EcoWeek - download.kataweb.itdownload.kataweb.it/economia/Focus/10/EcoWeek_07-16-EN.pdf · increase...

27 April 2007 07 - 16 Economic Research Department

OverviewPage 7

Germany remains the economic engine of the euro zone

Focus 1 Page 8

The financial situation of Italian companies: how far from Modigliani-Miller?In recent years Italian non financial corporations managed to curb the cost of funding and lengthen the average maturity of debt. The improvement was particularly relevant for mid-size manufacturing firms who drove economic recovery in 2006. A wider supply of finance is needed to support a full implementation of the restructuring process of the productive system.

Focus 2 3

Ukraine: The economy performs well despite challenges The political situation in Ukraine remains unstable. The President dissolved parliament on 2 April 2007, but the political standoff is unlikely to have a dramatic impact on the economy. Ukraine’s economy has picked up from the post-crisis levels of the 1990’s due to a favourable environment in its main export markets. Domestic consumption has become an increasingly important driver of GDP. One major concern is the increase in private credit in foreign currencies.

Recently released and forthcoming data and surveys

Page 21

EditorialUnited States: growth potential and mobilisation of labour

Between the spring of 1995 and the spring of 2000, employment growth averaged 2.4% per year. GDP growth then stood at 4% p.a., and productivity gains 2.6% p.a.

After the recession in the early 2000s and the subsequent phase of anaemic growth, the increase in employment rebounded to 1.8% p.a. between the spring of 2004 and the spring of 2006, with 3.5% GDP growth p.a., reflecting a dip in productivity gains, down to 1.7% p.a. The unemployment rate dropped during this period to a pace of 0.55 percentage point p.a. (cf. Chart 1, page 2). Since the phase of muted economic activity that began in the spring of 2006, the GDP growth rate has not exceeded 2.3% (annualised) under the twofold effect of the real estate correction and the short sharp contraction in factory output. Employment, nevertheless, has continued to grow at a robust pace, i.e. 1.5% p.a., while the joblessness rate has contracted by 0.2 percentage point.

Philippe d’Arvisenet

(continued page 2)

Eco

Wee

kCorporate & Investment Banking

economic-research.bnpparibas.com

EcoWeek 07- 16

2 Economic Research Department

Editorial (continued) United States: Potential growth and mobilisation of labour

These data confirm both the faltering in productivity gains that seems to be more severe than a mere cyclical effect (we will dedicate the editorial of the next issue of EcoWeek to this question), but also the decline in the pace of job creation needed to stabilise the unemployment rate (cf. Chart 2). The foregoing relates more precisely to the slowdown in the labour force linked to the distortion in the age pyramid (population ageing), which affects trends in the working-age population and the gradual change in the working-age population in age brackets characterised by lower activity rates1 as well as changes in behaviours (propensity to work in a given age bracket).

Chart 1: US: Labour force participation and unemployment rate

65,5

66,0

66,5

67,0

67,5

68,0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

3

4

5

6

7

8

Labor force

participation rate, %

Unemployment

rate, %

Source : BLS

Chart 2: US: Labour market

3

4

5

6

7

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

-2

-1

0

1

2

3

4

Unemployment rate, %

Total employment,

nonfarm payroll, y/y %

Source : BLS

1 Labour-to-working-age population ratio.

As an illustration, with an unemployment rate comparable to the one that currently prevails, i.e. 4.4%, the activity rate stood at 67.2% in late 1998. However, after picking up for two years, the activity rate now does not exceed 66.2%, the same level as in early 1993 when the unemployment rate exceeded 7%!

This point leads us to look at the pace of potential growth, the rate that stabilises the unemployment rate. We will study below the factors that, with respect to the mobilisation of labour, seem likely to dampen US potential growth.

Potential growth is an indicator of the long-run pace of wealth accumulation by companies. It determines the financial equilibria of governments and welfare regimes. Lastly, assessing it correctly is a crucial element in terms of conducting monetary policy. This is because it is a key factor drawn upon to estimate the output gap that conditions the appearance of possible inflationary pressures and, accordingly, the decisions of monetary authorities.

Several methods can be used to calculate potential growth. It can be estimated by drawing on trends in past growth, and the Hodrick-Prescott filter is most often used in this approach. This technique, however, is controversial on several grounds2.

We can also refer to Okun’s Law that links moves in the

unemployment rate ( u) with growth ( y ):

u = b – a y from which one can infer the growth rate

compatible with a stable unemployment rate.

Lastly, and this is the approach we use in this study, one can break down potential growth between mobilisation of labour, on the one hand, and productivity gains, on the other. For potential output Y can be expressed as the product of available labour (L) expressed as a number of hours (L x H) and hourly labour productivity :

Y = L x H x or as a difference: y = l + h +

2 See for instance: P. Sorenson, H.J. Whitta Jacobsen “Introducing advanced macroeconomics: growth and business cycles”, Mc Graw Hill, UK, 2005. The estimations obtained at the extreme points of the long-run trend are fragile, as results depend on arbitrary choices of parameters. Lastly, the methodology takes into account structural shocks only in a gradual manner (cf. Appendix).

EcoWeek 07- 16


Mobilisation of labour The labour force (L) depends on the working-age population (P) and the activity rate (participation rate) (a), the ratio between labour force (employment + joblessness) and the working-age population

L = P x a, or as a difference:

L = a P+ P a

Activity rates differ according to population category (i) (gender x age bracket). Thus, a larger weight of age brackets with a high (low) activity rate will result in a rise (decrease) in the overall activity rate and, therefore, in the availability of labour. A rise (decrease) in the activity rate in a given age bracket will have similar effects. Accordingly, to obtain an estimation of the labour force, one needs to take into account the demographic structure or, more specifically, the structure of the working-age population (Pi), activity rates specific to each age bracket and changes in said rates (ai).

Table 1: Changes in a few characteristic elements

Employment(‘000 / month)

Change in joblessness rate

Joblessness rate Annual change in

activity rate Working-agepopulation

Job creation that maintains the

joblessness rate constant

1985-1995 173 -0.17 5.6 0.2 1.32 140 1996-2000 241 -0.33 3.9 0.09 1.69 180 2001-2004 -8 0.39 5.5 -0.20 0.79 85 2005-2006 190 -0.9 4.8 0.10 0.9 110

Sources: Aaronson et al, BNP Paribas calculations

The demographic situation: the effect of population ageing

The proportion of the elderly population characterised by a lower activity rate than the average is increasing while the proportion of the population aged 16 to 24 is shrinking (Tables 2 and 3).

Table 2: Structure of the population by age

Aged 1965 1995 2005 2015 16-19 10.2 7.3 7.2 6.3 20-24 9.8 8.9 9.0 8.5 25-54 52.9 57.3 54.9 51.0 55-64 13.2 10.5 13.3 16.2 65 and over 13.8 16.0 15.5 18.1 Sources, US Census Bureau, BNP Paribas calculations

During the lifespan cycle, the activity rate initially increases before levelling off and finally decreasing.

Table 3: Activity rate (% - 2005)

Men Women Aged 16 to 19 45 45 25 to 29 90 70 At 55 80 71 At 70 30 20 Source: Bureau of Labor Statistics

This demographic effect has conditioned, along with changes in activity rates by age x gender, the evolution of the labour force.

According to Aaronson S. et al, the modification in the structure of the population by age bracket, on its own, accounts for 0.62 percentage point of the 2.36 percentage point rise in the overall activity rate recorded between 1980 and 1995 and the entire 0.44-percentage point decline witnessed from 1995 to 2005. In the period 2005-2010, the distortion in the age pyramid, i.e. primarily population ageing, apparently contributed 0.9-percentage point to the fall in the overall activity rate on the basis of unchanged behaviours (stabilised activity rate for each gender and age group).

Table 4: Changes in activity rates

Men Women

1985 2005 1985 2005 16-17 44.9 30.6 43.1 33.9 18-19 68.7 57.9 63.3 55.9 20-24 83.6 79.1 71.9 70.0 25-54 93.2 40.4 69.5 75.1 55-59 79.1 77.6 52.3 65.6 60-61 68.5 65.5 41.8 53.7 62-64 45.9 52.5 29.8 39.9 65-69 25.9 33.5 13.7 23.7 70 and over 11.2 13.5 4.4 7.1 Sources, BLS, Fed, BNP Paribas calculations

EcoWeek 07- 16


Changes in the activity rate

The youth activity rate has decreased For around twenty years, the youth activity rate has declined although the trend cannot be extended in all certainty (Table 5). The high sensitivity of the activity rate of the youngest members of the labour force to fluctuations in the cycle5 naturally cannot explain this trend. It is related to the lengthening of the time spent on studies stemming from budgetary measures aimed at curbing their cost, but undoubtedly also the wealth effect and the perception that studies are more profitable against a backdrop of a faltering in real wages, in particular for unskilled workers (Chart 3). The effect of the faltering in the youth activity rate on potential growth is ambiguous, as the correlative contraction in available labour could be eventually offset by the favourable impact on productivity gains and labour force attachment of the increase in human capital it leads to.

