15 1.10 1.05 1.00 0.95 0.90 0.85 3Q09 3Q10 3Q11 3Q12 3Q13 3Q14 3Q15 World Trade Eurozone exports NEER (RHS) Sharp depreciation of the euro since mid-2014 helped to mitigate the fall of World trade in the first half of 2015 Global trade might be recovering in Q3 Source: CPB, Eurostat and BBVA Research 11
Strong private consumption; uneven investment recovery Europe s future Eurozone: private consumption and real labour income (% YoY) 4 3 2 1 Eurozone: investment rate and capacity utilization (%) 25 24 23 90 85 80 0-1 22 75-2 Supportive fundamentals 21 Recovery in machinery investment 70-3 3Q01 3Q04 3Q07 3Q10 3Q13 3Q16 HH disposable income Private consumption 20 65 1Q04 1Q07 1Q10 1Q13 1Q15 Investment rate Current level of capacity utilization (RHS) Source: Eurostat and BBVA Research Source: Eurostat and BBVA Research 12
More favorable fiscal policy than in previous years EMU: structural deficit adjustment 2010-2015 (%GDP) 9 7 5 3 1-1 Euro Germany France Italy Spain Portugal Ireland Source: BBVA Research and IMF Struct.Def. at the end of 2015 Structural adjustment 2015 2014 2013 2012 2011 Almost neutral fiscal policy in 2015 European Commission more careful in not forcing pro-cyclical adjustments Relaxation of fiscal effort in exchange for structural reforms 13
The ECB remains firm on full implementation of QE and its willingness and ability to act if needed ECB Monthly purchases under the APP, bn EUR 70 60 50 40 30 20 10 0 Some froantloading ahead of lower market liquidity March April May June July Aug. Sept. ABSPP CBPP3 PSPP Public sector bond purchases as % of total APP (rhs) Source: Bloomberg and BBVA Research 85% 84% 83% 82% 81% 80% 79% 78% 77% 76% 75% Markets are increasingly pricing in more QE Despite being premature for the ECB to take action, they loose no chance (also today!) to state that they are very willing to act Risks are undoubtedly towards a QE extension, especially if the risk scenario of low growth materializes. 14
Where do we stand after the crisis? GDP per working age population (Q1-2008=100) 108 103 98 109,0 Ireland 105,4 Germany 105,4 USA 102,7 France 102,6 UK 100,6 Eurozone 98,8 97,8 Spain Portugal 93 93,0 Italy 88 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Sources: Eurostat, Haver and BBVA Research 15
Where do we stand in spite of the crisis? Share of global demand over the next 10 years (6 months ago) Western Europe 6,1% Europa Del Este 5,9% 1980 2014 2045 Japan 1,0% North America 10,6% Africa 6,5% Middle East 5,0% Source: BBVA Research, IMF, Quah D., 2011, The Global Economy s Shifting Centre of Gravity. Asia exjapón 57,8% Oceanía 0,8% Latin America 6,3% World growth gravity Asia-Pacífic will Explain around 75% of the increase in GDP between 2014 and 2024. 16
Structural reforms needed also in core countries France Labor markets Product market and services liberalization Reducing size of public sector and tax burden Italy Reforming public sector and reduce tax burden Completing political reforms Germany Services liberalization Improving infrastructure Eurozone Address demographic decline. A common immigration policy? Further reform labor markets and promote labor mobility Multiple reforms to enhance productivity growth 17
Europe: Many risks pointing downwards aside from the lack of advances in further integration China Other EME s US Uncertainties about the magnitude of the deceleration, and on the command onf the situation by Chinese authorities Impact from China, low commodity prices, potential domestic policy mistakes Complications from Fed exit Geopolitical Ukraine and Russia, ISIS and larger inflow of refugees Political woes Failure to implement reforms Stagnation Greece Elections and populist governments, complications from refugee crisis Lack of recovery and no ownership of the reforms 18
Geopolitical Risks: A complex framework especially close to Europe BBVA conflict heatmap (Jan to Sep-15) (Number of conflicts / Total events) ISIS attacks in MENA and Turkey while many countries are involved (Turkey, Russia, Iran China) Fighting intensified in Ukraine Refugee crisis escalates Source: www.gdelt.org and BBVA Research 19
The refugee crisis reinforces political rifts in Europe but also opens up a long-term growth opportunity BBVA Research Refugees Flows Map (1H 2015) (Number of media citations about refugees inflows and outflows) The Middle East & North Africa are facing complex and multiple emergency situations During 1S2015 around 350.000 refugees reached Europe, now accelerating Defining a comprehensive EU action plan is crucial Source: www.gdelt.org & BBVA Research 20
3 Spain 21
Spain: a tremendous adjustment GDP 2008-2013 -8,0% 2013-2016 +7,4% Jobs -17,5% +7,2% CA* Risk +10,1 pp of GDP +397 pb -0,1 pp of GDP -328 pb */ Current Account 22
