38856398 European Austerity SocGen (1)
Transcript of 38856398 European Austerity SocGen (1)
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All you ever wanted to knowabout 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 FRANCEBY THE AMF).PLEASE SEE IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION IN APPENDIX
Daniel Fermon Phone: +33 (1) 42 13 58 81
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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
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Source: SG Cross Asset Research, IMF
Public financesimpacted by WW2
Start of Japanslost decade
Public debt/GDP 1900/2015e
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Question 1Why is it necessary for Europeancountries 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 (%)
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Japan UK Spain US Germany Italy Ireland France Greece Portugal
Source: OECD, IMF, SG Cross Asset Research
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Fears of higher cost of debt fully justi fied
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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Debt remain a major threat for developed economies
Question 1Why is it necessary for Europeancountries to deliver austerity plans?
Answer 1Because, if governments do notrapidly address their debtproblems, the cost of debt couldexplode, as in Greece. Thus, fearsof escalating interest rates and the
resulting dire consequences fortheir economies are seen to justifythe need for austerity measures.
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Recap of austerity measures
yCountry Debt toGD P BudgetBalance Austerity plan details2011e 2011e Sizeb n Size, %of GDP Years Spending cuts Pension reform Tax increasesGreece 129.4 -7.0 35 17 3 State salary freeze until 2014Holiday bonuses partly abolished
Pensions freeze until 2012Retirement age extended to 65
VAT raised from 21 to 23%One-off tax on companies
Italy 119.2 -3.9 24 2 3 State salary freeze for 3 years13bn of spending cuts 2011-12
Retirement pushed back by 3 to 6months
New taxes on stock options and bonusesPossible expansion of toll roads
Belgium 97.9 -4.0 22 15 5 Elections and regional divisions are delaying a clear deficit reduction strategyPortugal 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 3-year freeze on public spendingState 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 to15%
- 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 30bnCut in public sector payrolls
- Taxes on nuclear power plantsFinancial transaction tax
UK 73.4 -7.5 110 9 5 25% cut in government spending Retirement age raised from 65 to66
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% in20106bn cut in public sector
investment
Pensions freeze VAT up from 16% to 18%, and 8% from7%
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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Dow Jones IndustrialAverage
End of
economicstimulus
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 cutPension ref orm
Public lay-off s
Distributionstillunknown
Greece 17%UK 9%
Portugal 7%
Germany 4%
France 3%Ireland 2%
Italy 2%
Spain 1%
Size of austeritymeasures in % of
2009 country GDP
End of Bush Tax cuts inJanuary 2011 ?
Source: SG Cross Asset Research
Many European countries on the road to austerity
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Still plenty of fog
Question 2What do we really know about thedifferent austerity measures?
Answer 2At present all we know is that theausterity plans in Europe willrepresent 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 3Do past examples fully justifythese austerity measures?
Keep your eyes on the stars, and your feet on theground.Theodore Roosevelt.
