Jarní predikce růstu Evropské ekonomiky, snížení odhadu (výtah z dokumentu v AJ)

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Euroland - Still Stuck in a Recession Rut

Morgan Stanley & Co.

International plc

Elga BartschElga.Bartsch@morganstanley.com

Key PointsAlas, the euro area recession seems set to linger a bit longer

this spring. After a sharper then expected contraction in 4Q, we

no longer expect a stabilisation in activity before mid-year.

Inflation should stay below but close enough to the ECB target.

And it does not offer a strong enough argument to cut policy

rates given the controversy about a negative deposit rate.

Depending on how the Italian political situation evolves, the

eurozone could soon find itself at a cross-roads. We explore

different policy reactions in our bull and bear cases.

Exhibit 1

Still Below Consensus on our Growth Forecasts

Real GDP Forecast for 2013 (YoY%)

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

Germany France Italy Spain

Morgan Stanley Consensus EC OECD Off ic ia l govt.

Source: EC, OECD, National data, Morgan Stanley Research forecasts

Another round of euro area forecast cuts Our call for the

recession to extend into early 2013 has been confirmed by

incoming data. Q4 GDP came in weaker than expected. 1Q

activity data is rather mixed thus far. Financial fragmentation

remains elevated and is receding only very gradually. New

political uncertainties have emerged post the Italian election,

underlining that the CRIC cycle is not dead. Together these

factors introduce small downside risk to our FY 2013 GDPforecasts, which we are cutting further below the consensus to

-0.7% from -0.5% before. We are also shifting the cyclical

trough out by one quarter to mid-year. While we spot some

green shoots here and there around the euro area, they are still

very timid, as many indicators remain subdued and meaningful

improvements are largely confined to the manufacturing sector.

Our surprise gap, one indicator in our business cycle compass,

has not been able to break out of the neutral range yet, and

hence has not provided a statistically significant signal for a

turning point in the business cycle either.

Exhibit 2

Business Cycle Compass Still Stuck on Neutral

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

-1.0 -0.8 -0.5 -0.3 0.0 0.3 0.5 0.8 1.0

Grey ZoneSlowing down

Recovering

Turning Point (Down)

Turning Point (Up)

Strong and

Accelerating

Strong and Steady

Recession Deepening Recession Continuing

Y-Axis:ManufacturingIndicator

AboveTrend

Belo

wTrend

Feb 2013

X-Axis : Surprise Gap AccelerationDeceleration

Upswing

Downturn

Source: National data, Eurostat, Morgan Stanley Research forecasts

Looking ahead, our base case is still for a timid recovery

in 2H. But we have had to lower our growth trajectory

somewhat in late 2013 and early 2014. Several factors will

likely delay stabilisation and also limit the strength of the

recovery. An additional factor weighing on 2014 is that some

countries, e.g. France and Netherlands, aim to postpone

additional austerity to 2014. That year, they will have to take

additional measures to bring the deficit to 3% of GDP. Alas, the

ECB has not followed our initial script and cut interest rates in

late 2012 and started OMT support in early 2013. As a result,

financial conditions in the euro area remain relatively tight and

financial fragmentation elevated. The EUR, even though it no

longer seems set to overshoot, remains above fair value for

many euro area countries even if not for the euro area as a

whole. As a result of the growth downgrade, we should see

some more fiscal slippage across many euro area countries.

Exhibit 3

Euro Economies Likely to Trough a Little Later

Real GDP (1Q 2008 = 100)

90

94

98

102

2008 2009 2010 2011 2012 2013 2014

GER FRA ITA SPA IRE POR

Source: Eurostat, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Our forecast reductions are concentrated in Italy, France,

the Netherlands and Portugal in terms of countries, and in

consumer expenditure and investment spending in terms of thedemand components. Going against the grain, we are slightly

raising our forecasts for Germany, Austria and Ireland. All

three seem to be benefitting more than we previously

acknowledged from the global economic recovery and their

strong competitive position. In the case of Ireland, the strong

external performance is boosted by domestic factors after the

government secured a favourable deal on the legacy debt of

IBRC. In terms of the different demand components, the main

source of growth over the forecast horizon will likely be external

demand. But the external impulse will remain somewhat muted,

given the past appreciation of the EUR and its relatively

elevated exchange rate.

Exhibit 4

Capacity Utilisation Far Below Long-Term Average,Unemployment Rate Still Rising Very Steeply

68

70

72

74

76

78

80

82

84

86

88

1985Q1 1989Q1 1993Q1 1997Q1 2001Q1 2005Q1 2009Q1 2013Q1

6%

7%

8%

9%

10%

11%

12%Capacity Ut il isat ion Rate, LHS Unemployment Rate, RHS

Source: European Commission, Morgan Stanley Research

Fundamental factors still weighing on domestic demand

With the rate of capacity utilization still in recession territory,

with credit conditions, especially for SME, still relatively tight

and with business sentiment still well below the long-term

average (which we would deem to be consistent with trend

growth), we expect investment spending to contract further,

albeit at a slower pace, this year. Similarly, consumer spending

is likely to retrench further as unemployment is still rising

steeply, additional austerity is set to bite and house pricescontinue to correct in many euro area countries. In this context,

we would stress the discrepancy between the more depressed

levels of consumer confidence and less gloomy business

sentiment which is close to an all time high. Euro area

consumer spending dynamics will likely remain subdued for

years to come as, contrary to the US or the UK, private sector

deleveraging has not really started yet and the sovereign debt

crisis left deep scars on social welfare systems. We will closely

watch household savings behaviour for signs of shifts.

Exhibit 5

Consumers Much More Gloomy Than Corporates

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1997 1999 2001 2003 2005 2007 2009 2011 2013

Company-Consumer Spread Industry Consumer

Source: European Commission, Morgan Stanley Research

Inflation below 2% not enough for ECB to cut rates again...

We are also lowering our inflation estimates marginally for

2014. But at 1.6%, we see inflation higher than the ECBs own

1.3% projection. One reason for the difference is that we are

including planned but not yet approved changes in indirect

taxes and administrative prices that we expect to become

effective over the forecast horizon. The ECB staff do not do so,

under their forecast conventions.

provided that the euro does not overshoot

The renewed weakening in the EUR in recent weeks, which

has already caused monetary conditions in the euro area to

ease again according to our Monetary Conditions Index (MCI),and the fact that market interest rates are effectively

constrained by the zero-bound set by the deposit rate, will likely

induce the ECB to leave rates unchanged for the foreseeable

future. At the last meeting, some members of the Governing

Council seem to have argued in favour of a rate reduction, but

in the end the consensus prevailed to leave rates unchanged.

Hence, we see only an outside chance of the ECB lowering

rates again (seeECB Watch: Hinting at Holding Operations,

March 6, 2013).

No credit easing either, but maybe some forward guidance

Equally, the ECB does not seem to be in a hurry to embark on

additional measures of credit easing, e.g. purchases of loanportfolios. While the ECB is closely monitoring financial

conditions in the euro area, notably in the money markets, to

assess whether its accommodative policy stance is transmitted

to the wider financial sector and the economy, the Council

acknowledges that some factors causing financial

fragmentation are beyond its control. For the first time, ECB

President Mario Draghi, at the March press conference, stated

that the ECBs policy stance will stay accommodative for as

long as needed possibly a first attempt at providing some

forward guidance that ECB rates will stay low for a long time.

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Exhibit 6

Weaker EUR Helped to Ease Monetary Conditions

Euroland MCI and components (base: 0 = 01/01/99)

-400

-350

-300

-250

-200

-150

-100

-50

0

50

100

150

200

250

300

350

400

1999 2001 2003 2005 2007 2009 2011 2013

-400

-350

-300

-250

-200

-150

-100

-50

0

50

100

150

200

250

300

350

400

Refi Rate Effect

Exchange Rate Effect

MCI

3M Euribor Effect

Source: ECB, Morgan Stanley Research

Several factors could easily tilt the balance towards

additional ECB easing: a marked rise in the EUR, a renewed

downtrend in economic sentiment, or a drop-off in inflation that

would push projections towards the deflation danger zone (see

Strategy and Economics: What if the Euro Overshoots?

February 4, 2013). But with the ECB apparently reluctant to

contemplate a deposit rate cut, effective further stimulus

through traditional interest rate policy is not sufficiently likely to

make it our base case. Instead, we expect the ECB to ponder

different unconventional measures to unclog the bank lending

channel and reduce financial fragmentation.

