EIU Webinar_European Debt Crisis_Nov 23 2010

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The European debt crisis: Will confidence be restored?

An EIU webinar analyzing the risk outlook for Europe

John BowlerDirector, Country Risk Service

Matteo NapolitanoSenior Editor / Economist

November 23, 2010

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Today’s Presenters

John BowlerDirector, Country Risk Service

Matteo NapolitanoSenior Editor, Economist

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Weak public finances

0

20

40

60

80

100

120

140

-12 -10 -8 -6 -4 -2 0

Budget balance (% of GDP)

Pu

bli

c d

ebt

(% o

f G

DP

)Italy

Greece

Ireland Portugal

Spain

UK

2010 data. Source: EIU, Country Data.

- 30%

Prepare for opportunity.

0

2

4

6

8

10

12

14

Jan 1

201

0

Jan 1

3 20

10

Jan 2

5 20

10

Feb 4

201

0

Feb 1

6 20

10

Feb 2

6 20

10

Mar

10

2010

Mar

22

2010

Apr 1

201

0

Apr 1

3 20

10

Apr 2

3 20

10

May

5 2

010

May

17

2010

May

27

2010

Jun

8 20

10

Jun

18 2

010

Jun

30 2

010

Jul 1

2 20

10

Jul 2

2 20

10

Aug 3

201

0

Aug 1

3 20

10

Aug 2

5 20

10

Sep 6

201

0

Sep 1

6 20

10

Sep 2

8 20

10

Oct 8

201

0

Oct 2

0 20

10

Nov 1

201

0

Nov 1

1 20

10

Greece Ireland Germany Portugal Spain Italy

Market perception of eurozone sovereign risk

2010 data. Source: Haver Analytics.

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Euro zone: Private-sector debt

0

500

1,000

1,500

2,000

2,500

3,000

Sp

ain

Po

rtu

ga

l

Ire

lan

d

Gre

ec

e

NL

Ita

ly

Ge

rma

ny

Fra

nc

e

1999 (Greece 2001) 2009

Bank claims on private sector, € bn. Source: IMF, International Financial Statistics.

211% of GDP

112%

111%

92%

234% 192% 150%

110%

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Periphery has lost competitiveness

90

95

100

105

110

115

120

125

130

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Germany Greece Portugal

Spain Italy France

Average real wage index, 1999 Q1=100. Source: Economist Intelligence Unit, CountryData.

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Greece: Fiscal adjustment on track but is it sufficient?

• January-September 2010 versus 2009 Revenue + 3.3% Spending – 10.0%

◦ Primary spending – 11.6%◦ Interest charges + 8.0%

Budget deficit € 16.3bn (€ 23.6bn in 2009)

Public debt (end June) € 316bn (135% of GDP)• Fiscal tightening

Economic contraction, undermining debt sustainability Austerity fatigue, social unrest

• Market access still closed for government and banks• In Greece’s interest to default earlier rather than later ? • B rated for sovereign risk

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Ireland: the cost of a property and banking bust

• Anglo-Irish bail-out Fiscal deficit in 2010 33% of GDP Risk of further losses

• Public debt/GDP 24% in 2007, 98% in 2010

• Run on banks Half of banks’ non-deposit

funding (€83bn) from ECB • EU/IMF loan

More spending cuts Raise corporate tax from 12.5% ? Recapitalise/restructure banks

• Can Ireland grow fast again ? Average GDP growth 5.5% in

2001-07• Downgraded to BB in October

-10

-8

-6

-4

-2

0

2

4

6

8

2001

2003

2005

2007

2009

2011

GDP growth

Real GDP growth, %. Source: EIU, Country Data.

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• 2010 fiscal deficit 7.5% of GDP

• Public debt 82% of GDP• Political agreement to cut

2011 deficit by 3% of GDP• Banks dependent on ECB

liquidity• Borrowing costs

unsustainable EU/IMF funding ?

• Lack of competitiveness, low growth, low savings

• Downgraded to BB in October -14

-12

-10

-8

-6

-4

-2

0

2001

2003

2005

2007

2009

2011

Current account (% of GDP)

Portugal: finally a greater sense of urgency

Current-account (% of GDP). Source: EIU, Country Data.

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Saving the eurozone

• Funding pressures eased by €750bn EU-IMF financing How costly will it be to draw on €440bn EFSF? ECB bond purchases (around €65bn to date)

• Restoring solvency Economic growth

◦ Competitiveness Fiscal consolidation Fiscal transfers Default

• Tougher fiscal surveillance• New debt resolution mechanism

Burden sharing for new creditors

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Is leaving the eurozone the solution?

• Boost to competitiveness Would this materially change growth

prospects ? Not a substitute for reform

• How to manage an orderly devaluation ? Printing of banknotes Redenomination of banks’ euro liabilities

◦ Depositors suffer losses Problem of insolvency exacerbated

• Not a rational choice but one which could be made in extremis

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East-central Europe: An uneven recovery…

80

85

90

95

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105

110

115

120

125

130

q1

06

q2

06

q3

06

q4

06

q1

07

q2

07

q3

07

q4

07

q1

08

q2

08

q3

08

q4

08

q1

09

q2

09

q3

09

q4

09

q1

10

q2

10

q3

10

Poland Czech Republic Slovakia Hungary Romania Latvia

Seasonally adjusted GDP, rebased to Q1 2006=100Source: Eurostat/Haver Analytics.