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Fiscal adjustements take an average 8 years to succeed
Country & period of consolidation Duration ofthe plan General government debt Structural primary balance Real GDPgrowth InflationRate Interestrates UnemploymentrateStart Peak End Swing Start End Average over the period
In years As a percentage of GDP In per cent
Short durationDenmark (1983-86) 3 65 77 72 13.4 -6.4 7.0 3.9 5.4 11.8 6.8
Sweden (1981-87) 6 47 71 62 8.6 -5.7 2.9 2.2 7.6 9.0 3.7
United Kingdom (1994-2000) 6 49 53 45 7.7 -4.4 3.3 3.5 1.8 7.0 7.3
Sweden (1994-2000) 6 78 84 64 11.8 -7.1 4.7 3.7 1.0 6.1 10.1Long durationWestern Germany (1980-89) 9 29 41 40 5.2 -3.7 1.5 1.9 2.9 7.8 5.2
Ireland (1980-89) 9 68 114 100 11.8 -7.0 4.8 3.1 9.3 10.5 14.5
Japan (1979-90) 11 41 77 64 7.0 -4.9 2.1 4.6 2.7 6.6 2.4
Italy (1986-97) 11 89 130 130 10.2 -3.4 6.7 2.1 5.0 10.6 10.2
Canada (1986-99) 13 67 102 91 11.1 -5.4 5.7 2.8 2.8 11.1 9.2Belgium (1984-98) 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 di fference: interest rates already very low
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Canada Benchmark bond 10yr US Benchmark bond 10yr
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establishmentof
austeritymeasure
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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 10yr
UK Benchmark bond 10yr US Benchmark bond 10yr
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measures
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 globalGDP
Source: SG Cross Asset Research
Current economic cycle
Governmentdebt
increasing
CapexM&A
EmergingMarkets IPOs
4 2012-2013e
Economies slow
1 2007- 2009
Crisis in developedeconomies
Interest ratecuts
2 2009- 2010e
Recovery in emergingmarkets and rise incommodity prices
3 2011-2012e
Rise in consumptionand investment
Improvingconsumerconfidence
Inflation/Interest ratehikes
Marketstress
Yuanrevaluation?
Previous economic cycle
1 2001-2003
US EconomicSlowdown
2 2003-.2004
Start of recovery
3 2004-2006
Recovery andGrowth
4 2006-2007
Growth stabilising
Corporatedebt
reduction
MarketStress
Capex
LBO andM&A
Interestrate drop
Low interest rates:consumer borrows
Interestrates rising
Highconsumerspendingand risinginflation
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Third difference: further depreciation of western currencies takestime to materialize
Source: SG Cross Asset Research, Datastream
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All countries cannot win at the same time
Question 3Do past examples fully justify theseausterity measures?
Answer 3No. Three major differences withthe situations observed in Canadaand Sweden in the 1990s suggestthat not all the austerity plans willbe successful and point to a major
risk on economic growth ifgovernments implement austerityplans in an uncoordinated manner.
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Question 4Which variable should you look at toanalyze the success of these austerityplans?
In matters of style, swim with the current; inmatters of principle, stand like a rock.Thomas Jefferson
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Unemployment rate jumped in many countries during the 2009recession
Unemployment rate in major countries2008 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
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Source: SG Cross Asset Research, Datastream, OECD
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Unemployment rise and saving rates major variables to analyzethe 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 4Which variable should you look atto analyze the success of theseausterity plans?
Answer 4Unemployment trends, savingrates, social movements andproperty markets are the keyvariables that can be analysed to
forecast the chances of successof the austerity plans. Dependingon the country, the austerityplans could be devastating.
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Question 5How to invest under an austerityplan scenario
You only have to do a very few things right in yourlife so long as you dont 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 moreof a risk for 2011
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US Government Bond Yields from 1929
Prime bankers' acceptances, 90 days f rom 1929
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US FED FUNDS MIDDLE RATE from 2004
End of f iscalstimulus
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Comparing 1929-1950 period with todays US 10YRbond 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 standpointAsset class Impact
- = +Fixed income overall positive Spain USA Portugal
UK France Greece
Ireland Germany Italy
Equities overall negative
Spain UK Portugal
Ireland FranceGermany
Italy
Greece
USA
Currencies overall neutral Expect emerging market currencies to continue torevaluate
Source: SG Cross Asset Research
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UK and Spain: r isk not pr iced in
Question 5How to invest under an austerityplan scenario
Answer 5Risk-reward is positive for theGreek, Italian and Portuguesebond markets. The executionrisks inherent in austerity plansmake us more cautious on bondmarkets in Ireland, Spain and the
UK. The UK could benefit fromrenewed currency depreciation ifits austerity measures have anoverall negative impact on theeconomy.
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report: Daniel Fermon
This research report was written by a non-US research analyst who is not an associated person of a FINRA member, who is not registered/qualified as a research analyst under FINRA Rulesand who may not be subject to the FINRA restrictions on communications with a subject company, public appearances and trading securities held in the research analyst (s) account (s).
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