Dear all,
As by now you must know, only three months after a rating action with stable outlook Moody’s has placed the Kingdom of Spain’s Aa1 rating on review for possible downgrade.
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Beyond any remarks regarding the timing of this announcement – one day before an extremely important benchmark auction – there are several considerations that the Spanish Treasury would like to make.
Firstly, it is important to state that Moody’s has not downgraded the Kingdom of Spain. It has simply changed the Aa1 Stable outlook to a Aa1 rating under review for a possible downgrade during the next 3 months. The downgrade may occur if the current macroeconomic situation, the prospects of which have actually improved since September of this year, deteriorates further.
Secondly, Moody’s insists that it does not question the solvency of the Kingdom of Spain and, in this respect, it is very clear in its belief that Spain will not require EFSF assistance.
Thirdly, Moody’s says that even in the worst case scenario in which the review process leads to a downgrade, the Kingdom of Spain would remain in the Aa area, i.e. close to the “safe haven” sovereigns and far from those which are currently most in doubt.
Regarding more specific aspects of the report, there are several points to be made.
• The Treasury’s financial requirements for 2011 will be significantly lower than in 2010, even without taking into account the privatisation of the State Lotteries and Bets agency, and Aena (the National Airport Management agency). Also, the Treasury will start the year from a very comfortable cash position, with no major bond redemptions until the month of April, coinciding with a large intake of taxation revenue. The Treasury would thus remain strong even if the current episode of market volatility were to be prolonged for the first quarter.
• Until now, even in the middle of a period of market turbulence, there have been no significant signs of vulnerability with respect to the Treasury’s ability to access the market. Demand in our auctions has remained strong, and debt holdings by non-residents have tended to increase.
• Although financing costs are higher now, their effect in the aggregate interest burden is not significant, since the cost of most of the debt that is being redeemed is greater than the debt that is being issued. Despite the latest increases, the cost of financing, still low both in historic terms and in comparison to our European peers, does not put its sustainability in doubt.
• As regards the situation in the Spanish banking sector: we must emphasise that, according to the Bank of Spain’s data, the system’s Tier 1 capital is currently at 9.6%. Therefore, Moody’s statement that the system needs EUR 15 billion additional funds to remain above the 8% mark can only be understood in a stressed macroeconomic scenario similar to the one used in July 2010, which is not being experienced today. In this sense, Moody’s does not explain which scenario it has in mind when it affirms that, in a more severe scenario than the current one, recapitalisation needs may exceed EUR 80bn.
• When Moody’s states that, in order to reach 12% Tier 1, the system would require an additional EUR 90 bn, one should be reminded that the 12% mark is an arbitrary one, far away from any present or future standard, even under the Basle III regime in 2019. If Moody’s believes that this should be the standard, it should apply it to every banking institution in the world and not just to the Spanish ones.
• With respect to the Spanish Autonomous Regions, it must be made clear that only two of them will not fulfil their fiscal targets and that, even so, on aggregate they will fulfil these targets.
• As for non-complying Autonomous Regions and Municipalities, the Government has reaffirmed its resolve, backed by the law, not to allow them to incur in further debt operations until they provide sufficient proof of their commitment to fiscal consolidation. This resolve has been shown, for example, with the City of Madrid.
• Moody’s statement regarding the transparency of Autonomous Regions’ accounts, it does not seem to have considered the commitments reached in thelast Fiscal and Financial Policy Council to provide individual, homogenous, quarterly accounts... of their budgetary execution. We must emphasise that this commitment is a new international benchmark of transparency for other countries with sub-sovereign autonomous regional governments. As a sign of this commitment, next week the Government will provide the information on the Autonomous Regions’ budget execution for the third quarter of 2010.
• The calendar for structural reforms of the pensions and collective bargaining system has not been postponed, but actually brought forward: the date to finalise pension reform has been broughtforward to end- January 2011, and the one for collective bargaining has been set for March 2011.
The Government respects every opinion and takes note of what it deems valuable in each of them. It nevertheless believes that the current political economy strategy, with an aggressive and credible commitment for fiscal consolidation, and an equally bold programme of structural reforms – most of which, it must be stated, have already been implemented or announced – will pave the way for a steady economic recovery and a stabilisation of the market’s sentiment towards Spain. Beyond the relatively short-lived horizons of occasional publications that influence (and are also heavily influenced by) the market, we believe that investors will analyse Spanish fundamentals and continue to see Spanish Government debt as a valuable investment.
Many thanks,
Spanish Treasury Team
Thursday, December 16, 2010
Tuesday, October 19, 2010
Cash Starved Catalonia
Cash-starved Catalonia turns to locals
By Victor Mallet in Madrid
http://www.ft.com/cms/s/0/5737e0ee-d879-11df-8e05-00144feabdc0.html
Published: October 15 2010 18:38 | Last updated: October 15 2010 18:38
Shunned by international investors, the usually ebullient Antoni Castells, finance minister for the Spanish region of Catalonia, is so short of cash that he has turned to Catalans themselves to buy bonds to finance the deficit.
This week’s move by Catalonia’s Generalitat, the autonomous regional government, to raise up to €2.5bn ($3.5bn) by selling bonds through local banks has fanned the smouldering fires of Catalan nationalism and exposed the financial weaknesses of Spain’s devolved system of government.
The neighbouring Mediterranean region of Valencia is also in dire financial straits and the outlook for each of the 17 Spanish regions is listed as “negative” by credit rating agencies.
Total debt of the autonomous regions has doubled to almost €105bn in five years, according to the Bank of Spain.
Artur Mas, leader of the moderate Catalan nationalist party Convergència i Unió and likely winner of next month’s regional election, declared that Catalonia’s bond plan showed “the coffers of the Generalitat are bare”.
By paying a generous 4.75 per cent interest rate on the one-year bonds as well as an estimated 2-3 per cent commission for the banks, Catalonia is paying a high price to keep itself liquid.
But a downcast Mr Castells, member of a tripartite government dominated by the Socialists, described the bond issue as “attractive” and “necessary” and said: “It can’t be said that we’re bankrupt. No one would say that in a serious country.”
He predicted that other regions would take the same approach to fundraising from local citizens.
After years of rapid economic growth, abundant tax income and rising expenditure, the autonomous regions – as well as the municipal authorities in many towns and villages – are reeling from a crisis that has made property taxes evaporate and forced the central government to slash the public sector deficit.
The future of regional finances is of vital importance to the credibility of Spain’s austerity plans and the stability of the eurozone, because the regions account for more than half of all Spanish spending, mainly on education and health, while the central government controls 30 per cent and the social security system spends the rest.
Lorenzo Bernaldo de Quirós of Freemarket, the Madrid-based consultant, said on Friday the financial difficulties of the regions had revealed the “botched” nature of Spain’s decentralised constitution of 1978. With money likely to remain tight, he forecast that the reluctance of richer regions such as Catalonia to continue subsidising poorer ones such as Andalucía would foment political disputes and regional nationalism.
“It’s an explosive situation,” he said, noting that the two available solutions – regional bankruptcy or the bail-out of a region by the central government – were both bad. “It’s a scenario that leads inexorably to a drastic reform of the system for public sector financing.”
An additional difficulty for Spain is the lack of up-to-date information on the debt and budget positions of the regions.
Economists said the headline number for the overall deficit was being improved, partly by cutting transfers from the centre to the regions and municipalities, while the regions’ debts are higher than the published figures because of billions of euros of unpaid bills to suppliers and “off balance sheet” debts incurred by public corporations.
“It certainly seems the central government is making considerable progress in controlling its own deficit but the same cannot be said of the autonomous communities and municipal authorities,” said Edward Hugh, a Barcelona-based independent economist.
“It is clear from everything we have seen to date that the underlying regional deficit is deteriorating rather than improving.”
By Victor Mallet in Madrid
http://www.ft.com/cms/s/0/5737e0ee-d879-11df-8e05-00144feabdc0.html
Published: October 15 2010 18:38 | Last updated: October 15 2010 18:38
Shunned by international investors, the usually ebullient Antoni Castells, finance minister for the Spanish region of Catalonia, is so short of cash that he has turned to Catalans themselves to buy bonds to finance the deficit.
This week’s move by Catalonia’s Generalitat, the autonomous regional government, to raise up to €2.5bn ($3.5bn) by selling bonds through local banks has fanned the smouldering fires of Catalan nationalism and exposed the financial weaknesses of Spain’s devolved system of government.
The neighbouring Mediterranean region of Valencia is also in dire financial straits and the outlook for each of the 17 Spanish regions is listed as “negative” by credit rating agencies.
Total debt of the autonomous regions has doubled to almost €105bn in five years, according to the Bank of Spain.
Artur Mas, leader of the moderate Catalan nationalist party Convergència i Unió and likely winner of next month’s regional election, declared that Catalonia’s bond plan showed “the coffers of the Generalitat are bare”.
By paying a generous 4.75 per cent interest rate on the one-year bonds as well as an estimated 2-3 per cent commission for the banks, Catalonia is paying a high price to keep itself liquid.
But a downcast Mr Castells, member of a tripartite government dominated by the Socialists, described the bond issue as “attractive” and “necessary” and said: “It can’t be said that we’re bankrupt. No one would say that in a serious country.”
He predicted that other regions would take the same approach to fundraising from local citizens.
After years of rapid economic growth, abundant tax income and rising expenditure, the autonomous regions – as well as the municipal authorities in many towns and villages – are reeling from a crisis that has made property taxes evaporate and forced the central government to slash the public sector deficit.
The future of regional finances is of vital importance to the credibility of Spain’s austerity plans and the stability of the eurozone, because the regions account for more than half of all Spanish spending, mainly on education and health, while the central government controls 30 per cent and the social security system spends the rest.
Lorenzo Bernaldo de Quirós of Freemarket, the Madrid-based consultant, said on Friday the financial difficulties of the regions had revealed the “botched” nature of Spain’s decentralised constitution of 1978. With money likely to remain tight, he forecast that the reluctance of richer regions such as Catalonia to continue subsidising poorer ones such as Andalucía would foment political disputes and regional nationalism.
“It’s an explosive situation,” he said, noting that the two available solutions – regional bankruptcy or the bail-out of a region by the central government – were both bad. “It’s a scenario that leads inexorably to a drastic reform of the system for public sector financing.”
An additional difficulty for Spain is the lack of up-to-date information on the debt and budget positions of the regions.
Economists said the headline number for the overall deficit was being improved, partly by cutting transfers from the centre to the regions and municipalities, while the regions’ debts are higher than the published figures because of billions of euros of unpaid bills to suppliers and “off balance sheet” debts incurred by public corporations.
“It certainly seems the central government is making considerable progress in controlling its own deficit but the same cannot be said of the autonomous communities and municipal authorities,” said Edward Hugh, a Barcelona-based independent economist.
“It is clear from everything we have seen to date that the underlying regional deficit is deteriorating rather than improving.”
Wednesday, September 22, 2010
Turkey - Breaking The Mold?
Turkey’s excellent second quarter GDP performance – second only to China in the G20 – has once more brought the country back into the focus of investor attention. Strong underlying fundamentals following major structural changes since the start of the century mean the economy is far more robust than it was. However, weaknesses remain, especially in the labour market and external trade balance, with the current account deficit continuing to be a cause for concern. Recent backtracking on the proposed fiscal rule legislation combined with loose monetary conditions raise issues about the willingness of the authorities to finally get the inflation driven external imbalances under control. Nonetheless Turkey remains the strongest economy in the CEE region, with low external indebtedness and substantial scope for above par catch-up growth.
SOME BACKGROUND
It is not hard to see why many investors consider Turkey to be a compelling destination for their investments at the present time. With a growth rate which equalled that of China in the second quarter driven by a strong expansion in consumer demand - car, home and consumer durable laons have now risen every week since January - the logic behind a bullish stance towards the country is all too clear. And there is no real mystery about the country’s recent success, since following a series of substantial structural reforms introduced in the wake of the 2000/2001 crisis Turkey’s macro fundamentals are now strong, making the country stand out clearly from the majority of its Eastern European Emerging Market peers due to vibrant internal demand and the comparative absence of banking sector issues. In addition, despite some recent concern over the medium term position the country still has a relatively sound fiscal outlook (together with comparatively low levels of both government and private debt), a secular disinflation trend and very favourable demographics which see the country’s population set to grow by over 1.5 percent per annum over the next 25 years.
On the other hand, not everything is going to be simply plain sailing in Turkey. The trade and current account deficits are swelling at a worrying rate as imports recover from last year’s slump. The foreign trade deficit jumped from $5.6 billion in June to $6.4 billion in July, the highest level since August 2008. In fact contrary to the CEE trend, auto sector exports actually fell in July, with overall export growth slowing to 6 per cent year on year, while imports of motor vehicles surged, producing a 24.6 per cent surge in overall imports.
The latest data suggests the current account deficit could be well over $38 this year, double last year’s level, and if current trends continue it could be up in the region of $50 billion, or around 7 per cent of GDP, in 2011.
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Also of concern is the inflation rate, which rebounded again in August after falling for several months. This ongoing inflation differential with its trading peers is putting pressure on the real exchange rate, and on the competitiveness of the manufacturing sector. In addition, the quality of the financing which Turkey is receiving could become a cause for concern, since the share of FDI has fallen, while the increasing dependence on short term sources of funding like loans and equities if not corrected raises the risk of an unorderly correction at some point in the future.
Vastly Improved Fundamentals
Before the turn of the century crisis, Turkey’s economy was effectively characterised by an ongoing series of booms and busts, as consumption booms generated by unrealistic wage increases lead to competitiveness losses, over-indebtedness and an inevitable erosion in investor confidence which caused the whole thing to unwind. The IMF supervised strengthening of the country’s macroeconomic policy framework in the early 2000s decisively broke this pattern leading to a considerable decline in country risk premia.
The post 2001 reforms vastly improved economic resiliency, productiveness and efficiency. The implementation of an IMF inspired programme of strict fiscal discipline meant the budget deficit fell sharply from 12.9 percent of GDP in 2002 to a low of 0.3% in 2005. While the level of deficit rose again during the crisis (hitting 5.9% in 2009) this uptick is not exceptional when seen in a wider context, and the fiscal position is now expected to improve rapidly as the economy expands. The government’s debt to GDP ratio also fell substantially, from 93 percent in 2002 to the current level of just under 45 percent. At the same time the Lira has become a much more stable currency and interest rate levels have fallen substantially.
Very Strong Second Quarter
After turning in an 11.7 percent annual growth rate in the first three months of the year, the economy continued to recover strongly in Q2, turning in an impressive 10.3 percent growth rate, which was only equalled by China among the major economies, while only Singapore and Taiwan turning in better performances globally. Quarter on quarter the economy grew by 3.7 percent, or at an annualised rate of 14.5 percent.