Spain: We are keeping our forecasts for 2015 1.4 % 3.2 2015 % 2.7 2016 % 2014 Source: BBVA Research 23
We are keeping our forecasts for 2015 Quarterly GDP growth and MICA-BBVA forecasts 0.9% 1.0% 0.6-0.7% The Spanish economy grew by a little more than expected in the second quarter although a slowdown is expected in the third First Quarter Second Quarter Third Quarter Observed Forecast Source: BBVA Research 24
We are keeping our forecasts for 2015 Average contributions to GDP growth in the second quarter (Yoy growth rate) Private consumption and machinery and equipment investment 2.5 Public sector consumption and residential investment 0.6 Rest 0.1 Most growth is from both private and public domestic demand Machinery and equipment investment has surprised on the high side and continues to contribute to growth in 3Q15 25
For Oil price fall Impact on of oil at USD50 a barrel (pp of average annual growth in 2015-16) 1.0 0. 7 0. 6 The oil price slide could add as much as one point to growth Spain EMU Global Source: BBVA Research 26
For Euro exchange rate favours exports Estimated effect on GDP after one year of a 10% depreciation in the EUR/USD rate (pp of average annual growth in 2015-16) 0.7 0.3 0.3 0.6 0.7 0.5 0.5 0.4 0.6 0.4 +0.5% 0.2 0.5 0.4 0.3 Effect on Spanish GDP 0.4 0.5 0.5 Source: BBVA Research 27
For Expansionary fiscal and monetary policy Contribution of public sector consumption to growth (pp of annualised quarterly growth) New retail lending transactions (% YoY) 35% First half of 2014 0.23 First half of 2015 0.81 25% 15% 5% -5% -15% -25% -35% Jul-04 jul-04 Jul-06 jul-06 jul-08 Jul-08 jul-10 Jul-10 jul-12 Jul-12 Jul-15 jul-15 28
Against A somewhat less encouraging environment than before 1 2 3 Lower world growth Increase in the risk premium Less euro depreciation 29
Risks Political uncertainty Spain/Italy risk premium differential (basis points) 30 20 10 0-10 -20 Pact to call elections on 27S Catalan elections Pact to present a "single list" -30 Jan Feb Mar Apr May Jun Jul Aug Sep Oct The Spanish risk premium is rising with respect to Italy The political uncertainty could have begun to have an impact on private spending Anecdotal evidence. Source: BBVA Research based on INE and Eurostat 30
Risks Government deficit Deficit of the public administrations (% GDP) Target Expected deficit 4.2 The risk of failing to meet 2015 budget targets is rising 4.5 31
Assessment A long and deep crisis Years passed until pre-crisis employment levels are attained 91 crisis Current crisis 2Q91=100 1Q08=100 32
Continuing the process of structural reforms to ensure a sustainable and inclusive growth Europe s future Labour market Internal flexibility Quality of contracts Long-term unemployment Public sector Consolidation Tax reform Efficiency Competitiveness Size of firms Exports R&D Long run factors Better education Training Institutions 33
4 Banking Union and challenges for the financial system 34
A lot has already been achieved with Banking Union 1.0 Europe s future There is a new genuinely European institutional setup 1. Single Rulebook Level playing field: CRDIV, BRRD, DGS 2. Single Supervision 3. Single Resolution No supervisory ring-fencing Cross border resolution & Resolution costs mutualized (private funds) Fragmentation has considerably eased but credit conditions still depend on location 35
Greece, first test to Banking Union 1.0: Very good progress but so much more needs to be done The Five Presidents Report shows the way forward FINANCIAL UNION BANKING UNION 2.0 Capital Markets Union Sovereign Treatment Revision* Immediate priority: FISCAL & ECONOMIC UNION Formalized economic convergence* Fiscal stabilization function * POLITICAL UNION EZ Parliament and Econ. Government One external representation EZ Treasury* 1. European Deposit Insurance Scheme: for now, reinsurance at European level 2. Fiscal backstop for the SRF * Second Stage: after 2017 GENUINE EMU by 2025? 36
Challenges for the European Financial System: Deleverage Europe s future Credit to the Private Sector (% GDP) 180 160 140 120 100 In some countries, credit is still far from its equilibrium level and credit composition is still not balanced (like real estate firms in Spain) 80 60 40 20 0 France Germany Greece Italy Portugal Spain Dec-09 Jun-15 The reduction of the credit stock has to be compatible with new credit to solvent demand Source: BBVA Research based on ECB and Eurostat 37
Challenges for the European Financial System: Legacy from the crisis Europe s future Share of central bank funding in credit institutions liabilities (total liabilities excluding capital, %) 14 12 10 8 44 Liquidity: It is crucial to restore the functioning of the interbank and wholesale markets (substituted by ECB liquidity) 6 4 2 0 France Germany Greece Italy Portugal Spain Dec-09 Jun-15 Public participation in banks should be reduced, as it can bring inefficiencies Source: BBVA Research based on ECB Risk Dashboard 38