Chart 3: US : Labour force participation and earning

65,5

66,0

66,5

67,0

67,5

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

-3

-2

-1

0

1

2

3

4

Labor force

participation rate, %Average real hourly

earnings, y/y %

Source : BLS

The rise in time spent on studies, however, does not explain the entire trend6.

Table 5: Youth activity rate (%)

Age 1985 2005 16 to 17 44.9 30.6 18 to 19 68.7 57.9 20 to 24 83.6 79.1 Sources: BLS, CPS, Aaronson et al

5 The elasticity of the activity rate to the employment gap is very low for workers aged 35 to 50, less than 0.1 for men and 0.2 for women, it rises to 2.,88 for men aged 16-17and 0.78 for the 18-19 age bracket ( 2.33 and 0.68, respectively, for women), cf. S. Aaronson et al (2006). 6 In reality, the decline in the teenager activity rate is apparently 20% explained by just the lengthening of time spent studying, nearly 65% by the contraction in waged activity in the population enrolled in educational institutions and the remainder by the decline in the propensity to work of youth not enrolled in educational institutions. For the 20-24 age bracket, the proportions are 28%, 28% and 43%, respectively.

The female activity rate has levelled off: the cohort effect

The activity rate of over-25 women has recorded a long-run increase (Table 4). Several factors have played, such as the narrowing wage differential between genders, the “welfare to work” policy, social attitudes, e.g. the activity rate among women with a child less than six years old climbed from 40% in 1970 to 60% in the 1990s, but the cohort effect accounts for most of the rise. The activity rate at a given age has increased as generations succeeded one another. In this respect, there are no two similar generations (Table 6). The important point is that this effect has tended to run out of steam and, accordingly, the upward potential in the female activity rate seems to have vanished. Accordingly, the rise in the female activity rate cannot be expected to offset the effect of population ageing on labour resources.

Table 6: Female activity rate (%)

Age 1980 2000 25 to 29 62 72 25 to 39 60 72 45 to 49 60 75 55 to 59 50 60 Source: BLS

The activity rate in elderly age brackets

As is the case with youth, the activity rate of over-60s is more sensitive to the cycle than the average. Looking past fluctuations, note an upward trend (Table 4). The lengthening of life expectancy and the uncertainty weighing on future levels of pension benefits naturally suggest that this trend will persist. It should, however, accelerate sharply to offset the negative impact on the overall activity rate, with the activity rate jumping from 20% to 40% in ten years for over-62s, a development some believe is hardly likely (S. Aaronson et al, 2006).

Obviously, one also has to add the slowdown in immigration since 9/11 and the decline in the number of hours worked in the wake of the contraction in factory employment — typically full-time jobs — and the modus operandi of activity in services: late store openings, Sunday work, etc. (Chart 4).

EcoWeek 07- 16


Chart 4: US: Average hours worked and unemployment

33

34

35

36

37

38

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

3

4

5

6

7

8

9

10

11

Unemployment rate, %

Average weekly hours worked

Source : BLS

All in all, the foregoing leads us to expect a noteworthy slowdown in US potential growth in the next ten years. We show below several projections of activity rates based on various scenarios about changes in demographics and behaviours. Looking past possible divergences with respect to the possible underlying hypotheses, the trend invariably heads towards a deceleration.

Table 7: Activity rate

Fed CBO* BLS** SSA*** 2005 7.661 66.5 66.0 66.3 2015 62.5 65.0 65.6 65.2

Labour force Fed CBO* BLS** SSA***

2005 0.8 1.2 1.2 1.5 2015 0.2 0.5 0.8 0.5 Sources: * Congress Budget Office ** Bureau of Labor Statistics *** Social Security Administration

Philippe d’Arvisenet

Appendix

A time series (xt) can be broken down between a long-run element (Tt) and a cyclical element (Lt):

Nt = Tt+ Lt

Our method consists in identifying each component. Looking for a trend via a linear regression (xt = at+b) is not an appropriate approach, it leads to a growth rate (a) that is constant over time or the slope of the trend can vary. In particular, the innovations likely to influence it do not appear steadily (e.g. the productivity shock in the USA in the late 1990s). The HP filter enables us to take into account inflections in the trend.

The filter is written:

2)11

1

2

2

1()()( tttt

T

tt

T

tTTTTTxMin

The first element measures the cycle, the second measures the inflection in the trend. We need to find (Tt) that minimises changes in the trend and is as close as possible to (xt).

The weight given to these two contradictory objectives depends

on the value chosen for parameter . The smaller , the more closely changes in the trend will resemble those in the original series (xt).

Bibliography

Aaronson S, Fallik B, Figura A, Pingle J., Wascer W “The recent decline in the labor force participation rate and the implications for potential labor supply”, Brookings Papers on Economic Activity, n° 1, 2006.

Aaronson D, Kyung-Hone Park, Sullivan D. “The decline in teen labor force participation”, Economic perspectives, Federal Reserve of Chicago, 2006 Q1.

EcoWeek 07-16


Most recent articles

APRIL 20 April 07/15 Editorial Overview Focus 1 Focus 2

ECB : data driven Euro and sterling boosted by rate hike expectations Appreciation of yuan to remain moderate Pension guarantee funds : a limited assurance

13 April 07/14 Editorial Overview Focus 1 Focus 2

Is the ECB really restrictive? Monetary status quo in the US, in the Eurozone aid in Japan ECB : toward a refi rate at 4% in June… and afterwards ? India : Medium-Term outlook – Strengths and weaknesses

MARCH 30 March 07/12 Editorial Overview Focus 1 Focus 2

Global liquidity : how could the carry trade be a risk ? Eurozone growth is still going strong Germany : where is the inflationary impact of the VAT hike hiding? Japan : quarterly flow of funds for Q4 2006

23 March 07/11 Editorial

Overview Focus 1 Focus 2

US real estate market correction : employment and the subprime marketFOMC : choosing between the lesser of two evils France : 2007 Presidential elections – Stakes and plans United Kingdom : Chancellor Gordon Brown’s last budget

16 March 07/10 Editorial Overview Focus 1 Focus 2

The US housing market correction continues The slowdown in US activity becomes clearer Capital flows to emerging markets United States : household debt slows while the debt of non-financial companies accelerates in 2006

9 March 07/09 Editorial

Overview Focus 1 Focus 2

US financial accounts in 2006 : a brief rundown on foreign accounts and the private sector Towards a refi rate of 4% in June Overheating in the Baltic countries United Kingdom : despite positive contribution, cooler reception for immigrants

2 March 07-08 Editorial Overview Focus 1

Focus 2

What prospects for monetary policy in the Eurozone ? Bond market rally and stock market tremors Italy’s competitiveness : how has the sick man of Europe got better?Eurozone : an in-depth look at inflation and inflation expectation

Our publications are available on economic-research.bnpparibas.com

Caroline Newhouse-Cohen EcoWeek 07-16


OverviewGermany remains the economic engine of the euro zone

The release of the Beige Book, Wednesday evening, was eagerlyawaited. The report gathers the most recent information aboutactivity and prices. The FOMC, which will meet a fortnight later,will be able to draw on the April Beige Book to draw its diagnosison the health of the US economy. It could therefore providevaluable information about a possible change in monetary policy.In this respect, a noteworthy point is that the April issue did notdiffer significantly from the March one. It showed that activity is muted or slowing down in most districts, apart from New York,Minneapolis and Dallas where it is better. Moreover, the BeigeBook highlighted the fact that activity in the manufacturing sectoris now growing at an anaemic pace, and this trend is noticeablypronounced for companies which activity is related to the residential real estate sector. For instance, data released duringthe week confirmed that the property market, in particular the newhousing segment, has not yet pulled out of the doldrums. The rise in new home sales in March, up 2.6% m/m, did not offset their 14.4% contraction in January and their 4.2% decline in February.Furthermore, the NAHB housing market index sagged in March,down to 36, and in April, down to 33.

In Germany, the improvement in the situation of companies is gradually spreading to households. The household confidenceindex of the GfK survey, thus, surged from 4.5 to 5.5 in May. Inparticular, German consumers are highly optimistic aboutdevelopments in the labour market and this has helped theirincome expectations pick up. Indeed, the unemployment rate hassteadily dropped for two years, sinking to 9.2% — its lowest levelsince May 2001. Moreover, hiring expectations in various surveys(PMI, IFO, and European Commission) point to further vigour in the job market in industry and services. The IFO businesssentiment index rose once more in April, up by a point from Marchto 108.6, slightly under its last peak, at 108.7, in December 2006.Its rise results from a combined improvement in indices coveringthe present situation and expectations, despite the slowdown inthe US economy, the euro’s appreciation and the VAT hike in

January 2007. Under these conditions, Angela Merkel’s governmenthas revised its 2007 growth forecasts upwards from 1.7% to 2.4%,versus 2.2% according to our own estimates, and believes the samepace will be maintained in 2008. Lastly, the improvement in Germancorporate and household sentiment is all the more significant as itwidely influences the improvement in economic sentiment in the eurozone as a whole, although there is an uncoupling between results of surveys and hard data.