The growth leaders in Q2 were construction, fisheries and manufacturing industries, which posted growth rates of 21.9 percent, 15.7 percent, and 15.4 percent, respectively. Industry and Trade Following the announcement of the figures Minister Nihat Ergün suggested Turkey could well grow by an annual 7 percent this year (up from a previous 6 percent forecast) and we do not find this suggestion at all unreasonable.
Unlike many of the over indebted economies which are to be found in the region (where growth is totally export dependent) the main engine of growth in the Turkish case is domestic demand, and in particular household consumption and investment. The construction and manufacturing industries grew by 21.9 percent and 15.4 percent growth, respectively, and both of these have high potential “multiplier effects” which means that they can reinforce growth in other sectors like retail sales and services in the second half of the year.
In fact Q2 GDP growth was significantly stronger than we expected, and well above the 8.5%Y consensus estimate, suggesting that the recently revised IMF forecast of 6.1 percent growth for the whole year may well need to be further adjusted upwards. Certainly the governments expectation of around 7% is far from being unrealistic. Export growth, which was up 12.1 percent on the year, was one upside surprise as was the rise in private consumption (up an annual 6.2 percent), although the latter was reflected in a surge in imports (up 17.8 percent) which meant the net trade contribution was negative (by 2 percentage points). Investment was up an impressive 28.7 percent, but this is not quite as impressive as it seems, due to the low base effect of the 2009 performance.
Public spending also accelerated, growing by 3.6 percent, although since revenue was also up the deficit actually fell over the period. Inventory growth, which contributed strongly (8.3pps) to headline growth in the first quarter, was modest (only 0.6pps) in the second one, suggesting we may see a gradual slowdown in manufacturing growth in the coming quarters. Indeed recent PMI readings have already begun to confirm this impression.
However, given that the Turkish economy actually plunged by "only" 11.0% year on year in the first half of 2009, GDP in real terms in the first half of 2010 was actually marginally up relative to its level before the onset of the global crisis, implying some real economic gains were made in the first half of the year, and that we are now truly talking of “recovery” in the Turkish context. The annual growth rates will evidently slow in the second half of the year, since Turkish economic conditions began to improve in the second half of 2009, with GDP falling only 2.7 percent year on year in the third quarter and the economy actually growing a seasonally adjusted 2.3 percent in the fourth quarter as compared to the third. Because the recovery had begun in the second half of last year, the base effects will affect results in the second half of this year, bringing annual GDP growth rates downward relatively sharply.
As stated aboveTurkey stands out from many regional peers as not being export-dependent and has a dynamic domestic economy to complement the export sector, which means the impetus behind overall GDP gains is much more broadly based. The strength of domestic demand also gives the Turkish government a far larger and growing potential tax base.
Unemployment rate continues to edge downwards
One of the reasons that domestic consumption is doing so well is the continuing fall in the unemployment rate, which stood at 10.5 percent in June, down from 11 percent in May, and 13 percent a year ago. The drop is evidently leading housholds to have an increased sense of job security and purchasing capacity.
Just as importantly the country is creating jobs. When compared with June 2009 the number of those employed rose by more than 1.5 million (to around 23.5 million), with the share of those occupied in the industrial sector (19.7 percent) rising significantly. Compared with a year earlier employment in agriculture was up 0.2 percentage points, while in industry it rose by1.2 pps, and in in services the share was actually down by 1.6 pps.
Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1 percent in February 2008. Two years later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in the jobless rate, and government forecasts that the rate may well fall to the single-digit level in the coming months do not seem unrealistic. Even more significantly, Turkey has achieved this improvement even as the labour force has risen sharply, from 51.6 million to 52.5 million. This feature again puts Turkey in a very different position to its regional peers, most of whom have either stagnant or falling labour forces due to their negative demographic trends. Turkey is evidently benifiting from phenomenon known as the “demographic dividend”, whereby as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fuelling credit and consumption growth. Turkey is thus rapidly approaching the demographic “sweet spot” where sustainable rapid catch up growth is totally realistic and achieveable.
However, this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. As the OECD are quick to point out, the Turkish economy makes far from satisfactory use of its existing labour resources. There is constant pressure on the industrial and service sectors to create the jobs to absorb the rapidly growing working-age population and enable the authorities to cope with the high rate of migration from rural areas. Turkey’s employment rate, at just above 40 percent, remains the lowest in the OECD area. Deep rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turksih women continue to withdraw from the labour force on marriage, which means the employment rate for women remains stuck around the 20 percent level, 40 percentage points lower than the equivalent rate for men.
Three Challenges – Inflation, The Current Account Deficit And Fiscal Control
Despite the fact Turkey is experiencing a secular disinflationary tend, the inflation rate rose in August, to 8.3 percent from 7.6 percent in July, reversing what had previously been a three-month run of declines. The main culprit, as is often the case in Turkey, was an increase in unprocessed food prices, reinforced by seasonal factors such as the arrival of Ramadan. In fact the surge was not unexpected, since Turkey’s central bank had previously forecast just such a “noticeable increase” produced by the seasonal jump in the price of fruit and other foods. The Bank has now kept its benchmark interest rate unchanged at 7 percent since November 2009, even as the economy returned to growth, basing their argument on the fact that the core inflation rate is falling toward the year-end target of 6.5 percent. Given that one of the key objectives of the central bank has to be reducing the level of interest rates they are unlikely to move rapidly towards monetary tightening and could resort to other tools to keep inflation in check, such as increasing reserve requirements to control credit growth. They are also likely to be reluctant to do anything on the interest rate front which could lead to an increase in short term capital flows, focusing their attention rather on bringing long term rates down to encourage FDI inflows.
The bank’s preferred measure of underlying inflation, ie excluding energy and food prices, fell to 4.2 percent in August from 4.5 percent a month earlier. On the other hand, they will also have noted that producer prices rose 1.15 percent during August (or 9 per cent over August 2009), a much faster pace than consensus expectations, a detail which may not alarm them but will certainly give them food for though. At the end of the day we doubt any of this will have much impact on the Bank’s policy stance, since they will surely stress that of the 9 core measures of inflation they track, six still posted annual declines in August. Indeed Central Bank Governor Durmus Yilmaz indicated at the start of September that in his opinion interest rates should stay on hold for the rest of this year, with only limited rises to be antipated in 2011. At the same time he has stressed that his ability to deliver on this front is conditional on fiscal decisions keeping to anticipated targets.
Current Account Deficit Worries
Turkey’s current account deficit increased sharply in July, and came in well above consensus expectations (US$3.0 billion). This means the current account deficit for the first seven months of the year totalled US$ 24.2 billion, up from US$ 7.9 billion registered in the same period of 2009. Even the non-energy current account deficit was up significantly, hitting US$6.5 billion in the first seven months compared with a surplus of US$6.5 billion in the same period of 2009. The underlying deterioration reflects the strength of the domestic consumer rebound and the impact of the inflation-driven real exchange rate appreciation.
Turkey has a long history of persistent current account deficits, and following an easing of the problem during the recession, with the recovery the old problem has simply re-emerged. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the issue subsided as a problem. But last year's narrowing was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so the anticipated widening of the deficit to a possible 7% of GDP in 2011 is essentially a reversion back to the norm. Which does not make it any the less problematic.
In addition to the rapid deterioration in the deficit, a further concern is raised by the quality of the financing which is supporting it. Capital inflows are increasingly short term and debt-based, while FDI (which is one the most stable and desireable ways to finance) remains below 2009 levels. At US$ 3.3 billion, FDI inflows over the first seven months fell short of the US$ 4.1 billion which entered the country during the same period of 2009. During the first six months of the year FDI coverage of the current account deficit came in at just over 10%, compared with 46% coverage over the same period in 2009.
As a result Turkey is becoming dependent on capital inflows which are increasingly short term and debt-based, making the country vulnerable to any renewed bout of risk aversion, which could see a rapid reversal in flows, triggering an abrupt adjustment in the real economy. There is one saving grace though, and that is to be found in the Net Errors and Omissions (NEO) category. This captures capital flows which remain essentially unidentified, and these dramatically improved during 2009, accounting for roughly US$5 billion in inflows. Although the dynamic behind such flows is unclear, movements are widely believed to reflect funds held abroad by companies and individuals which are repatriated during times of financial stress. These flows could be considered as a kind of automatic financial stabiliser (or cushion) for the Turkish economy, and it is not surprising to find that as conditions have improved so last year’s massive NEO inflow has steadily subsided, falling back to 0.5 billion $US in the first seven months of the year, from the 6.3 billion $US level seen during the same period last year.
With Turkey’s 2010 growth set to be much stronger than expected, the rapid widening of the current account has once more emerged as a key policy issue. A recent comprehensive analysis by the IMF argues that the root of the problem is Turkey’s considerable competitiveness gap. The IMF draw attention to the following evidence for the existence of the problem: (i) an above-normal current account gap - the IMF consider something like 2.5% of GDP to be normal in the case of an emerging economy like Turkey; (ii) real effective exchange rate appreciation driven by inflation differential between Turkey and its trading partners; and (iii) stagnation in the market share of Turkey’s exports.
The IMF analysis has implications for the secular outlook for the lira, since given that Turkey has a floating exchange rate regime, since if the loss of competitiveness reaches unbearable proportions the lira inevitably adjust downwards, an outcome which would not be unduly disruptive given that the country's external debt ratios are still modest, and that Turkey certainly does not have the same sort of problems many other emerging economies in the region have in terms of forex loan exposure.
Fiscal Policy Connundrum
Despite increasing during the crisis, Turkey’s fiscal deficit has been low in recent years, and debt to GDP has fallen steadily. The deficit hit 5.6% of GDP in 2009, and the IMF project it will fall to 3.4% by 2011. Gross debt peaked at 45.5% of GDP in 2009, and is now set to fall back steadily.
government to shelve the proposed Fiscal Rule legislation which would have committed the government to target a 1% fiscal deficit has come in for a lot of criticism, most notably from the IMF in their latest Article IV country report. The decision seems to reflect government concerns not to prematurely tie its hands in the face of what might be a quite closely contested election in 2011. Turkey, in the words of Fitch country analyst Edward Parker “somewhat tarnishes its fiscal credibility” by delaying the decision to place limits on budget spending, especially as the move suggests it may run a larger budget deficit next year than planned. At the same time Fitch stressed that it does not make any direct linkage between legislating the rule and future ratings decisions - “Fiscal outcomes are more important than fiscal rules. The path of the budget deficit and goverment debt-to- GDP ratio are likely to be important drivers of future rating actions. The passing or non-passing of rules alone will not be”. Which is indeed fortunate for Turkey, since the latest data showed that the country posted a budget surplus of TRY3.1 billion in August compared with a TRY1.5 billion deficit in the same period last year. So despite credibility slippage, in the short term the strong economic expansion may well assuage concerns about longer term sustainability.
But looking further into the future, as the International Monetary Fund warns: “Failure to pass the rule quickly may forfeit the window of opportunity that could close ahead of the approaching election cycle, and risk weakening the credibility of the authorities’ commitment to fiscal discipline.” Thus by taking what seems to be the easier path now the government may be storing up trouble for the future. Spending the lions share of this year’s excess tax revenues is only stimulating an economy which is not in need of stimulation, whereas saving them would not only be building a cushion for the future, it would also help reduce pressure on the current account deficit by draining some demand from the economy. As Turkish Central Bank Governor Durmus Yilmaz emphasised recently, fiscal and monetary policy simply form different pillars in one common strategy, and the central bank’s ability to keep interest rates low enough to keep make investment sufficiently attractive depends in part on government determination to keep to a medium term plan which limits the deficit. In order to preserve and reinforce domestic and international confidence in the sustainability of public finances, the Turkish government would be well advised to establish a clear and transparent framework for the future development of the deficit. As has unfortunately become only too clear in the case of the current Eurozone crisis, good times don’t last forever, and weakening vigilance when the pressure to take decisions is low often simply stores up even bigger problems for the future. It is far easier to take hard economic decisions when the winds are favourable, than it is when you face a tempest head-on.
Outlook Stable - Gradual Monetary Tightening, Ratings Agency Upgrades and Growing Political Consensus
While Turkey's central bank left its policy rate of choice, the one-week repo rate, unchanged at this months meeting, this decision responds to a number of policy objectives and there is little room for complacency on either the monetary or the fiscal front at this point if undesireable distortions are not to be produced in the real economy.
During the course of the crisis the central bank lowered rates 13 times from their October 2008 high of 16.75 percent, bringing the one-week repo rate to its current level of 7 percent. Evidently the Bank’s objective is to bring the level of interest rates permanently down to well below their historic levels, but their ability to do this is conditional on their success in reducing the endemically high levels of inflation which plague the economy. And as if to offer us a timely reminder that the problem remains with us, as we have noted inflation ticked up again in August to 8.3 percent.
Thus, as the IMF argue, bringing forward a moderate tightening in the monetary environment now could obviate the need for a sharper and larger tightening later on. A delayed tightening could be counterproductive since it might well attract further sizable capital inflows and be detrimental to banks because of their maturity mismatch. Tightening should be broad based with the aim of raising real borrowing costs and moderating inflation expectations. And as Governor Yilamz is arguing even greater recourse to contractionary monetary policy - with all the attendant risks - will be needed if the appropriate fiscal adjustment is not forthcoming.
Monetary tightening does not necessarily mean ongoing hikes in interest rates, removing the vestiges of the credit easing measures introduced during the crisis would also help, for example by tightening loan classification rules and increasing provisioning requirements. Naturally these measures are just as unlikely to prove popular with banks (and the builders and developers they lend to) as are fiscal tightening measures likely to win votes with electors, but in both cases the moves are necessary to provide for the long term health and stability of the economy.
A further measure which could prove useful would be increasing the volume of FX purchases by the central bank, this would serve the dual purpose of reducing liquidity and aiding competitiveness by reducing the impact any upward drift in the Lira produced by increases in the policy rate.
Rating Upgrades In View?
All the above is doubly to the point given that in the wake of the considerable strengthening of its macroeconomic policy framework and financial sector supervision, Turkey has significantly improved its terms of access to international capital markets. As a result, both during the crisis and in the current recovery period, Turkey’s risk premia has evolved very favourably, significantly reducing borrowing costs for government, banks and non-financial corporations. The country’s sovereign credit rating has been upgraded in recent months, although it has not yet reached “investment grade”. Further improvements in Turkey’s international capital market standing are to be anticipated, but in this context it is important that the subsequent lowering in long-term capital costs serves to stimulate long-term sustainable growth, and not get diverted into an unsustainable construction and consumer credit boom of the kind which we have just seen in some CEE peer countries.
Moody's Investors Service recently upgraded Turkey's government bond rating to Ba2 from Ba3, and the outlook was changed to stable from positive. An further upgrade from S&P’s, who raised Turkey's long-term foreign currency and local currency sovereign credit ratings to BB and BB+ in February, would not be a surprise. ." Among other comments of interest they said at the time they believed Turkey's banking system to be one of the strongest and least-leveraged in Eastern Europe and noted that local capital markets are continuing to develop, enabling the government to begin to place local currency debt at maturities as high as 10 years. Their decision to maintain a positive outlook on the rating is a reflection of the possibility of further upgrade over the next 12-24 months. Fitch’s last move was in 2009, when they rated Turkey BB+.
