What could debt restructuring imply for the Eurozone? Adrian Cooper acooper@oxfordeconomics.com June 2011
What could debt restructuring imply for the Eurozone? New stage in Eurozone debt crisis: first wave of solutions was not enough We think that a range of measures will be adopted that will allow the Eurozone economy to continue to grow, albeit slowly Eurozone GDP growth at 1.9% this year, and again 1.9% on average in 2012-15 Even if attempting an orderly restructuring, risks are very large and skewed to the downside A disorderly restructuring could plunge the Eurozone back in recession
Forecast sees positive, albeit low growth Eurozone: Recoveries compared 100= Trough 112 Early 1970s 110 108 Early 1990s 106 2008-11 104 102 Early 1980s 100 98 Q-5 Q-3 Q-1 Q1 Q3 Q5 Q7 Q9 Q11 Q13 Source: Oxford Economics
Core Eurozone faring relatively well Divergence GDP per person - US$, 2005 prices 41,000 39,000 37,000 Periphery: Italy, Greece, Ireland, Portugal, Spain Core: Germany, France, Austria, Belgium, Finland, Netherlands, Slovakia Forecast 35,000 33,000 Core 31,000 29,000 27,000 Periphery 25,000 2000 2004 2008 2012 Source : Oxford Economics/Haver Analytics
Financial stress Key risks to Oxford Economics forecast Eurozone debt crisis Confidence in peripheral countries finances deteriorates further, leading to an eventual debt restructuring Pressure intensifies to cut budget deficits rapidly in all major economies Rising unemployment and business failures feed back into banking New wave of loan losses for global banks leads to tighter credit conditions Limited scope for monetary policy offset Oxford forecast Gradual rise in business confidence encourages corporates to invest But weak banks & excess capacity limit scale of investment recovery Consumer spending recovery limited by pace of job growth and fiscal retrenchment But recovery strong enough that fiscal crisis remains contained Fiscal crisis in USA Emerging overheating Commodity price pressure
New stage in Eurozone crisis Eurozone: Bond yields % 17 15 Spain Greece Portugal Ireland 13 11 9 7 5 3 1-1 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Source: Oxford Economics; Haver Analytics
New stage in Eurozone crisis Eurozone: Implied default probabilities Cumulative default probability based on 5-year credit default swaps, % 80 70 60 50 40 30 20 10 0 Greece Ireland Portugal Spain Source : CMA Datavision
and debt challenge requires additional action Government debt % GDP 180 Forecast 160 140 120 100 80 60 40 20 Portugal Greece Ireland Spain 0 2000 2004 2008 2012 Source : Oxford Economics/Haver Analytics
given rising financing burden Eurozone: Peripheral interest burden Debt interest as % of government revenues 30 25 20 Portugal Greece Ireland 15 10 5 0 2010 2011 2012 2013 2014 2015 Source : Oxford Economics,IMF, Irish Dept. of Finance
Can an orderly restructuring work? An additional package from the EU/IMF would be only a shortterm solution Deals with liquidity issue Not with solvency issue Would face strong opposition To be orderly, restructuring needs To involve the EU and IMF To be small, especially with small haircuts Come with a clear and credible plan to get public finances back in order Come with support to banks
Can an orderly restructuring work? But, by nature, a limited restructuring also implies little relief to the debt burden Fiscal and economic reform effort largely unchanged Risks not being enough to restore investors confidence Risks triggering a disorderly restructuring
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Looking at the implications of debt restructuring Credit conditions Official policy rates & Government bond yields Interbank spreads Lending spreads Availability of credit/other lending criteria Lending rates Household Corporate Government finances Household wealth/ equities Consumer spending Housing investment/ prices Business investment GDP
Defining orderly restructuring 60% write down on Greece s government debt Negative wealth effects within the Eurozone and beyond, in proportion to countries initial exposures to Greek debt, with the biggest losers France and Germany. Government bond spreads widen by a further 200 basis points initially in the peripheral countries. Spreads widen by 100bp initially in Italy. Interbank spreads initially rise in the Eurozone by 50bp about half the rise seen at the peak of the global financial crisis - as bank counterparty risks spikes, but return to central scenario levels by 2015.
Defining orderly restructuring Corporate and consumer borrowing spreads rise by up to 100bp in the Eurozone, again around half the rise seen at the peak of the global financial crisis. Banks tighten credit standards dramatically in Greece, and in the other peripherals by an amount equivalent to the tightening seen in the major economies during the global financial crisis. For the rest of the Eurozone and UK, standards tighten by around a quarter of the amount seen during the financial crisis. Fiscal tightening is accelerated by 1.5% of GDP by 2015 for Spain, Portugal and Ireland as these countries seek to avoid being dragged into default with Greece. Extra fiscal tightening of 0.5% of GDP elsewhere in the Eurozone.
Defining orderly restructuring Equity prices initially fall by 30% in Greece, and by 15% in the Eurozone. The global stock market impacts are comparable to those associated with the collapse of Bear Stearns at the start of 2008, but a more permanent scar is assumed to be left on the Eurozone given that it is at the epicentre of the financial disruption. The risk premium for emerging markets rises by around half the level seen at the worst point of the global financial crisis at the end of 2008.
Orderly restructuring implies significant impact Eurozone: GDP % year 5 Forecast 4 3 2 1 0-1 -2 Orderly Greek default -3-4 Eurozone muddles through -5-6 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Oxford Economics
From orderly to disorderly But the process is assumed to remain orderly All these shocks gradually wane Restructuring is accompanied by support to banks Restructuring is accompanied by clear and credible plan to sustain primary surpluses Demanding conditions Restructuring could quickly tip from orderly to disorderly
Banks exposure poses major contagion risk World: Bank exposures to peripherals US$ billion, 2010Q4 ROW US Government debt Banks Private & Other Japan Italy UK France Germany 0 100 200 300 400 500 600 Source : Oxford Economics/BIS
Orderly restructuring implies significant impact Eurozone: GDP % year 5 4 3 2 1 0-1 -2-3 -4-5 Baseline Orderly Greek default Eurozone debt crisis Forecast -6 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Oxford Economics
Alternative scenarios Alternative GDP growth forecasts 2009 2010 2011 2012 Oxford Forecast (50%) US -2.6 2.9 2.5 2.9 Eurozone -4.1 1.7 1.9 1.7 China 9.2 10.3 9.0 8.4 World -0.8 4.8 4.1 4.5 Emerging overheating (20%) US -2.6 2.9 1.9 1.3 Eurozone -4.1 1.7 1.5 0.7 China 9.2 10.3 8.0 5.6 World -0.8 4.8 3.5 2.8 US fiscal crisis (5%) US -2.6 2.9 1.7 1.9 Eurozone -4.1 1.7 1.5 1.0 China 9.2 10.3 8.3 7.1 World -0.8 4.8 3.5 3.5 Eurozone debt crisis (10%) US -2.6 2.9 1.7-0.1 Eurozone -4.1 1.7 0.4-2.0 China 9.2 10.3 8.5 5.9 World -0.8 4.8 3.1 1.4
All sectors affected Eurozone: Sectoral impact of EZ debt crisis % difference from base in 2012 Construction Government Education Hotels & rest Health Utilities Financial services Total GVA Distribution Manufacturing Business services Transp & comm Mining Agriculture 0-2 -4-6 -8 Source : Oxford Economics