FCRM | Economic Department & Country Limits | MVdG - LdF | Dec. 2008 | 1 Getting you there....

FCRM | Economic Department & Country Limits | MVdG - LdF | Dec. 2008 | 1

Getting you there.

Apocalypse now… or just a roller coast?


INTRODUCTION

I. the nature of the crisis

II. The different countries in the economic crisis:USEuropeJapanEmerging markets

III. CONSEQUENCES & CONCLUSION


I. The nature of the crisis

from Financial Crisis to Economic Crisis to Financial Crisis

Financial world Real economy

Drop in asset value

No liquidity

Reduced credit supply

deleverageLow consumption, deflation?


I. The nature of the crisis : this is a confidence crisis lack of confidence on financial markets

1/12/08US INTEREST RATESJASONDJFMAMJJASONDJ01234567US BOND 10YUS FEDERAL FUNDS TARGET RATE - MUS INTERBANK 3 MTH (LDN:BBA) - OUS DISCOUNT RATEUS T-Bill 3MUS INTERBANK O/N (LDN:BBA) - OFF01234567EMU INTEREST RATESJASONDJFMAMJJASONDJ01234567GERMAN BOND 10YECB REPOEURIBOR 3 MECB MARGINAL LENDINGECB OVERNIGHT DEPOSITEONIA01234567Source: Thomson Datastream 10Y3MLibor 3m10YEuribor 3MFed FundsRepoLibor O/NEoniaDiscount


I. The nature of the crisis : this is a confidence crisis

Lack of confidence on financial markets

Sources: Bank of England, Bloomberg, Chicago Board Options Exchange, Debt Management Office, London Stock Exchange, Merrill Lynch, Thomson Datastream and Bank calculations.

(a) The liquidity index shows the number of standard deviations from the mean. It is a simple unweighted average of nine liquidity measures, normalised on the period 1999–2004. The series shown is an exponentially weighted moving average. The indicator is more reliable after 1997 as it is based on a greater number of underlying measures. The recent fall in the indicator is largely due to a sharp decline in the interbank market liquidity measure.


I. The nature of the crisis : a confidence crisis fulfilled by the methodology used

– The market value probably overestimates the ultimate credit losses that will take place

– This is therefore a sell fulfilling confidence crisis that creates a liquidity squeeze beyond the reality

Source: Bank of England


I. The nature of the crisis the answers to the financial crisis

– Recapitaliastion has been done:– -firstly by take over and mergers

– Then by state intervention:– Nationalization (investment in the

equity)– Guarantees

– The amounts at stake are however limited when compared to assets still at risk

Sub-Prime Crisis: Banks losses & Capital raised since 07/2007

-800 -750 -700 -650 -600 -550 -500 -450 -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800

WORLD

AMERICAS

EUROPE

ASIA

Wachovia

Citigroup

Merryll Lynch

Washington Mutual

UBS

HSBC

Bank of America

National City

J P Morgan

Wells Fargo

RBS

Morgan Stanley

Lehman Brothers

Credit Suisse

IKB

Fortis

BNP Paribas

Credit Losses & Writedowns (USD bn) Capital raised (USD bn)

-800 -750 -700 -650 -600 -550 -500 -450 -400 -350 -300 -250 -200 -150 -100 -50 0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800

Source: Bloomberg

10/11/2008


The nature of the crisis :Banking sector difficulties will continue and worsen in the coming year

– Interbank market remains illiquid, 3-month Libor remains relatively high and banks are paying in average well above Libor or Euribor

– on top of the financial difficulties, banks will face increasing credit difficulties: credit crunch but also increasing NPL

– Credit crunch: in Europe, the un-drawn committed lines are estimated at USD 3 tr. This will impede banks to extend new credits

– Existence of massive trading books than cannot be traded

– Very low capital base

– => deleverage will be a necessity


I. The nature of the crisis: financial crisis will continue Tightened lending conditions will prevail


I. The nature of the crisis: financial crisis will continue Tightened lending conditions will prevail

Source IMF

FCRM | Economic Department & Country Limits | MVdG - LdF | Dec. 2008 | 11 Source: IMF


I.The nature of the crisis : This is a confidence crisis confidence is affected in the real economy

Source :IMF; WEO Nov 08


I. The nature of the crisis: the real economy is affectedTwo remarkable events: banking crisis and oil prices

1/12/08OIL PRICE AND USD|EUR EXCHANGE RATE0001020304050607080204060801001201401600.800.901.001.101.201.301.401.501.60Crude Oil-WTI Spot Cushing U$/BBUS $ TO EURO (WMR&DS) - EXCHANGECONFIDENCE: US AND EUROZONE00010203040506070820406080100120140160-30-25-20-15-10-505US CONSUMER CONFIDENCE INDEX SAEM CONSUMER CONFIDENCE INDICATOSource: Thomson Datastream