Standard & Poors upgraded its rating of Japan’s sovereign debt from AA - to AA. This was the first upgrade since 1975, after threesuccessive downgrades between February 2001 and April 2002. Therating agency justified its decision by the efforts made by thegovernment to cut public expenditure combined with the progressivenormalisation of monetary policy. Indeed, the 2007 Finance Act,voted in early March, projects a reduction in the fiscal deficit thatshould hardly exceed 5% of GDP. Furthermore, the primary balance(budget balance ex interest paid on the public debt) will likely comeclose to breaking even, with the deficit close to 0.2% of GDP.

This week’s chart

The IFO index not far from its historic highs

80

90

100

110

120

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Business climate

Current

Expectations

Source: IFO

Interest and foreign exchange rate

Thursday26 April

Thursday19 April

Highest in52 weeks

Lowest in 52 weeks

Libor 3-month 5.32 5.32 5.54 5.13

10-year US Gvt’Bond 4.70 4.67 5.25 4.43

Euribor 3-month 4.00 3.98 4.00 2.8410-year Bund 4.22 4.20 4.23 3.66

Libor 3-month yen 0.64 0.63 0.69 0.0910-year JGB 1.67 1.68 2.00 1.57

Sources: Financial Times, Thursday’s closing prices

Thursday26 April

Thursday19 April

Highest in52 weeks

Lowest in 52 weeks

EUR/USD 1.3605 1.3608 1.3660 1.2493

USD/JPY 119.39 118.29 121.91 109.80

EUR/JPY 162.40 160.95 162.40 140.39

EUR/GBP 0.6831 0.6795 0.6944 0.6556

USD/CHF 1.2076 1.2037 1.2756 1.1920

EUR/CHF 1.6429 1.6379 1.6434 1.5491

Sources: Financial Times, Thursday’s closing prices

Giovanni Ajassa / Paolo Ciocca Banca Nazionale del Lavoro

EcoWeek 07-16


Focus 1 The financial situation of Italian companies: How far from Modigliani-Miller?

The financial structure of companies does matter in Italy. Thanks to a prolonged season of declining interest rates, from 2001 to 2005 the Italian non financial corporations managed to curb the cost of funding and lengthen the average maturity of debt. The fall of interest charges was particularly relevant for mid-size manufacturing firms who have been the main actors of the export and fixed investment-led recovery of the economy experienced in 2006.

The gradual reversal towards a less accomodative stance of European monetary policy now posit Italian companies in a more challenging situation. Additional financial resources will be asked by firms to carry on the restructuring process of the productive system needed to enhance competitiveness. Beside the enduring support of self-financing and bank credit, the supply of funds should widen and deepen. The financial health of Italian companies will also benefit from a more efficient judicial system, higher creditor protection and lower enforcement costs.

NFCs in the Italian economy

Non financial companies (NFCs) are the backbone of the economic system. In Italy, the area encompassing firms with more than 5 employees who produce goods and non financial services account for 52% of total value added of the institutional sectors1. The weight of NFCs is even higher in France (56%) and in Germany (62%).

Unfortunately, no specific official data are available to illustrate the main structural features of Italian firms belonging to the NFCs’ perimeter. The lower threshold of 5 employees falls exactly halfway within the span of employees featuring micro-firms (1-9 employees). Inside micro-firms, sole proprietorships with 1-5 employees are included into the household sector. Bearing this caveat in mind, a broad picture about Italian NFCs may nevertheless be derived from structural data on firms operating in industry and non financial services (see table 1).

The panorama of Italian non financial businesses is featured by an overwhelming presence of micro initiatives. The number of

1 Latest figures released by ISTAT refer to year 2005. See ISTAT,

« Conti economici nazionali per settore istituzionale : anni 1999-2005 », February 2007.

Italian micro companies amounts to some 4 millions which compares with the 2.3 millions of French micro-firms and the 2.7 millions of German ones. The Italian medium-size non financial firms (from 50 o 249 employees) are some 21 thousands which is basically the same magnitude as in France (25,000 medium size firms). Increasing size brings about improving productivity. The average value added per employee of medium size Italian firms is two times the productivity of Italian micro-companies. The average propensity to export more than doubles as size increases from small to medium-large with the share of foreign sales over total turnover rising from 13.7% to 32.3%.

Table 1: Italy: main indicators of firms operating into industry and non financial services (2004)

SIZE CLASS

Number of

enterprises

Number of

persons

employed

Turnover per

enterprise

(eur thousands)

Value added per

employee (eur

thousands)

Average

number of

employees

Micro (1-9) 3,991,336 7,626,547 178 25.1 1.9

Small (10-49) 190,367 3,401,778 3,030 40.5 17.9

Medium (50-249) 20,960 2,002,145 21,558 49.6 95.5

Large (250+) 3,199 2,927,272 237,130 60.3 915.1

Total 4,205,862 15,957,742 594 37.9 3.8

Source: Istat

During the 2002-2005 period non financial companies did not escape the general slowdown of the Italian economy with nominal growth of sectoral value added falling even below the national overall average (see chart 1).

Chart 1: Nominal growth of value added in Italy: total economy and non financial companies (y/y)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2000 2001 2002 2003 2004 2005 2006

Total economyNon financial companies

Source: Istat (2000-2005) and BNL estimates (2006)


EcoWeek 07-16


The weakness of economic activity affected NFCs’ gross investments whose annual nominal growth was nil in 2003 and slightly above inflation in the two following years. A substantial recovery has taken place in 2006 as Italian exports gathered renewed momentum (+5.5% y/y) and the real growth of fixed investment for the entire economy turned back to be significantly positive (+2.4%). On this basis, we estimate that the nominal growth rate of the value added produced by Italian NFCs might have increased to 3.5% in 2006. Sectoral gross investment should have risen by some €10 billion after quasi-stagnation in 2004-2005 (see chart 2). Self financing is expected to have marked a substantial increase as well. All in all the recovery of NFCs fixed capital formation was lead by the continuous driving force of the international economic cycle and by some fundamental improvement of the financial situation of firms.

Improving accounts

Beside national accounts released by Istat (the Italian Statistics Office), additional insights into the evolution of the financial situation of Italian NFCs may be derived working on more restricted samples. A benchmark survey is annually run by Mediobanca and covers 2010 companies, typically representative of the Italian manufacturing and service industries2.

Out of the 45,000 Italian manufacturing enterprises with over 20 staff recorded by Istat in 2001, the Mediobanca survey represents 31% of workforce, 44% of sales, 43% of total value added, 55% of total foreign sales. In the services sector, the Mediobanca sample covers 86% of turnover for utilities, 31% for transport and 19% for distribution to retail. All companies with over 500 staff are included. The sample of companies is "closed" over the period so as to ensure like-for-like comparisons. The companies themselves provide assistance in collating the data and ensuring that it is accurately processed.

Looking at NFCs’ profit and loss account recorded by the Mediobanca survey, the effect of economic slowdown is clearly mirrored by the U-shaped development of net sales’ growth rate whose minimum point was touched in 2002 (-0.8%; see table 2). After the sharp difficulties suffered in 2002-2003, the overall recovery of firms’ profitability was marked by the ratio between net profit and total sales coming back in the neighbourhood of 5-6% in 2004-2005. The return on equity increased to 6.1% in 2004 and to 8.2% in 2005.

2 See Mediobanca, « Dati cumulativi di 2010 società italiane », August

2006.

Chart 2: Gross investment and self-financing of Italian NFCs (€bn; current prices)

80.0

100.0

120.0

140.0

160.0

180.0

200.0

2000 2001 2002 2003 2004 2005 2006

Gross investmentSelf-financing

Sources: Istat (2000-2005) and BNL estimates (2006)

Table 2: Italian NFCs’ profit and loss account (main items)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Net sales

euro bln 314 336 342 358 420 433 430 443 477 513

% annual change 7.0 1.8 4.7 17.4 3.1 -0.8 3.1 7.6 7.4

exports (as a % of total sales) 25.8 26.5 26.9 26.3 26.1 26.2 26.3 25.3 25.5 25.7

Value added/Total sales 31.3 30.4 31.1 29.9 27.4 27.2 26.7 27.0 26.7 24.8

Gross operating margin/Total sales 13.2 13.3 14.6 13.9 13.5 13.6 13.0 13.6 14.0 12.8

Financial costs/Total sales 4.0 3.2 2.5 2.2 2.5 2.7 2.8 2.7 2.4 2.4

Net profit/Total sales 1.3 1.2 3.2 5.5 4.3 2.4 0.0 2.5 5.9 4.6

R.O.E. 2.6 2.5 6.3 12.4 9.0 4.4 0.0 4.2 6.1 8.2

Source: Mediobanca

Thus regaining a “fair” measure with the yield of risk-free 10 years Italian government bond standing at 3.5% in 2005. Beside economic recovery, the improvement of firms’ accounts was helped by favourable financial developments. Thanks to effects of the accomodative stance of ECB monetary policy on credit conditions, interest charges paid by Italian NFCs were considerably diminishing through the 2001-2004 period. According to the Mediobanca survey, for the overall sample of companies the average cost of funding decreased from 6.6% in 2001 to 5.1% in 2004 (see chart 3, following page). The reduction was even higher within the segment of medium-size companies where the interest charge went down from 6.5% to 4.7%.


