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● What if there were a disorderly break-up of the Euro-area? We
think peripheral currencies would fall by c.50%, pushing net
foreign liabilities to 200-250% of GDP for the periphery ex. Italy,
resulting in a 40% default on both sovereign and private loans.
● Losses to core European banks would be around €300 bn, €630
bn to peripheral banks ex. Italy and €150 bn to the ECB.
Peripheral European banks’ net foreign liabilities should rise by
c.€800 bn. Historically, into disorderly defaults, GDP falls by 9%
and NPLs rise to 22%. A deposit freeze, strong DM (our FX team
sees a new DM rising by 40%) and a trade war would all be likely.
● EPS could fall by 40%, the S&P 500 could go to 750 and
European banks could drop another 40%. Core European
exporters would suffer (see the Credit Suisse Delta 1 Euro
breakup basket—Bloomberg CSERXEUR), while peripheral
exporters would likely win. In dollar terms, local markets
underperform post-de-pegging.
● We think the chance of a general break-up of the Euro is just
10%. The cost of not bailing out the peripheral countries is higher
than the cost of bailing them out; the cost to Greece of an exit is
10-20% of GDP; Italy/Spain are not at risk of a default, in our
view; aggregate leverage, government deficits in the Euro-area
are all lower than in the US or the UK; and government bond
spreads are pricing in an overly aggressive haircut
We think Greece is unlikely to be ejected from the Euro until the ringfencing
for the rest of the periphery has been set up. The biggest
danger in our view would be for Italy to choose to leave the Euro.
The underlying problem
The underlying problem is the lack of competitiveness in the periphery,
as much as debt. We still believe an 8% to 15% decline in wages
might be needed to restore competitiveness in peripheral Europe.
Since wages are half of nominal GDP, nominal GDP could easily end
up contracting by more, leaving consensus GDP forecasts far too high.
This, in turn, indicates that these economies are likely to miss their
fiscal deficit targets – and, hence, could be forced to tighten fiscal
policy yet further. We note that in the Baltic States, the best example
of “internal devaluation”, nominal wages fell 10-15% from peak,
compared to a 4.4% decline in Greece so far on Eurostat data (wages
in Spain and Italy are still rising at 0.6% and 1.8% YoY and core CPI
is rising at 1.6% and 2.2%, compared to 1.6% in Germany).
We believe that even if the government debt problem vanished
overnight, the peripheral European economies (which together
amount to a third of Euro-area GDP) would still be left with on-going
deflation as they sought to restore competitiveness.
We also worry that government debt levels could end up being higher
than the market realises, as a consequence of private sector
deleveraging. Private sector leverage is still very high in some countries
The solution
a) A Eurobond would work, but takes too long to set up, requires
constitutional reform and—in some countries—a referendum;
b) turning the EFSF into a bank and repoing bonds with the ECB (to
increase its size 10 fold) could work—but it would also require
parliamentary approval and might violate the prohibition against
ECB lending to EU institutions;
c) the silent solution: the ECB continues to buy/repo peripheral
European debt (it already holds €140 bn of peripheral European
debt and repos €300 bn). This is a de facto fiscal transfer.
National central banks have €500 bn of reserves; and
d) the best solution, in our view: raise the EFSF to €900bn, with
€400bn used for a TARP-like facility, c€300bn for a debt buyback
at market prices and the remainder being put into an EFSF bank
used to purchase peripheral bonds (leveraged through repos with
the ECB). Soft QE and a weaker Euro need to be part of the
solution, in our view.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● What if there were a disorderly break-up of the Euro-area? We
think peripheral currencies would fall by c.50%, pushing net
foreign liabilities to 200-250% of GDP for the periphery ex. Italy,
resulting in a 40% default on both sovereign and private loans.
● Losses to core European banks would be around €300 bn, €630
bn to peripheral banks ex. Italy and €150 bn to the ECB.
Peripheral European banks’ net foreign liabilities should rise by
c.€800 bn. Historically, into disorderly defaults, GDP falls by 9%
and NPLs rise to 22%. A deposit freeze, strong DM (our FX team
sees a new DM rising by 40%) and a trade war would all be likely.
● EPS could fall by 40%, the S&P 500 could go to 750 and
European banks could drop another 40%. Core European
exporters would suffer (see the Credit Suisse Delta 1 Euro
breakup basket—Bloomberg CSERXEUR), while peripheral
exporters would likely win. In dollar terms, local markets
underperform post-de-pegging.
● We think the chance of a general break-up of the Euro is just
10%. The cost of not bailing out the peripheral countries is higher
than the cost of bailing them out; the cost to Greece of an exit is
10-20% of GDP; Italy/Spain are not at risk of a default, in our
view; aggregate leverage, government deficits in the Euro-area
are all lower than in the US or the UK; and government bond
spreads are pricing in an overly aggressive haircut
We think Greece is unlikely to be ejected from the Euro until the ringfencing
for the rest of the periphery has been set up. The biggest
danger in our view would be for Italy to choose to leave the Euro.
The underlying problem
The underlying problem is the lack of competitiveness in the periphery,
as much as debt. We still believe an 8% to 15% decline in wages
might be needed to restore competitiveness in peripheral Europe.
Since wages are half of nominal GDP, nominal GDP could easily end
up contracting by more, leaving consensus GDP forecasts far too high.
This, in turn, indicates that these economies are likely to miss their
fiscal deficit targets – and, hence, could be forced to tighten fiscal
policy yet further. We note that in the Baltic States, the best example
of “internal devaluation”, nominal wages fell 10-15% from peak,
compared to a 4.4% decline in Greece so far on Eurostat data (wages
in Spain and Italy are still rising at 0.6% and 1.8% YoY and core CPI
is rising at 1.6% and 2.2%, compared to 1.6% in Germany).
We believe that even if the government debt problem vanished
overnight, the peripheral European economies (which together
amount to a third of Euro-area GDP) would still be left with on-going
deflation as they sought to restore competitiveness.
We also worry that government debt levels could end up being higher
than the market realises, as a consequence of private sector
deleveraging. Private sector leverage is still very high in some countries
The solution
a) A Eurobond would work, but takes too long to set up, requires
constitutional reform and—in some countries—a referendum;
b) turning the EFSF into a bank and repoing bonds with the ECB (to
increase its size 10 fold) could work—but it would also require
parliamentary approval and might violate the prohibition against
ECB lending to EU institutions;
c) the silent solution: the ECB continues to buy/repo peripheral
European debt (it already holds €140 bn of peripheral European
debt and repos €300 bn). This is a de facto fiscal transfer.
National central banks have €500 bn of reserves; and
d) the best solution, in our view: raise the EFSF to €900bn, with
€400bn used for a TARP-like facility, c€300bn for a debt buyback
at market prices and the remainder being put into an EFSF bank
used to purchase peripheral bonds (leveraged through repos with
the ECB). Soft QE and a weaker Euro need to be part of the
solution, in our view.
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