Our theme of the eurozone crisis being only contained,

rather than resolved, gained traction in recent weeks (see

European Economics: Crisis Contained, Not Resolved,

January 7, 2013). Not only did it become clear that OMT

activation is further off than many investors expected, but it is

also evident that large-scale direct bank recapitalisations by

the ESM are unlikely. Instead the political focus on creating a

banking union has moved towards tightening capital rules and

harmonizing bank resolution regimes, with the latter likely to

foresee far-reaching bail-ins of bond holders and, possibly,

even depositors. As we had feared, the bailout for Cyprus turns

out to be rather difficult to agree politically, notably in Germany,

and the political situation and program execution in Greece

continue to raise concerns.

Depending on how the Italian political situation evolves,

the eurozone could soon find itself at a cross-roads (see

Economics & Strategy: Framing Europe After the Italian

Elections, March 4, 2013). The election outcome is widely seen

as an outcry against austerity. In our view, however, it is more

of a protest vote against economic, social and politicalsclerosis in the country. The reaction of political Europe to this

election outcome is key for the euro area growth outlook.

In our bull case, we assume that Europe responds by

redoubling its structural reforms efforts, notably labour

market reforms that lower the hurdles to job creation. In

addition, Europe reconsiders austerity and gives countries with

a strong reform record more time to cut deficits. Given that

most countries already took major steps to rein in deficits,

markets view this as positive and bond yields start to fall,

especially in the periphery. The ECB cuts rates in response to

downside risks to price stability emerging due to supply-side

reforms. GDP would be stable in 2013 and expand by an abovetrend 1.8% in 2014.

In our bear case, social unrest spreads and leads to

political procrastination and reform blockage, challenging

the consensus view that the worst is behind us. Financial

fragmentation increases again, uncertainty about economic

policy weighs on investment spending and job creation. The

discussion about euro membership spreads to larger countries,

including core countries where anti-euro parties are starting to

attract voter support. The ECB does not react for a long time as

the Council is deeply divided about non-conventional

measures. The economy slides deeper into recession, falls

1.7% in 2013 and barely stabilises in 2014 (-0.2%).

Exhibit 7

Bull and Bear Cases GDP Growth

2012 2013e 2014e 2013e 2014e 2013e 2014e

Subjective Prob. 60% 20% 20%

EU-15 -0.4 -0.4 1.0 -1.4 -0.1 0.3 1.9

EMU -0.5 -0.7 0.9 -1.7 -0.2 0.0 1.8

Austria 0.8 0.9 1.5 -0.1 0.4 1.6 2.3

Belgium -0.2 0.2 1.2 -0.8 0.1 1.1 2.2

Finland -0.2 0.0 1.4 -1.0 0.3 0.7 2.2

France 0.0 -0.3 0.6 -1.0 -0.4 0.7 1.7

Germany 0.7 0.5 1.6 -0.5 0.5 1.2 2.4

Greece -6.6 -4.0 0.0 -6.4 -1.4 -2.3 1.2

Ireland 0.7 1.1 2.4 -0.9 1.3 1.8 3.2Italy -2.2 -1.7 0.4 -2.7 -0.7 -1.0 1.2

Netherlands -0.9 -0.8 0.5 -1.8 -0.6 -0.1 1.3

Portugal -3.2 -3.0 0.3 -4.0 -0.8 -2.3 1.1

Spain -1.4 -1.5 0.8 -2.5 -0.3 -0.8 1.6

Base Case Bear Case Bull Case

Source: National data, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Exhibit 8

Euroland Detailed Macro Economic Forecasts, 2009-14E1Q 2Q 3Q 4Q 1QE 2QE 3QE 4QE 1QE 2QE 3QE 4QE 2009 2010 2011 2012 2013E 2014E

GDP Eurostat (qoq) -0.1 -0.2 -0.1 -0.6 -0.3 -0.2 0.2 0.2 0.3 0.3 0.3 0.3

GDP Eurostat (qoq, annualised) -0.2 -0.7 -0.3 -2.3 -1.0 -0.6 0.6 1.0 1.0 1.0 1.2 1.2

GDP (yoy) -0.1 -0.5 -0.6 -0.9 -1.1 -1.1 -0.8 0.0 0.5 0.9 1.0 1.1 -4.3 2.0 1.5 -0.5 -0.7 0.9

Private Consumption (qoq, ann.) -1.0 -1.9 -0.4 -1.6 -0.8 -0.4 0.4 0.4 0.4 0.4 0.8 0.8 -0.9 0.9 0.1 -1.2 -0.7 0.4

Government Consumption (qoq, ann.) 0.7 -0.6 -0.4 -0.3 -0.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.6 0.7 -0.1 -0.1 -0.4 0.0

Gross Fixed Investment (qoq, ann.) -5.6 -6.5 -3.0 -4.4 -2.0 -1.0 0.2 1.2 1.2 1.4 1.5 1.5 -12.8 -0.2 1.6 -3.9 -2.3 1.0

Machinery & Equipment (qoq, ann.) -10.3 -8.9 -5.0 -5.9 -3.9 -2.0 0.0 2.0 2.0 2.6 2.6 2.6 -18.7 6.3 4.6 -5.9 -3.6 1.7

Construction (qoq, ann.) -3.9 -5.5 -1.3 -2.0 -1.2 -0.8 0.0 0.4 0.4 0.4 0.4 0.4 -9.9 -4.4 -0.3 -3.1 -1.3 0.3

Other (qoq, ann) 4.9 -1.7 0.4 0.8 0.8 1.6 2.4 3.2 3.0 3.0 3.0 3.0 -5.3 3.8 2.3 1.5 1.1 2.9

Contribution to Growth

Inventories (qoq, ann.) -0.4 -0.2 -1.1 -0.4 -0.6 -0.1 0.7 0.2 0.4 -0.1 -0.5 -0.5 -0.9 0.6 0.2 -0.7 -0.3 0.1

Net Exports (qoq, ann.) 1.6 2.0 1.6 -0.2 0.5 -0.1 -0.4 0.4 0.2 0.6 1.0 1.0 -0.8 0.7 1.0 1.6 0.4 0.4

Final Domestic Demand (qoq, ann.) -1.5 -2.4 -0.8 -1.8 -1.0 -0.4 0.3 0.4 0.4 0.5 0.7 0.7 -2.7 0.6 0.3 -1.4 -0.9 0.4

GDP Gap (actual versus potential) -3.6 -2.8 -2.4 -3.7 -5.2 -5.0

Main Euro Area Countries

Germany (qoq, ann.) 2.0 1.1 0.9 -2.4 1.4 1.0 1.4 1.7 1.6 1.6 1.6 1.6 -5.1 4.2 3.0 0.7 0.5 1.6

France (qoq, ann.) -0.4 -0.4 0.6 -1.1 -0.8 0.1 0.3 0.3 0.7 0.8 0.7 0.7 -3.1 1.6 1.7 0.0 -0.3 0.6Italy (qoq, ann.) -3.2 -2.9 -0.8 -3.7 -2.4 -1.2 0.4 0.4 0.4 0.4 0.8 0.8 -5.5 1.8 0.6 -2.2 -1.7 0.4

Spain (qoq, ann.) -1.7 -1.6 -1.3 -3.2 -1.6 -1.2 -0.8 0.6 1.2 1.4 1.6 1.8 -3.7 -0.3 0.4 -1.4 -1.5 0.8

Employment, Income, Profits

Employment (qoq) -0.4 0.0 -0.3 -0.4 -0.3 -0.2 -0.1 -0.1 0.0 0.0 0.1 0.1 -1.8 -0.5 0.5 -0.7 -0.9 -0.1

Unemployment Rate, % of labour force 10.9 11.3 11.5 11.8 11.9 12.0 12.1 12.1 12.2 12.3 12.3 12.2 9.6 10.1 10.2 11.4 12.0 12.3

Compensation per Employee (qoq) 0.5 0.2 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 1.6 1.8 2.1 1.7 1.2 1.2

Real Disposable Income (qoq) 0.2 -0.7 -0.3 -0.9 -0.5 0.4

Savings Ratio (% of disposable income) 15.3 13.8 13.4 13.7 13.8 13.8

Gross Operating Surplus (qoq) -6.5 4.3 2.4 0.1 1.1 2.4

Productivity, Costs, Inflation

Labour Productivity per capita (qoq) 0.4 -0.2 0.2 -0.2 0.1 0.1 0.3 0.3 0.3 0.3 0.3 0.2 -2.5 2.5 1.0 0.2 0.2 1.0

Unit Labour Costs (yoy) 1.7 1.3 1.5 1.3 1.4 1.2 1.0 0.5 0.3 0.2 0.2 0.2 4.3 -0.7 1.1 1.5 1.0 0.2

Inflation (HICP), yoy 2.7 2.5 2.5 2.3 1.8 1.5 1.4 1.3 1.4 1.5 1.6 1.7 0.3 1.6 2.7 2.5 1.5 1.6