EcoWeek 07-16


Starting from 2005 the gradual reversal of the monetary policy stance has exerted an effect, although limited, on companies’ cost of funding. According to figures released by the Bank of Italy, between November 2005, when the lowest level was recorded, and February 2007 the average rate on short term corporate loans in Italy rose by 1%, against a 1.5% rise in official rates. Based on our estimates, during 2006 the cost of funding for the 2010 companies should have increased in the neighbourhood of 6% (around 5.3% in the case of medium size firms).

The indebtedness: longer maturity

The slowdown of industrial production in the first two months of 2007 confirms that economic recovery has not yet consolidated in Italy. The incoming period will be crucial to establish whether the upturn of 2006 is going to be sustained or it will end up to be simply a false start. A key-point will be represented by fixed capital formation. The virtuous transformation of Italian manufacturing needs to deepen and to spread to nearby sectors, especially into the services’ area. New investments are necessary for enhancing productivity and competitiveness. Investments have to be financed through self-financing, debt or equity. The structure of Italian non-financial companies’ indebtedness may prove helpful.

Looking at the situation of corporate debts in Italy, the main issue which comes from an analysis through the last decade is a substantial lengthening of the debt maturity of Italian firms. In 1997 banking medium and long term debt accounted for only 20% of NFCs' non-equity total financial liabilities while short term bank loans made up for some 30% of the same total. In 2006 (figures of institutional sectors’ financial accounts are updated till the 3rd

quarter: see table 3) the situation appears to have been reverted: the weight of medium and long term banking debts has risen close to 29% while short term loans accounted for no more than 22% of the net of equity total financial liabilities.

Restricting the view only to bank liabilities, at the end of 2006 the weight of medium and long term banking debt on overall bank indebtedness of Italian NFCs has grown to 60% which compares to a Euro-zone average standing around 70%. Summing short and medium-long term components together, the overall banking indebtedness of Italian NFCs has increased substantially through the last five years. When normalised to GDP, the share of bank debts by non financial companies has increased from 41.2% in 2001 to 49.3% in 2006 in Italy. A slower growth has been experienced in the Euro- zone (from 41.5 to 45%: see chart 4).

Chart 3: Interest charges paid by Italian NFCs (%)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2001 2002 2003 2004 2005 2006

All companiesMedium-size companies

Sources: Mediobanca (2001-2005) and BNL estimates (2006)

Table 3: Financial assets and liabilities of Italian NFCs (€ billions)

1997 1998 1999 2000 2001 2002 2003 2004 2005 Q3 2006

Total assets 664 771 977 1,157 1,088 1,016 1,091 1,259 1,397 1,436of which:

cash, deposits and securities 141 147 156 171 167 175 182 211 248 261

shares and other equity 248 325 498 661 580 468 518 616 697 713

trade credit recivable 235 248 269 263 275 316 330 349 337 327

Total liabilities 1,408 1,580 1,961 2,173 2,162 2,169 2,243 2,487 2,646 2,675

of which:

bank short-term debt 238 239 244 275 292 288 287 281 284 296 bank medium and long-term debt 161 173 189 206 223 253 296 329 356 391

securities 20 24 20 21 33 42 45 59 61 68

trade debt payable 219 231 249 238 248 291 305 322 311 302

shares and other equity 603 739 1,053 1,200 1,115 1,039 1,043 1,216 1,319 1,306

BALANCE -744 -809 -983 -1,016 -1,074 -1,153 -1,151 -1,228 -1,249 -1,239

Sources: Bank of Italy, BNL calculations

Chart 4: Share of medium-long term loans on total bank debt of NFCs (%)

40

45

50

2001 2002 2003 2004 2005 2006

ItalyEuro-area

Sources: Bank of Italy, Istat, ECB and Eurostat, BNL calculations

A rather negligible role into the financing of Italian companies continues to be played by securities whose outstanding stock in September 2006 amounted to €68 billion (just 5% of NFCs’ non-equity financial liabilities). Through the whole year, net bond issues


EcoWeek 07-16


by Italian firms equalled €4.4 billion which compares to some €83 billion of net bond issues by Italian banks and other financial corporations.

The availability of abundant banking credit at a reasonable cost and with an increasing average maturity represents a favourable environment for firms’ investment activity in new fixed capital. Short term debt usually matures before investment cash flow and makes the company exposed to refinancing debt at more expensive rates: this is going to be the case for European firms in the near term scenario of less accomodative monetary policy within the Euro-zone. With a financial structure increasingly tilted towards medium and long term debt, Italian companies appear now to be in a better position to cover the borrowing requirements of new investment projects. However, some structural problems remain to be solved as the lengthening of debt maturity is signalling not only the push of demand factors but also some supply-side constraints.

As some structural analyses3 have convincingly illustrated, in Italy the process of lengthening bank debt maturity tends to concentrate on companies with higher size, older age and wider tangible assets. This situation may be interpreted as an evidence of non-negligible asymmetric information problems on the funds’ supply side at least for new and smaller businesses. The tendency to rely on proxies of the borrower’s quality such as size, age and tangible assets may also signal a situation of inadequate judicial efficiency. High enforcement costs of loan contracts and low loan’s recovery rates in case of default may cause lenders to focus the financing supply on “safer” (as larger, older and wealthier) incumbents. This kind of asymmetric information problems may also be helpful in explaining the relevance that in Italy is played by trade debt (amounting to some €300 billion at September 2006 and equal to the 22% of net of equity NFCs’ total financial liabilities). Actually, trade credit represents in-kind finance through which suppliers lend inputs instead of cash. Therefore, trade creditors tend to have an advantage over other short term lenders in enforcing credit contracts as they are less dependent on judicial creditor protection. This happens to be the case in Italy4.

3 See S. Magri, «Debt maturity of Italian firms», Working Papers,

Banca d’Italia, no. 574, January 2006. 4 See A. Carmignani, « Funzionamento della giustizia civile e struttura

finanziaria delle imprese : il ruolo del credito commerciale », Working Papers, Banca d’Italia, no. 497, June 2004.

Chart 5: The leverage ratio of Italian NFCs (%; € billions for shareholders’ equity and total financial debt)

0

50

100

150

200

250

300

350

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

34

35

36

37

38

39

40

41

42

43

44

45

Shareholders' equity Total financial debt (l. sc.) Leverage (r. sc.)

Sources: Mediobanca, BNL calculations

A further evidence of the relevance of supply factors in moulding the financial structure of Italian NFCs is given by the fact that the substantial lengthening of companies’ average debt maturity has been accompanied by a rather stable (sometimes, declining) profile of firms’ average leverage. Calculations based on Mediobanca data available till 2005 show that the leverage ratio of Italian NFCs has remained within the 40-43% range in the past five years (see chart 5). By leverage ratio it is meant the ratio between total financial debt and the sum of total financial debt plus shareholders’ equity. In line with some theoretical hypotheses about credit markets with asymmetric information5, non-increasing leverage of firms implies lower risks for the lenders who may become more willing to tilt financing supply on the medium-long term. Again, this could be the case in Italy.

Market imperfections combine with dimensional and geographical differences. Since December 2006 to February 2007 the growth rate of total performing bank loans to Italian non financial companies has nearly doubled by going from +6.3% to 12.1%. However, out of some €70 billion of additional credit, a good 55 went to larger companies with 20 or more employees based in the North-Centre area of the country6. Again, the development of banking indebtedness of Italian companies mirrors the demand drivers of the economic upturn which is basically lead by the fixed investments of larger and innovating industrial companies. However, the concentration of the financing supply underlines the ample room for widening the spectrum of financing tools as well as the array of actors that could be involved in the process of sustaining a more durable economic recovery.

5 See S. Magri, ibidem.

6 Calculations are based on new statistical evidence released by the Bank

of Italy. See Banca d’Italia, « Bollettino economico », no. 48, March 2007.


EcoWeek 07-16


Conclusion: filling the gaps

Although being the homeland of one of the two co-authors of the celebrated irrelevance proposition of financial structures on economic values, in Italy financial structure does matter. During the last years the native country of Franco Modigliani has taken substantial advantage from an environment where the cost of funding new investments has become more favourable for non financial companies. Thanks to a prolonged season of low interests rates and relaxed credit conditions, Italian NFCs managed to restructure their financial indebtedness by lengthening the banking debt maturity and reducing the real burden of debt servicing. Self-financing means increased. The leverage ratio stabilized after the sharp increase of late Nineties. All in all, the improved financial situation helped Italian firms to afford new fixed capital formation. In 2006 fixed investments grew by 2.4% y/y and contributed by 0.5 to the overall annual growth of the GDP (+1.9%).