I. The nature of the crisis: :Oil prices have been followed by all commodities

– Global indexes are down 45 % compared to their peak in July

– Metals and energy affected by the global credit crunch

– The supply adjustment is very rapid and this means that prices will stabilize at a level a bit higher than the current one

– In most cases prices are now approaching or below the marginal cost of production

– Some agri prices might continue to decline because of the better climatic conditions


I.The nature of the crisis: The freight evolution confirms that global trade is affected

Datastream CommoditiesRecent Values:Latest ValueHigh over 12 MthsLow over 12 MthsAvg over 12 MthsPerformance:Actual Value% Change-1M-3M-12MBackground Information:Start DateCurrencyDatatype01/12/0811.09Baltic Exchange Dry Index (BDI) - PRICE INDEX01/05/1985U$PI 982 -27.19 715 11793 715 7136 6929 -89.68BALTICFPRICE INDEX28/11/0820/05/0828/11/08 9922 -92.79PRICE INDEXNDJFMAMJJASON000'S 024681012BALTICFSource: Thomson Datastream


I.The nature of the crisis : an economic crisis preceded by a financial oneThe crisis will be long and deep

– When preceded by a financial stress (on banks, securities or exchange rate), crises are deeper and longer

– In today’s case, the financial stress is extreme, all segments of the financial sector being affected



I.1: the nature of the crisis: no easy solution; back to Keynes!

Monetary policy

Cut in interest rates

Increase in credits to the private sector

Interbank market: need of confidence

Fiscal policy

Public expenditures

Increase of private consumption

Higher interest rates;

The economy will not be saved by credit growth


INTRODUCTION





II.1. US recession pulled by the housing market… and will affect the real & financial economy furtherUS Houses started1/12/08909192939495969798990001020304050607086008001000120014001600180020002200240060080010001200140016001800200022002400US NEW PRIVATE HOUSING UNITS AUTHORIZED BY BLDG.PERMIT (AR) VUS NEW PRIVATE HOUSING UNITS STARTED (AR) VOLA(R.H.SCALE)

Source: Thomson Datastream


II. SECOND PERIOD: impact on the real economy …and it will continue to affect the real and the financial economy


II.1 US recessionUnemployment soaring towards 7% - 8%... US Unemployment and Consumption Expenditures (inverted)1/12/08909192939495969798990001020304050607083.504.004.505.005.506.006.507.007.508.00-10123456US UNEMPLOYMENT RATE SADJPERCENTAGE CHANGE FOR 1 YEAR - ££#0q#0q#0qSource: Thomson Datastream


II.1: US :Household indebtedness is worsening

– The indebtedness level is in fact reducing but the net wealth is contracting more rapidly because of the drop in real estate and stock markets



II.1 US recession… and with it default paymentsUS DELINQUENCY RATES1/12/082000200120022003200420052006200720081.001.502.002.503.003.504.004.505.005.50US DELINQUENCY RATES - AGRICULTURAL LOANS SADJUS DELINQUENCY RATES - COMMERCIAL & INDUSTRIAL SADJUS DELINQUENCY RATES - CONSUMER LOANS - ALL SADJUS DELINQUENCY RATES - CONSUMER LOANS - CREDIT CARDS SADJUS DELINQUENCY RATES - CONSUMER LOANS - OTHER SADJ1.001.502.002.503.003.504.004.505.005.50



II.1 US recessionUS OFFICIAL RECESSION INDICATORS1/12/08Personal Income less Transfer Payments (yoy %)000102030405060708-5051000.501.00US PERSONAL INCOME LESS TRANSFERUS NBER BUSINESS CYCLE(ECONOMICTotal Nonfarm Employment (yoy %)000102030405060708-202400.501.00US EMPLOYED - TOTAL NONFARM VOLNUS NBER BUSINESS CYCLE(ECONOMICIndustrial Production (yoy %)000102030405060708-10-5051000.501.00US INDUSTRIAL PRODUCTION - TOTALUS NBER BUSINESS CYCLE(ECONOMICBusiness Sales (yoy %)000102030405060708-10-505101500.501.00US BUSINESS SALES (MFG & TRADE)US NBER BUSINESS CYCLE(ECONOMICSource: Thomson Datastream