Core inflation, yoy 1.6 1.6 1.5 1.5 1.2 1.3 1.3 1.3 1.5 1.5 1.5 1.6 1.4 1.0 1.4 1.5 1.3 1.5

Balance Sheets

Current Account (% of GDP) -0.2 0.0 0.1 1.2 1.7 1.8

General Government Balance (% of GDP) -6.3 -6.2 -4.1 -3.6 -3.1 -3.1

General Government Gross Debt (% of GDP) 80.0 85.6 88.1 93.4 97.0 98.7

Policy Rates

ECB Refi Rate 1.00 1.00 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 1.40 1.00 1.25 0.88 0.75 0.75 Source: National Statistics, Eurostat, Morgan Stanley Research forecasts QoQ = Quarter on Quarter, YoY = Year on Year

Exhibit 9

European Interest Rate Forecasts at a Glance, 2013-14E

Current Mar 13E Jun 13E Sep 13E Dec 13E Mar 14E Jun 14E Sep 14E Dec 14E

EURO AREAECB Deposit (Floor) Rate 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

ECB Refi Rate (EoP) 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75

ECB Marginal Lending (Ceiling) Rate 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

3M Money market rate and futures 0.20 0.20 0.22 0.25 0.30 0.34 0.41 0.47 0.55

UNITED KINGDOM

BoE repo rate (EoP) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75

3M Money market rate and futures 0.50 0.51 0.47 0.43 0.43 0.44 0.47 0.51 0.57

SWEDEN

Riksbank Repo (EoP) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.50

3M Money market rate and futures 1.26 1.26 1.25 1.29 1.37 1.45 1.54 1.63 1.72

Riksbank's Own Repo Forecast (Avg) 1.00 0.96 0.95 1.00 1.21 1.39 1.58 1.77

Source: Reuters, Bloomberg, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Germany Recovery Reloaded?

Morgan Stanley & Co.International plc Elga Bartsch

Elga.Bartsch@morganstanley.com

Key PointsWe are revising up our German GDP forecasts by 0.5 ppts over

2013-14.

But we remain cautious on the longer-term growth dynamics in

Europes largest economy.

Subdued domestic demand dynamics and a balanced budget

are likely to keep the current account surplus elevated.

Germany saw a surprisingly sharp fall in activity in late

2012, when GDP contracted a non-annualised 0.6%Q on weak

foreign trade. Given the sharp surge in sentiment indicators,

notably the Ifo business climate in recent months, it is widely

expected that activity will bounce back sharply in 1Q. While we

have also penciled in a rebound, we are somewhat more

cautious given the notable gap between business surveys and

actual activity, e.g. order inflow or production volumes. Beyond

an initial bounce in early 2013, we would expect growth to

return to the trend rate. Compared to November, we are slightly

raising our estimate for 2013 to 0.5% from 0.3% and we are

also upping out 2014 forecast to 1.6% from 1.3% before.

While Germany should return to growth earlier than the

euro area, we are cautious on longer-term growth. Our

main concern is the weakness in investment spending, which

we also deem to be a key reason for current account surplus

remaining high. Not only did investment spending contract

sharply last year, but concerns about energy policy, wealth

taxes, public infrastructure and the availability of skilled

workers are likely to weigh on investment decisions in future.

Our concerns are supported by several large German

corporates announcing major cost-cutting plans late last year.

Meanwhile consumer spending should remain solid over the

forecast horizon. Despite a gradual recovery in the course of

this year and into next, the rate of expansion of consumer

expenditure will likely stay modest at an average of less than

1% p.a. over the forecast horizon. Consumer demand shouldbe support by a labour market that remains in good shape even

though job creation will likely slow as slower growth, the

introduction of minimum wages and sizeable pay rises in a

number of key sectors are likely to temper corporate hiring

intentions.

Germany seems to be benefitting more than we previously

acknowledged from the global economic recovery and its

strong competitive position overseas. Looking at the

breakdown of the German trade balance surplus shows that

Germanys export success largely comes from trade withcountries outside the euro area. Given the deep recession in

much of the periphery, Germanys trade surplus with the rest of

the region has started to level off in recent years a process

that we would expect to continue. Better than expected, the

German public sector posted a small budget surplus of 0.2% of

GDP last year. This year, we expect no meaningful further

improvement in the budget balance on the back of the lagged

impact of last years slowdown on the tax intake and from

several expansionary measures ahead of the election (cut in

pension contributions, abolition of fee for medical treatment,

increase in income tax threshold). The debt level that until

recently was pushed higher by bank rescues and eurozone

bail-out, should start to level off though.

Exhibit 10

German Trade Surplus with EMU Shrinking

-15

-10

-5

0

5

10

15

20

25

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Jan-

10

Jan-

12

-15

-10

-5

0

5

10

15

20

25Ex EMU Trade Balance, EUR bnEuro Area Trade, EUR bnEMU Imports, yoy, RHSEMU Exports, yoy, RHS

Source: Statistisches Bundesamt, Morgan Stanley Research

Exhibit 11

Germany Main Macro Forecasts, 2010-14E2010A 2011A 2012A 2013E 2014E

Real GDP 4.2 3.0 0.7 0.5 1.6

Private Consumption 0.9 1.7 0.8 0.6 1.3

Government Consumption 1.7 1.0 1.0 1.8 1.4

Gross Fixed Investment 6.1 6.2 -2.2 -0.4 2.9

Machinery and Equipment 10.3 7.0 -4.4 -2.4 3.9

Exports 13.7 7.8 4.1 3.8 5.7

Imports 11.1 7.4 2.3 3.8 5.5

Contribution to GDP Growth (%)

Final Domestic Demand 1.9 2.2 0.2 0.6 1.5

Net Exports 1.9 0.7 1.1 0.3 0.6Inventories 0.3 0.1 -0.7 -0.5 -0.5

Unemployment Rate (% of Labour Force) 7.1 6.0 5.5 5.8 5.9

Real Disposable Income 0.7 -0.6 0.5 0.7 1.0

Personal Saving Rate (% of Disp. Income) 12.1 10.2 9.9 9.9 9.6

Inflation (CPI) 1.2 2.0 2.0 1.7 1.6

GDP Deflator 0.9 0.8 1.3 2.0 1.6

Unit Labour Costs -3.1 4.1 3.0 1.7 0.8

Current Account (% of GDP) 6.0 5.7 6.3 6.0 6.2

General Government Balance (% of GDP) -4.1 -0.8 0.2 0.2 0.5

Primary Government Balance (% of GDP) -1.6 1.8 2.6 2.4 2.6

General Government Debt (% of GDP) 82.5 80.5 81.4 80.4 78.0

Net Government Debt (% of GDP) 49.8 51.3 N/A N/A N/A Source: National Statistics, Deutsche Bundesbank, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

France Fiscal Uncertainty Clouds Economic Outlook

Morgan Stanley & Co.International plc Olivier Bizimana

Olivier.Bizimana@morganstanley.com

Key PointsWe expect the economy to contract in 2013 and to return to

sub-par growth next year, on the back of fiscal tightening and

lingering uncertainties.

Domestic demand growth is headed towards a new normal.

Despite an extra year to reduce the government deficit to the

target of 3% of GDP, fiscal consolidation looks set to remain

challenging.

Lacklustre macroeconomic environment. We forecast the

French economy to contract at an annual rate of 0.3% in 2013.

In particular, fiscal tightening should continue to be a drag on

domestic demand. The economy is expected to return to

growth in 2014, although it should remain subpar, averaging

0.6%. The risks to the outlook remain higher than normal.

We think the uncertainty about future fiscal policy is the

main hurdle to healthy economic expansion going forward.

Indeed, the fear of future tax hikes could cause consumers and

businesses to become extremely cautious about their spending

decisions. A second risk is a worsening of the structural issues

labour market rigidities, weak competitiveness, sizable and

growing public debt which could further temper the

economys momentum.

A double-dip recession.Key data flows released in early

2013 point to a renewed recession, with real GDP shrinking

by 0.2%Q in the first quarter, following a contraction of 0.3% in

4Q 2012 the technical definition of a recession is two

consecutive quarters of contraction. The French economy

already experienced a recession in the first half of 2012. Real

GDP is set to restart growing at a disappointing pace in the

second half of this year. We believe it may take a while before

the economy advances at full speed, since the need to tackle

fiscal problems should continue to dampen domestic demand.

