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● A possible ‘Grand Deal’ on the problems facing the Euro-area has
to sort out three issues: The ring-fencing of the rest of Europe, the
recapitalisation of banks and the solvency of Greece.
● In a perfect world, it would also address the most critical issue
(growth). The first three look likely to be resolved over the next
weeks, but we struggle to see the Euro-area returning to growth
quickly (even if there are announcements related to EIB
infrastructure spending).
● Bottom line we think a re-leveraged EFSF of €1.5–2 tn is required,
and that would be enough if growth returns (and thus the leverage
calculations get no worse) and fiscal commitments are maintained.
We examine what can go right, the problems and the uncertainties.
Figure 1: Possible uses of the EFSF guarantee (€ bn)
Total guarantees 779
IR, GR and PT contribution 53
Guarantees excluding IR, GR and PT 726
Funds committed to IR and PT programmes (€48.5 bn)* 86
Guarantees after IR & PT programmes 640
Bank recapitalisations (€100 bn)* 177
Guarantees after bank recapitalisations 463
Guarantees required to cover the €1.4 tn funding requirements of ES, IT,
GR, PT, IR by end-2013 (assuming a leverage factor of 4.5x)
308
Remaining funds 155
* Funds that will have to be paid out in cash will have to be raised in the markets and will
be subject to cash buffers and overguarantees. We assume the ratio between guarantees
and usable funds is 1.77x; Source: Thomson Reuters, Credit Suisse research
What is going right?
● European politicians seem to be realising the gravity of the situation.
● The Allianz plan of turning the EFSF into a sovereign bond insurer
looks promising. This plan gets around: (1) most of the legal
difficulties to do with Lisbon Treaty 123 forbidding the ECB to
monetise debt; (2) the German constitutional court’s objection to
inter-sovereign transfers and (3) the immediate threat of a
downgrade to France due to higher contingent liabilities. The plan
is likely to give the EFSF effective firepower of around €1.5 tn–2 tn
(given 25% guarantees of Spain/Italy and 40% for the rest). This
would make the arithmetic work, just.
● Direct sovereign money is likely to be used rather than the EFSF
to recapitalise banks in core Europe (but that still leaves around
€80 bn for peripheral European bank recapitalisations that needs
to come from the EFSF or private sources).
● The ECB still seems to be hinting that even after the unveiling of
the new plan, it could buy peripheral European debt.
● Any move towards federalisation means that the Euro-area can be
viewed more like a single entity—and the aggregate Euro-area
government debt to GDP ratio is below that in the US, while the
fiscal deficit is better and the current account is in balance.
What are the key uncertainties about the likely new
package?
● Can the banks be recapitalised by borrowing from governments
using the guarantees backed from the ‘re-leveraged EFSF’? This
looks likely, and would be good news.
● Can governments use funds borrowed from the ‘re-leveraged
EFSF’ to buy back debt at market prices (around €300 bn of
buying would reduce government debt to GDP to sustainable
levels in Portugal, Ireland and Greece)? In passing, our
economics team believe that post PSI and debt buyback (in
accordance with the 21 July agreement), Greece can avoid a
default for some time, provided it sticks to the fiscal targets and
privatisation targets, which in our opinion, is unlikely.
● If the banks are not nationalised, they could end up tightening
lending conditions (as they reduce RWA to push up capital ratios)
and try to reduce their loan-to-deposit ratio from an aggregate of
135%, which would put downward pressure on growth.
● Implementation of fiscal targets must be part of the plan—but it is
very unclear what the safeguard or enforcement mechanisms will
be or whether these mechanisms ultimately involve a treaty
change, which in turn would require a mix of parliamentary
approval, constitutional reforms (Germany) or referenda (Ireland).
● The old debt would trade on a discount to the new debt (as it
appears that the Allianz proposal will guarantee only new debt).
The stock of outstanding debt in peripheral Europe is €3.4 tn
(versus €1.4 bn of financing requirements up to the end of 2013).
The critical issue for the debt service ratio is the bond yield on
new debt (not old debt), but if the old debt were to fall in value,
banks would have to mark to market, in our view.
What are the problems?
● Growth has to be the most critical variable to fiscal sustainability.
There seems to be little in what we know of the plans to stimulate
growth, apart from maybe front loading of EIB spending. Further,
the outlook on the growth front is bleak: European PMIs are
already consistent with zero GDP growth at best, 2012 fiscal
tightening in Europe is estimated by the IMF to be 1.2% of GDP
and banks are tightening lending conditions again. Last, we
estimate a c.5-15% decline in wages is required in the periphery
to get real effective exchange rates back to fair value or to
generate a current account surplus. Yet wages have yet to fall in
Italy and Spain—these two economies account for 28% of Euroarea
GDP.
● BTP spreads are moving up again (Berlusconi surviving his 51st
vote of no confidence) and OAT spreads are at a new high.
● Banks’ aggregate CDS spread are staying at extreme levels and
Italian bank borrowings from the ECB have risen to €105 bn from
€30 bn in May.
● The EUR rally (up around 5% since the beginning of October; we
continue to believe a weak EUR is critical to stimulate European
growth; each 10% off the EUR TWI boost growth by 0.7 pp, on
IMF projections).