Moody's decision to only move Turkey up one notch was rather conservative, since for reasons best known to themselves the agency still rates Turkey one notch behind Egpyt, but it does reflect the way the agencies are, at least in Turkey’s case, rather behind the curve in comparison with the markets. Turkey CDS (in the 160 to 165 bp range) now consistently trade below higher rated counterparts such as Romania (BB+) and Hungary (BBB-, investment grade).
Turkey’s external debt ratios are still low (gross debt 43.4% of GDP, net debt 26.7%) and the country certainly does not have anything like the problems other emerging European countries have in terms of of the external liabilities of households and corporates. Thus they could live with a weaker currency and they have proven willingness to pay since they did so in 2000/01 when the temptation to restructure must have been very strong.
The principal obstacle to upgrades at the present time seems to be the shelving of the fiscal rule legislation, but matters may well change on this front after next years election.
Essentially, despite the fact that growth will slow somewhat in the second half of the year we still expect Turkey to be the fastest-growing economy in the region, with risks mostly centred on the external environment (growth in the EU, and global risk appetite) although evidently continuing domestic political stability such that consumer confidence is maintained is also critical, and it should be noted that confidence has slipped back in recent months. In this context the result of the recent referendum vote – which was solidly in favour of the government proposed reforms – augurs well for the future.
The outlook is then for growth in the 6 to 7 percent range in 2010, followed by a further 5 percent in 2011, especially with the likelihood of additional pre-election spending on the part of the government. Fixed capital investment should continue increase at a brisk pace in the second half of the year, buoyed in part by faster privatisation - Turkey’s state asset sales agency recently recieved 12 bids for a 36-year license to operate the Iskenderun port in southern Turkey. The port, one of the largest in Turkey, serves south and southeastern Turkey as well as Middle Eastern countries.
At the same time given the robust expansion in domestic consumption – bank credit to households is rising at a 40 percent annual rate – any slowing of demand for Turkish exports from Western Europe as fiscal tightening sets in will not have as much of a dampening effect on GDP gains as it will elsewhere in the region, although there will evidently be some impact. Despite pre-election spending we anticipate a somewhat lower growth rate due to base effects, tightening liquidity and an expectation that export conditions may well remain depressed.
Finally it should be stressed that the country needs to address the two major structural weaknesses which hinder growth. In the first place it needs to stem the loss of international price competitiveness which tends to occur during cyclical upswings, worsening the current account deficit. As growth strengthens, capital inflows gather pace, the exchange rate appreciates, and increases in minimum and average wages accelerate, leading the internal and external imbalances of the economy widen. To make lasting progress in breaking out of this cycle the inflation problem needs to be brought definitively under control via the utilisation of adequate and appropriate monetary and fiscal tools and the implementation of systematic labour market reforms. At the same time, the structurally low employment ratio needs to be corrected, in particular by ensuring improved labour market access for the country’s female population. Only in this way can the excessive dependency ratios be reduced, and the country’s saving ratio increased in a way which reduces dependence on external sources of funding.
- Turkey’s economy surprised everyone on the upside in the second three months of 2010. The economy grew by a seasonally adjusted 3.7% over the first quarter, and by a China like 10.3% over the previous year. Turkey is one of the few countries in the CEE region to have strong independent domestic demand, making its economy relatively immune from short term movements in external demand.
- While the general outlook is extremely positive for the Turkish economy, and rating upgrades can be expected, controlling the widening current account deficit will be the key to sustained success. In this context shelving of the fiscal rule legislation has sent out a strong negative signal to markets, not so much about current intentions as about the dangers of agenda slippage as we move further down the road. It is necessary to put this situation in some sort of perspective however, since government debt to GDP is still low, as is the level of household and external indebtedness. There are reasonable grounds, therefore, for optimism that once next years elections have passed, and with EU accession negotiations as an anchor, the overall policy mix can continue to evolve in a positive direction.
- Turkey’s economy is now reaping the benefits of substantial structural changes on the macro front, aided by very strong underlying demographics. Turkey’s working age population is set to rise significantly in the years to come, posing a challenge for job creation, but offering the country the prospect of ever lower dependency ratios and strong internal demand momentum. In contrast to many of its regional neighbours the country has taken the opportunity offered by the strong underlying global environment of the early years of the century to set some of its ongoing macro problems straight, and in particular to put its national balance sheet in order. Thus it has avoided the accumulation of excessive debt, whether public or private, internal or external. Handled responsibly the country now faces the prospect of rapid convergence towards developed economy levels of activity and living standards between now and the early 2020s.
SOME BACKGROUND
It is not hard to see why many investors consider Turkey to be a compelling destination for their investments at the present time. With a growth rate which equalled that of China in the second quarter driven by a strong expansion in consumer demand - car, home and consumer durable laons have now risen every week since January - the logic behind a bullish stance towards the country is all too clear. And there is no real mystery about the country’s recent success, since following a series of substantial structural reforms introduced in the wake of the 2000/2001 crisis Turkey’s macro fundamentals are now strong, making the country stand out clearly from the majority of its Eastern European Emerging Market peers due to vibrant internal demand and the comparative absence of banking sector issues. In addition, despite some recent concern over the medium term position the country still has a relatively sound fiscal outlook (together with comparatively low levels of both government and private debt), a secular disinflation trend and very favourable demographics which see the country’s population set to grow by over 1.5 percent per annum over the next 25 years.
On the other hand, not everything is going to be simply plain sailing in Turkey. The trade and current account deficits are swelling at a worrying rate as imports recover from last year’s slump. The foreign trade deficit jumped from $5.6 billion in June to $6.4 billion in July, the highest level since August 2008. In fact contrary to the CEE trend, auto sector exports actually fell in July, with overall export growth slowing to 6 per cent year on year, while imports of motor vehicles surged, producing a 24.6 per cent surge in overall imports.
The latest data suggests the current account deficit could be well over $38 this year, double last year’s level, and if current trends continue it could be up in the region of $50 billion, or around 7 per cent of GDP, in 2011.
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Also of concern is the inflation rate, which rebounded again in August after falling for several months. This ongoing inflation differential with its trading peers is putting pressure on the real exchange rate, and on the competitiveness of the manufacturing sector. In addition, the quality of the financing which Turkey is receiving could become a cause for concern, since the share of FDI has fallen, while the increasing dependence on short term sources of funding like loans and equities if not corrected raises the risk of an unorderly correction at some point in the future.
Vastly Improved Fundamentals
Before the turn of the century crisis, Turkey’s economy was effectively characterised by an ongoing series of booms and busts, as consumption booms generated by unrealistic wage increases lead to competitiveness losses, over-indebtedness and an inevitable erosion in investor confidence which caused the whole thing to unwind. The IMF supervised strengthening of the country’s macroeconomic policy framework in the early 2000s decisively broke this pattern leading to a considerable decline in country risk premia.
The post 2001 reforms vastly improved economic resiliency, productiveness and efficiency. The implementation of an IMF inspired programme of strict fiscal discipline meant the budget deficit fell sharply from 12.9 percent of GDP in 2002 to a low of 0.3% in 2005. While the level of deficit rose again during the crisis (hitting 5.9% in 2009) this uptick is not exceptional when seen in a wider context, and the fiscal position is now expected to improve rapidly as the economy expands. The government’s debt to GDP ratio also fell substantially, from 93 percent in 2002 to the current level of just under 45 percent. At the same time the Lira has become a much more stable currency and interest rate levels have fallen substantially.
Very Strong Second Quarter
After turning in an 11.7 percent annual growth rate in the first three months of the year, the economy continued to recover strongly in Q2, turning in an impressive 10.3 percent growth rate, which was only equalled by China among the major economies, while only Singapore and Taiwan turning in better performances globally. Quarter on quarter the economy grew by 3.7 percent, or at an annualised rate of 14.5 percent.
The growth leaders in Q2 were construction, fisheries and manufacturing industries, which posted growth rates of 21.9 percent, 15.7 percent, and 15.4 percent, respectively. Industry and Trade Following the announcement of the figures Minister Nihat Ergün suggested Turkey could well grow by an annual 7 percent this year (up from a previous 6 percent forecast) and we do not find this suggestion at all unreasonable.
Unlike many of the over indebted economies which are to be found in the region (where growth is totally export dependent) the main engine of growth in the Turkish case is domestic demand, and in particular household consumption and investment. The construction and manufacturing industries grew by 21.9 percent and 15.4 percent growth, respectively, and both of these have high potential “multiplier effects” which means that they can reinforce growth in other sectors like retail sales and services in the second half of the year.
In fact Q2 GDP growth was significantly stronger than we expected, and well above the 8.5%Y consensus estimate, suggesting that the recently revised IMF forecast of 6.1 percent growth for the whole year may well need to be further adjusted upwards. Certainly the governments expectation of around 7% is far from being unrealistic. Export growth, which was up 12.1 percent on the year, was one upside surprise as was the rise in private consumption (up an annual 6.2 percent), although the latter was reflected in a surge in imports (up 17.8 percent) which meant the net trade contribution was negative (by 2 percentage points). Investment was up an impressive 28.7 percent, but this is not quite as impressive as it seems, due to the low base effect of the 2009 performance.
Public spending also accelerated, growing by 3.6 percent, although since revenue was also up the deficit actually fell over the period. Inventory growth, which contributed strongly (8.3pps) to headline growth in the first quarter, was modest (only 0.6pps) in the second one, suggesting we may see a gradual slowdown in manufacturing growth in the coming quarters. Indeed recent PMI readings have already begun to confirm this impression.
However, given that the Turkish economy actually plunged by "only" 11.0% year on year in the first half of 2009, GDP in real terms in the first half of 2010 was actually marginally up relative to its level before the onset of the global crisis, implying some real economic gains were made in the first half of the year, and that we are now truly talking of “recovery” in the Turkish context. The annual growth rates will evidently slow in the second half of the year, since Turkish economic conditions began to improve in the second half of 2009, with GDP falling only 2.7 percent year on year in the third quarter and the economy actually growing a seasonally adjusted 2.3 percent in the fourth quarter as compared to the third. Because the recovery had begun in the second half of last year, the base effects will affect results in the second half of this year, bringing annual GDP growth rates downward relatively sharply.
As stated aboveTurkey stands out from many regional peers as not being export-dependent and has a dynamic domestic economy to complement the export sector, which means the impetus behind overall GDP gains is much more broadly based. The strength of domestic demand also gives the Turkish government a far larger and growing potential tax base.
Unemployment rate continues to edge downwards
One of the reasons that domestic consumption is doing so well is the continuing fall in the unemployment rate, which stood at 10.5 percent in June, down from 11 percent in May, and 13 percent a year ago. The drop is evidently leading housholds to have an increased sense of job security and purchasing capacity.
Just as importantly the country is creating jobs. When compared with June 2009 the number of those employed rose by more than 1.5 million (to around 23.5 million), with the share of those occupied in the industrial sector (19.7 percent) rising significantly. Compared with a year earlier employment in agriculture was up 0.2 percentage points, while in industry it rose by1.2 pps, and in in services the share was actually down by 1.6 pps.
Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1 percent in February 2008. Two years later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in the jobless rate, and government forecasts that the rate may well fall to the single-digit level in the coming months do not seem unrealistic. Even more significantly, Turkey has achieved this improvement even as the labour force has risen sharply, from 51.6 million to 52.5 million. This feature again puts Turkey in a very different position to its regional peers, most of whom have either stagnant or falling labour forces due to their negative demographic trends. Turkey is evidently benifiting from phenomenon known as the “demographic dividend”, whereby as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fuelling credit and consumption growth. Turkey is thus rapidly approaching the demographic “sweet spot” where sustainable rapid catch up growth is totally realistic and achieveable.
However, this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. As the OECD are quick to point out, the Turkish economy makes far from satisfactory use of its existing labour resources. There is constant pressure on the industrial and service sectors to create the jobs to absorb the rapidly growing working-age population and enable the authorities to cope with the high rate of migration from rural areas. Turkey’s employment rate, at just above 40 percent, remains the lowest in the OECD area. Deep rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turksih women continue to withdraw from the labour force on marriage, which means the employment rate for women remains stuck around the 20 percent level, 40 percentage points lower than the equivalent rate for men.
Three Challenges – Inflation, The Current Account Deficit And Fiscal Control
Despite the fact Turkey is experiencing a secular disinflationary tend, the inflation rate rose in August, to 8.3 percent from 7.6 percent in July, reversing what had previously been a three-month run of declines. The main culprit, as is often the case in Turkey, was an increase in unprocessed food prices, reinforced by seasonal factors such as the arrival of Ramadan. In fact the surge was not unexpected, since Turkey’s central bank had previously forecast just such a “noticeable increase” produced by the seasonal jump in the price of fruit and other foods. The Bank has now kept its benchmark interest rate unchanged at 7 percent since November 2009, even as the economy returned to growth, basing their argument on the fact that the core inflation rate is falling toward the year-end target of 6.5 percent. Given that one of the key objectives of the central bank has to be reducing the level of interest rates they are unlikely to move rapidly towards monetary tightening and could resort to other tools to keep inflation in check, such as increasing reserve requirements to control credit growth. They are also likely to be reluctant to do anything on the interest rate front which could lead to an increase in short term capital flows, focusing their attention rather on bringing long term rates down to encourage FDI inflows.
The bank’s preferred measure of underlying inflation, ie excluding energy and food prices, fell to 4.2 percent in August from 4.5 percent a month earlier. On the other hand, they will also have noted that producer prices rose 1.15 percent during August (or 9 per cent over August 2009), a much faster pace than consensus expectations, a detail which may not alarm them but will certainly give them food for though. At the end of the day we doubt any of this will have much impact on the Bank’s policy stance, since they will surely stress that of the 9 core measures of inflation they track, six still posted annual declines in August. Indeed Central Bank Governor Durmus Yilmaz indicated at the start of September that in his opinion interest rates should stay on hold for the rest of this year, with only limited rises to be antipated in 2011. At the same time he has stressed that his ability to deliver on this front is conditional on fiscal decisions keeping to anticipated targets.
Current Account Deficit Worries
Turkey’s current account deficit increased sharply in July, and came in well above consensus expectations (US$3.0 billion). This means the current account deficit for the first seven months of the year totalled US$ 24.2 billion, up from US$ 7.9 billion registered in the same period of 2009. Even the non-energy current account deficit was up significantly, hitting US$6.5 billion in the first seven months compared with a surplus of US$6.5 billion in the same period of 2009. The underlying deterioration reflects the strength of the domestic consumer rebound and the impact of the inflation-driven real exchange rate appreciation.