Towards a new normal. Domestic demand is expected togrow at a relatively subdued pace, well bellow its historical

trend. Private consumption, which is the traditional engine

of growth, should remain broadly flat. Household income

growth should remain weak, as a reflection of continued job

destruction and the stubbornly high unemployment. Moreover,

given the persistent macroeconomic uncertainty, the

household savings rate is set to remain elevated. Corporate

investment should experience a sharp fall on average this year,

on the back of weak demand prospects and difficult credit

conditions. Finally, the contribution from net exports isexpected to be neutral. Exports and imports should slow

markedly, in line with the weak foreign and domestic demand.

Difficult deficit reduction.The European Commission is

likely to give France an extra year to reduce its deficit to

the threshold of 3% of GDP (see Economics and Strategy:

France's 2013 Deficit Target, February 19, 2013). Hence, the

risk of an austerity trap would be averted. The structural fiscal

adjustment should nevertheless continue this year and could

even be more significant than previously anticipated in 2014.

Moreover, paradoxically, fiscal uncertainty is likely to increase,

since the government has not yet laid out a comprehensive

strategy of fiscal consolidation. Overall, we expect the generalgovernment budget deficit to fall to 3.9% of GDP (after 4.5% of

GDP in 2012) and debt-to-GDP ratio to rise to 93.4% n 2013.

Exhibit 12

France Main Macro Forecasts 2010-2014E2010A 2011A 2012A 2013E 2014E

Real GDP 1.6 1.7 0.0 -0.3 0.6

Private Consumption 1.4 0.2 0.0 0.2 0.5

Government Consumption 1.7 0.2 1.4 0.9 0.5

Gross Fixed Investment 1.1 3.6 0.0 -1.7 0.7

Contribution to GDP Growth (%)

Final Domestic Demand 1.5 0.9 0.3 0.0 0.6

Net Exports 0.0 0.0 0.7 0.0 0.0

Inventories 0.1 0.9 -1.1 -0.3 0.0

Unemployment Rate (% of Labour Force) 9.3 9.2 9.9 10.4 10.7

Real Disposable Income 0.4 0.5 -0.4 0.5 0.4

Savings Rate (% of Disp. Income) 15.9 16.2 16.1 16.1 15.9

Inflation (CPI) 1.5 2.1 2.0 1.2 1.6

Unit Labour Costs 0.8 1.2 1.9 1.8 1.6

Current Account (% of GDP) -1.6 -2.0 -2.1 -2.0 -2.2

General Government Balance (% of GDP) -7.1 -5.2 -4.5 -3.9 -3.5

Primary Government Balance (% of GDP) -4.7 -2.6 -2.0 -1.3 -0.8

General Government Debt (% of GDP) 82.6 86.1 90.1 93.4 94.9

Net Government Debt (% of GDP) 57.3 63.0 N/A N/A N/A Source: INSEE, Morgan Stanley Research estimates

Exhibit 13

Towards a new normal for domestic demand

-3

-2

-1

0

1

2

3

4

1990 1994 1998 2002 2006 2010 2014

Real GDPDomestic demand (excl. invent.)Domestic demand: average 1990-2007Domestic demand: average 2010-2014

Forecasts

New normal

Annual growth, %

Source: INSEE, Morgan Stanley Research estimates

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Italy More Politics, Less Reform

Morgan Stanley & Co.International plc Daniele Antonucci

Daniele.Antonucci@morganstanley.com

Key PointsPolitical instability is likely to persist, even if the process of

government formation turns out to be successful. This might

complicate an OMT application, if needed.

Some institutional reforms might take place, but economic

reforms are likely to be postponed further. As such, were

cautious on Italys medium-term growth prospects.

Fiscal policy is likely to remain tight, thus weighing on

near-term growth. We now think that GDP will shrink by 1.7%

this year, 0.5ppt more than in our previous forecast.

Uncertain political situation

Political uncertainty is set to continue in the near term, with the

possibility of government formation only in late March. And its

also likely to be a factor in the medium term, with

heterogeneous parliaments and unstable governments

negatively affecting sentiment. We have further cut our GDP

forecast, and now expect a 1.7% contraction this year from

1.2% before.

There are scenarios where no governments can be formed (we

assign a 30% probability): after a stalemate where an interim

government acts as a caretaker rather than focusing on boldpolicy measures, Italy heads to the polls again. Our bear case

is of an extended political paralysis, downside risk to growth

through the sentiment channel, and a postponement of urgent

structural reforms, such that GDP might shrink by nearly 3%

this year and continue to contract in 2014.

But there are also scenarios where an agreement on a

programme focused on institutionalreforms can be reached

(we assign a 70% probability). An alternative to new elections

for which we see little appetite is either a minority government

where the centre-left seeks external support from the Five Star

Movement, or a broad coalition ranging from the centre-left to

the centre-right. Both options are likely to be unstable. We thinkit would be more difficult to sign for ESM support, if needed,

with Grillo than with a centre-left / centre-right coalition (seeFraming Europe After the Italian Elections, March 4, 2013).

Structural reforms less likely

With the current political situation, Italy seems unlikely to

deliver at least for some time on much needed economic

reforms, which Europe is asking for, to strengthen its economic

fabric. The scar left by the recession is likely to have damaged

the supply side of the Italian economy, thus further lowering thepace of potential growth to 0.5% or so. This is an important

point because, with no macroeconomic levers (being part of

the eurozone) and fiscal policy likely to remain tight under most

scenarios, the only viable alternative is to boost long-term

growth and resilience via microeconomic reforms.

Fiscal policy to remain prudent

Virtually alone within southern Europe and also compared to

many core countries Italy has had a primary budget deficitin

only one year over the past two decades. We expect this

strategy to be maintained in our base case, with a rising

surplus. But this is likely to continue to have negative

repercussions for the economy, and is the other main reasonwhy, apart from structural deficiencies, Italian growth remains

stagnant.

Exhibit 14

Italy Main Macro Forecasts, 2010-14E2010A 2011A 2012E 2013E 2014E

Real GDP 1.8 0.6 -2.2 -1.7 0.4

Private Consumption 1.2 0.1 -4.3 -2.8 -0.3

Government Consumption -0.6 -0.8 -1.0 -1.2 -0.8

Gross Fixed Investment 2.0 -1.3 -9.0 -4.2 0.6

Construction -3.6 -1.6 -8.4 -3.4 0.9

Contribution to GDP Growth (%)

Final Domestic Demand 1.0 -0.4 -4.5 -2.7 -0.2

Net Exports -0.4 1.5 2.7 0.9 0.5

Inventories 1.2 -0.5 -0.4 0.0 0.1

Employment -1.0 0.8 -0.2 -0.5 0.3

Unemployment Rate (% of Labour Force) 8.4 8.4 10.6 12.0 12.1

Real Disposable Income -0.5 -1.1 -3.7 -1.3 -0.7

Personal Saving Rate (% of Disp. Income) 12.8 11.6 12.1 13.6 13.2

Inflation (CPI) 1.5 2.8 3.0 1.7 2.0

Unit Labour Costs -0.8 1.1 1.5 2.2 0.9

Current Account Balance (% of GDP) -3.6 -3.1 -2.5 0.6 1.0

General Government Balance (% of GDP) -4.5 -3.8 -3.0 -2.6 -2.3

Primary Government Balance (% of GDP) 0.1 1.2 2.5 3.7 4.1

General Government Debt (% of GDP) 119.3 120.8 127.0 129.1 128.1

Net Government Debt (% of GDP) 99.5 94.1 N/A N/A N/A Source: ISTAT, Bank of Italy, Morgan Stanley Research

Exhibit 15

Further weakness ahead in Italy

Real GDP Growth

-4

-3

-2

-1

0

1

2

2001 2003 2005 2007 2009 2011 2013

-8

-6

-4

-2

0

2

4

% Q/Q (LHS)

% Y/Y

MS forecasts

Source: ISTAT, Morgan Stanley Research

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Spain Rebalancing and Deleveraging

Morgan Stanley & Co.International plc Daniele Antonucci

Daniele.Antonucci@morganstanley.com

Key PointsThe pace of economic contraction no longer seems to be

accelerating, but the outlook remains weak.

While the probabilities (20%) are symmetric, the fall in our bear

case is bigger than the gain in our bull case.

Deleveraging is a drag, but rebalancing is unfolding faster than

expected.

Economic outlook still fragile, but no longer worsening

Activity should stabilise towards year-end, somewhat later than

expected in our previous forecast update. The negative

carry-over effect from a sharp contraction in 4Q last year

implies such an unfavourable base effect that in the annual

comparison GDP will fall visibly in 2013 too. This is despite an

improvement of the sequential pace of growth, as suggested

by the more encouraging picture depicted by the main surveys.

Mind the tails

Our bear case encompasses a relapse due to the economy not

being able to sustain a significant fiscal adjustment, coupled

with economy-wide deleveraging. With unemployment rising

further and GDP shrinking by 2.5%, discontent might rise too.