Looking ahead, important challenges deploy on both sides of demand and supply of NFCs’ financing. On the demand side, the process of restructuring of the Italian productive system needed to overcome competitive difficulties has just begun and will ask for more fixed investments by firms and related financing resources in the future. This means that, on the supply side, the response should also come through the widening and deepening of the overall provision of financing means. Italian banks are implementing the transition to the so-called “Basle II” credit culture with more and more emphasis on firms’ individual rating and project evaluation: this would mean reducing the degree of asymmetric information and moral hazard problems on credit markets.

Beside banks, major steps will have to be taken by other segments of Italian finance industry. The capacity by the Italian stock exchange of channelling financing resources should increase substantially. In 2006 equity capital raised through issues of shares (counting both IPOs and capital increases by already listed companies) totalled only €10.4 billion. IPOs were 21 compared with 15 the previous year. In December 2006 the number of listed companies (311) at Milan stock exchange amounted just to 1.3% of the overall 24,000 Italian firms with 50 or more employees. Although in 2006 has risen from 48% to 53%, the ratio between the stock market capitalization and the GDP remains substantially lower in Italy than in the EU-25 average (90.4%: see chart 6). There is ample room for increasing the share of innovative and competitive mid-size firms who decide to go public. Equally, there is a wide space to raise investments by private equity and venture capital companies operating in Italy which in 2006 amounted only to some €3.7 billion with still very little funds devoted into the financing of start-ups.

Chart 6: The ratio between stock market capitalization and GDP (%)

0

20

40

60

80

100

120

2000 2001 2002 2003 2004 2005 2006

Italy EU 25

Sources: Borsa Italiana, Istat, Eurostat, BNL calculations

Last but not least, the agenda for reducing the distance toward a wider and increasingly efficient financing of Italian NFCs cannot miss mentioning a substantial lowering of costs connected with the judicial enforcement of contracts. Although slightly diminishing, bankruptcy costs are still comparatively higher in Italy than elsewhere in the European Union7. Steps have been taken to improve the relevant legislation but practical effects lag to show up.

The Modigliani-Miller world of perfect credit markets, no bankruptcy costs, and neutral finance8 is an enlightening utopia which obliges listing what real world lacks and trying to fill the gaps. The challenge for Italian non financial companies, and for the entire economic system, is to deal with a list that is a bit longer than for others.

7 According to the Confederation of Italian industry (Confindustria), in Italy

the average duration of bankruptcy proceedings amounted to 8 years in 2005. The recovery rate of credits from companies gone bankrupt was 14% with legal costs taking 5% of initial credits. 8 See M. Pagano, « The Modigliani-Miller theorems : a cornerstone of

finance », BNL Quarterly Review, vol. LVIII, nos 233-234, June-September 2005, pp.237-47.

Serhiy Yahnych EcoWeek 07-16


IMPORTANT DISCLOSURE This analysis has been produced by JSCIB UkrSibbank and has been reviewed, but not amended, by BNP Paribas. BNP Paribas owns a 51% controlling stake in JSCIB UkrSibbank. This analysis does not contain investment research recommendations.

Focus 2 Ukraine: The economy performs well despite challenges

The political situation in Ukraine remains unstable. The President dissolved parliament on 2 April 2007, but the political standoff is unlikely to have a dramatic impact on the economy.

Ukraine’s economy has picked up from the post-crisis levels of the 1990’s due to a favourable environment in its main export markets. Domestic consumption has become an increasingly important driver of GDP.

One major concern is the increase in private credit in foreign currencies.

Not another Orange Revolution

On 2 April 2007, the President issued a decree dissolving the Verkhovna Rada (Ukrainian Parliament). The main reason given was floor crossing by deputies which, according to the President, distorted voting results. The parliamentary majority appealed to the constitutional court, which started hearings on 17 April. It is hard to predict the time the Court will need to hear the case and reach a verdict. So far, little progress has been made: the coalition continues to reject the presidential decree and wants it to be retracted, while the President claims the decree is irreversible and is preparing for early elections.

Current tensions will probably be resolved through a political compromise and early elections since none of the parties benefit from drawing out uncertainty (especially loyal business groups). The political standoff is unlikely to have a big impact on the economy. It could trigger a slight decline in industrial production and GDP (limited to a few percentage points) as well as a slight upturn in consumer price inflation.

Although the political environment has been turbulent since 2004, it has not had a significant impact on economic performance. It has delayed some much-needed structural reforms, but in general, it has not prevented Ukrainian enterprises from doing business successfully.

Reversing a long nosedive

Ukraine was the second largest economy in the USSR, an important industrial and agricultural component of the centralized Soviet economy. After gaining independence in 1991, the country started on the road to market reforms and privatisation. In 1999, output fell to less than 40% of the 1991 level as economic and industrial links between companies disintegrated with the collapse of the USSR. The economic downturn in Ukraine was harsher than in many other transition economies, partly because the country has so few natural resources, and timid structural reforms failed to encourage entrepreneurship.

Chart 1: Real GDP growth – regional comparison

20

40

60

80

100

120

140

160

180

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07f 08f

20

40

60

80

100

120

140

160

180volume, index 1990=100

Russia

Kazakhstan

Ukraine

CEEC

Sources: IMF, BNP Paribas –Economic Research

Chart 2: GDP and Industrial Production, UAH billions

0

100

200

300

400

500

600

700

800

00 01 02 03 04 05 06 07F 08F 09F

GDP Industrial Production

Sources: SSC Forecast, UkrSibbank




Since 2000, the economy has grown strongly, with average annual growth of about 7.4%, driven mainly by a strong rise in industrial production. Ukrainian steel and chemical exports have flourished due to the upturn in the world economy and a favourable commodity market environment. After a slump in 2005, with GDP growth of only 2.6%, the Ukrainian economy rebounded in 2006 with growth of 7.1%. The upsurge in economic activity last year shows that Ukraine’s problems in 2005 were not caused by overheating, but by the accumulation of structural imbalances and the dependence of industrial production on the world market environment.

For the first time since 1998, GDP grew faster than industrial production in 2006, demonstrating the strength of other components of GDP. Growth seems to be less dependent on industrial performance now that the consumer services sector (food industry, trade, financials and other services) is gradually becoming the new growth engine, buoyed by domestic consumption. Fuelled by retail sales, consumption rose over 25% in 2006. Although we expect domestic consumption to slow to 18-21% yoy in 20071, it should remain one of the main support factors for GDP growth in 2007-08, alongside massive investment in modernization. We estimate real GDP growth at 5.5% in 2007, although it could be even higher given the potential for better performances in the industrial, retail and construction sectors. Thereafter, economic growth rates are likely to slow to 4-5% per year.

Ukraine imports most of its energy supplies from Russia (natural gas and oil). Consequently, industry is potentially vulnerable to energy price shocks since natural gas is a vital energy source for key segments of the economy2. In January 2006, imported natural gas prices rose to $95 per 1,000 m3 from $55, raising concerns about the sustainability of Ukrainian industry. Thanks to comfortable margins, however, industry managed to absorb these price shocks. In January 2007, natural gas prices surged to $130 per 1,000 m3. Although recent evidence suggests that Ukrainian industry can absorb energy price shocks fairly well, it is unclear whether things will still go so smoothly once imported gas prices reach Central European levels3. Ukrainian industry is still extremely wasteful and several times less efficient than their western

1 Due to higher utility rates and income taxes and since the potential for further increases in household income have been exhausted in both the corporate and public sector. Household revenue growth has far exceeded GDP growth for several years in a row, and we believe there is little room for further wage increases. 2 Natural gas as a share of the total cost of final production rose as high as 70% in some industrial segments in 2005 3 Imported energy prices will be back on agenda by year-end 2007 as Ukraine renegotiates natural gas prices again. According to the agreement reached in 2006, the transportation fee for Russian gas is fixed while gas prices for Ukraine are set at the beginning of each year. Ukraine is unlikely to be able to maintain its preferential prices (see Table 2). Currently, the price per thousand m3 is $130, but according to our baseline scenario it will increase to $160 next year and to $210-230 in 2009.

European counterparts. Although the majority of industrial companies have either started or announced plans to modernize and invest in energy-saving technologies, it will take some time for energy efficiency to improve.

Milder consumer inflation

For most of 2006, consumer prices stayed almost unchanged, with CPI growth of only 3.8% in the first 8 months, mainly due to high import volumes, which helped sustain inflationary pressures.