Turkey has a long history of persistent current account deficits, and following an easing of the problem during the recession, with the recovery the old problem has simply re-emerged. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the issue subsided as a problem. But last year's narrowing was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so the anticipated widening of the deficit to a possible 7% of GDP in 2011 is essentially a reversion back to the norm. Which does not make it any the less problematic.
In addition to the rapid deterioration in the deficit, a further concern is raised by the quality of the financing which is supporting it. Capital inflows are increasingly short term and debt-based, while FDI (which is one the most stable and desireable ways to finance) remains below 2009 levels. At US$ 3.3 billion, FDI inflows over the first seven months fell short of the US$ 4.1 billion which entered the country during the same period of 2009. During the first six months of the year FDI coverage of the current account deficit came in at just over 10%, compared with 46% coverage over the same period in 2009.
As a result Turkey is becoming dependent on capital inflows which are increasingly short term and debt-based, making the country vulnerable to any renewed bout of risk aversion, which could see a rapid reversal in flows, triggering an abrupt adjustment in the real economy. There is one saving grace though, and that is to be found in the Net Errors and Omissions (NEO) category. This captures capital flows which remain essentially unidentified, and these dramatically improved during 2009, accounting for roughly US$5 billion in inflows. Although the dynamic behind such flows is unclear, movements are widely believed to reflect funds held abroad by companies and individuals which are repatriated during times of financial stress. These flows could be considered as a kind of automatic financial stabiliser (or cushion) for the Turkish economy, and it is not surprising to find that as conditions have improved so last year’s massive NEO inflow has steadily subsided, falling back to 0.5 billion $US in the first seven months of the year, from the 6.3 billion $US level seen during the same period last year.
With Turkey’s 2010 growth set to be much stronger than expected, the rapid widening of the current account has once more emerged as a key policy issue. A recent comprehensive analysis by the IMF argues that the root of the problem is Turkey’s considerable competitiveness gap. The IMF draw attention to the following evidence for the existence of the problem: (i) an above-normal current account gap - the IMF consider something like 2.5% of GDP to be normal in the case of an emerging economy like Turkey; (ii) real effective exchange rate appreciation driven by inflation differential between Turkey and its trading partners; and (iii) stagnation in the market share of Turkey’s exports.
The IMF analysis has implications for the secular outlook for the lira, since given that Turkey has a floating exchange rate regime, since if the loss of competitiveness reaches unbearable proportions the lira inevitably adjust downwards, an outcome which would not be unduly disruptive given that the country's external debt ratios are still modest, and that Turkey certainly does not have the same sort of problems many other emerging economies in the region have in terms of forex loan exposure.
Fiscal Policy Connundrum
Despite increasing during the crisis, Turkey’s fiscal deficit has been low in recent years, and debt to GDP has fallen steadily. The deficit hit 5.6% of GDP in 2009, and the IMF project it will fall to 3.4% by 2011. Gross debt peaked at 45.5% of GDP in 2009, and is now set to fall back steadily.
government to shelve the proposed Fiscal Rule legislation which would have committed the government to target a 1% fiscal deficit has come in for a lot of criticism, most notably from the IMF in their latest Article IV country report. The decision seems to reflect government concerns not to prematurely tie its hands in the face of what might be a quite closely contested election in 2011. Turkey, in the words of Fitch country analyst Edward Parker “somewhat tarnishes its fiscal credibility” by delaying the decision to place limits on budget spending, especially as the move suggests it may run a larger budget deficit next year than planned. At the same time Fitch stressed that it does not make any direct linkage between legislating the rule and future ratings decisions - “Fiscal outcomes are more important than fiscal rules. The path of the budget deficit and goverment debt-to- GDP ratio are likely to be important drivers of future rating actions. The passing or non-passing of rules alone will not be”. Which is indeed fortunate for Turkey, since the latest data showed that the country posted a budget surplus of TRY3.1 billion in August compared with a TRY1.5 billion deficit in the same period last year. So despite credibility slippage, in the short term the strong economic expansion may well assuage concerns about longer term sustainability.
But looking further into the future, as the International Monetary Fund warns: “Failure to pass the rule quickly may forfeit the window of opportunity that could close ahead of the approaching election cycle, and risk weakening the credibility of the authorities’ commitment to fiscal discipline.” Thus by taking what seems to be the easier path now the government may be storing up trouble for the future. Spending the lions share of this year’s excess tax revenues is only stimulating an economy which is not in need of stimulation, whereas saving them would not only be building a cushion for the future, it would also help reduce pressure on the current account deficit by draining some demand from the economy. As Turkish Central Bank Governor Durmus Yilmaz emphasised recently, fiscal and monetary policy simply form different pillars in one common strategy, and the central bank’s ability to keep interest rates low enough to keep make investment sufficiently attractive depends in part on government determination to keep to a medium term plan which limits the deficit. In order to preserve and reinforce domestic and international confidence in the sustainability of public finances, the Turkish government would be well advised to establish a clear and transparent framework for the future development of the deficit. As has unfortunately become only too clear in the case of the current Eurozone crisis, good times don’t last forever, and weakening vigilance when the pressure to take decisions is low often simply stores up even bigger problems for the future. It is far easier to take hard economic decisions when the winds are favourable, than it is when you face a tempest head-on.
Outlook Stable - Gradual Monetary Tightening, Ratings Agency Upgrades and Growing Political Consensus
While Turkey's central bank left its policy rate of choice, the one-week repo rate, unchanged at this months meeting, this decision responds to a number of policy objectives and there is little room for complacency on either the monetary or the fiscal front at this point if undesireable distortions are not to be produced in the real economy.
During the course of the crisis the central bank lowered rates 13 times from their October 2008 high of 16.75 percent, bringing the one-week repo rate to its current level of 7 percent. Evidently the Bank’s objective is to bring the level of interest rates permanently down to well below their historic levels, but their ability to do this is conditional on their success in reducing the endemically high levels of inflation which plague the economy. And as if to offer us a timely reminder that the problem remains with us, as we have noted inflation ticked up again in August to 8.3 percent.
Thus, as the IMF argue, bringing forward a moderate tightening in the monetary environment now could obviate the need for a sharper and larger tightening later on. A delayed tightening could be counterproductive since it might well attract further sizable capital inflows and be detrimental to banks because of their maturity mismatch. Tightening should be broad based with the aim of raising real borrowing costs and moderating inflation expectations. And as Governor Yilamz is arguing even greater recourse to contractionary monetary policy - with all the attendant risks - will be needed if the appropriate fiscal adjustment is not forthcoming.
Monetary tightening does not necessarily mean ongoing hikes in interest rates, removing the vestiges of the credit easing measures introduced during the crisis would also help, for example by tightening loan classification rules and increasing provisioning requirements. Naturally these measures are just as unlikely to prove popular with banks (and the builders and developers they lend to) as are fiscal tightening measures likely to win votes with electors, but in both cases the moves are necessary to provide for the long term health and stability of the economy.
A further measure which could prove useful would be increasing the volume of FX purchases by the central bank, this would serve the dual purpose of reducing liquidity and aiding competitiveness by reducing the impact any upward drift in the Lira produced by increases in the policy rate.
Rating Upgrades In View?
All the above is doubly to the point given that in the wake of the considerable strengthening of its macroeconomic policy framework and financial sector supervision, Turkey has significantly improved its terms of access to international capital markets. As a result, both during the crisis and in the current recovery period, Turkey’s risk premia has evolved very favourably, significantly reducing borrowing costs for government, banks and non-financial corporations. The country’s sovereign credit rating has been upgraded in recent months, although it has not yet reached “investment grade”. Further improvements in Turkey’s international capital market standing are to be anticipated, but in this context it is important that the subsequent lowering in long-term capital costs serves to stimulate long-term sustainable growth, and not get diverted into an unsustainable construction and consumer credit boom of the kind which we have just seen in some CEE peer countries.
Moody's Investors Service recently upgraded Turkey's government bond rating to Ba2 from Ba3, and the outlook was changed to stable from positive. An further upgrade from S&P’s, who raised Turkey's long-term foreign currency and local currency sovereign credit ratings to BB and BB+ in February, would not be a surprise. ." Among other comments of interest they said at the time they believed Turkey's banking system to be one of the strongest and least-leveraged in Eastern Europe and noted that local capital markets are continuing to develop, enabling the government to begin to place local currency debt at maturities as high as 10 years. Their decision to maintain a positive outlook on the rating is a reflection of the possibility of further upgrade over the next 12-24 months. Fitch’s last move was in 2009, when they rated Turkey BB+.
Moody's decision to only move Turkey up one notch was rather conservative, since for reasons best known to themselves the agency still rates Turkey one notch behind Egpyt, but it does reflect the way the agencies are, at least in Turkey’s case, rather behind the curve in comparison with the markets. Turkey CDS (in the 160 to 165 bp range) now consistently trade below higher rated counterparts such as Romania (BB+) and Hungary (BBB-, investment grade).
Turkey’s external debt ratios are still low (gross debt 43.4% of GDP, net debt 26.7%) and the country certainly does not have anything like the problems other emerging European countries have in terms of of the external liabilities of households and corporates. Thus they could live with a weaker currency and they have proven willingness to pay since they did so in 2000/01 when the temptation to restructure must have been very strong.
The principal obstacle to upgrades at the present time seems to be the shelving of the fiscal rule legislation, but matters may well change on this front after next years election.
Essentially, despite the fact that growth will slow somewhat in the second half of the year we still expect Turkey to be the fastest-growing economy in the region, with risks mostly centred on the external environment (growth in the EU, and global risk appetite) although evidently continuing domestic political stability such that consumer confidence is maintained is also critical, and it should be noted that confidence has slipped back in recent months. In this context the result of the recent referendum vote – which was solidly in favour of the government proposed reforms – augurs well for the future.
The outlook is then for growth in the 6 to 7 percent range in 2010, followed by a further 5 percent in 2011, especially with the likelihood of additional pre-election spending on the part of the government. Fixed capital investment should continue increase at a brisk pace in the second half of the year, buoyed in part by faster privatisation - Turkey’s state asset sales agency recently recieved 12 bids for a 36-year license to operate the Iskenderun port in southern Turkey. The port, one of the largest in Turkey, serves south and southeastern Turkey as well as Middle Eastern countries.
At the same time given the robust expansion in domestic consumption – bank credit to households is rising at a 40 percent annual rate – any slowing of demand for Turkish exports from Western Europe as fiscal tightening sets in will not have as much of a dampening effect on GDP gains as it will elsewhere in the region, although there will evidently be some impact. Despite pre-election spending we anticipate a somewhat lower growth rate due to base effects, tightening liquidity and an expectation that export conditions may well remain depressed.
Finally it should be stressed that the country needs to address the two major structural weaknesses which hinder growth. In the first place it needs to stem the loss of international price competitiveness which tends to occur during cyclical upswings, worsening the current account deficit. As growth strengthens, capital inflows gather pace, the exchange rate appreciates, and increases in minimum and average wages accelerate, leading the internal and external imbalances of the economy widen. To make lasting progress in breaking out of this cycle the inflation problem needs to be brought definitively under control via the utilisation of adequate and appropriate monetary and fiscal tools and the implementation of systematic labour market reforms. At the same time, the structurally low employment ratio needs to be corrected, in particular by ensuring improved labour market access for the country’s female population. Only in this way can the excessive dependency ratios be reduced, and the country’s saving ratio increased in a way which reduces dependence on external sources of funding.
Thursday, September 9, 2010
More New Things On Spain
National Bank of Greece plans €2.8bn fundraising
http://www.ft.com/cms/s/0/47bea202-bb22-11df-b3f4-00144feab49a.html
By Anousha Sakoui in London and Kerin Hope in Athens
Published: September 8 2010 09:44 | Last updated: September 8 2010 10:31
National Bank of Greece, the country’s largest bank, is planning to raise €2.8bn ($3.5bn) in new capital, in a move designed to bolster confidence in the Greek banking sector, according to bank officials.
News of the capital raising sent the bank’s shares off 9 per cent in early Wednesday trading, with other Greek banks also suffering – Alpha Bank’s shares were down 4 per cent.
Vassilios Rapanos, NBG chairman, told the Financial Times on Tuesday that the bank would raise €630m in a rights issue and another €1.18bn through a convertible bond issue with a maturity of seven days.
The issue comes amid an eight-month liquidity squeeze on Greek banks, which have been excluded from the wholesale banking market during the country’s sovereign debt crisis.
“This fundraising will give the bank one of the strongest capital adequacy ratios in Europe... it sends a message to shareholders and depositors alike that we can face the future with confidence,” Mr Rapanos said.
The plan is subject to board approval, but could be launched as early as next week. The share capital increase had been previously authorised and was fully underwritten.
On completion, NBG’s capital adequacy ratio would exceed 14 per cent, Mr Rapanos said. NBG plans to raise another €1bn early next year through a public offering of about 20 per cent of Finansbank, its wholly owned Turkish subsidiary, on the Istanbul stock exchange – a plan that has still to be approved by Turkish regulatory authorities.
Credit Suisse, Deutsche Bank, Goldman Sachs, Morgan Stanley and Greece’s state-controlled Postal Savings Bank are underwriting both issues.
The bank would use part of the funds to pay back a €358m capital injection from the Greek government made during the credit crunch. It could avoid drawing down funds from a €10bn bank stability fund set up by the European Union and International Monetary Fund as part of the €110bn bail-out package that enabled Greece to avert a sovereign default this year.
Spanish lenders hasten back to bonds
By Victor Mallet in Madrid
http://www.ft.com/cms/s/0/5eab8258-b9da-11df-8804-00144feabdc0.html?ftcamp=rss
Published: September 6 2010 19:16 | Last updated: September 6 2010 19:16
Spanish banks that were squeezed out of wholesale finance markets in May have returned in force with a series of bond issues since late July and raised more than $4bn in the first five days of September alone, according to company announcements and figures from Dealogic, the data provider.
But both bank executives and analysts say that recent issuance has been confined to the big five listed commercial banks and to La Caixa, the big Barcelona-based savings bank, and that the interest rate spread paid by even strong Spanish financial institutions remains relatively high.
Shunned by investors during the eurozone sovereign debt crisis, Spanish financial institutions issued no covered bonds – a previously popular form of financing secured on mortgage portfolios – in either May or June. Total debt issuance by Spanish banks fell to a negligible $2.3bn in May and $3.8bn in June, Dealogic said.
But since July the Spanish banks and savings banks have again been able to sell covered bonds to international investors. Total debt issuance reached $15.8bn in July, fell back to $1.7bn in the normally quiet holiday month of August, and accelerated again to top $4.1bn so far this month, including $2.5bn of covered bonds.
To add to the total, Santander, the biggest bank by market capitalisation in the eurozone, said it sold on Monday €1bn ($1.3bn) of three-year unsecured bonds at 145 basis points over the benchmark swap rate, amid brisk international demand
Other deals this month include €1bn of three-year covered bonds issued by La Caixa and another €1bn in two-year, mortgage-backed securities – double the initial plan – by Banco Sabadell.
