european business cycle & structural headwinds · or short position at any time, including...

European business cycle & structural headwinds

RBS European Economics

http://strategy.rbsm.com

Jacques CaillouxChief European Economist+44 (0) 20 7085 [email protected]

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Business cycle as usual: no sign of self sustainable domestic demand


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Recovery in world trade has been led by AsiaWorld Industrial ProductionLevels, Volumes, Indices, 100 = 2000 – Last observation Aug-10


World tradeLevels, Volumes, Indices, 100 = 2000 – Last observation Aug-10

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Exports growth remain the key driver of the European business cycle

World trade and Euro area GDP in volumes, y/y rate of growth


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Asia is helping but Europe is not decoupling from the US


Rising share of exports to Asia….Share of euro area exports to Asia

But still no decoupling between the US and EuropeIndustrial output in the US and the euro area, % y/y

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And domestic demand still driven by external sectorExport oriented firms drive the domestic cycle


Exports and domestic employment% y/y

Exports and Domestic capital spendingy/y

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The consumer: losers and winners Retail sales excluding cars, 100 = start of the crisis


Germany -0.9% year to date!!

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The debt overhang: When sovereign balance sheets are too small

to cope with private sector burden


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Periphery crisis is back on: Bond yields in selected countriesAs of Nov. 22nd

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Total economy debt, sectoral decomposition(sum of loans and debt securities except for financials) % of GDP

Corporate sector Households

Financials Public sector


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Income growth and funding costs: Not enough growth!!

1991-2000 2000-2007 2008-2015

Nominal Growth

Long term rates

Nominal Growth

Long term rates

Nominal Growth

Long term rates

Greece 12.4 14.5 7.5 4.7 1.8 7.9Ireland 11.2 7.1 8.9 4.4 0.5 5.9

Portugal 8.6 9 4.2 4.5 1.6 5.2Spain 7.1 8.5 7.6 4.4 1.9 4.1Italy 5.5 9.2 3.8 4.6 2.1 4.0

Finland 4.1 7.8 4.5 4.4 2.1 3.0

Netherlands 5.6 6.3 4.5 4.4 2.1 2.9

Belgium 4.2 6.8 4.1 4.5 3.1 3.5

France 3.4 6.6 4 4.4 2.7 3.1

Germany 5.1 6.3 2.4 4.3 2.5 2.7

UK 5.5 7.4 5.3 4.8 3.5 3.2United States 5.6 6.5 5.1 4.7 3.2 2.7

Source: RBS

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Nominal growth minus LT interest rates

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It’s all about financial contagion risks and policy makers now know thatDebt securities issued by the periphery in the hand of foreign institutions

Total debt securities held by non residents, Eur bn (End 2009)

Public sector Banks Non banks

ST LT Total

ST (inc. deposits

by non residents)

LT (inc.LT deposits) Total

ST (inc. loans) LT total

Grand total

Grand total, % GDP

GR 2 201 202 91 21 111 1 24 25 338 142

ES 44 226 270 393 377 770 33 421 455 1494 142

PT 17 78 95 78 106 184 18 36 54 333 205

IE* 15 59 74 486 166 652 94 509 603 1329 809

IT 63 714 777 278 316 594 137 196 333 1704 111Total 141 1278 1418 1325 985 2310 283 1186 1469 5198 165

Source: JEDS, Joint External Debt HubNote: (*) The Irish data overestimate foreign exposure to Ireland as a large part of the exposure is through the IFSC

The Eur 2 trillion exposure


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The contagion channel (ii)


Banks’ exposure to sovereigns, Eurbn

BIS data, Q1-2010 (Eurbn) DE ES FR IT EA GB JP US ROW Total

Greece 17.1 0.7 20.0 2.4 17.0 2.7 3.2 4.0 1.5 68.5

Ireland 2.5 0.1 6.4 0.7 2.8 5.4 1.3 1.4 1.3 22.0

Portugal 7.3 7.8 15.1 1.6 8.5 1.9 1.7 1.2 1.3 46.6

Spain 22.2 34.7 1.7 14.1 5.6 9.3 3.6 3.3 94.4

CEBS Germany France Belgium Netherlands Spain Austria Italy

Greece 18.7 11.6 4.7 3.2 1.0 7.8 1.8

Portugal 12.1 4.9 3.0 2.3 6.8 2.7 0.3

Ireland 12.9 2.5 0.6 0.6 0.1 1.1 0.2

Spain 36.5 6.6 3.5 2.9 203.3 2.4 1.4

Italy 77.3 48.2 25.2 10.3 11.6 14.7 144.9

Other EU 270.2 164.9 71.9 93.0 18.9 352.0 47.8Total 427.8 238.6 108.9 112.2 241.8 380.7 196.4

Source: RBS Global Banking & Markets

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Reliance of periphery banks on ECB funding Via repo operations. Euro bn

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Trends in deposits in banking sector Y/y growth rates

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Bank bonds: Redemptions

Total EUR bank bond redemptions decline modestly in 2012 from 2011


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Large amount of issuance due over coming years