Challenges for the European Financial System: Profitability has not returned to pre-crisis levels Europe s future Return on Equity (%) 8,0 6,0 4,0 2,0 Why?: low interest rates, risk aversion, stricter regulation and supervision, lower liquidity and competition from non-bank players 0,0-2,0-4,0-6,0-8,0 France Germany Greece Italy Portugal Spain 2009 2015* What can be done?: Cost cutting has to come from a significant change, like digital banking or further consolidation (first domestic and second pan-european) Source: BBVA Research based on IMF GFSR Oct-15 and Bank of Spain 39
Europe s future New York, Oct 22 2015 40
Mar-05 Dec-05 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Mar-14 Dec-14 Sep-15 Europe s future In China a sharp downward trend in economic indicators puts in doubt the soft-landing scenario China: Economic growth, alternative indicators (YoY, %) Source: BBVA Research 24 21 18 15 12 9 6 3 0 Official GDP Li Kequian growth OCDE Leading Indicator (RHS) 104 102 100 98 96 94 92 90 Alternative measures of economic growth (Li Kequian) and synthetic leading indicators (OECD) are slowing faster than GDP However, both might overweight manufacturing activities vs services activities
In China, the rebalancing to services and urban employment goes on China: sectorial breakdown GDP % Source: BBVA Research 52% 50% 48% 46% 44% 42% 40% 20 18 16 14 12 10 8 6 4 2 China: urban employment, % total GDP % Source: BBVA Research 52% 50% 48% 46% 44% 42% 40% 38% 2006 2010 2014 2015 (1st half) Industry Industry (YoY, rhs) Services Services (YoY, rhs) GDP, % 2013 2014 2015 2016 current forecast 7,7 7,3 6,7 6,2 0 38% 2006 2010 2014 Urban Employment Annual change, millions 2012 2013 2014 11.9 11.4 10.7
Still, risks are clearly biased to the downside as the challenges China faces are huge China: debt and growth Source: BBVA Research 215 195 175 155 135 115 95 75 2007 2008 2009 2010 2011 2012 2013 2014 2015 (f) Non financial Private Sector. Debt, % GDP (LHS) Economic growth, % y/y GDP (RHS) 2016 (f) 14,5 13,0 11,5 10,0 8,5 7,0 5,5 4,0 China turned on the taps in 2008, pushing up debt leading to inefficient investments, and perhaps financial bubbles The risk: tensions between decentralizing economic decisions and keeping political control
Germany: robust domestic fundamentals GDP growth (%) 1.6% 1.5% 2014 2015 Source: Eurostat and BBVA Research 1.9% 2016 Private consumption continues to grow at rates consistent with favorable labour market conditions Lower global demand hampers the growth of exports The uncertainty caused by geopolitical conflicts could lead businesses to further delay their investment plans to 2016 44
Germany: solid labour market Deviation from EZ18 average (pp) +18.2pp The positive divergence with the average of the area is gradually expanding GDP per working age population -2.5pp Public consumption Source: BBVA Research and Eurostat +4.8pp ULC evolution 2008-2014 Increased public investment would help correct the current account surplus The competitive advantages of German companies from the rest of EMU have been reduced, mainly since 2012. 45
France: doubts in 2015 but more balanced growth expected in 2016 GDP growth (%) 1.3% 1.7% The recovery in 2015 and 2016 will be based on domestic factors, especially consumption The delay in the adjustment of the deficit should also help 0.2% 2014 2015 2016 The loss of competitiveness is the main problem in the medium term Source: Eurostat and BBVA Research 46
France: the easing of fiscal targets will help the economy recover Deviation from EZ18 average (pp) +12.4pp Stable income above average GDP per working age population +1.6pp Public deficit Source: BBVA Research and Eurostat -4.6pp Current account balance Timid reforms underway France has failed to correct the current account deficit in recent years, as other countries did 47
Italy: more optimism, and moderate growth in 2015 GDP growth (%) -0.4% 0.7% Source: Eurostat and BBVA Research 1.3% 2014 2015 2016 We continue to expect a slow recovery in 2015 (0.7%), driven by exports and investment Investment will continue to improve as reforms aimed at improving the business environment are implemented The declaration of unconstitutionality of costcutting measures can slow fiscal adjustment 48
Italy: reforms are coming; they are badly needed to increase the growth potential Deviation from EZ18 average (pp) -9.5pp GDP per working age population +40.2pp Public debt Source: BBVA Research and Eurostat -4.4pp Private debt Income has deteriorated sharply in the past two decades A slow privatization program is delaying debt reduction (132.1% of GDP in 2014) The private sector has been able to correct the high debt imbalance more rapidly 49