all you ever wanted to know about european austerity plans…gesd.free.fr/sgauster.pdf · all you...
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All you ever wanted to know about European austerity plans…
(…but were afraid to ask)
October 2010
Written by a non-U.S. research analyst not registered/qualified under FINRA rules THIS RESEARCH REPORT IS THE PRODUCT OF SOCIETE GENERALE (AUTHORIZED IN FRANCE BY THE AMF). PLEASE SEE IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION IN APPENDIX
Daniel Fermon Phone: +33 (1) 42 13 58 81
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1
Austerity Plans - Kill or Cure?
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010e 2015e 0%
50%
100%
150%
200%
250%
300%
UK Japan
0%
50%
100%
150%
200%
250%
300%
US
Source: SG Cross Asset Research, IMF
Public finances impacted by WW2
Start of Japan’s lost decade
Public debt/GDP – 1900/2015e
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Question 1 Why is it necessary for European countries to deliver austerity plans?
“In the middle of every difficulty lies opportunity”. Albert Einstein
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European government debt is held by non residents (%)
0
10
20
30
40
50
60
70
80
90
Japan UK Spain US Germany Italy Ireland France Greece Portugal
Source: OECD, IMF, SG Cross Asset Research
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4
Fears of higher cost of debt fully justified
Senior 5-year CDS (bp) and austerity plan annoucements: a limited impact
Doubts on future of eurozone after S&P downgraded Greek debt to junk
Source: SG Cross Asset Research, Datastream
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5
Debt remain a major threat for developed economies
Question 1
Why is it necessary for European countries to deliver austerity plans?
Answer 1
Because, if governments do not rapidly address their debt problems, the cost of debt could explode, as in Greece. Thus, fears of escalating interest rates and the resulting dire consequences for their economies are seen to justify the need for austerity measures.
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Question 2 What do we really know about the different austerity measures? “Waiting is painful. Forgetting is painful. But not knowing which to do is the worst kind of suffering” Paulo Coelho.
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Recap of austerity measures
y Country Debt to
GDP Budget Balance
Austerity plan details
2011e 2011e Size €bn
Size, % of GDP
Years Spending cuts Pension reform Tax increases
Greece 129.4 7.0 35 17 3 State salary freeze until 2014 Holiday bonuses partly abolished
Pensions freeze until 2012 Retirement age extended to 65
VAT raised from 21 to 23% Oneoff tax on companies
Italy 119.2 3.9 24 2 3 State salary freeze for 3 years
€13bn of spending cuts 201112 Retirement pushed back by 3 to 6 months
New taxes on stock options and bonuses Possible expansion of toll roads
Belgium 97.9 4.0 22 15 5 Elections and regional divisions are delaying a clear deficit reduction strategy
Portugal 86.1 4.6 11 7 4 5% pay cuts for public sector
Sell €6bn of state assets (e) VAT increased from 20% to 21% and
then to 23% Crisis tax created
France 87.7 6.0 45 3 3 3year freeze on public spending
State subsidies cut by 10% Retirement age raised from 60 to 62 by 2018
Top rate income tax to 41% Taxes raised on capital gains + life insur.
Ireland 92.8 11.1 4 2 2 3 austerity budgets over a year.
Public sector salaries cut by up to 15%
VAT up from 21% to 21.5% 2008 +2% on top income tax rate
Germany 69.3 3.8 80 4 4 Welfare spending cut by €30bn
Cut in public sector payrolls Taxes on nuclear power plants
Financial transaction tax UK 73.4 7.5 110 9 5 25% cut in government spending Retirement age raised from 65 to
66 VAT up from 17.5 to 20% Total of £40bn in tax increases
Spain 68.7 6.5 15* 1 2 Civil service payrolls cut 5% in
2010 €6bn cut in public sector investment
Pensions freeze VAT up from 16% to 18%, and 8% from 7%
Overview of European austerity measures
Source: SG Cross Asset Research *Agreed €15bn cost-saving plan in May on top of an €50bn package in January. So €65bn overall
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Fears of 1937 rerun in the US at the end of economic stimulus
End of economic stimulus: consequences on equity markets
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1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
1942
Dow Jones Industrial Average
End of economic stimulus
Source: SG Cross Asset Research, Datastream
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End of Bush tax cuts for the US in 2011
European Union = 21% of global
GDPRest of the world
USA
Tax Increase
Spending cut Pension ref orm
Public lay -of f s
Dis
trib
utio
n st
ill u
nkno
wn
Greece 17%UK 9%
Portugal 7%Germany 4%
France 3%Ireland 2%
Italy 2%Spain 1%
Size of austerity measures in % of 2009 country GDP
End of Bush Tax cuts in January 2011 ?