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… that is stronger in countries with milder imbalances…

-25

-20

-15

-10

-5

0

Cze

ch

Re

pu

blic

Slo

va

kia

Hu

ng

ary

Ro

ma

nia

La

tvia

GDP in Q3 2010 relative to peak (% difference, seasonally adjusted)

Source: Eurostat/Haver Analytics.

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…but which may now have peaked

-20

-15

-10

-5

0

5

10

15

20

Ja

n-0

6

Ap

r-0

6

Ju

l-0

6

Oc

t-0

6

Ja

n-0

7

Ap

r-0

7

Ju

l-0

7

Oc

t-0

7

Ja

n-0

8

Ap

r-0

8

Ju

l-0

8

Oc

t-0

8

Ja

n-0

9

Ap

r-0

9

Ju

l-0

9

Oc

t-0

9

Ja

n-1

0

Ap

r-1

0

Ju

l-1

0

Oc

t-1

0

-20

-15

-10

-5

0

5

10

15

20

Industrial growth (unweighted average of Poland, Czech, Hungarian, Slovak andRomanian output; % change, y/y)German manufacturing inventories (% change, y/y, inverted scale)

Source: Eurostat/Haver Analytics.

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85

90

95

100

105

110

115

120

125

130

Jan

4 2

010

Jan

13

2010

Jan

22

2010

Feb

2 2

010

Feb

11

2010

Feb

22

2010

Mar

3 2

010

Mar

12

2010

Mar

23

2010

Ap

r 1

2010

Ap

r 12

201

0

Ap

r 21

201

0

Ap

r 30

201

0

May

11

2010

May

20

2010

May

31

2010

Jun

9 2

010

Jun

18

2010

Jun

29

2010

Jul

8 20

10

Jul

19 2

010

Jul

28 2

010

Au

g 6

201

0

Au

g 1

7 20

10

Au

g 2

6 20

10

Sep

6 2

010

Sep

15

2010

Sep

24

2010

Oct

5 2

010

Oct

14

2010

Oct

25

2010

No

v 3

2010

No

v 12

201

0

Polish zloty Hungarian forint Czech koruna Romanian leu Thai baht

Currencies rally, but less than other emerging markets

Currencies versus US$, Index Jan 4 2010= 100, Source: Haver Analytics

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Sounder public finances than in eurozone periphery…

0

20

40

60

80

100

120

140

-12 -10 -8 -6 -4 -2 0

Budget balance (% of GDP)

Pu

bli

c d

ebt

(% o

f G

DP

)

Poland

Greece

IrelandPortugal

Spain

Czech Republic

2010 data. Source: EIU, Country Data.

- 30%

Romania

Latvia

Hungary

Slovakia

Prepare for opportunity.

… and sounder private finances as well

0

50

100

150

200

250

Sp

ain

Po

rtu

ga

l

Ire

lan

d

Gre

ec

e

Po

lan

d

Ro

ma

nia

Hu

ng

ary

Cze

ch

Re

pu

blic

La

tvia

2004 2009

Bank claims on private sector, % of GDP. Source: IMF, International Financial Statistics.

Prepare for opportunity.

Few ratings upgrades to date

0102030405060708090

100P

ola

nd

(BB

B)

Ro

ma

nia

(BB

)

Hu

ng

ary

(B)

Cze

ch

Re

pu

blic

(BB

B)

La

tvia

(B

)

Jan-09 Nov-09 Nov-10

Sovereign risk score and rating (latest rating in brackets) Source: EIU, Country Risk Service.

Upgraded to BBB

in September 2010

Downgraded to B

in April 2009

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Poland: good growth, but no urgency on fiscal policy

• Economy kept growing throughout the global crisis Large domestic market Avoidance of excesses previously; strong financial

supervision• But fiscal deficit got out of hand in 2008-09

Little consolidation planned in 2010-11… … and no sense of urgency afterwards

• Public debt likely to break through legal ceilings, forcing action • However, markets could punish Polish assets, particularly if

global mood turns against emerging markets

Prepare for opportunity.

Czech Republic/Slovakia: export dependency

• Economies tracked slump and recovery in global trade FDI-driven economies Tied into German supply chain, allowing them to tap into

more dynamic markets Small domestic markets will continue to be a weakness Avoided excesses previously; strong financial supervision

• Both are front-loading fiscal adjustment Less insulated than Poland, therefore less complacent? But coalition politics could force a watering down

Prepare for opportunity.

Hungary/Romania/Latvia: domestic imbalances still to be worked through

• Hungary Domestic economy is still weak; households exposed to

currency risk Government is strong, but uncertainties over policy direction May yet need to strike a deal with the IMF if investor mood

sours• Romania

Fiscal austerity to hold back recovery Political instability is hampering policy execution Social unrest could escalate

• Latvia Suffered an enormous contraction, has begun timid recovery Still at risk of political instability Will need further wage adjustment to become competitive

again

Prepare for opportunity.

What about the euro accession process?

• There is scepticism on both sides of the divide Enthusiasm in candidate countries has waned The future of the euro area still hangs in the balance Until new governance rules are in place, no appetite for expansion The crisis showed the value of a floating currency Larger countries could adopt a Sweden-type stance

• Only Latvia has a firm accession target date (2014) Encouraged by Estonia’s accession, scheduled for January 2011 Low political weight; little change to euro zone’s structure

Euro accession would entrench currency board • There is a serious risk that Estonia will be the last

country to enter the euro area in this decade

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Questions and Answers

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Economist Intelligence Unit analysts have been featured in the media for their analysis of the European debt crisis.

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