DEFELICE, GREGORIO April 0711

Global Interdependence Center International Conference

Sovereign Debt Issues in the Eurozone Gregorio De Felice

0

Rome, 7 April 2011

Outline A major role in sovereign debt crises is played by foreign debt, even inside monetary unions Public and private debts alone are not good indicators Some fundamentals (current account balances, fiscal deficits) are improving in many Eurozone countries Government spreads will not drop soon There are many reasons why risk premia will remain high for some time 1

The drift in credit standing is linked to an excess of foreign debt All countries in the euro area now experiencing rating downgrades and fiscal problems had been running large current account deficits, leading a major worsening of the Net Financial Position vs. non-residents.

Change in CDS spreads and Net Financial Position

100 50

FRA

0 NFP

BEL

NET

GER ITA

AUS

-50

IRL SPA

-100

GRE

POR

-150 0

100

200

300 CDS, 2010-07 2

400

500

Reliance on foreign capital more important than total leverage The strongest forward warning that a financial crisis was brewing came from trends in the countries’ Net Financial Position. The deficits of Ireland, Greece, Spain and Portugal have more than doubled since 2000.

Total leverage and Net Financial Position (% of GDP) 80 60

low leverage, external surplus

40

BE DE

20 NFP/GDP

high leverage, external surplus

NL

0

FI

SL A

F

-20

IT

-40

SK

-60 -80 ES EI GR

-100 -120

low leverage, large external deficit

-140 100

150

200

250

300

PT

high leverage, large external deficit

350

400

450

Total Debt/GDP NFP: Financial Liabilities - Financial Assets for the Rest of the World Sector, year 2009. Total Debt: sum of loans and non-share securities for general government, households and nonfinancial companies. Source: Intesa Sanpaolo, based on Eurostat Financial Accounts and national sources 3

The outlook for current account balances is improving Austerity measures in peripheral countries also help in rebalancing current accounts.

The most noticeable improvement is taking place in Ireland, where a surplus is now likely. Deficits will remain very large in Greece and Portugal, also due to debt servicing costs. Belgium is more unlikely to be drawn into the crisis, being a surplus country.

Spain

Italy 0 -1 -2 -3 -4 -5 '01-'08 '09

'10

'11

'12

0 -1 -2 -3 -4 -5 -6 -7 '01-'08 '09

'12

3 2 1 0 -1 -2 -3 -4

Greece 0 -2 -4 -6 -8 -10 -12 '01-'08 '09

'10

'10

Portugal

'11

'12

0 -2 -4 -6 -8 -10 -12 '01-'08 '09

Ireland

'11

'10

'11

'12

Belgium 3 2 1 0

'01-'08 '09

'10

'11

'12

Percentage contribution on GDP – Forecast data in orange. Source: European Commission 4

'01-'08 '09

'10

'11

'12

Smaller deficits, smaller refinancing requirements Scheduled gross issuance by maturity (EUR bn)

Gross issues of medium/long-term bonds is expected to drop to EUR 835bn in 2011 from EUR 929bn in 2010; 40bn are explained by suspended Greek and Irish issues.

Net issues will fall by around EUR 130bn.

The amount of bonds reaching maturity in 2011 is EUR 530bn vs. EUR 490bn in 2010.

300 250 200 150 100 50 0 2-3 yr

5 yr

10 yr

15 yr 30 yr

50 yr

Inf l

Flt

Mt n

2010

202

231

268

71

53

9

46

34

17

2011 F

186

202

226

75

42

5

52

33

17

Scheduled gross issuance by issuer (EUR bn) 250 200 150 100 50 0 GER FRA ITA

SP

NE

BE

PT

AT

GR IRE

FI

SK

207 210 225 92

49

42

23

20

20

20

16

7

2011 F 199 198 197 94

49

39

18

21

0

0

15

7

2010

Source: Bloomberg, Intesa Sanpaolo

5

Significant progress in 2011, but more will be needed For Spain, Portugal, the Netherlands, Italy the adjustment planned for 2011 represents a sizeable part of the total adjustment required to stabilize the debt/GDP ratio. However, an additional correction in excess of 4% of GDP will be required for Ireland, Spain, France, Greece.

Investors will not be satisfied with fiscal plans, and will wait for actual results.

15.0%

Planned in 2011

Baseline target

Debt to 60% in 20y

12.5% 10.0% 7.5% 5.0% 2.5% 0.0%

IRL

ESP

GRC

FRA

SLO

CYP

POR

SLK

NET

BEL

ITA

AUT

LUX

MAL

FIN

DEU

Planned in 2011

2.4% 3.2% 2.5% 1.6% 0.6% 0.3% 3.2% 3.3% 2.0% 0.2% 0.6% 0.7% 0.6% 1.3% 1.5% 0.9%

Baseline target

11.5% 8.4% 8.6% 5.6% 4.4% 3.8% 6.1% 6.4% 4.2% 2.3% 2.2% 1.7% 1.3% 2.2% 1.9% 1.5%

Debt to 60% in 20y 14.0% 8.7% 12.0% 6.8% 4.0% 4.0% 7.3% 6.0% 4.4% 4.4% 5.9% 2.1% 0.9% 2.6% 1.7% 2.1% Baseline target: net adjustment required to achieve a primary balance consistent with a stable debt/GDP ratio, with GDP growth at potential.

Debt to 60% in 20y: net adjustment required to achieve a primary balance consistent with a 60% debt/GDP ratio in 2030 (Greece: 2050), with GDP growth at potential. Source: Intesa Sanpaolo estimates, based on Eurostat and European Commission data.

