European sovereign debt crisis

AIECE General Meeting

May 6, 2010
Milan

Bart De Ketelbutter

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 Next big
g phase
p in the financial crisis

ƒ Let us not be overly optimistic C l bi 1998

Colombia,
because of buoyant world Finland, 1991
trade, IP & GDP growth Chile, 1980

ƒ Financial crisis still among us Indonesia, 1997

(all our risks relate to it) Spain, 1977

ƒ Next big phase in the financial Historical Average

crisis (after subprime, banking Sw eden, 1991

& economic crisis) Korea, 1997

ƒ Reinhart & Rogoff: Public debt Philippines, 1997

soars in wake of fin.crises & Norw ay, 1987

defaults often follow Japan 1992

Japan,

Mexico, 1994
Cumulative rise in real debt in the 3Y Malaysia, 1997
following the banking/financial crisis
0 50 100 150 200 250 300
Index= 100 in year of crisis
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Bond y
yield spreads
p against
g German Bunds

• It s
started
d with G Greece
(statistics falsified) &
2009 deficit estimate
suddenly doubled
• Credit downgrades
• Spreads of ES, PT, IR
also on the rise
• Last week even small
rises in other countries
• Reasons behind crisis?

GR 714 IT 110
PT 286 BE 62
IR 225 FR 33
Spreads on 28/04: ES 115 NL 29
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1.State of p
public finances

Deficit Debt
Greece ‐12,7
12 7 112 6
112,6 ƒ D
Deteriorated
t i t d strongly
t l d
due
Spain ‐11,2 54,3 to recession, stimulus &
Portugal
g ‐8,0
, 77,4
, capital
p injections
j in banks
Ireland ‐12,5 65,8 ƒ In some countries : Over-
Italy ‐5,3 114,6 reliance on above-trend
France ‐8,3 76,1 receipts
i t ffrom bubbly
b bbl
Belgium ‐5,9 97,2 sectors (e.g. construction
Germany ‐3,4
34 73 1
73,1 in ES, financ.sector in UK)
NL ‐4,7 59,8 ƒ LT cost of ageing
Austria ,
‐4,3 69,1
,
Finland ‐2,8 41,3
EA12 ‐6,4 78,7
UK ‐12,1 68,6
Ameco Autumn 09 fc for 2009
US ‐11,3 65,2
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2. Phasing
g out of exceptional
p monetary
y stimulus

ƒ D
Departure
t from
f near 0% IRs
IR
ƒ Fade out almost limitless
provisioning of liquidity
ƒ End QE
ƒ Has p
powered financial assets
ƒ Carry-trade on gov.bnds,
popular strategy
ƒ Removal of subsidy to public
debt
ƒ Mainly
M i l h hurts
t mostt indebted
i d bt d
countries (higher ylds ,made
them main beneficiaries
carry-trade)
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 3.Competitiveness,
p , CA deficits and foreign
g debt

ULC Ch 
ULC Ch CA/GDP 
CA/GDP
• Entrance in euro area
Country
08‐99 change 08‐99 lowered interest rates
Greece 40.4 ‐8.6 & unleashed credit
Ireland 37 5
37.5 ‐5.3
53 boom
Portugal 35.5 ‐3.2 • Higher wage growth
Spain 33.3 ‐6.8 and inflation
Italy 16.7 ‐4.0 • Deterioration of
Belgium 17.8 ‐4.7
competitiveness
Austria 8.6 5.1
France 19.7 ‐5.8 • Strongest
St t rise
i over last
l t
NL 24.9 0.0 10Y seen in the four
Finland 19 8
19.8 ‐5.4
54 problem countries
Germany 3.4 7.8 • Related: The level of
EA12 17.9 ‐1.2 foreign debt and the
U
UK 24.3 0.7 dependence on foreign
US 17.2 ‐1.8 capital (PT)
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4. The functioning of the euro area: more
integration?

ƒ Lack of means to address these imbalances

ƒ Lack to reach consensus rapidly in times of crisis
ƒ Initial plan for Greece was vague and incredible
& markets did not buy it
ƒ The
h EA is no optimall currency area
ƒ US neither, but regional imbalances are
attenuated
tt t dbby th
the federal
f d l budget
b d t (bulk
(b lk off taxing
t i
& spending) and stronger labour mobility
ƒ Euro area needs to integrate more and go
towards a fiscal & political union or else ...

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What next? – The new p
plan for Greece

ƒ M
More inflation
i fl ti tto erode
d debt
d bt overhang,
h defaults,
d f lt
general loss of confidence in sovereign debt?
ƒ The new plan for Greece:
ƒ 110bn EUR loan package from EA & IMF
ƒ Condition of spending cuts & tax hikes
ƒ Effort needed not entirely unprecedented, but ... (cf.
Belgian case)
ƒ 10 bn EUR to stabilise bankingg system
y
ƒ ECB suspends colleteral rule for Greek bonds
ƒ Plus: No need to turn to bond market next 3Y
ƒ Enough to restore confidence? No
ƒ Insolvency remains a problem, some kind of debt
restructuring still likely

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Questions remain
Q

ƒ Amounts lent to Greece still need to be approved in

national parliaments
ƒ Will Greece really be able to achieve these draconian
measures
ƒ Contagion risk not addressed (ES, PT): Will they be
saved too?
ƒ Markets risk testing this & see if countries are really
prepared
p epa ed to restore
esto e health
ea t in public
pub c finances
a ces
ƒ Not only in Europe (US, UK, Japan)
y
ƒ Policymakers need to find way
y to convince markets
they’ll do whatever necessary to get ahead of the
crisis

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Effects of full-blown sovereign
g debt crisis

ƒ Higher interest rates

ƒ Premature and severe tightening of fiscal
policy
l
ƒ Hit to bank assets (writedowns on sovereign
d bt) and
debt) d fi
financial
i l panic:
i ThThe sovereign
i
version of Lehman?

Æ Would imperil the still fragile economic

recovery

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Foreign
g banks’ exposure
p to p
problem countries

ƒ Bulk with European

banks
in bn EUR
ƒ Includes debt of public
and private sector Greece 163,9

Portugal 198,3

ea d
Ireland 601,8
60 ,8

Spain 795,4

Italy 984,2

Source: BIS

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