Should market sentiment take a turn for the worse, this wouldraise the probability of seeking external ESM/OMT support,

which we think to be low for now.

Deleveraging remains a significant drag

The overall economy is in the process of engineering a

significant balance-sheet repair. This process is necessary and

welcome but, as long as it continues, Spain is unlikely to

become a quick turnaround story on the domestic front. From

the consumer to the construction, banking and government

sectors, the belt-tightening is such that theres virtually no

sector that could make up for the shortfall in demand when the

others are in a significant deleveraging mode. As such, we

expect continued weakness on the national consumption front.

Rebalancing story continuing

Yet the Spanish economy is continuing to shift away from

domestic demand, and construction in particular, and into an

export-led model at a fast pace, as shown by the rapid

improvement of its current account balance, which is now in

surplus. This is underappreciated in the market, we think.

Spains exports are structurally strong and getting stronger.

With unit labour costs having come down for quite a while

courtesy of recession-driven wage moderation and labourmarket reforms and productivity rising, Spain is recovering a

good part of its lost price competitiveness, thus adding to an

already robust export performance. We expect this process to

continue and eventually bring back somegrowth.

Exhibit 16

Spain Main Macro Forecasts, 2010-14E2010A 2011A 2012E 2013E 2014E

Real GDP -0.3 0.4 -1.4 -1.5 0.8

Private Consumption 0.7 -1.0 -2.1 -3.4 0.0

Government Consumption 1.5 -0.5 -3.7 -5.1 -1.8

Gross Fixed Investment -6.8 -6.0 -10.1 -7.1 -1.5

Construction -9.8 -9.0 -11.5 -7.2 -2.6

Contributions to GDP Growth (%)

Final Domestic Demand -0.9 -1.9 -4.0 -4.3 -0.6

Net Exports 0.2 2.4 2.4 2.9 1.1

Inventories 0.3 0.0 0.2 -0.2 0.4

Unemployment Rate (% of Labour Force) 20.1 21.7 25.1 26.6 25.7

Inflation (CPI) 1.8 3.2 2.4 2.2 1.1

Current Account Balance (% of GDP) -4.4 -3.7 -2.0 1.5 2.0

General Government Balance (% of GDP) -9.7 -9.4 -9.9 -8.0 -7.5

Primary Government Balance (% of GDP) -7.7 -7.0 -6.9 -4.1 -3.3

General Government Debt (% of GDP) 61.5 69.3 89.3 100.2 103.9

Net Government Debt (% of GDP) 40.2 49.5 N/A N/A N/A Source: INE, Bank of Spain, Morgan Stanley Research estimates

Public finances slow progress over a long timeframe

Government debt is high and rising, and the primary budget

deficit is still large. We think that the official growth projections

are too optimistic. Thus, the fiscal targets remain out of reach,

even though Spains progress is taking place somewhat faster

than expected by the consensus. There seems to be a shifttowards an evaluation on the fiscal progress in structuralterms,

i.e., abstracting from cyclicalswings, thus making Spains effort

more adequate. The chances are that the European

Commission might give Spain extra time to bring its budget

deficit below 3% of GDP, thus giving it some economic respite.

Exhibit 17

Spain no longer living beyond its means

Current Account (bn, 4Q Sum)

-60

-40

-20

0

20

40

1999 2001 2003 2005 2007 2009 2011

-12

-10

-8

-6

-4

-2

0

2

4

Trade bal. ex energy Energy

Services Current transfers

Factor incomes CA (% of GDP, RHS)

Source: Bank of Spain, Morgan Stanley Research

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Netherlands Austerity Adjourned

Morgan Stanley & Co.International plc Elga Bartsch

Elga.Bartsch@morganstanley.com

Key PointsThe Dutch economy should continue to contract as domestic

demand and net exports decline, making the Netherlands the

weakest amongst the core countries.

Weak labour and housing markets, pension and budget cuts,

falling house prices and high debt levels are depressing

consumers. Ample free capacity and tight credit conditions is

weighing on investment spending.

The EDP target of a 3% budget deficit will likely be missed in

2013. We expect the government to adopt additional austeritymeasures in 2014 though and have cut our growth forecasts.

Netherlands continues to be the weakest core economy:

The Dutch economy should shrink further this year on our

downwardly revised forecasts of -0.8%. Given the commitment

to additional austerity next year, we also lowered our 2014

forecast to 0.5%. The underperformance vis--vis the euro

area is underpinned by survey data, where consumer

confidence and business sentiment corrected again in early

2013. Dutch manufacturers continue to report declining order

books, and only recently have become less gloomy about the

production outlook. Tight credit conditions, particularly forSMEs, will dampen investment spending.

Housing market correction is creating headwinds: A

number of policies, such as low taxation of homeownership,

have artificially raised house prices in the past (see ING (ING.

AS) Factoring in a tougher backdrop - cut to EW, February 18,

2013). Nominal house prices have declined by around 20%

now from the peak in August 2008, a more gradual decline than

that seen in some of the peripheral countries. Transactions

have plunged by 78% in Q4 2012 compared to the Q3 2008

peak. In combination with very elevated household debt and

what seems to be an underfunded pension system, the

housing market is a concern.

High household debt poses a risk to consumer spending

and public finances: Dutch households are the most indebted

in the euro area. Past government policy has led to households

taking out high mortgage debt (seeEuropean Commission,

The housing market in the Netherlands, 2012). Mortgage

products were being designed to fully benefit from tax

exemptions, longer maturities and more flexible terms such as

higher loan-to-value ratio. As a result of the high leverage,

Dutch consumer are struggling more than their euro area peerswith falling house prices because of the high proportion of

housing assets in total household wealth. The highly

leveraged households also pose a risk to fiscal balances

through measures such as excluding mortgage interest rate

from taxable income, exemption of net housing wealth from

capital tax etc. This resulted in substantial fiscal costs equal to

13.1bn or 2.2% of GDP in 2011. Apart from this, the

government is also accumulating implicit liabilities through the

national mortgage guarantee scheme equal to 24% of GDP.

Going forward, the government is proposing applying

restrictions on the deduction of mortgage interest payments

from taxable income.

Additional austerity adjourned until 2014: This year, the

Netherlands is likely to miss the 3% deficit target set out in the

Stability Programme. Despite a meaningful overshoot the

government has already indicated that it will not take additional

measures. The negative budget impact of the nationalization of

SNS Reaalis likely to offset proceeds from selling 4G mobile

telco licenses. Instead, the government will take additional

austerity measures worth 4.3bn (0.7% of GDP) in 2014. The

measures include a 1-year salary freeze for civil servants and

healthcare workers and scrapping tax breaks worth 640mn for

companies. Despite these additional measures, which still

need to be finalized and approved, the deficit might not hit the

3% target. Additional austerity will also test the coalition, which

lacks a majority in the upper house and which thus depends on

support from opposition parties.

We acknowledge the contribution of Gaura Sengupta

Exhibit 18

Netherlands Main Macro Forecasts, 2010-14E2010A 2011A 2012A 2013E 2014E

Real GDP 1.6 1.1 -0.9 -0.8 0.5

Private Consumption 0.3 -1.0 -1.4 -1.5 0.1

Government Consumption 0.7 0.1 0.7 0.3 0.0

Fixed Gross Investment -7.2 5.7 -4.7 -3.0 1.7

Exports 11.2 3.9 3.1 2.6 4.8

Imports 10.2 3.6 2.8 2.3 4.8

Contributions to GrowthDomestic Final Demand -1.0 0.5 -1.3 -1.1 0.4

Net Exports 1.5 0.5 0.5 0.4 0.5

Inventories 1.2 -0.1 -0.1 -0.2 -0.4

Employment -1.0 0.0 -0.3 -0.5 0.0

Unemployment Rate (%, ILO Definition) 4.5 4.4 5.3 6.4 6.8

Real Household Disposable Income -0.3 -0.8 -0.5 -1.0 0.7

Inflation (CPI) 1.3 2.3 2.5 2.3 1.8

GDP Deflator 1.1 1.2 0.8 1.8 1.6

Compensation Per Employee 2.0 1.5 2.3 1.8 2.5

Current Account Balance (% of GDP) 7.7 9.7 7.8 8.7 9.0

General Government Balance (% of GDP) -5.1 -4.4 -4.0 -3.6 -3.1

Primary Government Balance (% of GDP) -3.2 -2.4 -2.4 -2.1 -1.7

General Government Debt (% of GDP) 63.1 65.5 71.2 74.7 76.4

Net Government Debt (% of GDP) 34.4 38.7 N/A N/A N/A Source: National Statistics, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Belgium Walking a Fine Line

Morgan Stanley & Co.International plc Olivier Bizimana

Olivier.Bizimana@morganstanley.com

Key PointsBelgiums economy is expected to almost stagnate this year

and to recover gradually in the course of 2014.