Chart 3: CPI vs PPI

-5

0

5

10

15

20

25

30

35

00 00 01 01 02 02 03 03 04 04 05 05 06 06 07

CPI, y/y % PPI, y/y %

Source: SSC

In the fall, however, higher energy prices carried through to the rest of the economy, pushing consumer inflation back into double digits (11.6% in 2006). In 2007, inflation has been moderate so far (1.3% YTD in Q1 2007), mainly because some municipalities are contesting the increase in utility prices. Consumer inflation will probably continue to slow in H1 2007, although the downward potential is limited by another hike in imported gas prices, which will keep producer price inflation high (17.6% yoy in March). We believe consumer inflation could reach 9.5% in 2007, and could rise even higher in the case of early elections, which are usually accompanied by big spending by the political parties.




Table 1: Key indicators of the Ukrainian economy

National accounts 00 01 02 03 04 05 06 07F

Nominal GDP, UAH bn. 170.0 204.0 226.0 267.0 345.0 419.0 535.9 595.0

Nominal GDP, $ bn. 31.0 38.0 42.0 50.0 65.0 82.0 106.1 116.7

Real GDP, % chg. 5.9 9.2 5.2 9.6 12.1 2.6 7.1 5.5

Real industrial production volume % chg. 13.2 14.2 7.0 15.8 12.5 3.1 6.2 5.3

Population incomes (monetary), UAH bn. 86.9 109.4 185.1 215.7 274.2 370.6 475.2 550.0

Consolidated budget

Budget surplus (deficit), % GDP 0.6 -0.3 0.7 -0.2 -3.2 -1.9 -0.7 -2.8

Inflation

CPI as at YE, % chug 25.8 6.1 -0.6 8.2 12.3 10.3 11.6 9.5

PPI as at YE, % chug 20.8 12.3 0.8 5.2 9.0 13.6 14.1 13.0

Money supply and interest rates

Money supply ( 3) as at YE, % chg. 45.4 42.0 41.7 47.3 32.4 54.3 34.7 35.0

Average loan interest rate of commercial banks, % 41.5 32.3 25.4 17.9 17.4 16.3 15.1 15.0

Balance of payments USD Bn

Export of goods 15.7 17.1 18.7 23.7 33.4 34.3 38.8 42.7

Import of goods 14.9 16.9 18.0 23.2 29.7 36.1 43.7 49.7

Trade balance 0.8 0.2 0.7 0.5 3.7 -1.9 -4.9 -7.0

Current account 1.5 1.4 3.2 2.9 6.8 1.8 -1.6 -3.5

Current account, %GDP 4.8 3.7 7.5 5.8 10.5 2.2 -1.5 -3.0

Direct foreign investments 0.6 0.8 0.7 1.4 1.7 6.5 5.3 5.0

Gold and currency reserves 1.5 3.1 4.4 6.9 9.5 19.4 22.3 23.1

Coverage of merchandise imports by reserves (month) 1.2 2.2 3.0 3.6 3.8 6.4 6.1 5.6

External debt

External government debt as at the period end, $ bn. 10.4 10.2 10.2 10.8 12.9 13.6 13.5 18.0

External debt, %GDP 61.1 53.6 51.1 47.5 47.3 46.1 44.7 51.5

Exchange rates

Exchange rate UAH/USD, end of period 5.4 5.3 5.3 5.3 5.3 5.1 5.1 5.1

Exchange rate UAH /EUR, end of period 5.1 4.7 5.5 6.5 7.1 6.0 6.4 6.8

Sources: SSC, NBU. Forecasts: UkrSibbank

Table 2: Gas prices for selected European countriesCountry 2006 2007

Germany 290 320 Romania 285 320 Moldova 160 170 Poland 230 240 Georgia 110 235 Belarus 47 100 Ukraine 95 130 Source: Kommersant




Foreign trade: further deterioration expected

Since 2005, Ukraine’s trade deficit has been widening, to $6.7 bn in 2006.4 The biggest deterioration in the trade balance was with Europe and Asia, mainly due to higher import volumes from these regions and the deterioration of Ukraine’s market share in Asian steel markets. Export growth, mainly with the Russian Federation, helped offset the increase in imported energy prices from CIS countries. Note, however, that the increase in the merchandise trade deficit should not be interpreted as a decline in the external competitiveness of Ukrainian enterprises; import volumes have exceeded exports mainly due to the boom in household consumption. According to our estimates, the trade deficit is likely to swell above $8bn in 2007 due to higher gas prices and vigorous domestic demand.

Ukraine’s export performance mainly depends on prices in world steel markets (non-precious metals represent about 43% of total exports). In the medium term, world metal prices are likely to edge down gradually due to the slowdown in the world economy, despite the shortage of steel production facilities. High export concentration could become a problem in the long term, especially since Ukraine’s main exports are highly cyclical.5 From a short-term perspective, however, there is no need to worry based on the recovery in the EU, ongoing expansion in Asia and solid GDP growth in Russia, which is still the single biggest market for Ukrainian goods.

In 2006, Ukraine reported its first current account deficit since the economic recovery began in the early 2000s, although at 1.6% of GDP, it is lower than for most of the central and eastern European countries (CEE).

The deficit was fully covered by external capital inflows (FDI and debt issuance), which has allowed the central bank to build up its foreign reserves. This year, we expect the current account deficit to increase to $3bn-4bn in the full year (around 3.0% of GDP), mainly due to higher energy prices.

For the moment, it is unclear whether this deficit will be fully covered by inflows of foreign capital: although we do not expect investors to close Ukrainian positions, political tensions could temporarily halt external financing. If political uncertainty persists, the central bank’s foreign reserves could decline to $20bn-21bn in

4 Based on SSC methodology. SSC and NBU use different calculation methodologies for foreign trade ratios.

5Demand for Ukrainian goods is strongly correlated to the increase of world industrial

production.

2007, which is still enough to support the current UAH exchange rate.6

Chart 4: Merchandise trade, $m.

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

50000

00 01 02 03 04 05 06

-8000

-6000

-4000

-2000

0

2000

4000

6000Export

Import

Surplus/Deficit (rhs)

Source : SSC

Table 3: Main Ukrainian Exports

Share, %

Non-precious metals 42.6

Mineral items 10.9

Chemical products 9.1

Machinery 8.2

Products of vegetable origin 5.4

Transport vehicles 5.0

Source: UkrSibbank

Chart 5: Current Account and FX reserves, %

0

5 000

10 000

15 000

20 000

25 000

2004 2005 2006

-2 000

-1 500

-1 000

-500

0

500

1 000

1 500

2 000

2 500

3 000FX Reserves

Current Account (rhs)

Source : NBU

6 The central bank’s foreign reserves are 2 to 3 times higher than the security holdings of non-residents (UkrSibbank estimates).




Since 2005, the NBU has maintained a de-facto dollar peg, allowing the interbank UAH/USD exchange rate to fluctuate within a narrow band of 5.00 to 5.06. Given the real appreciation of the hryvnya and the rising current account deficit, there are calls for a gradual shift towards greater exchange rate flexibility. Earlier this year, the regulator expressed its intent to relax the band gradually, although this is unlikely to occur before Q4 2007.

Chart 6: USD/UAH exchange rate

60

70

80

90

100

110

120

130

140

150

160

98 99 00 01 02 03 04 05 06 07

2,5

3,0

3,5

4,0

4,5

5,0

5,5

6,0CPI-based index, 2000=100

Real Effective

Nominal USD/UAH (rhs)

Appreciation

Source : IMF, NBU

Ukraine and WTO

Based on our (optimistic) assumptions, Ukraine could join WTO in Q3 2007. Current political tensions are unlikely to stop the WTO accession process, although they cold trigger some delays. To join WTO, Ukraine must complete negotiations with Kyrgyzstan (or convince WTO representatives that Kyrgyzstan’s claims are unfounded). To complete WTO membership, Ukraine must show the working group that all required laws have been adopted and approved without technical remarks. We do not believe joining WTO will have a big impact on Ukraine’s macroeconomic indicators in 2007, although it could trigger significant inflows of foreign investment.

Private credit growth – can it continue?

Like other CEE countries, lending to the private sector in Ukraine has grown very rapidly in recent years. This can be attributed to a variety of factors, including macroeconomic stabilization after the collapse in the 1990’s; comprehensive legal reforms; financial sector privatisation and, last but not least, excessive global liquidity. Over the past five years, private lending in volume has increased almost nine fold, rebounding from the depressed levels of a post-crisis economy. In December 2006, private lending in volume reached UAH245.2bn (USD48.6bn), equalling 46.5% of GDP.

Banks are the mainstay of the Ukrainian financial system: capital markets (fixed income and equities) account for only a small fraction of GDP. This means bank lending is the main source of external financing in Ukraine.

Chart 7: Private Credit

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2001 2002 2003 2004 2005 2006

0

50

100

150

200

250

300

Credit to GDP

Private Credit, bn UAH

Source : Ministry of Finance

The notable exception is the big industrial companies, which make extensive use of international capital markets for financing. Another increasingly important source of external financing is FDI, inflows of which totalled 5% of GDP in 2006.7

Is private credit growing too quickly in Ukraine? Although no one can say for sure, the question can be approached either through theoretical insights or direct comparisons with other countries.