Spanish bankers say they are relieved that wholesale finance markets – previously closed to all but the strongest banks such as Santander, and even then at prohibitively high rates of interest – are once again open.
“It’s a start,” said Iñigo Vega, a banks analyst at Iberian Equities in Madrid. “They are in the market again, which is a good sign. But it’s only six groups, which leaves 50 per cent of the system still out of the market.”
Big Spanish lenders such as Santander, BBVA and La Caixa are not only hogging the debt markets. They are also competing vigorously for domestic retail banking deposits by offering rates of interest to savers that their weaker rivals cannot afford.
In addition to raising medium-term debt, Spanish banks have also found it easier in recent weeks to access short-term liquidity, for example through “repo” transactions using Spanish government debt as security.
In this market too, however, the strongest banks are dominant, leaving weaker cajas, the unlisted savings banks, heavily dependent on the emergency liquidity provided by the European Central Bank.
Fears rise as EU nations aim to raise borrowing
By David Oakley, Capital Markets Correspondent
Published: September 5 2010 12:37 | Last updated: September 5 2010 20:16
http://www.ft.com/cms/s/0/abe5bf60-b8dc-11df-99be-00144feabdc0.html?ftcamp=rss
The eurozone debt crisis is about to enter a critical phase as governments prepare to step up borrowing in the capital markets to fund their faltering economies.
Some strategists are warning that some of the weaker economies could fail to raise the amount of money they need as eurozone governments attempt to issue double the amount of debt this month compared with August.
Eurozone governments will try to raise €80bn ($103bn) in September compared with new bond issuance of €43bn in August. Spain is expected to attempt to borrow €7bn in September compared with €3.5bn in August, according to ING Financial Markets.
Spain, Portugal and Ireland , so-called peripheral eurozone economies, are considered most in danger of being shunned by investors as worries persist over the health of their banks and economies. Greece is no longer a concern because it has emergency loans to cover its funding for the next two years.
Padhraic Garvey, head of rates strategy for developed markets at ING Financial Markets, said: “We are heading into a critical period as the chances rise that a government may fail to raise the money it needs.
“Spain, Portugal and Ireland are the obvious ones to worry about. Are investors willing to stay long, or buy the debt of these countries? I’m still not seeing investors willing to buy into the periphery.”
Some strategists say the return of most investors from holidays this week could increase volatility in these markets because many have put decisions on their portfolios on hold during the summer.
With most investors back at their desks, some could start selling peripheral debt in the coming weeks, particularly as the outlook for the global economy has deteriorated. In spite of some better than expected data out of the US last week, worries about a double-dip recession have increased.
But other strategists insist governments will have little difficulty in funding themselves, even if they have to pay higher premiums or yields to attract investors. They say countries such as Portugal and Ireland have already raised most of the money they need this year.
Government bond yields of the peripheral countries, however, may come under further selling pressure.
Yield spreads against Germany, the eurozone’s benchmark economy, could also widen. On Tuesday, Ireland saw the extra premium it has to pay over Germany jump to a record 356 basis points.
A double-dip recession would hit the economies of Spain, Portugal and Ireland particularly hard, although even core countries, such as France and Germany, could struggle to attract investors, say strategists.
In Europe’s Debt Crisis, Lending Was Still Strong
By JACK EWING
Published: September 5, 2010
http://www.nytimes.com/2010/09/06/business/global/06bi.html?_r=2&ref=business
Even as Europe’s sovereign debt crisis intensified early this year, banks continued to load up on debt from Greece and other countries with the most acute fiscal problems, according to a report released on Sunday.
The report suggests that the European Central Bank inadvertently encouraged institutions to increase their risk as it tried to stabilize the banking system.
Banks increased the amount of credit they extended to governments and the private sector in Greece, Ireland, Portugal and Spain by 4.3 percent, or $109 billion, in the first quarter of 2010 compared with the previous quarter, the quarterly report from the Bank for International Settlements said. The additional credit brought banks’ total exposure to those countries to $2.6 trillion. The Bank for International Settlements, in Basel, Switzerland, serves as a clearinghouse for the world’s central banks.
European banks increased their holdings to the four countries more than banks from the United States or other places outside of Europe, possibly because banks in the euro zone could use debt from Greece and the other countries as collateral for low-interest loans from the European Central Bank, the report said.
The European Central Bank has been lending euro zone banks as much as they want at 1 percent interest, provided the banks could provide collateral like government bonds. The liquidity has helped weaker banks survive periods when they were unable to borrow from other banks or outside investors.
The fact that higher-risk European debt was less liquid, or harder to sell quickly, “was less of a concern for euro area banks than for other banks since the former could ‘liquefy’ this debt in their operations with the E.C.B.,” the Bank for International Settlements said.
The data suggest that the European Central Bank was effectively encouraging euro zone banks to buy debt from Greece and the other troubled countries. The policy supported Greece and Spain as they sold new bonds but also meant that euro zone banks were taking on more risk at a time when the central bank had been trying to stabilize the European financial system.
The central bank has been trying to dial down its support for euro zone banks, but last week extended the policy of unlimited lending to banks at least through mid-January, amid signs that some institutions are still unable to raise all the money they need.
The central bank has tightened its criteria for the collateral. The bank now imposes so-called haircuts of as much as 29 percent on government debt used as collateral, meaning that banks cannot borrow at the full face value of the bonds. That policy could reduce the incentive for banks to buy the riskier debt.
German and French banks continued to be the most heavily exposed to debt from the countries on the periphery of the euro zone. French exposure to Greece alone was $111.6 billion, though only $27 billion of that was government debt. The rest was credit to Greek businesses and individuals, derivatives contracts or other categories. German banks’ exposure to Greece totaled $51 billion, of which $23.1 billion was government debt.
American banks hold $41.2 billion in debt or other exposure to Greece, the report said. Only $5.4 billion of that sum was government debt.
German banks were particularly exposed to Ireland, with total exposure of $205.8 billion, exceeded only by British banks, with $222.4 billion. Almost all the German credit to Ireland was in the private sector, the report said.
The Bank for International Settlements did not give any information on individual institutions, but Germany’s high exposure to Ireland probably stems at least in part from Hypo Real Estate, a bank in Munich. Hypo Real Estate’s subsidiary in Dublin suffered liquidity problems in late 2008. The German government now owns the bank.
Beware the Greeks, though not just yet
Posted by Cardiff Garcia on Sep 03 15:37.
http://ftalphaville.ft.com/blog/2010/09/03/333366/beware-the-greeks-though-not-just-yet/
Here’s an interesting chart ripped from the CFR Geo-Graphics blog:
http://blogs.cfr.org/geographics/2010/09/02/greek-debt-2/
Notice anything strange?
The European Stabilization Mechanism was announced on May 11, the date represented by the blue bar in the middle of each time-to-maturity listed. For maturities of one and two years, the market’s expectation for a default (represented by Greek-German spreads) remains lower than before the ESM was announced. For a three-year maturity, it’s roughly the same as before.
But if you go any further along the timeline, the market is now pricing in more risk than before the ESM came into play.
Why has the market increased its confidence in Greek short-term debt but reduced it for the long-term?
Some of this might be explained by a simple preference for long-term bunds driven by other factors, but CFR offers a less sanguine explanation (emphasis ours):
Greece will happily borrow from the ESM to avoid having to close its primary deficit (that is, excluding interest payments) too rapidly. Yet if Greece is successful in eliminating its primary deficit, its temptation to default will actually grow, as it can wipe out huge amounts of accumulated debt without any longer needing the financial markets to fund current expenditures. If faced with the choice between paying Greek debts and letting Greece default, its northern neighbors may, once their banks are on more solid footing, find it more attractive simply to let Greece default. This is the story line that the markets are now pricing into government bond spreads.
Oh dear.
Bond yields fall below 6%
Irish bond yields hovered below 6 per cent as the Government announced it would split Anglo Irish Bank into two separate entities.
The interest rate or yield on Government 10-year bonds fell back after the Government said Anglo would be divided into a funding bank and an asset recovery unit, which would be wound down over time.
At close, the yield on Irish bonds was 5.991 per cent, down from an earlier high of 6.047 per cent.
Earlier, credit-default swaps on Ireland rose 21 basis points to 402.5, surpassing a previous closing high of 396 in February 2009, according to data provider CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
Shares in Irish banks were also hit this afternoon, with Bank of Ireland closing at 70 cent, down about 3 per cent, having been off almost 7 per cent earlier in the session. AIB closed at 75.5 cent, down less than one cent.
Irish Life and Permanent fell 3.66 per cent to close at €1.63.
Credit-default swaps on the nation's banks also soared, with contracts on Anglo Irish Bank climbing 58.5 basis points to 774.5, the highest level since March 2009. AIB jumped 29.5 basis points to 521.5 and Bank of Ireland increased 21 basis points to 409, CMA prices show.
A basis point on a credit-default swap contract protecting €10 million of debt from default for five years is equivalent to €1,000 a year.
Minister for Finance Brian Lenihan and Taoiseach Brian Cowen have insisted the cost of dealing with the problems in Irish banks are manageable because they are spreading the costs out over 15 years and the State has no immediate funding requirements.
But analysts said they need to be more specific.
"They will have to put clarity on the language and clarity on the numbers. This business of saying it's manageable is not going to wash with the markets," said Alan McQuaid, economist with Bloxham Stockbrokers in Dublin.
"The market is saying, 'You are trying to juggle too many balls, you're weighed down by Anglo and you are not going to be able to generate enough economic growth and implement fiscal austerity and meet budget targets by 2014, it's just impossible,' that's what the market is telling you."
A senior member of German chancellor Angela Merkel's party said today that Ireland, Portugal and Spain probably won't need support from the euro zone rescue fund.
The €440 billion European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.
"I see - and Mr Regling stressed that as well in the past days - that the stabilisation fund is probably not going to be used," Leo Dautzenberg, parliamentary Finance Committee spokesman for Ms Merkel's Christian Democratic Union, said today in an interview.
In a speech in Riga, Ms Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won't agree to have the euro fund turned into a permanent facility to provide aid.
"The crisis mechanisms now in place are temporary," she said in the Latvian capital. "Germany won't agree to an indefinite prolongation. Otherwise, people would say 'we've got such a nice rescue package in place that this can go on forever.'"
http://www.ft.com/cms/s/0/47bea202-bb22-11df-b3f4-00144feab49a.html
By Anousha Sakoui in London and Kerin Hope in Athens
Published: September 8 2010 09:44 | Last updated: September 8 2010 10:31
National Bank of Greece, the country’s largest bank, is planning to raise €2.8bn ($3.5bn) in new capital, in a move designed to bolster confidence in the Greek banking sector, according to bank officials.
News of the capital raising sent the bank’s shares off 9 per cent in early Wednesday trading, with other Greek banks also suffering – Alpha Bank’s shares were down 4 per cent.
Vassilios Rapanos, NBG chairman, told the Financial Times on Tuesday that the bank would raise €630m in a rights issue and another €1.18bn through a convertible bond issue with a maturity of seven days.
The issue comes amid an eight-month liquidity squeeze on Greek banks, which have been excluded from the wholesale banking market during the country’s sovereign debt crisis.
“This fundraising will give the bank one of the strongest capital adequacy ratios in Europe... it sends a message to shareholders and depositors alike that we can face the future with confidence,” Mr Rapanos said.
The plan is subject to board approval, but could be launched as early as next week. The share capital increase had been previously authorised and was fully underwritten.
On completion, NBG’s capital adequacy ratio would exceed 14 per cent, Mr Rapanos said. NBG plans to raise another €1bn early next year through a public offering of about 20 per cent of Finansbank, its wholly owned Turkish subsidiary, on the Istanbul stock exchange – a plan that has still to be approved by Turkish regulatory authorities.
Credit Suisse, Deutsche Bank, Goldman Sachs, Morgan Stanley and Greece’s state-controlled Postal Savings Bank are underwriting both issues.
The bank would use part of the funds to pay back a €358m capital injection from the Greek government made during the credit crunch. It could avoid drawing down funds from a €10bn bank stability fund set up by the European Union and International Monetary Fund as part of the €110bn bail-out package that enabled Greece to avert a sovereign default this year.
Spanish lenders hasten back to bonds
By Victor Mallet in Madrid
http://www.ft.com/cms/s/0/5eab8258-b9da-11df-8804-00144feabdc0.html?ftcamp=rss
Published: September 6 2010 19:16 | Last updated: September 6 2010 19:16
Spanish banks that were squeezed out of wholesale finance markets in May have returned in force with a series of bond issues since late July and raised more than $4bn in the first five days of September alone, according to company announcements and figures from Dealogic, the data provider.
But both bank executives and analysts say that recent issuance has been confined to the big five listed commercial banks and to La Caixa, the big Barcelona-based savings bank, and that the interest rate spread paid by even strong Spanish financial institutions remains relatively high.
Shunned by investors during the eurozone sovereign debt crisis, Spanish financial institutions issued no covered bonds – a previously popular form of financing secured on mortgage portfolios – in either May or June. Total debt issuance by Spanish banks fell to a negligible $2.3bn in May and $3.8bn in June, Dealogic said.
But since July the Spanish banks and savings banks have again been able to sell covered bonds to international investors. Total debt issuance reached $15.8bn in July, fell back to $1.7bn in the normally quiet holiday month of August, and accelerated again to top $4.1bn so far this month, including $2.5bn of covered bonds.
To add to the total, Santander, the biggest bank by market capitalisation in the eurozone, said it sold on Monday €1bn ($1.3bn) of three-year unsecured bonds at 145 basis points over the benchmark swap rate, amid brisk international demand
Other deals this month include €1bn of three-year covered bonds issued by La Caixa and another €1bn in two-year, mortgage-backed securities – double the initial plan – by Banco Sabadell.
Spanish bankers say they are relieved that wholesale finance markets – previously closed to all but the strongest banks such as Santander, and even then at prohibitively high rates of interest – are once again open.
“It’s a start,” said Iñigo Vega, a banks analyst at Iberian Equities in Madrid. “They are in the market again, which is a good sign. But it’s only six groups, which leaves 50 per cent of the system still out of the market.”
Big Spanish lenders such as Santander, BBVA and La Caixa are not only hogging the debt markets. They are also competing vigorously for domestic retail banking deposits by offering rates of interest to savers that their weaker rivals cannot afford.
In addition to raising medium-term debt, Spanish banks have also found it easier in recent weeks to access short-term liquidity, for example through “repo” transactions using Spanish government debt as security.
In this market too, however, the strongest banks are dominant, leaving weaker cajas, the unlisted savings banks, heavily dependent on the emergency liquidity provided by the European Central Bank.