We fear further weakness in the core could push Belgium back

into recession in 2013.

Fiscal consolidation should continue in 2013, although weaker

growth is likely to reduce the pace of adjustment.

The Belgian economy is expected to expand at a sluggish pace

of 0.2% in 2013, following a small contraction in 2012. We see

a gradual, but fragile, recovery in the course of 2014, with real

GDP increasing by 1.2%. Still, the risks to our forecasts are on

the downside. The main threat is the persistent weakness

of economic conditions in the core eurozone that could

push the Belgian economy back into recession.

In the near term, we expect business conditions to

continue to improve somewhat. Yet, at this stage, we remain

cautious, as Belgiums leading indicators have been volatile

since the end of 2012, suggesting that the economic

stabilisation is fragile. We forecast real GDP to rise at an

anaemic 0.1%Q on average in 1H 2013, after a small

contraction of 0.1%Q in 4Q 2012. Economic activity is

expected to pick up pace in 2H 2013 and into 2014. In

particular, exports should benefit from the recovery in global

trade, as evidenced by the rebound in sentiment in the

manufacturing sector. Yet export growth is likely to be

constrained by slow economic growth in the core eurozone.

Domestic demand should remain resilient, although

growing at modest rates. In particular, we expect corporate

investment to shrink in 2013, amid the high level of uncertainty

and tight financing conditions. Household consumption should

grow at a subdued pace throughout 2013, as a reflection of

weak consumer confidence. However, the underlying

fundamentals of consumption remain relatively solid, with aresilient labour market. Looking ahead, we project job growth

to continue, although at a modest pace, and the unemployment

rate to remain fairly stable at 7.5% on average in 2013 and

2014 (from 7.3% in 2012). Whats more, we expect CPI

inflation to slow to a rate of about 1.2% on average in 2013

from 2.8% in 2012, which should support households

purchasing power.

Belgiums budget position has continued to improve. The

general government deficit declined sharply to 2.9% of GDP in

2012, according to our estimates (versus 3.7% of GDP in 2011).However, this level remains slightly higher than the

governments own deficit target of 2.8% of GDP, essentially

because of lower than expected revenue due to the economic

downturn at the end of 2012. The government last autumn

agreed on consolidation measures in the 2013 draft budget in

order to reduce the deficit to 2.15% of GDP in 2013. However,

in the meantime, GDP growth forecast for this year has been

revised down to 0.2%, from 0.7% previously. Hence, the

federal government needs to find additional savings amounting

to around 2.8bn, in order to be able to meet its deficit target,

according to the estimates of the Belgian Monitoring

Committee. At the time of writing though, the government has

not yet unveiled the precise measures to be implemented. Onour forecast, the general government deficit is projected to fall

only slightly to 2.7% of GDP in 2013. The debt-to-GDP ratio

should continue to rise to 100.4% in 2013, from 99.8% in 2012.

Exhibit 19

Belgium - Main Macro Forecasts 2010-14E2010A 2011A 2012E 2013E 2014E

Real GDP 2.4 1.8 -0.2 0.2 1.2

Private Consumption 2.7 0.2 -0.6 0.4 1.1

Government Consumption 0.7 0.8 0.1 0.7 1.3

Fixed Gross Investment -1.4 4.1 -0.5 -1.1 1.2

Contributions to Growth

Domestic Final Demand 1.3 1.1 -0.4 0.2 1.1

Net Exports 0.7 -0.1 0.5 0.2 0.1

Inventories 0.4 0.7 -0.3 -0.2 0.0

Unemployment Rate (%, ILO Definition) 8.3 7.2 7.3 7.5 7.5

Real Household Disposable Income -1.0 -1.4 0.0 1.3 1.1Savings Rate (% of Disp. Income) 15.4 14.4 15.0 15.8 15.7

Inflation (CPI) 2.2 3.5 2.8 1.2 1.6

GDP Deflator 2.0 2.0 2.1 2.0 1.9

Current Account Balance (% of GDP) 1.4 -1.0 -0.4 0.1 0.0

General Government Balance (% of GDP) -3.8 -3.7 -2.9 -2.7 -2.5

Primary Government Balance (% of GDP) -0.4 -0.4 0.6 0.8 1.0

General Government Debt (% of GDP) 95.5 97.8 99.8 100.4 99.8

Net Government Debt (% of GDP) 79.8 81.3 N/A N/A N/A Source: BNB, Morgan Stanley Research forecasts

Exhibit 20

EMUs bellwether returns gradually to growth

Belgium: GDP growth contributions

-1.0

-0.5

0.0

0.5

1.0

1.5

Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14

Domestic demand (excl. inventories) Inventory changes

Net exports GDP

%,Q

Forecasts

Source: BNB, Morgan Stanley Research

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Greece Shock Absorption

Morgan Stanley & Co.International plc Daniele Antonucci

Daniele.Antonucci@morganstanley.com

Key PointsFiscal austerity and a slowdown of core Europe will continue to

weigh on Greeces growth in 1H 2013.

Growth should begin to pick up gradually thereafter, as Greece

absorbs the various shocks that have hit its economy.

The incentive for Greece to exit the eurozone to boost

competitiveness via a weaker exchange rate is no longer there.

We expect Greece to achieve a primary budget surplus this

year and maintain it thereafter.

Fiscal and external drag

The combination of extra fiscal tightening and a slowdown of

growth in core Europe will mainly be felt in the first part of 2013.

Hard data, e.g., industrial production or retail sales, show

deteriorating economy activity in recent months, as expected.

Diminishing Grexit fears

Yet uncertainty around Greeces future in the eurozone a key

factor for economic stabilisation has diminished since last

summer. Combined with improvements in the financial sector,

e.g., better deposits data, the dissipation of such risks is clearly

a positive for the Greek economy (see Greece: From

Shake-Up to Shape-Up?January 21, 2013).

Exhibit 21

Deposits coming back to Greece

Deposits (ex. MFIs) (% Y/Y)

-30

-20

-10

0

10

20

30

2007 2008 2009 2010 2011 2012 2013

-20

-15

-10

-5

0

5

10

15

20

Corporations

Households (RHS)

Source: Bank of Greece, Morgan Stanley Research

Despite poor hard data, recent developments in soft data show

that sentiment in Greece is improving. In fact, we expect to

witness a peculiar situation of weakening hard data alongside

improving soft data in the first half of this year.

but rising political risks in Southern EuropeNevertheless, political developments elsewhere in southern

Europe are a downside risk to Greeces growth outlook. The

outcome of the recent Italian elections has introduced yet

another source of uncertainty for the eurozone. Given the

systemic risk that Italy poses for the region as a whole, this

political instability could have negative ramifications for Greece

if concerns over the eurozones weakest link re-emerge.

Moreover, despite its small size and whilst not our base case,

Cyprus risks reigniting systemic risk if a bailout involves

haircuts to banks depositors or sovereign debt holders (see

Cyprus Should We Worry?February 12, 2013). Our bearcase sees Greece shrinking by around 6.5% this year.

If these political uncertainties prove short-lived, we expect

Greeces recovery to pick up pace going into next year, with

moderate growth returning sometime late in 2014. In fact, with

the progressive attenuation and elimination of shocks from a

severe credit crunch, fiscal austerity, structural reforms and

euro exit fears, Greece may truly stabilise next year.

Recouping lost competitiveness, primary surplus in sight

Greeces price competitiveness improved substantially in the

past year. Although this process has further to go given that

Greece was uncompetitive even when it joined the EMU its

worth noting that Greece has recovered virtually all the lost

ground since the inception of the monetary union. We think that

the incentive for Greece to exit the eurozone to boost its

competitiveness via a weaker exchange rate is no longer there.

We expect Greece to achieve a primary budget surplus this

year and maintain it thereafter. Although its likely to be

fractional in 2013, we think that it will gradually rise to over 3%

of GDP. However, maintaining this surplus depends crucially

on economic stabilisation and on successful implementation of

the measures agreed with the Troika.