● Oil price at US$100/bbl for North Sea Brent (we estimate each 10%
rise in oil prices takes 0.2 pp off continental European GDP growth).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● A possible ‘Grand Deal’ on the problems facing the Euro-area has
to sort out three issues: The ring-fencing of the rest of Europe, the
recapitalisation of banks and the solvency of Greece.
● In a perfect world, it would also address the most critical issue
(growth). The first three look likely to be resolved over the next
weeks, but we struggle to see the Euro-area returning to growth
quickly (even if there are announcements related to EIB
infrastructure spending).
● Bottom line we think a re-leveraged EFSF of €1.5–2 tn is required,
and that would be enough if growth returns (and thus the leverage
calculations get no worse) and fiscal commitments are maintained.
We examine what can go right, the problems and the uncertainties.
Figure 1: Possible uses of the EFSF guarantee (€ bn)
Total guarantees 779
IR, GR and PT contribution 53
Guarantees excluding IR, GR and PT 726
Funds committed to IR and PT programmes (€48.5 bn)* 86
Guarantees after IR & PT programmes 640
Bank recapitalisations (€100 bn)* 177
Guarantees after bank recapitalisations 463
Guarantees required to cover the €1.4 tn funding requirements of ES, IT,
GR, PT, IR by end-2013 (assuming a leverage factor of 4.5x)
308
Remaining funds 155
* Funds that will have to be paid out in cash will have to be raised in the markets and will
be subject to cash buffers and overguarantees. We assume the ratio between guarantees
and usable funds is 1.77x; Source: Thomson Reuters, Credit Suisse research
What is going right?
● European politicians seem to be realising the gravity of the situation.
● The Allianz plan of turning the EFSF into a sovereign bond insurer
looks promising. This plan gets around: (1) most of the legal
difficulties to do with Lisbon Treaty 123 forbidding the ECB to
monetise debt; (2) the German constitutional court’s objection to
inter-sovereign transfers and (3) the immediate threat of a
downgrade to France due to higher contingent liabilities. The plan
is likely to give the EFSF effective firepower of around €1.5 tn–2 tn
(given 25% guarantees of Spain/Italy and 40% for the rest). This
would make the arithmetic work, just.
● Direct sovereign money is likely to be used rather than the EFSF
to recapitalise banks in core Europe (but that still leaves around
€80 bn for peripheral European bank recapitalisations that needs
to come from the EFSF or private sources).
● The ECB still seems to be hinting that even after the unveiling of
the new plan, it could buy peripheral European debt.
● Any move towards federalisation means that the Euro-area can be
viewed more like a single entity—and the aggregate Euro-area
government debt to GDP ratio is below that in the US, while the
fiscal deficit is better and the current account is in balance.
What are the key uncertainties about the likely new
package?
● Can the banks be recapitalised by borrowing from governments
using the guarantees backed from the ‘re-leveraged EFSF’? This
looks likely, and would be good news.
● Can governments use funds borrowed from the ‘re-leveraged
EFSF’ to buy back debt at market prices (around €300 bn of
buying would reduce government debt to GDP to sustainable
levels in Portugal, Ireland and Greece)? In passing, our
economics team believe that post PSI and debt buyback (in
accordance with the 21 July agreement), Greece can avoid a
default for some time, provided it sticks to the fiscal targets and
privatisation targets, which in our opinion, is unlikely.
● If the banks are not nationalised, they could end up tightening
lending conditions (as they reduce RWA to push up capital ratios)
and try to reduce their loan-to-deposit ratio from an aggregate of
135%, which would put downward pressure on growth.
● Implementation of fiscal targets must be part of the plan—but it is
very unclear what the safeguard or enforcement mechanisms will
be or whether these mechanisms ultimately involve a treaty
change, which in turn would require a mix of parliamentary
approval, constitutional reforms (Germany) or referenda (Ireland).
● The old debt would trade on a discount to the new debt (as it
appears that the Allianz proposal will guarantee only new debt).
The stock of outstanding debt in peripheral Europe is €3.4 tn
(versus €1.4 bn of financing requirements up to the end of 2013).
The critical issue for the debt service ratio is the bond yield on
new debt (not old debt), but if the old debt were to fall in value,
banks would have to mark to market, in our view.
What are the problems?
● Growth has to be the most critical variable to fiscal sustainability.
There seems to be little in what we know of the plans to stimulate
growth, apart from maybe front loading of EIB spending. Further,
the outlook on the growth front is bleak: European PMIs are
already consistent with zero GDP growth at best, 2012 fiscal
tightening in Europe is estimated by the IMF to be 1.2% of GDP
and banks are tightening lending conditions again. Last, we
estimate a c.5-15% decline in wages is required in the periphery
to get real effective exchange rates back to fair value or to
generate a current account surplus. Yet wages have yet to fall in
Italy and Spain—these two economies account for 28% of Euroarea
GDP.
● BTP spreads are moving up again (Berlusconi surviving his 51st
vote of no confidence) and OAT spreads are at a new high.
● Banks’ aggregate CDS spread are staying at extreme levels and
Italian bank borrowings from the ECB have risen to €105 bn from
€30 bn in May.
● The EUR rally (up around 5% since the beginning of October; we
continue to believe a weak EUR is critical to stimulate European
growth; each 10% off the EUR TWI boost growth by 0.7 pp, on
IMF projections).
● Oil price at US$100/bbl for North Sea Brent (we estimate each 10%
rise in oil prices takes 0.2 pp off continental European GDP growth).
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