Source: SG Cross Asset Research
Many European countries on the road to austerity
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Still plenty of fog
Question 2 What do we really know about the different austerity measures? Answer 2 At present all we know is that the austerity plans in Europe will represent more than €350bn or 3% of European GDP for the next four years.
http://blog.athos99.com/arbre-dans-le-brouillard/
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Question 3 Do past examples fully justify these austerity measures? “Keep your eyes on the stars, and your feet on the ground”. Theodore Roosevelt .
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Fiscal adjustements take an average 8 years to succeed
Country & period of consolidation Duration of the plan
General government debt Structural primary balance Real GDP growth
Inflation Rate
Interest rates
Unemployment rate
Start Peak End Swing Start End Average over the period
In years As a percentage of GDP In per cent
Short duration
Denmark (198386) 3 65 77 72 13.4 6.4 7.0 3.9 5.4 11.8 6.8
Sweden (198187) 6 47 71 62 8.6 5.7 2.9 2.2 7.6 9.0 3.7
United Kingdom (19942000) 6 49 53 45 7.7 4.4 3.3 3.5 1.8 7.0 7.3
Sweden (19942000) 6 78 84 64 11.8 7.1 4.7 3.7 1.0 6.1 10.1
Long duration
Western Germany (198089) 9 29 41 40 5.2 3.7 1.5 1.9 2.9 7.8 5.2
Ireland (198089) 9 68 114 100 11.8 7.0 4.8 3.1 9.3 10.5 14.5
Japan (197990) 11 41 77 64 7.0 4.9 2.1 4.6 2.7 6.6 2.4
Italy (198697) 11 89 130 130 10.2 3.4 6.7 2.1 5.0 10.6 10.2
Canada (198699) 13 67 102 91 11.1 5.4 5.7 2.8 2.8 11.1 9.2
Belgium (198498) 14 107 141 123 10.3 3.6 6.7 2.3 2.6 8.3 8.9
Examples of successful large fiscal adjustments
Source: European Commission AMECO database; OECD; BIS; Datastream; national data; SG Cross Asset Research
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First difference: interest rates already very low
4
5
6
7
8
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10
Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99
Canada Benchmark bond 10yr US Benchmark bond 10yr
Ann
ounc
emen
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esta
blis
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t of
aust
erity
mea
sure
s
3
5
7
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Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99Sw edish Benchmark bond 10yr Germany Benchmark bond 10yrUK Benchmark bond 10yr US Benchmark bond 10yr
Ann
ounc
emen
t &
esta
blis
hmen
t of
aus
terit
y m
easu
res
Long-term interest rates: same pattern observed in Canada and Sweden
Source: SG Cross Asset Research, Datastream
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Second difference: austerity measures much larger with 21% of global GDP
Source: SG Cross Asset Research
Current economic cycle
Government debt
increasing
Capex M&A
Emerging Markets IPOs
4 2012-2013e
Economies slow
1 2007- 2009
Crisis in developed economies
Interest rate cuts
2 2009- 2010e
Recovery in emerging markets and rise in commodity prices
3 2011-2012e
Rise in consumption and investment
Improving consumer confidence
Inflation/ Interest rate hikes
Market stress
Yuan revaluation?
Previous economic cycle
1 2001-2003
US Economic Slowdown
2 2003-…….2004
Start of recovery 3 2004-2006
Recovery and Growth
4 2006-2007
Growth stabilising
Corporatedebt
reduction
Market Stress
Capex
LBO and M&A
Interest rate drop
Low interest rates: consumer borrows
Interest rates rising
High consumer spending and rising inflation
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15
Third difference: further depreciation of western currencies takes time to materialize
Source: SG Cross Asset Research, Datastream
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All countries cannot win at the same time
Question 3 Do past examples fully justify these
austerity measures? Answer 3 No. Three major differences with
the situations observed in Canada and Sweden in the 1990s suggest that not all the austerity plans will be successful and point to a major risk on economic growth if governments implement austerity plans in an uncoordinated manner.
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Question 4 Which variable should you look at to analyze the success of these austerity plans? “In matters of style, swim with the current; in matters of principle, stand like a rock”. Thomas Jefferson .