Fears rise as EU nations aim to raise borrowing
By David Oakley, Capital Markets Correspondent
Published: September 5 2010 12:37 | Last updated: September 5 2010 20:16
http://www.ft.com/cms/s/0/abe5bf60-b8dc-11df-99be-00144feabdc0.html?ftcamp=rss
The eurozone debt crisis is about to enter a critical phase as governments prepare to step up borrowing in the capital markets to fund their faltering economies.
Some strategists are warning that some of the weaker economies could fail to raise the amount of money they need as eurozone governments attempt to issue double the amount of debt this month compared with August.
Eurozone governments will try to raise €80bn ($103bn) in September compared with new bond issuance of €43bn in August. Spain is expected to attempt to borrow €7bn in September compared with €3.5bn in August, according to ING Financial Markets.
Spain, Portugal and Ireland , so-called peripheral eurozone economies, are considered most in danger of being shunned by investors as worries persist over the health of their banks and economies. Greece is no longer a concern because it has emergency loans to cover its funding for the next two years.
Padhraic Garvey, head of rates strategy for developed markets at ING Financial Markets, said: “We are heading into a critical period as the chances rise that a government may fail to raise the money it needs.
“Spain, Portugal and Ireland are the obvious ones to worry about. Are investors willing to stay long, or buy the debt of these countries? I’m still not seeing investors willing to buy into the periphery.”
Some strategists say the return of most investors from holidays this week could increase volatility in these markets because many have put decisions on their portfolios on hold during the summer.
With most investors back at their desks, some could start selling peripheral debt in the coming weeks, particularly as the outlook for the global economy has deteriorated. In spite of some better than expected data out of the US last week, worries about a double-dip recession have increased.
But other strategists insist governments will have little difficulty in funding themselves, even if they have to pay higher premiums or yields to attract investors. They say countries such as Portugal and Ireland have already raised most of the money they need this year.
Government bond yields of the peripheral countries, however, may come under further selling pressure.
Yield spreads against Germany, the eurozone’s benchmark economy, could also widen. On Tuesday, Ireland saw the extra premium it has to pay over Germany jump to a record 356 basis points.
A double-dip recession would hit the economies of Spain, Portugal and Ireland particularly hard, although even core countries, such as France and Germany, could struggle to attract investors, say strategists.
In Europe’s Debt Crisis, Lending Was Still Strong
By JACK EWING
Published: September 5, 2010
http://www.nytimes.com/2010/09/06/business/global/06bi.html?_r=2&ref=business
Even as Europe’s sovereign debt crisis intensified early this year, banks continued to load up on debt from Greece and other countries with the most acute fiscal problems, according to a report released on Sunday.
The report suggests that the European Central Bank inadvertently encouraged institutions to increase their risk as it tried to stabilize the banking system.
Banks increased the amount of credit they extended to governments and the private sector in Greece, Ireland, Portugal and Spain by 4.3 percent, or $109 billion, in the first quarter of 2010 compared with the previous quarter, the quarterly report from the Bank for International Settlements said. The additional credit brought banks’ total exposure to those countries to $2.6 trillion. The Bank for International Settlements, in Basel, Switzerland, serves as a clearinghouse for the world’s central banks.
European banks increased their holdings to the four countries more than banks from the United States or other places outside of Europe, possibly because banks in the euro zone could use debt from Greece and the other countries as collateral for low-interest loans from the European Central Bank, the report said.
The European Central Bank has been lending euro zone banks as much as they want at 1 percent interest, provided the banks could provide collateral like government bonds. The liquidity has helped weaker banks survive periods when they were unable to borrow from other banks or outside investors.
The fact that higher-risk European debt was less liquid, or harder to sell quickly, “was less of a concern for euro area banks than for other banks since the former could ‘liquefy’ this debt in their operations with the E.C.B.,” the Bank for International Settlements said.
The data suggest that the European Central Bank was effectively encouraging euro zone banks to buy debt from Greece and the other troubled countries. The policy supported Greece and Spain as they sold new bonds but also meant that euro zone banks were taking on more risk at a time when the central bank had been trying to stabilize the European financial system.
The central bank has been trying to dial down its support for euro zone banks, but last week extended the policy of unlimited lending to banks at least through mid-January, amid signs that some institutions are still unable to raise all the money they need.
The central bank has tightened its criteria for the collateral. The bank now imposes so-called haircuts of as much as 29 percent on government debt used as collateral, meaning that banks cannot borrow at the full face value of the bonds. That policy could reduce the incentive for banks to buy the riskier debt.
German and French banks continued to be the most heavily exposed to debt from the countries on the periphery of the euro zone. French exposure to Greece alone was $111.6 billion, though only $27 billion of that was government debt. The rest was credit to Greek businesses and individuals, derivatives contracts or other categories. German banks’ exposure to Greece totaled $51 billion, of which $23.1 billion was government debt.
American banks hold $41.2 billion in debt or other exposure to Greece, the report said. Only $5.4 billion of that sum was government debt.
German banks were particularly exposed to Ireland, with total exposure of $205.8 billion, exceeded only by British banks, with $222.4 billion. Almost all the German credit to Ireland was in the private sector, the report said.
The Bank for International Settlements did not give any information on individual institutions, but Germany’s high exposure to Ireland probably stems at least in part from Hypo Real Estate, a bank in Munich. Hypo Real Estate’s subsidiary in Dublin suffered liquidity problems in late 2008. The German government now owns the bank.
Beware the Greeks, though not just yet
Posted by Cardiff Garcia on Sep 03 15:37.
http://ftalphaville.ft.com/blog/2010/09/03/333366/beware-the-greeks-though-not-just-yet/
Here’s an interesting chart ripped from the CFR Geo-Graphics blog:
http://blogs.cfr.org/geographics/2010/09/02/greek-debt-2/
Notice anything strange?
The European Stabilization Mechanism was announced on May 11, the date represented by the blue bar in the middle of each time-to-maturity listed. For maturities of one and two years, the market’s expectation for a default (represented by Greek-German spreads) remains lower than before the ESM was announced. For a three-year maturity, it’s roughly the same as before.
But if you go any further along the timeline, the market is now pricing in more risk than before the ESM came into play.
Why has the market increased its confidence in Greek short-term debt but reduced it for the long-term?
Some of this might be explained by a simple preference for long-term bunds driven by other factors, but CFR offers a less sanguine explanation (emphasis ours):
Greece will happily borrow from the ESM to avoid having to close its primary deficit (that is, excluding interest payments) too rapidly. Yet if Greece is successful in eliminating its primary deficit, its temptation to default will actually grow, as it can wipe out huge amounts of accumulated debt without any longer needing the financial markets to fund current expenditures. If faced with the choice between paying Greek debts and letting Greece default, its northern neighbors may, once their banks are on more solid footing, find it more attractive simply to let Greece default. This is the story line that the markets are now pricing into government bond spreads.
Oh dear.
Bond yields fall below 6%
Irish bond yields hovered below 6 per cent as the Government announced it would split Anglo Irish Bank into two separate entities.
The interest rate or yield on Government 10-year bonds fell back after the Government said Anglo would be divided into a funding bank and an asset recovery unit, which would be wound down over time.
At close, the yield on Irish bonds was 5.991 per cent, down from an earlier high of 6.047 per cent.
Earlier, credit-default swaps on Ireland rose 21 basis points to 402.5, surpassing a previous closing high of 396 in February 2009, according to data provider CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
Shares in Irish banks were also hit this afternoon, with Bank of Ireland closing at 70 cent, down about 3 per cent, having been off almost 7 per cent earlier in the session. AIB closed at 75.5 cent, down less than one cent.
Irish Life and Permanent fell 3.66 per cent to close at €1.63.
Credit-default swaps on the nation's banks also soared, with contracts on Anglo Irish Bank climbing 58.5 basis points to 774.5, the highest level since March 2009. AIB jumped 29.5 basis points to 521.5 and Bank of Ireland increased 21 basis points to 409, CMA prices show.
A basis point on a credit-default swap contract protecting €10 million of debt from default for five years is equivalent to €1,000 a year.
Minister for Finance Brian Lenihan and Taoiseach Brian Cowen have insisted the cost of dealing with the problems in Irish banks are manageable because they are spreading the costs out over 15 years and the State has no immediate funding requirements.
But analysts said they need to be more specific.
"They will have to put clarity on the language and clarity on the numbers. This business of saying it's manageable is not going to wash with the markets," said Alan McQuaid, economist with Bloxham Stockbrokers in Dublin.
"The market is saying, 'You are trying to juggle too many balls, you're weighed down by Anglo and you are not going to be able to generate enough economic growth and implement fiscal austerity and meet budget targets by 2014, it's just impossible,' that's what the market is telling you."
A senior member of German chancellor Angela Merkel's party said today that Ireland, Portugal and Spain probably won't need support from the euro zone rescue fund.
The €440 billion European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.
"I see - and Mr Regling stressed that as well in the past days - that the stabilisation fund is probably not going to be used," Leo Dautzenberg, parliamentary Finance Committee spokesman for Ms Merkel's Christian Democratic Union, said today in an interview.
In a speech in Riga, Ms Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won't agree to have the euro fund turned into a permanent facility to provide aid.
"The crisis mechanisms now in place are temporary," she said in the Latvian capital. "Germany won't agree to an indefinite prolongation. Otherwise, people would say 'we've got such a nice rescue package in place that this can go on forever.'"
Wednesday, September 8, 2010
New and Things
Fall in German exports signals slower growth
By Ralph Atkins
http://www.ft.com/cms/s/0/e6a6e508-bb1a-11df-b3f4-00144feab49a.html
Published: September 8 2010 09:32 | Last updated: September 8 2010 09:32
German exports fell in July in the latest sign that growth in Europe’s largest economy is slowing.
News of the 1.5 per cent decline on the previous month, reported by the German statistical office, followed figures earlier this week that showed growth in industrial orders had also cooled more than expected in July.
They added to evidence that after a strong growth spurt in the three months to June, the pace of expansion would moderate over the rest of the year.
Exports powered Germany’s climb out of last year’s deep recession, buoyed especially by demand from China, for instance for luxury German-made cars. Despite the latest month-on-month decline, German exports in July were almost 19 per cent higher than a year before.
Even if German growth slows over the rest of the year, economists generally do not expect a double-dip back into recession. Although worries have grown about the outlook for the US economy, demand for German exports from Asia is expected to remain robust.
Germany’s recovery had also broadened beyond exports. The figures showed imports had risen faster over the past year. In July, imports were almost 25 per cent higher than a year before, although compared with the month before they were down 2.2 per cent. The year-on-year increase was probably the result of a surge in goods and materials imported to manufacture products that were then exported, but it could also have reflected a pick-up in domestic demand.
Germany’s economy will feel the impact of fiscal austerity programmes across the eurozone, compounded by the weakness of the southern European economies worst hit by this year’s crisis over public finances.
But Carsten Brzeski, economist at ING in Brussels, pointed out that Spain, Portugal, Greece and Ireland accounted for only about 5 per cent of German exports in the first half of this year. “German exports are now normalising,” he said, but “even at a slower pace, the export sector should remain an important growth driver”.
ECB steps up eurozone bond buying
By David Oakley and Jennifer Hughes in London and Kerin Hope in Athens
Published: September 8 2010 19:30 | Last updated: September 8 2010 19:30
The European Central Bank has stepped in to shore up the eurozone government bond markets in what appears to be its biggest such intervention since early July. The ECB has bought between €100m and €300m of Greek, Irish and Portuguese bonds so far this week, traders said on Wednesday, as worries over the health of some highly indebted eurozone economies resurfaced.
Yields on Greek bonds rose to levels last seen before the €750bn emergency rescue package was launched to avert the collapse of the eurozone bond markets in May.
Although the amount of bonds bought by the ECB this week has been small, some strategists said the purchases were a sign that the European sovereign debt crisis was not over.
The ECB has bought €61bn in government bonds – mostly of the weaker eurozone economies of Greece, Ireland and Portugal – since it launched its intervention programme on May 10 as part of the multibillion-euro international bailout.
It bought €16.5bn in bonds in the first week of the programme but has since scaled back its buying. In recent weeks, as the eurozone crisis appears to have eased, it has bought only very small amounts of government debt.
The so-called peripheral bond markets of Greece, Ireland and Portugal have come under pressure as doubts over their economies and banks have deepened.
Greek yields for two-year bonds jumped nearly a quarter of a point on Wednesday to 10.33 per cent, while Irish yields edged slightly higher to 3.21 per cent. Portuguese two-year yields were flat at 3.28 per cent.
Portuguese auctions of three-year and 11-year bonds were well subscribed, although traders said the government had to pay high yields to attract investors.
Market confidence in Greece was hit by numbers showing that the country sank deeper into recession in the second quarter and fears that street protests were about to resume.
Domenico Crapanzano, head of euro rates sales and trading at Jefferies, said: “Hopes that the eurozone debt crisis had seen the worst are premature. It is far from over.”
Steven Major, head of global fixed-income research at HSBC, said: “Many investors are still reluctant to buy the bonds of the weaker eurozone economies, even at very high yields.” Across the eurozone as a whole, one of the biggest concerns has been the state of the European banking sector, in Germany as well as in the weaker economies.
The Basel Committee on Banking Supervision and the Group of Governors and Heads of Supervision, are set to finalise on Sunday banks’ minimum level of so-called tier one capital.
ECB: Bank Rules Will Be Eased In
http://online.wsj.com/article/SB10001424052748703453804575479040076363192.html?mod=WSJEUROPE_hpp_LEFTTopWhatNews
FRANKFURT—Tighter standards for banks' capital and liquidity won't hurt the economy, European Central Bank governing council member Axel Weber said Wednesday.
Mr. Weber told a banking conference the lengthy transition phase foreseen by international regulators working on the new requirements, known as Basel III, will help to ensure that banks don't find themselves too overburdened and unable to lend.
"The real challenge lies in bringing harmonized international rules into line with differing national circumstances," Mr. Weber said.
He said the aim of greater systemic stability wasn't an end in itself, and that the economic costs of the 2007 to 2008 banking crisis had been immense.
German regulators had expressed reservations about the preliminary agreement reached by international regulators in July on new standards for bank capital and liquidity. The Bank for International Settlements' committee of Governors and Heads of Supervision intends to agree a more detailed version of the requirements next week.
Europe's Bank Stress Tests Minimized Debt Risk
http://online.wsj.com/article/SB10001424052748704392104575475520949440394.html
LONDON—Europe's recent "stress tests" of the strength of major banks understated some lenders' holdings of potentially risky government debt, a Wall Street Journal analysis shows.
As part of the tests, 91 of Europe's largest banks were required to reveal how much government debt from European countries they held on their balance sheets. Regulators said the figures showed banks' total holdings of that debt as of March 31.
At the time, worries about banks' government-debt holdings were fanning fears about the health of Europe's banking system as a whole. Release of the bank data was considered the main benefit of the stress tests, which were widely criticized as being lenient overall.