Exhibit 22

Greece Main Macro Forecasts, 2010-14E2010A 2011A 2012E 2013E 2014E

Real GDP -4.4 -6.1 -6.6 -4.0 0.0Final Domestic Demand -8.2 -7.8 -9.0 -7.7 -2.3

Unemployment Rate (% of Labour Force) 12.6 17.7 24.2 26.1 26.2

Inflation (CPI) 4.7 3.3 1.5 0.1 -0.2

Current Account Balance (% of GDP) -10.1 -9.9 -5.5 -3.0 0.1

General Government Balance (% of GDP) -10.7 -9.4 -7.1 -4.3 -3.4

Primary Government Balance (% of GDP) -4.9 -2.3 -1.9 0.3 1.9

General Government Debt (% of GDP) 148.3 170.6 162.0 173.0 174.4

Net Government Debt (% of GDP) 117.2 138.7 N/A N/A N/A Source: National Statistics, Morgan Stanley Research estimates (E)

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Portugal Lower Market Risks, Higher Macro Risks

Morgan Stanley & Co.International plc Daniele Antonucci

Daniele.Antonucci@morganstanley.com

Key PointsA market return might be facilitated by the upcoming extension

of the maturities of the official loans, along with a stabilisation

of the rating, together with ESM/OMT support, once Portugal

has issued more and across the curve, if needed.

Economic rebalancing is progressing at a faster pace than

expected. Thats a good sign. Yet fiscal austerity is weakening

the real economy to a more substantial extent than envisaged

earlier. We revise down our GDP forecasts to -3% from -2%.

Steps to prepare market access likely to continueEuropean policymakers are in the process of debating a

lengthening of the maturities of the official loans (EFSF and

EFSM) that Portugal has to repay. The finance ministers hope

to reach a deal in April, even though the debate is ongoing and

the details have to be finalised by the Troika. It seems more

likely that Portugal will get a shorter extension of the terms of

the loans relative to the concession than Greece was granted

recently, i.e., a 15-year extension. Yet this would be a positive

development because it would avoid bottlenecks in repaying

the loans, thus facilitating a market return. One issue is that

countries such as Germany, which require parliamentary

approval in many cases, are looking at whether there are

solutions that would avoid going back to parliament. The ratingoutlook was raised to stable from negative by S&P, while the

overall rating was affirmed at BB. An important market driver

for the eurozone periphery, going forward, is likely to be a

trough or at least stabilisation of the rating cycle.

and European policy might help too

If Portugal were to struggle to fully come back to the market in

2014 when the financial assistance programme expires, or just

to facilitate a market return, then one option is to have second,

bridge, programme, but of a different nature. The current

bailout package doesnt talk about bond buying just loans.

But this could perhaps be modified further down the line. From

the perspective of Portugals funding, that wouldnt actually

make any difference. Rather than via outright loans, the

sovereign would continue to cover its funding needs via debt

issuance that the official sector would purchase (the ESM can

only buy 50% of the total at issuance). We wouldnt rule out that

such a situation maybe not right away, but after some time

might be just enough to create the perception of some kind of

return to the market, in the hypothetical scenario where

Portugal were to struggle to return without support. Further

down the line, this market comeback, even if initially driven

mainly by the official sector, might lower the hurdle for the ECBto purchase Portuguese bonds as well, especially if private

investors start playing a role too.

Exhibit 23

Portugal Main Macro Forecasts 2010-2014E2010A 2011A 2012E 2013E 2014E

Real GDP 1.9 -1.6 -3.2 -3.0 0.3

Final Domestic Demand (ppt contr.) 1.0 -5.6 -7.1 -4.2 -0.9

Net Exports (ppt contr.) -0.1 4.7 4.0 1.6 0.9

Inventories (ppt contr.) 0.9 -0.7 -0.1 -0.3 0.3

Unemployment Rate (% of Labour Force) 10.8 14.2 15.5 17.9 18.6

Inflation (CPI) 1.4 3.7 2.8 0.6 0.6

Current Account Balance (% of GDP) -10.0 -6.5 -1.4 -1.3 -0.7

General Gov't Balance (% of GDP) -9.8 -4.4 -5.1 -5.0 -3.4

Primary Gov't Balance (% of GDP) -7.0 -0.4 -0.8 -0.6 1.0

General Gov't Debt (% of GDP) 93.5 108.1 120.9 129.4 131.3Net Government Debt (% of GDP) 70.1 74.8 N/A N/A N/A

Source: Statistics Portugal, Bank of Portugal, Morgan Stanley Research estimates (E)

Rebalancing and austerity

Just like in Spain, economic rebalancing is progressing in

Portugal too, and faster than expected. This is a positive

development and, if continued, might well create the conditions

for exports to provide a bigger cushion to the downturn, and

eventually to generate somegrowth. Yet the significant fiscal

tightening that is currently feeding through the economy, along

with a severe credit crunch, has depressed economic activity to

a much bigger extent than expected. With such a negative

carry-over into this year, after the sharp fall in activity in 4Q2012, the chances are that the economy will shrink at a faster

pace than projected. We revise down our forecasts and now

see GDP falling by 3% rather than 2% as in our previous

forecast exercise.

Exhibit 24

Economic activity still very weak

Manufacturing Confidence Indicators

25

30

35

40

45

50

55

60

65

2005 2006 2007 2008 2009 2010 2011 2012 2013

-5

-4

-3

-2

-1

0

1

2

3

Euro area (LHS)

Italy (LHS)

Spain (LHS)

Greece (LHS)

Portugal (RHS)

Source: European Commission, Markit, Morgan Stanley Research

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Ireland Heading for the Exit

Morgan Stanley & Co.International plc Elga Bartsch

Elga.Bartsch@morganstanley.com

Key PointsIreland should be the fastest growing economy in the euro area

in 2013. Growth will be driven by net exports. Domestic

demand continues to decline.

Mortgage arrears, which are still on the rise, have become a

focus as the government aims to address legal hurdles to a

quick resolution.

Additional measures to facilitate a smooth exit from the bailout

programme, such as a loan extension, should support positive

market sentiment.

On our upwardly revised, but still cautious forecasts,

Ireland is the fastest growing economy in the euro area.

Growth will be largely driven by net exports. Domestic demand

will continue to contract, but at a slower pace. Consumer

expenditure will fall further as austerity measures (e.g. the new

property tax or higher PRSI charges) dent consumers

purchasing power. On a brighter note, labour market conditions

are starting to improve. Overall investment spending should

contract further, despite a sharp rise in inward FDI, as credit

conditions remain tight for domestic firms and housing remains

in the doldrums. Domestic demand should bottom this year

and start to make a small contribution to growth next year.

Deficit targets will likely be met comfortably in 2013

thanks to a deficit undershoot in 2012. The 2012 deficit will

likely be below 8% of GDP, lower than the governments

estimate of 8.2% of GDP and the troika target of 8.6%. The

majority of the consolidation measures worth 3.5bn (2.1% of

GDP) are expenditure cuts. The 2014 deficit should also

benefit from the promissory note deal with the ECB (see

Economics and Strategy: Ireland: Comeback Continues),

provided that the government is not giving in to political

pressure to use the gains from the IBRC deal to ease some of

the planned austerity measures.

Extending public sector pay cuts under another CrokePark agreement: An important step is the extension of the

public-sector pay agreement known as Croke Park, which was

scheduled to expire in 2014. Under the new agreement, the

government aims to save 1bn in public sector pay over a

three-year period starting from July 1, 2013. Measures include

pay cuts for employees with salaries of 65,000 and above,

longer working hours, lower overtime rates, and a reduction in

pension levies (see Labour Relations Commission Proposals

for Public Service Agreement,. The agreement still needs to be

approved by the majority of public sector workers

Heading for the exit of the bail-out programme: The troikais in talks about additional support to Irelands exit from the

bailout programme at year-end, e.g. an extension of the

EFSM/EFSF loans. Whether Ireland will be granted the

15-year extension remains to be seen though. Similarly, we are

cautious as to whether Ireland will be able to secure a direct

bank recapitalization by ESM. A third option to support Ireland

would be the ECBs OMT programme. In our view, the OMT is

an effective back-stop, also for Ireland, but will probably not be

activated for Ireland because it would require an ESM credit

line, which effectively would imply another bailout programme.

Focus back on banks, notably the issue of mortgage

arrears: After the IBRC deal, the focus is shifting to the issue ofmortgage arrears, which seem to hinder a recovery in the

property market. While arrears of less than 90-days seem to be

stabilizing, arrears of more than 180-days continue to increase.

The rise in long-term arrears reflects the lack of a resolution

regime, which the government is trying to address through

reforming insolvency legislation in order to allow out-of-court

settlements between creditors and debtors. The government is

also aiming to close legal loopholes, which prevent banks from

repossessing homes. Tracker mortgages, which are seen as a

drag on bank profitability, are another concern after a plan to

deal with tracker mortgages by transferring them off bank

balance sheets into a SPV fell through earlier this year.