Gross bond issuance

2008 2009 2010 2011 2012 2013 2014 2015

Germany 148 158 211 198 256 181 177 158

France 131 179 198 194 219 188 165 194

Italy 193 268 239 205 273 230 194 205

Spain 57 107 98 95 101 120 94 93

Nether 27 48 53 52 52 58 34 48

Belgium 31 35 38 36 36 29 21 37

Austria 10 23 23 17 15 16 25 19

Portugal 14 15 23 17 17 17 21 23

Ireland 11 34 20 23.5 23 22 26 23

Finland 5 10 12 15 12 11 10 12

Greece 33 57 18 -

Total 660 935 933 853 1004 871 768 812Source: RBS

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Redemptions & Coupons Payments of Europe’s Periphery

• Total sovereign redemptions & coupon payments of Europe’s periphery (Greece, Spain, Ireland, Portugal and Italy) up until the end of 2013 amount to €1,016bn. Italy alone has redemptions & coupons of more than €600bn.

• Portugal, Ireland, Spain and Greece have no significant redemptions & coupons until year-end (less than €10bn altogether). Italy, however, has remaining redemptions & coupons payments in 2010 of €66bn and €12bn, respectively.

Coupons & Redemptions of the Europe’s Periphery (€b n)

Rest of 2010 2011 2012 2013 Total

Greece 2 40 41 34 117

Portugal 2 14 13 12 40

Ireland 1 8 9 10 29

Spain 3 63 62 65 193

Italy 78 200 215 144 637

Total (w/o Greece & Italy) 6 85 84 87 262

Total (w/o Italy) 8 125 125 120 379

Total 86 325 341 264 1,016

Source: RBS (as of end of Aug 2010, excluding projected redemptions from upcoming new issuance)

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Stress Testing Spain: cheapest & least credible option

RBS Stress test expected loss assumptions by exposu re

As % of asset exposure 1. Likely published stress

2. Centralcase stress

3. Maximum stress case

Sovereign 3% 5% 30%

Interbank 0% 0% 5%

Public sector 3% 5% 10%

Corporate + SME 5% 10% 10%

Corporate Real Estate 15% 20% 20%

Prime mortgage 2% 3% 4%

Other mortgage 5% 6% 13%

Consumer credit 8% 10% 12%

Other loans 8% 10% 10%

Acquired land 30% 50% 50%

Weighted average EL 7% 11% 14%

Source: Company data, US Federal Reserve, RBS estimates

RBS Stress test scenarios against FY11F

(€bn) 1. Likelypublished stress

2. Central case stress

3. Maximum stress case

Low hurdles: CT1 target 4%, CLR 1% - 0.9 - 23.0 - 54.7

High hurdles: CT1 target 6%, CLR 2% - 19.9 - 51.7 - 89.1

Low hurdles: Tier 1 target 6%, CLR 2% - 1.6 - 27.9 - 61.4

Source: Company data, Bank of Spain, CECA, RBS estimates

The credibility of the stress tests has been weakened by

(i) The exclusion of sovereign exposures outside the trading book from the stress test

(ii) The use of a Tier 1 capital ratio target as opposed to core T1

(iii) Allowing banks to exhaust all cumulative provision loss reserves in the stress scenario

(iv) Crediting banks with tax loss generated from the stress test, even though these can only be applied against future years of profitability.

Outcome of the Spanish stress test Outcome needed to restore confidence


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Protect yourself against sovereign risk: Bet on SupraCorps!SupraCorps v Sov-X v Sen Fins – 10 European corporat es selected for their resilience in face of soverei gn stress.

GDF Suez; E.ON; Vodafone; KPN; BAT; Imperial Tobacco; Danone; Nestle; Tesco; Sanofi Aventis

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Credit dynamics suggest more monetary easing is warranted


Euro area credit multiplierLoans to euro area residents / Base money

Loans growth to euro area residents ex financials% 6m annualised change

RB

S7461

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A flawed European policy response� EFSF/IMF support: Eur465bn available

– 6 weeks between the time the call is made and the cash is disbursed– Total amount of financing available: Eur 465bn (EFSF 250; EFSM: 60; IMF: 155). – EFSM gets accessed first, then EFSF (EFSF 27 countries; EFSM 16 countries)– Total funding requirement for Ireland, Portugal and Spain for 2 years is Eur 280bn – EFSF rating very sensitive to French AAA

� Reform of the Treaty & Permanent facility: fundamen tally flawed– European Council has decided to revise the Lisbon Treaty (“simplified version

procedure” - Art 48) to integrate a permanent crisis resolution mechanism.– Objective: Reduce moral hazard for debtors and creditors; prevent contagion from

materialising in case of sovereign stress. So initial intention is to make the region more robust.

– Constrain: No bail out clause & German constitution– Private sector involvement likely necessary not to contradict the no bail out clause.– Discussion of private sector involvement at a time that the periphery remains very fragile

is VERY negative

� Back to the drawing board – Pressure on the periphery to be too high to allow for proposal to go forward– Meanwhile ECB will be forced to continue providing the backstop


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