An examination of the banks' disclosures indicates that some banks didn't provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for "short" positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.
Because of the limited nature of most banks' disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.
But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests' reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks' own financial statements.
The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe's financial system. "That would certainly be unhelpful to people's perceptions" of the tests' credibility, said UBS banking analyst Alastair Ryan. Reducing banks' reported holdings of government debt "was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there's not a problem."
Representatives of several banks said they were simply following the guidance provided by the Committee of European Banking Supervisors, the London-based group that coordinated the tests. A CEBS spokeswoman declined to comment.
The stress tests' upbeat results—only seven banks flunked, and were deemed short of just €3.5 billion ($4.51 billion) of capital—initially soothed markets. But fears have flared up again as heavily indebted countries like Ireland and Greece continue to struggle. Among other warning signs, the costs of insuring many bank and government bonds against default in countries such as Portugal, Ireland, Greece and Italy have jumped above their pre-stress-test levels.
There's no established protocol for how banks should report these holdings. Until recently, investors generally didn't worry about government-debt holdings, viewing them as essentially risk-free. So most banks simply lumped the holdings into broader asset categories on balance sheets.
Things changed last spring as fears of government defaults intensified. Greece for a time appeared poised to default on its public debts, until a massive European Union bailout defused that crisis.
The banks based their stress-test disclosures on a template provided by CEBS. The template asked for banks to disclose their "gross" and "net" exposures to sovereign risk in each E.U. country. Most banks' disclosures didn't define "gross" and "net" beyond saying that the latter were "net of collateral held and hedges."
The implication was that the disclosures—particularly the gross exposure figures—were all-encompassing. In a document it published along with the test results, CEBS said "the disclosure of total exposures to sovereign debt by individual banks allows for a full assessment of their respective capital positions."
But some banks' figures didn't represent their total holdings. Barclays, for example, excluded some government bonds it was holding for trading purposes. The rationale, according to Barclays officials, was that the bonds were directly related to transactions the big U.K. bank was performing for corporate or government clients, and that the holdings vary widely from day to day. Barclays didn't disclose that it wasn't listing its full holdings.
Excluding the bonds reduced Barclays' portfolio of Italian sovereign debt—which the bank said was £787 million ($1.22 billion)—by about £4.7 billion, Barclays officials said. The bank's holdings of Spanish government bonds, listed at £4.4 billion, shrank by about £1.6 billion.
Barclays said it excluded the holdings based on guidance from CEBS, which was communicated to the bank via the U.K.'s Financial Services Authority. "We've done exactly what CEBS told us," a Barclays spokesman said.
An FSA spokeswoman declined to comment.
The Barclays officials said they believe other big European banks also excluded significant slices of their trading portfolios from stress-test disclosures.
In its midyear results last month, Barclays reported its sovereign-bond portfolios based on a broader definition than the stress tests used. As a result, Barclays' reported holdings of debt issued by the Italian, Spanish and Irish governments swelled.
Other banking companies excluded bonds held by subsidiaries. France's Crédit Agricole didn't count sovereign debt held by its insurance unit. A Crédit Agricole spokeswoman said the company followed guidance from regulators.
Some banks' figures also were whittled down by accounting for "short" positions they held in various countries' debt. For example, if a bank held €100 million of Greek debt and €25 million of short positions in Greek debt, the gross figure was listed as €75 million.
CEBS didn't disclose that the banks were calculating the figures in that way.
It was unclear how much that practice reduced the gross exposures that banks reported. A few banks, including Barclays, opted to provide investors with more comprehensive figures—in which short positions were not netted out—as part of their midyear results.
There are other signs that banks' disclosures understated the actual government-debt exposure in the European banking system. Jacques Cailloux, chief European economist at Royal Bank of Scotland, compared banks' stress-test disclosures with figures compiled by the Bank for International Settlements. His conclusion: The BIS data shows banks in some countries holding far more sovereign debt than was picked up in the stress tests.
BIS data from March 31 indicates that French banks were holding about €20 billion of Greek sovereign debt and €35 billion of Spanish sovereign debt. In the stress tests, four French banks, which represent nearly 80% of the assets in France's banking system, reported holding a total of €11.6 billion of Greek government debt and €6.6 billion of Spanish debt.
Spanish Bonds
Investors are putting European governments under renewed scrutiny. The extra yield that investors demand to hold Spanish 10-year debt over German bunds has surged 36 basis points since July 27, touching 185 points yesterday. It hit a euro-era high of 221 points on June 16.
The spreads on Irish and Portuguese debt this week climbed to 373 basis points and 354 basis points respectively, the highest since at least 1997. In Belgium, which still doesn’t have a government 2 1/2 months after inconclusive elections, the spread on its 10-year bonds was the highest since July.
On the budget, Zapatero’s room for maneuver has narrowed since August, when borrowing costs were falling so fast that he said the government could reverse some spending cuts. The spread widened 35 basis points in the four days after his comments.
Portugal's borrowing costs jump in bond sale
By BARRY HATTON
http://www.businessweek.com/ap/financialnews/D9I3N4VO0.htm
LISBON, Portugal
Portugal raised euro1.04 billion ($1.3 billion) in a debt auction Wednesday that drew strong investor interest, but the sharply higher borrowing cost reflected market concerns that Europe's debt crisis may be flaring up again.
Portugal, which in recent years has generated little wealth and piled up heavy debts, is regarded as one of the most financially vulnerable countries in the 16-nation eurozone.
Portugal's Public Debt Management Agency said it sold euro378 million in 11-year bonds and euro661 million in 3-year bonds. However, the average interest yield on the longer bonds was 5.973 percent, up from 5.312 percent on 10-year bonds at an auction last month. The 3-year bond yield was 4.086 percent, up from 3.62 percent in a 4-year bond auction in July.
"Portugal is seen to some extent as the eurozone's weakest link" after Greece and Ireland, said Filipe Silva, a debt manager at Banco Carregosa in Porto, Portugal. "Investors are ready to take a risk but they will only do it at a higher price."
Portugal's financial difficulties could aggravate international fears about the continent's broader financial problems.
The Wall Street Journal reported on Tuesday that EU stress tests of 91 banks in July understated some of their holdings of potentially risky debt. That fueled market concerns about underlying weaknesses in the bloc and wider fears about the strength of the global economic recovery.
Despite its fragile economy Portugal has had no difficulty raising funds on international markets this year, and the agency said there was demand for more than twice the amount available. But the success has come at the price of steadily rising borrowing costs.
Moody's Investor Service in July downgraded Portuguese bonds to A1 from Aa2, citing sluggish growth prospects.
Portugal, along with Spain and Ireland, is widely seen as a potential candidate for a bailout like the one provided to Greece to keep it from defaulting on its debts.
That has pushed up the government's borrowing costs just as it is trying to cut spending.
The center-left Socialist government has adopted an austerity plan which seeks to reduce to budget deficit to 7.3 percent this year from 9.3 percent in 2009.
Its record has been patchy so far. The Finance Ministry reported last month that although tax revenue this year was up almost 6 percent through July, primary current spending also jumped 5.7 percent. The increase stemmed from larger welfare payouts amid a jobless rate that has risen to 11 percent, according to EU figures.
Ireland, Portugal Probably Won't Tap EU Fund, Coalition's Dautzenberg Says
http://www.bloomberg.com/news/2010-09-08/ireland-portugal-probably-won-t-tap-eu-fund-coalition-s-dautzenberg-says.html
Portugal, Spain and Ireland, all of which saw their bond-yield spreads over Germany rise this week, probably won’t need support from the euro-region rescue fund, a senior lawmaker from Chancellor Angela Merkel’s party said.
The Luxembourg-based 440 billion-euro ($558 billion) European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.
“I see -- and Mr. Regling stressed that as well in the past days -- that the stabilization fund is probably not going to be used,” Leo Dautzenberg, parliamentary Finance Committee spokesman for Merkel’s Christian Democratic Union, said today in an interview.
Irish and Portuguese government bonds fell yesterday, pushing the yields on 10-year securities to records versus benchmark German bunds. In a speech in Riga the same day, Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won’t agree to have the euro fund turned into a permanent facility to provide aid.
“The crisis mechanisms now in place are temporary,” Merkel said in the Latvian capital. “Germany won’t agree to an indefinite prolongation. Otherwise, people would say ‘we’ve got such a nice rescue package in place that this can go on forever.’”
European central banks bought Greek, Irish and Portuguese bonds today, according to a trader involved in the transactions, as the securities’ premiums to German debt surged for a third day.
The Portuguese-German 10-year bond spread widened as much as 18 basis points to 372 basis points today, and was at 363 points as of 12:23 p.m. in London. The Irish-German spread was 8 basis points wider at 381 basis points.
The rescue fund, which is limited to three years, is the main part of a 750 billion-euro aid package hammered out by European Union finance ministers to combat a sovereign debt crisis. Another 60 billion euros will come from the commission - - the EU’s executive arm -- and 250 billion euros from the International Monetary Fund.
ECB chief needs to be much bolder
http://www.irishtimes.com/newspaper/finance/2010/0908/1224278447559.html
ANALYSIS : Trichet has the power to calm market fears – he should exercise it, writes DAN O'BRIEN, Economics Editor
IF THE massive rescue package agreed by the European countries in early May was about calming market fears, it is clearly not working.
Yesterday’s developments in the government debt market saw yields on Irish government bonds soar past the peaks reached at the height of the crisis in late April and early May. Other peripheral countries also experienced big increases. This is alarming.
The EU rescue package brought the situation back from the brink in May, but within weeks, yields on the weaker countries’ debt began to rise, sometime in leaps, sometimes in baby steps, but almost always in a ratchet-like fashion.
Apart from Greece, Ireland and Portugal have been the most seriously affected. Spain is in the firing line, but to a lesser extent.
The latest ratcheting up of yields for the peripheral euro-area countries appears to have been caused by a number of factors, including a continued weakening of sentiment towards Ireland. Negative comments on European banks in the Wall Street Journal and a downgrading of AIB and Bank of Ireland by Dublin stockbrokers Davys added to fears yesterday.
The euro area can be likened to 16 climbers roped together on a mountain in appalling weather conditions. Greece has gone over the edge. The other 15 can easily take the strain of keeping the Greeks dangling, however uncomfortable it may be for them. Ireland is now closest to the edge, and moved even closer yesterday. Just behind it is Portugal, and a good bit further back is Spain. If all three go over, 12 countries will be supporting four, something that the May bailout package anticipates as a worst-case scenario.
Thankfully, the mountaineering metaphor is less applicable since the European Central Bank was given new powers as part of the rescue package in May. These powers allow it to go into the market where government bonds are traded and, using the money it prints, buy up bonds.
There is, in theory, no limit to the amount it can print. This means there is no limit to the amount it can buy. This is a formidable weapon. It has been timid in deploying it.
Whereas it bought tens of billions worth of bonds in the weeks after it was first given this power, in July and August it effectively ceased doing so. Over the past three weeks, it has been more active, buying more than €650 million worth. But this is a small amount relative to the size of the market, and it has clearly not stemmed the panic.
The future of the euro is not in question yet, but if the slide is allowed to continue, it could be.
This is now the European sovereign debt crisis, Mark II. Jean Claude Trichet needs to be much bolder. He has the power to calm the panic. He should exercise it.
Also.....
Credit default swaps (CDS) for Portugal, Spain, Italy, and Belgium have all surged this week. Markit's stress gauge for the group is now higher than during the debt crisis, when the EU launched its €440bn bail-out fund and the European Central Bank began buying eurozone bonds.
Joachim Fels, chief global economist at Morgan Stanley, said strains had reached a point where "one or several governments" may soon have to tap soon the rescue mechanism.
"Neither the European sovereign debt crisis nor the banking sector crisis has been resolved and both continue to mutually reinforce each other," he said, adding that the EU's stress tests for banks had failed to restore confidence.
Investors are bracing for a flood of fresh bond issuance, while concern is mounting that austerity measures in Ireland, Greece, and Spain have left these countries trapped in a downward spiral.
By Ralph Atkins
http://www.ft.com/cms/s/0/e6a6e508-bb1a-11df-b3f4-00144feab49a.html
Published: September 8 2010 09:32 | Last updated: September 8 2010 09:32
German exports fell in July in the latest sign that growth in Europe’s largest economy is slowing.
News of the 1.5 per cent decline on the previous month, reported by the German statistical office, followed figures earlier this week that showed growth in industrial orders had also cooled more than expected in July.
They added to evidence that after a strong growth spurt in the three months to June, the pace of expansion would moderate over the rest of the year.
Exports powered Germany’s climb out of last year’s deep recession, buoyed especially by demand from China, for instance for luxury German-made cars. Despite the latest month-on-month decline, German exports in July were almost 19 per cent higher than a year before.
Even if German growth slows over the rest of the year, economists generally do not expect a double-dip back into recession. Although worries have grown about the outlook for the US economy, demand for German exports from Asia is expected to remain robust.
Germany’s recovery had also broadened beyond exports. The figures showed imports had risen faster over the past year. In July, imports were almost 25 per cent higher than a year before, although compared with the month before they were down 2.2 per cent. The year-on-year increase was probably the result of a surge in goods and materials imported to manufacture products that were then exported, but it could also have reflected a pick-up in domestic demand.
Germany’s economy will feel the impact of fiscal austerity programmes across the eurozone, compounded by the weakness of the southern European economies worst hit by this year’s crisis over public finances.
But Carsten Brzeski, economist at ING in Brussels, pointed out that Spain, Portugal, Greece and Ireland accounted for only about 5 per cent of German exports in the first half of this year. “German exports are now normalising,” he said, but “even at a slower pace, the export sector should remain an important growth driver”.
ECB steps up eurozone bond buying
By David Oakley and Jennifer Hughes in London and Kerin Hope in Athens
Published: September 8 2010 19:30 | Last updated: September 8 2010 19:30
The European Central Bank has stepped in to shore up the eurozone government bond markets in what appears to be its biggest such intervention since early July. The ECB has bought between €100m and €300m of Greek, Irish and Portuguese bonds so far this week, traders said on Wednesday, as worries over the health of some highly indebted eurozone economies resurfaced.
Yields on Greek bonds rose to levels last seen before the €750bn emergency rescue package was launched to avert the collapse of the eurozone bond markets in May.
Although the amount of bonds bought by the ECB this week has been small, some strategists said the purchases were a sign that the European sovereign debt crisis was not over.
The ECB has bought €61bn in government bonds – mostly of the weaker eurozone economies of Greece, Ireland and Portugal – since it launched its intervention programme on May 10 as part of the multibillion-euro international bailout.
It bought €16.5bn in bonds in the first week of the programme but has since scaled back its buying. In recent weeks, as the eurozone crisis appears to have eased, it has bought only very small amounts of government debt.
The so-called peripheral bond markets of Greece, Ireland and Portugal have come under pressure as doubts over their economies and banks have deepened.