A growing number of studies on credit growth in the developing countries of Europe have tried to identify an equilibrium (fundamental) value of credit. Although results tend to point to a big shortfall (lower than equilibrium level), the scope and reliability of the research seems to be limited by data quality and the high degree of uncertainty of the tools used. Despite the similarities in credit expansion in Ukraine and in the other CEE countries, Ukraine’s future is shrouded in uncertainty, making it difficult to draw conclusions from direct comparisons. High dependency on steel exports, uncertainty over EU membership and the rising cost of energy imports could amplify the macroeconomic risks connected to extensive credit growth.

The de-facto dollar peg and high inflation provide big incentives for unhedged borrowings in foreign currencies. A major concern is the rapid growth of unhedged loans in foreign currencies, which are cheaper than UAH loans. If the UAH were to suddenly devaluate, many borrowers would be unable to repay their loans. We believe

7 According to NBU preliminary estimates




the NBU will formulate a policy to respond to the credit growth problem this year8.

In November 2006, the regulator issued a draft decree on capital exports and imports prohibiting currency lending to individuals and legal entities (with a few exceptions). We think there is very little chance that such radical currency lending restrictions will be adopted given the substantial risks for the economy: domestic UAH-denominated rates would skyrocket. The regulator is more likely to attempt market interventions first, such as raising mandatory reserves on foreign currency loans.

Concluding remarks

In our view, the widespread concerns about the Ukrainian economy can be boiled down to three issues: rising natural gas prices in a country highly dependent on steel exports; political tensions; and the rapid growth of private credit (especially in foreign currencies).

Although higher energy prices and political uncertainty have been issues for some time and are unlikely to have a significant impact on the economy (at least not in 2007), the (arguably) excessive growth of private credit is a relatively new problem. Private credit is growing at a similar pace throughout the CEE countries and it is difficult to say whether growth is excessive with respect to macroeconomic development. Due to a rigid FX rate and interest rate differentials, credit growth is stronger in foreign currencies than in the local currency. The central bank seems to be striving for an adequate response to this problem.

8 The regulator will most likely try to address macroeconomic risks through market intervention first and, if this fails, then to turn to administrative measures.In April, NBU adopted a new regulation concerning forex retail lending which increases the reserve requirement for foreign currency loans, thus making FX lending less attractive. According to the document, banks have time until Oct.1 2007 to comply with the new reserve regulations.

Chart 8: Private Credit in CEE Countries

0%

10%

20%

30%

40%

50%

60%

70%

Cro

atia

Slo

veni

a

Ukr

aine

Bul

garia

Hun

gary

Cze

ch R

ep

Slo

vaki

a

Pol

and

Rom

ania

0

10

20

30

40

50

60

70

80

% GDP

Eur bn.

Sources : NBU, BNP Paribas –Economic Research

Chart 9: Foreign vs domestic currency credit growth

0%

20%

40%

60%

80%

100%

120%

2002 2003 2004 2005 2006 2007

Credit growth, local currency

Credit growth, foreign currency

Source : NBU

Caroline Newhouse-Cohen Ecoweek 07-16


Recently released and forthcoming data and surveys

United States

To watch next week

The April ISM survey in the manufacturing sector will be available on Tuesday 1 May. After it dropped to 50.9 in March, we expect the composite index to decline further and slip under the 50 mark that separates expansion and contraction in activity in the sector. The slowdown in activity is persisting, due to the contraction in demand.

The April ISM survey in the non-manufacturing sector will be released on Wednesday 2 May. The activity index had sharply deteriorated in March, sinking to its lowest level since April 2003, while remaining well above the 50-mark. In May, it should remain virtually unchanged.

The April Employment Report will be published on Friday 4 May. The non-farm payroll grew by 180,000 in March, partly because of the mild weather conditions that noticeably boosted hiring in the construction sector, where the headcount rebounded by 56,000 in March after plummeting 61,000 in February. In April, it is expected to grow by no more than roughly 50,000, and this would drive the unemployment rate up from 4.4% to 4.5%.

From 20 to 26 April

Consumer Confidence - Conference Board EcoFlash

Index 1985=100, sa Fév Mars Avr 07-167 Consumer confidence index

111.2 108.2 104.0

Present situation 137.1 138.5 131.3

Expectations 93.8 87.9 85.8

Source: The Conference Board

Durable goods report EcoFlash

Changes in %m/m, sa Jan Fév Mars 07-170 New orders -8.8 2.4 3.4

Core orders(*) -6.2 -2.3 4.7

Shipments -1.5 -1.4 0.8

Core shipments(*) -3.1 0.0 0.7

Unfilled orders 0.3 1.1 1.8

Core unfilled orders(*) 1.0 0.2 1.6

Inventories 0.4 0.1 0.3

Core inventories(*) 0.6 0.1 0.0

Source: Department of Commerce – Census Bureau (*) Capital goods excluding defence and aircraft

Home sales EcoFlash

Millions units, sa Jan Fév Mars 06-170 New homes 0.87 0.84 0.86 %, m/m -14.4 -4.2 2.6 %, y/y -25.6 -19.5 -23.5Existing homes 6.44 6.68 6.12

%, m/m 2.7 3.7 -8.4

%, y/y -4.6 -3.7 -11.3

Sources: US Department of Commerce – Census Bureau & National Association of Realtors

Eurozone

To watch next week

In the eurozone, the April European Commission survey(published on Monday 30 April) will likely show a further deterioration in the overall economic climate, down from 111.2 in March to below 111. The decline in confidence in services will probably account for this decline. Conversely, household confidence as well as confidence in the industrial sector may have picked up somewhat, in line with the improvement in conditions in the labour market, on the one hand, and in national activity surveys in the sector, on the other. The April PMI survey in the manufacturing sector will be published on Wednesday 2 May. The composite index will likely remain virtually unchanged from March when it came in at 55.4. A slight rebound is even probable, confirming the firmness of activity in the sector, although the prevailing trend has been a slowdown in the last few months. The PMI survey in services, expected on Friday 4 May, should continue to show that activity remains very solid for the time being, even though we expect it to falter in the next few months in line with the dip in the industrial sector and the tightening of monetary and financial conditions. The flash estimation of inflation (released on 30 April) will likely show a decline in headline inflation, down to 1.8% in April, unchanged from 1.9% in March.

In Germany, a further decline in the number of job seekers,close to 60k, seems possible in April (publication on Wednesday 2 May). This would pave the way for a further fall in the unemployment rate (9.2% in March).

Caroline Newhouse-Cohen Ecoweek 07-16


From 20 to 26 April

Germany – IFO survey EcoFlash

Index 2000=100 Feb Mar Apr 07-169 Business climate 107 107.7 108.6 Current assessment 111.6 112.4 113.2 Future expectations 102.6 103.2 104.3

Source : IFO

France - Household purchases in durable goods EcoFlash

Changes in %, SA-WDA Jan 07 Feb 07 Mar 07 07-163 Total m/m 1.0 -0.5 0.7

y/y 6.9 4.8 6.3Durable goods m/m 1.4 -0.8 1.5

y/y 15.0 11.8 12.0

Source: INSEE

France - Monthly manufacturing survey EcoFlash

Bal. of opinion, SA Feb 07 Mar 07 Apr 07 07-171 Business climate 108 109 111Past production * 12 14 21Inventories * 11 11 8Overall orders * 1 4 5Pers. output prospects * 13 13 14Overall output prospects * -2 -2 9

Source: INSEE * item of the composite index

France – Consumer confidence EcoFlash

Bal. of opinion, SA Jan 07 Feb 07 Mar 07 07-173 Composite index -24 -23 -22Future personal finances * -3 -3 -1Future nat. living standard * -28 -21 -20Buying opportunity * -10 -11 -12Unemployment – prospects 15 11 27Prices - Prospects -36 -37 -37

Source: INSEE * item of the composite index

France – Unemployment EcoFlash

ILO-definition, SA Dec 06 Jan 07 Feb 07 07-173 Job-seekers (k) 2 352 2 340 2 315 Monthly change (k) -19 -12 -25Unemployment rate (%) 8.6 8.5 8.4

Source: INSEE

Japan

From 20 to 26 April

Labour force survey EcoFlash

Changes in %, cvs Jan Feb Mar 07-172

Unemployment 4.0 4.0 4.0

Ratio job offers-to-applicants 1.06 1.05 1.03

Source : Cabinet Office

Consumption and household* income EcoFlash

Changes in %, m/m, Jan Feb Mar 07-172

real terms, s.a.