INTRODUCTION





II.2. EUROPE

UK: the housing market is the triggerUK HOUSING MARKET IN BIG TROUBLES (yoy %)1/12/08200020012002200320042005200620072008-20-100102030400123456PERCENTAGE CHANGE FOR 1 YEAR - UK HALIFAX HOUSE PRICE INDEX - NEW HOUSESPERCENTAGE CHANGE FOR 1 YEAR - UK HALIFAX HOUSE PRICE INDEX - EXISTING HOUSESPERCENTAGE CHANGE FOR 1 YEAR - UK GDP AT MARKET PRICES (CVM) CONA(R.H.SCALE)PERCENTAGE CHANGE FOR 1 YEAR - UK CONSUMER SPENDING(R.H.SCALE)HIGH 27.2 14/2/03,LOW -15.8 15/10/08,LAST -15.8 15/10/08HIGH 31.5 15/10/02,LOW -15.4 15/10/08,LAST -15.4 15/10/08Source: Thomson Datastream


II.2. EUROPE

also affected by the lack of productivity


II.2. EUROPE Germany officially in recession

Eurozone and Germany GDP Growth rates (qoq%)1/12/08200020012002200320042005200620072008-0.5000.501.001.502.001 quarter percentage change - EJ GDP CONA1 quarter percentage change - BD GDP (PAN BD FROM 1991) CURAHIGH 1.18 15/2/00,LOW -0.20 15/8/08,LAST -0.20 15/8/08HIGH 1.76 15/2/08,LOW -0.41 14/2/03,LAST -0.02 15/8/08-0.5000.501.001.502.00Source: Thomson Datastream


II.2. EUROPESpain has tumbled on its real estateSPAIN: HOUSING SECTOR AND GDP GROWTH1/12/0820002001200220032004200520062007200845678910-50-40-30-20-100102030ES GDP (CURRENT) (%YOY) CURAPERCENTAGE CHANGE FOR 1 YEAR - ES HOUSES CONSTRUCTION COMMENCED VOLN(R.H.SCALE)



II.2. EUROPEFrench consumers are in a bad mood

FRANCE: HOUSEHOLDS CONFIDENCE AND GDP GROWTH1/12/0820002001200220032004200520062007200800.501.001.502.002.503.003.504.004.505.00-50-40-30-20-10010FR SURVEY - HOUSEHOLD CONFIDENCE INDICATOR SADJ(R.H.SCALE)FR GDP (%YOY) CONASource: Thomson Datastream


II.2. EUROPEBad news for investmentEMU: GDP Growth and Capacity Utilisation rates1/12/089697989900010203040506070800.501.001.502.002.503.003.504.004.505.0079808182838485EM INDUSTRY SURVEY: CAPACITY UTILISATION - EMU 11/12/13 SADJ(EA GDP CONAHIGH 84.80 15/5/07,LOW 79.50 14/2/97,LAST 81.60 14/11/08HIGH 4.62 15/5/00,LOW 0.47 15/5/03,LAST 0.63 15/8/08



INTRODUCTION





II.3. JAPAN – Exports do not help GDPJapan: GDP and Exports (yoy%)1/12/0896979899000102030405060708-15-10-50510152025-3-2-1012345JP EXPORTS OF GOODS - CUSTOMS BASIS CURAJP GDP (AR) CONA(R.H.SCALE)Source: Thomson Datastream


II.4: Conclusion on G3

– First time that there is such a correlation in the G3 + correlation with the rest of the world

– When an economic crisis is preceded by a financial one il last longer (7 to 8 quarters) and the total cumulative output loss is twice as big

– Risk of deflation because of– G3 low growth or recession– Oil and commodity prices

– Previous crisis were always linked to a problem in production (manufacturing) and could be solved by changes in inventories and by increasing credit

– This is an asset price adjustment with a credit crunch: the solution has to be a Keynesian one but with far larger amounts than those announced


II.4: conclusion on G3: IMF forecast: recession in advanced economies, growth below the trend in Emerging markets


INTRODUCTION





II.5 Emerging Markets, contagion is there:

– Affected with a lag of about 6 months

– Through:– Their exports– Their banking system– The ownership of their banking system– Their currency – Core inflation


II.5: Emerging markets: contagion is there Growth is revised downward and below the trend


II.5 Emerging markets: affected through their exports

Rising importance of South-South exports to 15% of their GDP (while South-North trade stagnates at 20% since 2000)

=> EM less vulnerable to « North » slowdown


II.5 Emerging markets: affected through their exports: reduced exports worldwide

OECD Exports Volumes indexes ((01/01/07 = 100)