Greek yields for two-year bonds jumped nearly a quarter of a point on Wednesday to 10.33 per cent, while Irish yields edged slightly higher to 3.21 per cent. Portuguese two-year yields were flat at 3.28 per cent.
Portuguese auctions of three-year and 11-year bonds were well subscribed, although traders said the government had to pay high yields to attract investors.
Market confidence in Greece was hit by numbers showing that the country sank deeper into recession in the second quarter and fears that street protests were about to resume.
Domenico Crapanzano, head of euro rates sales and trading at Jefferies, said: “Hopes that the eurozone debt crisis had seen the worst are premature. It is far from over.”
Steven Major, head of global fixed-income research at HSBC, said: “Many investors are still reluctant to buy the bonds of the weaker eurozone economies, even at very high yields.” Across the eurozone as a whole, one of the biggest concerns has been the state of the European banking sector, in Germany as well as in the weaker economies.
The Basel Committee on Banking Supervision and the Group of Governors and Heads of Supervision, are set to finalise on Sunday banks’ minimum level of so-called tier one capital.
ECB: Bank Rules Will Be Eased In
http://online.wsj.com/article/SB10001424052748703453804575479040076363192.html?mod=WSJEUROPE_hpp_LEFTTopWhatNews
FRANKFURT—Tighter standards for banks' capital and liquidity won't hurt the economy, European Central Bank governing council member Axel Weber said Wednesday.
Mr. Weber told a banking conference the lengthy transition phase foreseen by international regulators working on the new requirements, known as Basel III, will help to ensure that banks don't find themselves too overburdened and unable to lend.
"The real challenge lies in bringing harmonized international rules into line with differing national circumstances," Mr. Weber said.
He said the aim of greater systemic stability wasn't an end in itself, and that the economic costs of the 2007 to 2008 banking crisis had been immense.
German regulators had expressed reservations about the preliminary agreement reached by international regulators in July on new standards for bank capital and liquidity. The Bank for International Settlements' committee of Governors and Heads of Supervision intends to agree a more detailed version of the requirements next week.
Europe's Bank Stress Tests Minimized Debt Risk
http://online.wsj.com/article/SB10001424052748704392104575475520949440394.html
LONDON—Europe's recent "stress tests" of the strength of major banks understated some lenders' holdings of potentially risky government debt, a Wall Street Journal analysis shows.
As part of the tests, 91 of Europe's largest banks were required to reveal how much government debt from European countries they held on their balance sheets. Regulators said the figures showed banks' total holdings of that debt as of March 31.
At the time, worries about banks' government-debt holdings were fanning fears about the health of Europe's banking system as a whole. Release of the bank data was considered the main benefit of the stress tests, which were widely criticized as being lenient overall.
An examination of the banks' disclosures indicates that some banks didn't provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for "short" positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.
Because of the limited nature of most banks' disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.
But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests' reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks' own financial statements.
The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe's financial system. "That would certainly be unhelpful to people's perceptions" of the tests' credibility, said UBS banking analyst Alastair Ryan. Reducing banks' reported holdings of government debt "was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there's not a problem."
Representatives of several banks said they were simply following the guidance provided by the Committee of European Banking Supervisors, the London-based group that coordinated the tests. A CEBS spokeswoman declined to comment.
The stress tests' upbeat results—only seven banks flunked, and were deemed short of just €3.5 billion ($4.51 billion) of capital—initially soothed markets. But fears have flared up again as heavily indebted countries like Ireland and Greece continue to struggle. Among other warning signs, the costs of insuring many bank and government bonds against default in countries such as Portugal, Ireland, Greece and Italy have jumped above their pre-stress-test levels.
There's no established protocol for how banks should report these holdings. Until recently, investors generally didn't worry about government-debt holdings, viewing them as essentially risk-free. So most banks simply lumped the holdings into broader asset categories on balance sheets.
Things changed last spring as fears of government defaults intensified. Greece for a time appeared poised to default on its public debts, until a massive European Union bailout defused that crisis.
The banks based their stress-test disclosures on a template provided by CEBS. The template asked for banks to disclose their "gross" and "net" exposures to sovereign risk in each E.U. country. Most banks' disclosures didn't define "gross" and "net" beyond saying that the latter were "net of collateral held and hedges."
The implication was that the disclosures—particularly the gross exposure figures—were all-encompassing. In a document it published along with the test results, CEBS said "the disclosure of total exposures to sovereign debt by individual banks allows for a full assessment of their respective capital positions."
But some banks' figures didn't represent their total holdings. Barclays, for example, excluded some government bonds it was holding for trading purposes. The rationale, according to Barclays officials, was that the bonds were directly related to transactions the big U.K. bank was performing for corporate or government clients, and that the holdings vary widely from day to day. Barclays didn't disclose that it wasn't listing its full holdings.
Excluding the bonds reduced Barclays' portfolio of Italian sovereign debt—which the bank said was £787 million ($1.22 billion)—by about £4.7 billion, Barclays officials said. The bank's holdings of Spanish government bonds, listed at £4.4 billion, shrank by about £1.6 billion.
Barclays said it excluded the holdings based on guidance from CEBS, which was communicated to the bank via the U.K.'s Financial Services Authority. "We've done exactly what CEBS told us," a Barclays spokesman said.
An FSA spokeswoman declined to comment.
The Barclays officials said they believe other big European banks also excluded significant slices of their trading portfolios from stress-test disclosures.
In its midyear results last month, Barclays reported its sovereign-bond portfolios based on a broader definition than the stress tests used. As a result, Barclays' reported holdings of debt issued by the Italian, Spanish and Irish governments swelled.
Other banking companies excluded bonds held by subsidiaries. France's Crédit Agricole didn't count sovereign debt held by its insurance unit. A Crédit Agricole spokeswoman said the company followed guidance from regulators.
Some banks' figures also were whittled down by accounting for "short" positions they held in various countries' debt. For example, if a bank held €100 million of Greek debt and €25 million of short positions in Greek debt, the gross figure was listed as €75 million.
CEBS didn't disclose that the banks were calculating the figures in that way.
It was unclear how much that practice reduced the gross exposures that banks reported. A few banks, including Barclays, opted to provide investors with more comprehensive figures—in which short positions were not netted out—as part of their midyear results.
There are other signs that banks' disclosures understated the actual government-debt exposure in the European banking system. Jacques Cailloux, chief European economist at Royal Bank of Scotland, compared banks' stress-test disclosures with figures compiled by the Bank for International Settlements. His conclusion: The BIS data shows banks in some countries holding far more sovereign debt than was picked up in the stress tests.
BIS data from March 31 indicates that French banks were holding about €20 billion of Greek sovereign debt and €35 billion of Spanish sovereign debt. In the stress tests, four French banks, which represent nearly 80% of the assets in France's banking system, reported holding a total of €11.6 billion of Greek government debt and €6.6 billion of Spanish debt.
Spanish Bonds
Investors are putting European governments under renewed scrutiny. The extra yield that investors demand to hold Spanish 10-year debt over German bunds has surged 36 basis points since July 27, touching 185 points yesterday. It hit a euro-era high of 221 points on June 16.
The spreads on Irish and Portuguese debt this week climbed to 373 basis points and 354 basis points respectively, the highest since at least 1997. In Belgium, which still doesn’t have a government 2 1/2 months after inconclusive elections, the spread on its 10-year bonds was the highest since July.
On the budget, Zapatero’s room for maneuver has narrowed since August, when borrowing costs were falling so fast that he said the government could reverse some spending cuts. The spread widened 35 basis points in the four days after his comments.
Portugal's borrowing costs jump in bond sale
By BARRY HATTON
http://www.businessweek.com/ap/financialnews/D9I3N4VO0.htm
LISBON, Portugal
Portugal raised euro1.04 billion ($1.3 billion) in a debt auction Wednesday that drew strong investor interest, but the sharply higher borrowing cost reflected market concerns that Europe's debt crisis may be flaring up again.
Portugal, which in recent years has generated little wealth and piled up heavy debts, is regarded as one of the most financially vulnerable countries in the 16-nation eurozone.
Portugal's Public Debt Management Agency said it sold euro378 million in 11-year bonds and euro661 million in 3-year bonds. However, the average interest yield on the longer bonds was 5.973 percent, up from 5.312 percent on 10-year bonds at an auction last month. The 3-year bond yield was 4.086 percent, up from 3.62 percent in a 4-year bond auction in July.
"Portugal is seen to some extent as the eurozone's weakest link" after Greece and Ireland, said Filipe Silva, a debt manager at Banco Carregosa in Porto, Portugal. "Investors are ready to take a risk but they will only do it at a higher price."
Portugal's financial difficulties could aggravate international fears about the continent's broader financial problems.
The Wall Street Journal reported on Tuesday that EU stress tests of 91 banks in July understated some of their holdings of potentially risky debt. That fueled market concerns about underlying weaknesses in the bloc and wider fears about the strength of the global economic recovery.
Despite its fragile economy Portugal has had no difficulty raising funds on international markets this year, and the agency said there was demand for more than twice the amount available. But the success has come at the price of steadily rising borrowing costs.
Moody's Investor Service in July downgraded Portuguese bonds to A1 from Aa2, citing sluggish growth prospects.
Portugal, along with Spain and Ireland, is widely seen as a potential candidate for a bailout like the one provided to Greece to keep it from defaulting on its debts.
That has pushed up the government's borrowing costs just as it is trying to cut spending.
The center-left Socialist government has adopted an austerity plan which seeks to reduce to budget deficit to 7.3 percent this year from 9.3 percent in 2009.
Its record has been patchy so far. The Finance Ministry reported last month that although tax revenue this year was up almost 6 percent through July, primary current spending also jumped 5.7 percent. The increase stemmed from larger welfare payouts amid a jobless rate that has risen to 11 percent, according to EU figures.
Ireland, Portugal Probably Won't Tap EU Fund, Coalition's Dautzenberg Says
http://www.bloomberg.com/news/2010-09-08/ireland-portugal-probably-won-t-tap-eu-fund-coalition-s-dautzenberg-says.html
Portugal, Spain and Ireland, all of which saw their bond-yield spreads over Germany rise this week, probably won’t need support from the euro-region rescue fund, a senior lawmaker from Chancellor Angela Merkel’s party said.
The Luxembourg-based 440 billion-euro ($558 billion) European Financial Stability Facility, headed by former European Commission official Klaus Regling, was set up in May as the Greek debt crisis threatened to spill over to other euro states.
“I see -- and Mr. Regling stressed that as well in the past days -- that the stabilization fund is probably not going to be used,” Leo Dautzenberg, parliamentary Finance Committee spokesman for Merkel’s Christian Democratic Union, said today in an interview.
Irish and Portuguese government bonds fell yesterday, pushing the yields on 10-year securities to records versus benchmark German bunds. In a speech in Riga the same day, Merkel said that debt-laden governments must stick to their deficit- cutting programs because Germany won’t agree to have the euro fund turned into a permanent facility to provide aid.
“The crisis mechanisms now in place are temporary,” Merkel said in the Latvian capital. “Germany won’t agree to an indefinite prolongation. Otherwise, people would say ‘we’ve got such a nice rescue package in place that this can go on forever.’”
European central banks bought Greek, Irish and Portuguese bonds today, according to a trader involved in the transactions, as the securities’ premiums to German debt surged for a third day.
The Portuguese-German 10-year bond spread widened as much as 18 basis points to 372 basis points today, and was at 363 points as of 12:23 p.m. in London. The Irish-German spread was 8 basis points wider at 381 basis points.
The rescue fund, which is limited to three years, is the main part of a 750 billion-euro aid package hammered out by European Union finance ministers to combat a sovereign debt crisis. Another 60 billion euros will come from the commission - - the EU’s executive arm -- and 250 billion euros from the International Monetary Fund.
ECB chief needs to be much bolder
http://www.irishtimes.com/newspaper/finance/2010/0908/1224278447559.html
ANALYSIS : Trichet has the power to calm market fears – he should exercise it, writes DAN O'BRIEN, Economics Editor
IF THE massive rescue package agreed by the European countries in early May was about calming market fears, it is clearly not working.
Yesterday’s developments in the government debt market saw yields on Irish government bonds soar past the peaks reached at the height of the crisis in late April and early May. Other peripheral countries also experienced big increases. This is alarming.
The EU rescue package brought the situation back from the brink in May, but within weeks, yields on the weaker countries’ debt began to rise, sometime in leaps, sometimes in baby steps, but almost always in a ratchet-like fashion.
Apart from Greece, Ireland and Portugal have been the most seriously affected. Spain is in the firing line, but to a lesser extent.
The latest ratcheting up of yields for the peripheral euro-area countries appears to have been caused by a number of factors, including a continued weakening of sentiment towards Ireland. Negative comments on European banks in the Wall Street Journal and a downgrading of AIB and Bank of Ireland by Dublin stockbrokers Davys added to fears yesterday.
The euro area can be likened to 16 climbers roped together on a mountain in appalling weather conditions. Greece has gone over the edge. The other 15 can easily take the strain of keeping the Greeks dangling, however uncomfortable it may be for them. Ireland is now closest to the edge, and moved even closer yesterday. Just behind it is Portugal, and a good bit further back is Spain. If all three go over, 12 countries will be supporting four, something that the May bailout package anticipates as a worst-case scenario.
Thankfully, the mountaineering metaphor is less applicable since the European Central Bank was given new powers as part of the rescue package in May. These powers allow it to go into the market where government bonds are traded and, using the money it prints, buy up bonds.
There is, in theory, no limit to the amount it can print. This means there is no limit to the amount it can buy. This is a formidable weapon. It has been timid in deploying it.
Whereas it bought tens of billions worth of bonds in the weeks after it was first given this power, in July and August it effectively ceased doing so. Over the past three weeks, it has been more active, buying more than €650 million worth. But this is a small amount relative to the size of the market, and it has clearly not stemmed the panic.
The future of the euro is not in question yet, but if the slide is allowed to continue, it could be.
This is now the European sovereign debt crisis, Mark II. Jean Claude Trichet needs to be much bolder. He has the power to calm the panic. He should exercise it.
Also.....
Credit default swaps (CDS) for Portugal, Spain, Italy, and Belgium have all surged this week. Markit's stress gauge for the group is now higher than during the debt crisis, when the EU launched its €440bn bail-out fund and the European Central Bank began buying eurozone bonds.
Joachim Fels, chief global economist at Morgan Stanley, said strains had reached a point where "one or several governments" may soon have to tap soon the rescue mechanism.
"Neither the European sovereign debt crisis nor the banking sector crisis has been resolved and both continue to mutually reinforce each other," he said, adding that the EU's stress tests for banks had failed to restore confidence.
Investors are bracing for a flood of fresh bond issuance, while concern is mounting that austerity measures in Ireland, Greece, and Spain have left these countries trapped in a downward spiral.
Monday, August 30, 2010
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