Spending 2.7 -4.6 0.4

Disposable income -4.1 1.8 -1.0

Source : Cabinet Office, * Whose head of the family is salaried

Industrial production EcoFlash

Chnages in % m/m, s.a. Jan Feb Mar 07-172

Production -2.1 0.7 -0.7

Shipments -0.4 0.0 -1.5

Inventories -1.0 -0.6 -0.5

Inventory ratio -2.1 1.0 1.8

Source : METI

Consumer prices EcoFlash

Changes in % Feb Mar Apr 07-172

Tokyo

Total m/m, s.a. -0.4 0.4 0.4

y/y 0.0 0.1 0.2

Core * m/m, s.a. -0.2 0.3 0.3

y/y 0.0 -0.1 0.0

National

Total m/m, s.a. -0.5 0.3 na

y/y -0.2 -0.1 na

Core * m/m, s.a. -0.3 0.2 na

y/y -0.1 -0.3 na

Source : Cabinet Office, *: excluding fresh food

EcoWeek


Economic research department economic-research.bnpparibas.com

Philippe d'ARVISENET 33 1.43.16.95.58 [email protected] Economist

OECD COUNTRIES Philippe d'ARVISENET

Eric VERGNAUD 33 1.42.98.49.80 [email protected] of OECD CountriesStructural issues, forecasts

Caroline NEWHOUSE-COHEN 33 1.43.16.95.50 [email protected] economics

UNITED STATES, CANADAJean-Marc LUCAS 33.1.43.16.95.53 [email protected]

JAPAN, AUSTRALIA, NEW ZEALAND Caroline NEWHOUSE-COHEN 33 1.43.16.95.50 [email protected]

EURO ZONE, ITALY, EU ENLARGEMENT Clemente De LUCIA 33.1.42.98.27.62 [email protected]

FRANCE, EURO ZONE LABOUR MARKETMathieu KAISER 33.1.55.77.71.89 [email protected]

GERMANY, AUSTRIA, SWITZERLAND, PUBLIC FINANCES Frédérique CERISIER 01.43.16.95.52 [email protected]

SPAIN, PORTUGAL, GREECE, SINGLE EUROPEAN FINANCIAL MARKET Eric VERGNAUD 33 1.42.98.49.80 [email protected]

UNITED KINGDOM, NORDIC COUNTRIES, BENELUX, PENSIONS,LONG TERM FORECASTSRaymond VAN DER PUTTEN 33 1.42.98.53.99 [email protected]

BANKING ECONOMICS Van NGUYEN THE Head 33 1.43.16.95.54 [email protected]

Laurent QUIGNON 33 1.42.98.56.54 [email protected]éline CHOULET 33 1.57.43.02.91 [email protected]

COUNTRY RISK Guy LONGUEVILLE Head 33 1.43.16.95.40 [email protected]

François FAURE 33 1 42 98 79 82 [email protected] flows to emerging markets Bulgaria, Rumania, Turkey

ASIADelphine CAVALIER 33 1 43 16 95 41 [email protected] VINCENT 33.1 43 16 95 44 [email protected]

LATIN AMERICA Sylvain BELLEFONTAINE 33 1.42.98.26.77 [email protected]érénice PICCIOTTO 33 1.42.98.74.26 [email protected]

AFRICAStéphane ALBY 33 1.42.98.02.04 [email protected]ëlle LETILLY 33 1.42.98.56.27 [email protected]

EASTERN EUROPE Central Europe, Baltic countries, Balkan countriesJean-Loïc GUIEZE 33 1 42 98 43 86 [email protected]

RUSSIA, FORMER SOVIET REPUBLICS Tatiana ESANU 33 1.42.98.48.45 [email protected]

MIDDLE EAST – SCORINGPascal DEVAUX 33 1.43.16.95.51 [email protected]

EcoWeek


Our publications economic-research.bnpparibas.com

CONJONCTURE focuses each month both on the main economic issues and structural problems.

ECONOMIC MARKET MONITOR provides a detailed follow-up of the economic situation whilst analysing interest and exchange rate developments in OECD countries (8 issues per year).

PUBLIC FINANCES IN THE EURO ZONE is issued quarterly.

ECOFLASH comments and analyses the main economic events (data releases, economic policy decisions) in the hours following their release.

ECOWEEK focuses on specific and current economic issues (every Friday).

To receive our publications, please contact :

Francine BATHREAU 33-1-43-16-95-48

[email protected]

BNP Paribas is incorporated in France with Limited Liability. Registered Office 16 boulevard des Italiens, 75009 Paris.

BNP Paribas is regulated by the FSA for the conduct of its designated investment business in the UK and is a member of the London Stock Exchange.

BNP Paribas London Branch is registered in England and Wales under No. FC13447. Registered Office: 10 Harewood Avenue, London NW1 6AA

Tel: +44 (0)20 7595 2000 Fax: +44 (0)20 7595 2555 www.bnpparibas.com

The information and opinions contained in this report have been obtained from public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate or complete and it should not be relied upon as such. This report does not constitute a prospectus or other offering document or an offer or solicitation to buy any securities or other investment. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, they are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. No BNP Paribas Group Company accepts any liability whatsoever for any direct or consequential loss arising from any use of material contained in this report. All estimates and opinions included in this report constitute our judgements as of the date of this report. BNP Paribas and their affiliates (“collectively “BNP Paribas”) may make a market in, or may, as principal or agent, buy or sell securities of the issuers mentioned in this report or derivatives thereon. BNP Paribas may have a financial interest in the issuers mentioned in this report, including a long or short position in their securities, and or options, futures or other derivative instruments based thereon. BNP Paribas, including its officers and employees may serve or have served as an officer, director or in an advisory capacity for any issuer mentioned in this report. BNP Paribas may, from time to time, solicit, perform or have performed investment banking, underwriting or other services (including acting as adviser, manager, underwriter or lender) within the last 12 months for any issuer referred to in this report. BNP Paribas, may to the extent permitted by law, have acted upon or used the information contained herein, or the research or analysis on which it was based, before its publication. BNP Paribas may receive or intend to seek compensation for investment banking services in the next three months from an issuer mentioned in this report. Any issuer mentioned in this report may have been provided with sections of this report prior to its publication in order to verify its factual accuracy.

This report was produced by a BNP Paribas Group Company. This report is for the use of intended recipients and may not be reproduced (in whole or in part) or delivered or transmitted to any other person without the prior written consent of BNP Paribas. By accepting this document you agree to be bound by the foregoing limitations.

Analyst Certification

Each analyst responsible for the preparation of this report certifies that (i) all views expressed in this report accurately reflect the analyst’s personal views about any and all of the issuers and securities named in this report, and (ii) no part of the analyst’s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed herein.

United States: This report is being distributed to US persons by BNP Paribas Securities Corp., or by a subsidiary or affiliate of BNP Paribas that is not registered as a US broker-dealer, to US major institutional investors only. BNP Paribas Securities Corp., a subsidiary of BNP Paribas, is a broker-dealer registered with the Securities and Exchange Commission and is a member of the National Association of Securities Dealers, Inc. BNP Paribas Securities Corp. accepts responsibility for the content of a report prepared by another non-US affiliate only when distributed to US persons by BNP Paribas Securities Corp.

United Kingdom: This report has been approved for publication in the United Kingdom by BNP Paribas London Branch, a branch of BNP Paribas whose head office is in Paris, France. BNP Paribas London Branch is regulated by the Financial Services Authority (“FSA”) for the conduct of its designated investment business in the United Kingdom and is a member of the London Stock Exchange. This report is prepared for professional investors and is not intended for Private Customers in the United Kingdom as defined in FSA rules and should not be passed on to any such persons.

Japan: This report is being distributed to Japanese based firms by BNP Paribas Securities (Japan) Limited, Tokyo Branch, or by a subsidiary or affiliate of BNP Paribas not registered as a securities firm in Japan, to certain financial institutions permitted by regulation. BNP Paribas Securities (Japan) Limited, Tokyo Branch, a subsidiary of BNP Paribas, is a securities firm registered according to the Securities & Exchange Law of Japan and a member of the Japan Securities Dealers Association. BNP Paribas Securities (Japan) Limited, Tokyo Branch accepts responsibility for the content of a report prepared by another non-Japan affiliate only when distributed to Japanese based firms by BNP Paribas Securities (Japan) Limited, Tokyo Branch.

Hong Kong: This report is being distributed in Hong Kong by BNP Paribas Hong Kong Branch, a branch of BNP Paribas whose head office is in Paris, France. BNP Paribas Hong Kong Branch is regulated as a Licensed Bank by the Hong Kong Monetary Authority and is deemed as a Registered Institution by the Securities and Futures Commission for the conduct of Advising on Securities [Regulated Activity Type 4] under the Securities and Futures Ordinance Transitional Arrangements.

Singapore: This report is being distributed in Singapore by BNP Paribas Singapore Branch, a branch of BNP Paribas whose head office is in Paris, France. BNP Paribas Singapore is a licensed bank regulated by the Monetary Authority of Singapore is exempted from holding the required licenses to conduct regulated activities and provide financial advisory services under the Securities and Futures Act and the Financial Advisors Act.

© BNP Paribas (2004). All rights reserved.

EcoWeek - download.kataweb.itdownload.kataweb.it/economia/Focus/10/EcoWeek_07-16-EN.pdf · increase...

Documents

Transcript of EcoWeek - download.kataweb.itdownload.kataweb.it/economia/Focus/10/EcoWeek_07-16-EN.pdf · increase...