We acknowledge the contribution of Gaura Sengupta

Exhibit 25

Ireland Main Macro Forecasts, 2010-14E2010 2011 2012E 2013E 2014E

Real GDP -0.8 1.4 0.7 1.1 2.4

Private Consumption 0.6 -2.3 -1.4 -0.4 0.4

Government Consumption -4.6 -4.3 -3.5 -2.1 -1.1

Investment Spending -22.6 -12.8 0.6 -0.1 2.2

Exports 6.2 5.0 3.0 3.3 5.2

Imports 3.6 -0.3 0.4 2.9 5.1

Contribution to Growth

Domestic Demand -4.9 -3.9 -1.2 -0.6 0.3

Inventories 1.2 0.1 -0.7 0.4 0.4

Net Foreign Trade 3.0 5.2 2.7 1.3 1.6

Other Economic Indicators

Employment -4.1 -1.8 -0.8 0.2 0.4

Unemployment Rate (%) 13.9 14.7 14.9 14.5 14.3Current Account (% of GDP) 1.0 1.1 5.2 4.0 3.0

Inflation (YOY)

Consumer Prices -1.6 1.2 1.9 1.1 1.5

GDP Deflator -2.2 0.2 2.7 1.3 1.0

Wages Per Employee -3.2 -0.2 2.1 0.9 0.3

Unit Labour Costs (Total Economy) -5.7 -2.7 0.6 0.3 -1.6

Budget

Primary Govt. Deficit (% of GDP) -27.7 -10.0 -4.4 -2.4 0.2

General Govt. Deficit (% of GDP) -30.9 -13.3 -7.7 -7.2 -4.4

General Govt. Debt (% of GDP) 92.2 106.4 117.1 119.8 117.9 Source: Eurostat, CSO Ireland, Morgan Stanley Research forecasts

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Austria Timid Cyclical Upturn

Morgan Stanley & Co.International plc Elga Bartsch

Elga.Bartsch@morganstanley.com

Tomasz PietrzakTomasz.Pietrzak@morganstanley.com

Key PointsAt 0.9% on our forecasts, Austria is growing significantly faster

than the average EMU country. A gradual improvement in

quarterly GDP growth supports the recovery.

The slowdown we expect in euro area demand in 2013 is likely

to weigh on growth. Some offset might come from growing

CEE demand though.

2013 should see the Austrian economy outperforming the

euro area again. We see Austrian GDP growing significantly

faster than the average EMU country. That said, we are revising

our GDP forecast slightly lower amid weaker expected

economic activity in the euro area. We now expect GDP growth

to remain unchanged at 0.9% in 2013.

Investment dynamics to remain subdued in 2013. After

strong growth in 1Q last year, companies have scaled back on

their investments in machinery and equipment. Despite

favourable financing conditions, companies seem to be

exercising caution. Hence, we are unlikely to see robust growth

in investment before 2014. That said, we expect a gradual

quarterly upturn in investment in 2013, as companies are likely

to ensure the adequacy of the capital stock in anticipation of an

increase in demand next year. Due to base effects, however,

investment growth is likely to fall to 1.1% this year from 1.7%

recorded in 2012.

Private consumption is likely to pick up somewhat, but

without a marked fall in uncertainty to boost households

willingness to buy, private consumption is unlikely to pick up

sharply. That said, high wage settlements in 2012 and falling

inflation pressures will provide for a moderate increase in

consumption. Whats more, although employment growth is

likely to slow, it is still in positive territory. The small rise in the

unemployment rate that we expect to see this year is mostlyrelated to an increase in the supply of labour rather than a fall in

employment.

The key downside risk to the Austrian economy in the

coming year stems from weaker foreign demand. As a small,

open economy, Austria is more prone to be affected by swings in

the volume of international trade. While somewhat stronger

expected import growth coming out of Germany is likely to

support exports, the marked slowdown in economic activity in

the rest of the euro area, especially in the other key Austrian

export markets of Italy and France, is unlikely to leave theAustrian economy unscathed. Some of the relief will, however,

still come from the CEE region. The significance of the CEE

region to the Austrian export market has doubled in the last 20

years to around 18%. While our CEE economists remain

generally bearish on growth in 2013, they still expect the region

to grow at a faster pace than the euro area.

Budget deficit improving, but risks remain. The increase in

budget deficit close to the crucial 3.0% mark last year was

mainly due to large transfers to partially nationalised banks.

Despite a weak growth environment, implemented spending and

revenue measures (raising of social security contributions,

property tax, partial pay freezes, pension increases below theinflation rate) as well as substantial increase in wages and larger

corporate operating surpluses, are likely to help reduce the

budget deficit significantly in 2013. On the other hand, likely

additional support to the banking sector should have an adverse

effect.

Exhibit 26

Austria Macro Forecasts 2010-2014E2010A 2011A 2012A 2013E 2014E

Real GDP 2.1 2.7 0.8 0.9 1.5

Private Consumption 1.7 0.7 0.2 0.6 1.3

Gross Fixed Investment 0.8 7.3 1.7 1.1 2.3

Exports 8.7 7.2 2.0 2.5 4.8

Imports 8.8 7.2 1.2 2.3 4.9

Contribution to GDP Growth

Final Domestic Demand 1.1 1.8 0.4 0.6 1.2

Inventories -0.1 -0.1 0.2 0.0 0.1

Net Exports 0.4 0.4 0.5 0.3 0.2

Unemployment Rate (% of LF) 4.4 4.1 4.5 4.8 4.6

Consumer Prices 1.7 3.6 2.6 2.2 2.1

Current Account, EUR bn 9.7 1.7 4.5 4.3 4.6

Current Account (%of GDP) 3.4 0.6 1.4 1.3 1.4

General Government Balance (% of GDP) -4.5 -2.5 -2.9 -2.4 -2.0

General Government Debt (% of GDP) 72.0 72.4 74.1 75.4 75.2 Source: Statistics Austria, BoA, Morgan Stanley Research Estimates (E)

Exhibit 27

Export Trend Towards CEE, Away from Euro Area

Austria Exports (% of total) Euro area vs Central Eastern Europe

45

47

49

51

53

55

57

59

61

63

65

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

8

10

12

14

16

18

20

Euro Area ex SL, SK (LHS)

CEE RHS

Source: IMF, Morgan Stanley Research

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M O R G A N S T A N L E Y R E S E A R C H

March 13, 2013

European Economics

Finland More Stagnation

Morgan Stanley & Co.International plc Elga Bartsch

Elga.Bartsch@morganstanley.com

Key PointsOn our downwardly revised forecasts, we expect Finnish GDP

growth to come to a standstill in 2013. Incoming data support

our concerns about four sources of fatigue economic, export,

consumer and bailout weighing on Finland.

We expect Finnish GDP growth to come to a standstill in

2013, on the back of declining domestic demand and net

exports. Consumer expenditure is expected to be subdued due

to austerity measures, more moderate wage growth and

weaker labour market conditions. Investment is expected to

contract due to low expectations of future growth levels and

weak housing activity, which will affect construction. Exports

are expected to be impacted by the ongoing restructuring in the

electronics and forestry industries.

Growth will be damped by four sources of fundamental

fatigue economic, exports, consumer and, finally,

bailout. GDP in level terms is yet to recover to 2008 levels and

is not expected to reach those levels over our forecast horizon.

This prolonged period of weak growth will result in economic

fatigue, characterised by weak labour market conditions and

difficulty in improving fiscal balance. Labour market conditions

are expected to weaken further in 2013 as permanent layoffs

become more common than temporary layoffs. The impact of

economic fatigue on fiscal balance was evident in 2012, when

the deficit worsened as weak growth impacted tax revenues, in

particular corporate tax revenues. Deficit levels are expected to

improve in 2013 on the back of austerity measures aimed at

strengthening central government finances.

The second source of fatigue is export fatigue: Finland has

been losing market share in global trade for many years. The

cause can be traced to the ongoing restructuring on the

electronics and forestry industries. This is despite the fact that

structural factors have been largely supportive (see Bank of

Finland Bulletin 3/2012). Part of the loss in competitivenesscan be traced to the Nokias performance. At its heights Nokia

accounted for 4% of Finnish GDP and more than 20% of

exports (see Nokia and Finland in a Sea of Changeby Jyrki

Ali-Yrkk (Ed.) of Research Institute of the Finnish Economy,

2010). Nokias declining performance is expected to impact the

economy through multiple channels - damping export growth,

lower tax revenue, possible job cuts and reduced R&D

expenditure (see Nordic Economics: Bright Stars on European

Skies, January 23, 2013).

Consumer fatigue is also expected to take a toll on Finnishgrowth. Consumption expenditure is expected to be impacted

by the ongoing austerity measures, which will make real

disposable income grow slowly. The measures include a VAT

rate hike and non-adjustment of income tax bracket for inflation.

Apart from this, the rise in wages is expected to be more

moderate due to the collective wage agreement. Rising