Belgium

Canada

Denmark

France

Germany

Ireland

Italy

Japan

Korea

Sweden

Turkey

UK

80

85

90

95

100

105

110

115

120

125

130

135

140

145

150

janv

-07

févr

-07

mar

s-07

avr-

07

mai

-07

juin

-07

juil-

07

août

-07

sept

-07

oct-

07

nov-

07

déc-

07

janv

-08

févr

-08

mar

s-08

avr-

08

mai

-08

juin

-08

juil-

08

août

-08

sept

-08

oct-

08

nov-

08

déc-

08

Belgium Canada Denmark Finland France Germany Ireland Italy

Japan Korea Sweden Turkey UK


II.5 Emerging markets: affected through their exports: reduced imports worldwide

OECD Imports Volumes indexes ((01/01/07 = 100)

Belgium

Canada

Denmark

France

Germany

Ireland

Italy

Japan

Korea

Sweden

Turkey

UK

80

85

90

95

100

105

110

115

120

125

130

135

140

145

150

janv

-07

févr

-07

mar

s-07

avr-

07

mai

-07

juin

-07

juil-

07

août

-07

sept

-07

oct-

07

nov-

07

déc-

07

janv

-08

févr

-08

mar

s-08

avr-

08

mai

-08

juin

-08

juil-

08

août

-08

sept

-08

oct-

08

nov-

08

déc-

08

Belgium Canada Denmark Finland France Germany Ireland Italy

Japan Korea Sweden Turkey UK


II.5 Emerging markets: affected through their banking sector

– Credit growth has been excessive during recent years (above the needed catching up)

– This credit growth was based on massive external short term borrowing that has been used to finance long term domestic investments, or stock market investments

– The lack of liquidity results mainly from the needs in mature economies

Source:IMF


II.5: emerging markets affected through their banking sector

External ownership is not necessarily a strength


MSCI EM Indexes & JPM EMBI+ spreads1/12/0820052006200720080200400600800100012001400160018002000000'S 3000400050006000700080009000MSCI EM U$ - PRICE INDEXMSCI EM ASIA - PRICE INDEXMSCI EM EASTERN EUROPE - PRICEMSCI EM LATIN AMERICA - PRICE I2005200620072008050010001500200025003000JPM EMBI+ COMPOSITE - STRIPPEDJPM EMBI+ INVESTMENT GRDE. - STJPM EMBI+ BB RATED - STRIPPED SJPM EMBI+ B RATED - STRIPPED SP050010001500200025003000Source: Thomson Datastream

II.5 Emerging markets: affected through their banking sector: increasing cost of funding and of CDS


II.5: emerging markets affected through their banking sector



II.5: emerging markets affected through their banking sector and more generally the financial developments

– Non government issuance of bonds has been massive but peaked in 2007

– Credit growth has fuelled the bubbles and puts the stability of banking sectors at risk

– Interest rates were in most cases at historical lows, fuelling the credit bubble



II.5: emerging markets affected through core inflation

– Core inflation is linked to wages and to domestic demand

– Credit growth has also fuelled inflation especially in Central and Eastern Europe

– Tight financial markets have contributed to a bubble in real estate in countries with high liquidity (GCG)



II.5: emerging markets affected through their currencies

– Lower commodity prices have had a negative impact on emerging markets current account

– Portfolio and stock market outflows have also contributed to currency depreciation

– In emerging Europe most of household indebtedness is in foreign currency


II.5: conclusion on emerging markets

– No “decoupling”, slowdown, not a global recession– Current account balances will worsen – Financing will be difficult to find because of the low world liquidity and because of the

“crowding out” by mature economies– Increasing divergences between emerging markets based on the assessment of their

banking sectors– Defaults could take place

– Keynesian solutions will also be at the core of the policies


INTRODUCTION

I. RECESSION IN THE US-EUROPE-JAPAN

1. US « W »2. EUROPE 3. JAPAN

II. EMERGING MARKETS: TOUCH-AND-GO?

1. BEHIND THE UPGRADES2. FLIGHT TO QUALITY



Conclusion:This is not our worse case scenario!


Conclusion:The downside risks on the basic scenario are important



Getting you there.

Thank you

[email protected]


II. SECOND PERIOD: impact on the real economy …and it will continue to affect the real and the financial economy


II.5 Emerging markets: contagion is theremajor weaknesses:

– Foreign holdings of local currency debt strongly increased– Core inflation is up (not only due to commodities) and risks of deflation at the same time– Non government issuance of international bonds has peaked– Robust credit growth during recent years

– Other threats:– Increasing protectionism; trade could come to a standstill– Pressure up on interest rates– Wealth impact of stock drops– Corporates and banks could be affected by the drop of derivatives market

FCRM | Economic Department & Country Limits | MVdG - LdF | Dec. 2008 | 1 Getting you there....

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