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Unemployment rate jumped in many countries during the 2009 recession
Unemployment rate in major countries
2008 2010e Increase over the recession
Germany 7.40% 8.01% 8.24%
France 7.90% 9.50% 20.25%
Italy 6.80% 8.30% 22.06%
Portugal 7.60% 9.45% 24.34%
Greece 7.60% 9.50% 25.00%
UK 5.20% 7.80% 50.00%
USA 5.80% 9.30% 60.34%
Spain 11.30% 18.20% 61.06%
Ireland 6.10% 12.00% 96.72%
Source: SG Cross Asset Research
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Property bubble reveals the risk associated to austerity plans
1996 2001 2006 2011 2016 2021 2026
50
150
250
350
450
50
150
250
350
450
1980 1985 1990 1995 2000 2005 2010Japan lost decade UK Ireland Spain
OECD off icial data w ith 2009 and
2010 estimates
1996 2001 2006 2011 2016 2021 2026
50
150
250
350
50
150
250
350
1980 1985 1990 1995 2000 2005 2010Japan lost decade ItalyFrance Germany
OECD off icial data w ith 2009 and
2010 estimates
Nominal residential home price
Source: SG Cross Asset Research, Datastream, OECD
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Unemployment rise and saving rates major variables to analyze the success of austerity plans Austerity plans and social risk
Source: SG Cross Asset Research, Datastream
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Confidence in the future is essential
Question 4 Which variable should you look at
to analyze the success of these austerity plans?
Answer 4 Unemployment trends, saving
rates, social movements and property markets are the key variables that can be analysed to forecast the chances of success of the austerity plans. Depending on the country, the austerity plans could be devastating.
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Question 5 How to invest under an austerity plan scenario “You only have to do a very few things right in your life so long as you don’t do too many things wrong”. Warren Buffett .
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What is discounted by these plan so far
Successes (bp)
Failures (bp)
Source: SG Cross Asset Research, Datastream
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Worried about inflation? Austerity plans suggest deflation more of a risk for 2011
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72003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023
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1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949
US Government Bond Yields from 1929Prime bankers' acceptances, 90 days from 1929US Government Bond Yields from 2004US FED FUNDS MIDDLE RATE from 2004
End of f iscal stimulus
10
40
70
100
2000 2002 2004 2006 2008 2010 2012 2014 2016
10
40
70
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1930 1932 1934 1936 1938 1940 1942 1944 1946S&P Composite Real (Inflation-adjusted) Price - 1929 peak through 1945S&P Composite Real (Inflation-adjusted) Price - 2000 peak to the present
Comparing 1929-1950 period with today’s US 10YR bond yields
Comparing the S&P today and the S&P in the 30s
Source: SG Cross Asset Research, Datastream
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Key recommendations summary
Recommendations from a European austerity standpoint
Asset class Impact = +
Fixed income – overall positive Spain USA Portugal
UK France Greece
Ireland Germany Italy
Equities – overall negative
Spain UK Portugal
Ireland France Germany
Italy
Greece
USA
Currencies – overall neutral Expect emerging market currencies to continue to revaluate
Source: SG Cross Asset Research
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26
UK and Spain: risk not priced in
Question 5 How to invest under an austerity
plan scenario Answer 5 Risk-reward is positive for the
Greek, Italian and Portuguese bond markets. The execution risks inherent in austerity plans make us more cautious on bond markets in Ireland, Spain and the UK. The UK could benefit from renewed currency depreciation if its austerity measures have an overall negative impact on the economy.
All you ever wanted to know about European austerity plans…Austerity Plans - Kill or Cure?Question 1�Why is it necessary for European countries to deliver austerity plans? European government debt is held by non residents (%)Fears of higher cost of debt fully justifiedDebt remain a major threat for developed economiesQuestion 2�What do we really know about the different austerity measures?Recap of austerity measuresFears of 1937 rerun in the US at the end of economic stimulus End of Bush tax cuts for the US in 2011Still plenty of fogQuestion 3�Do past examples fully justify these austerity measures? Fiscal adjustements take an average 8 years to succeedFirst difference: interest rates already very low�Second difference: austerity measures much larger with 21% of global GDPThird difference: further depreciation of western currencies takes time to materialize �All countries cannot win at the same timeQuestion 4�Which variable should you look at to analyze the success of these austerity plans?�Unemployment rate jumped in many countries during the 2009 recession�Property bubble reveals the risk associated to austerity plans�Unemployment rise and saving rates major variables to analyze the success of austerity plans�Confidence in the future is essentialQuestion 5�How to invest under an austerity plan scenario�What is discounted by these plan so far�Worried about inflation? Austerity plans suggest deflation more of a risk for 2011�Key recommendations summary�UK and Spain: risk not priced inAPPENDIX -- DISCLAIMERSG leader in Global Cross Asset Research
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