6

Age-related spending: outlook Increase in age-related expenditure, 2010-2060, % of GDP Germany

Spain

France

Italy

UK

EU-27

10.2

8.9

13.5

14.0

6.7

10.2

2.5

6.2

0.6

-0.4

2.5

2.3

2010

7.6

5.6

8.2

5.9

7.6

6.8

2060/2010

1.6

1.6

1.1

1.0

1.8

1.4

2010

1.0

0.7

1.5

1.7

0.8

1.3

2060/2010

1.4

0.7

0.7

1.2

0.5

1.1

4.6

4.8

5.8

4.3

4.0

4.9

-0.4

-0.2

-0.2

-0.2

0.0

-0.2

23.3

20.0

29.0

26.0

19.2

23.2

5.1

8.3

2.2

1.6

4.8

4.6

Pension spending 2010 2060/2010 Healthcare

Long-term care

Unemployment benefits & education 2010 2060/2010 Total 2010 2060/2010 Source: European Commission, Sustainability Report 2009

7

Government spreads will not drop any time soon Main factors preventing a decline in risk premia: Fiscal consolidation will take years; a large credibility gap means investors want to see results; Uncertainty about the capital needs of banks at the global level; The support mechanism is clumsy; for large mid-risk countries may even be a negative factor; The consolidation plan for Greece is not credible: (1) there is a funding gap in 2012 that will require further loans and (2) long run sustainability is unlikely to be achieved without a haircut on debt.

Market is already pricing in a restructuring of government debt; Doubts on the plan for Ireland; Portugal may need support; Rating actions (rating agencies catching up with market valuations).

8

Bank fragility: recourse to ECB open market operations The recourse to the ECB open market operations as a stable source of funding remains high in some banking systems, and shows a deep interconnection between the sovereign crisis and stress in wholesale bank funding.

Pressure on banks to deleverage further may weaken their ability to act as a buffer in this government bond market period of stress .

Liabilities vs. the Eurosystem (% of total assets) Eurozone Spain Portugal Netherla Italy Ireland Greece France Germany Belgium Austria -5%

Public measures to support the banking sector 40

1.7% 2.0% 7.3% 0.8% 1.2%

Approved interventions (% GDP)

30

Realised interventions (% GDP)

25

8.2% 0.5% 1.4% 0.6% 0.9%

35

20.6

20 18.4% 15

12

11.1

8.3

10 5

36.5

2.6 1.4

0.7

1.3 0.7

0

0% 5% 10% 15% 20% % total assets change since end 2009

Capital endowement

Banking liabilitiy guarantees

Bank funding

Bad asset provisions

Total

Note: data for December 2010, except for France, Greece, Netherlands (November 2010). Data for Ireland do not include the special loans from the Central Bank of Ireland.

Source: Intesa Sanpaolo, from various sources (European Commission, ECB and NCBs).

9

The May 2010 crisis management framework Fiscal consolidation

EFSF

Lower risk premia

ECB (SMP)

Debt sustainability

(Eventual) conditional support programme

Reform of EU economic governance

IMF

10

EFSF loans to increase the burden on other countries ■ The loan to Greece and the guarantees provided for the loan to Ireland create contingent liabilities equal to 11% of the Euro area’s cumulative deficit in the next three years.

■ The weight of the bail-out quotas of the individual countries relative to the planned deficit in the next three years ranges from a low of 3% for Slovenia to a high of 73% for Finland.

The weight of the aid is considerable relative to future deficits (Bailout % cumulative deficit 2011-2013) 73%

14%11%13%14%

Source: European Commission, Intesa Sanpaolo 11

Slovakia

Slovenia

Finland

Portugal

Austria

Netherlands

3% Italy

France

Spain

9% 9% Greece

Germany

Source: European Commission, Intesa Sanpaolo

26%

19% 10% Ireland

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

Slovakia

Slovenia

Finland

Portugal

Austria

Netherlands

Italy

France

Spain

Greece

Ireland

Belgium

Germany

40 35 30 25 20 15 10 5 0

Belgium

The aid to Greece and Ireland impacts on the rest of the Euro area (EUR Bn)

New credit actions are possible Rating agencies are catching up with market valuations, belatedly downgrading sovereign issuers in the Eurozone.

Ratings & Spreads 1200 y = 5.1763x2 - 184.77x + 1650.8 R2 = 0.8871

1000 Spread on 10Y Bund

GR 800 IE 600 PT 400

200

E

IT

0

SL

A

B

3

4

5

6

7

8

9

10

11

Average Rating Source: Intesa Sanpaolo

12

F FI 15 16 NL

SK 12

13

14

17

Debt rollover risks for peripheral countries Bonds maturing in 2011 ex T-bill (EUR Bn)

Bond issues % total euro issues 100

40% 35% 30% 25% 20% 15% 10% 5% 0%

ITA

SPA

BEL

POR

80 60 40 20 0 Feb Mar Apr May Jun

Germany Netherlands Ireland

Dec

Nov

Oct

Sep

Aug

Jul

Jun

May

Apr

Mar

Feb

Jan

Jan

Medium/long-term debt rollover risk

Jul

France Belgium Finland

Aug Sep

Oct

Italy Portugal Austria

Nov Dec

Spain Greece

Rollover risk (2011 issues % redemptions)

25% 280%

2011 Gross issuance / total debt T-bill outstanding /Total debt

263% 240%

20%

18.4%

208%

17.8%

196% 204%

202%

200%

14.8% 15%

14.1%

14.0% 13.6% 13.5%

13.0%

160%

182%

170% 164%

158%

158%

135%

120%

10% ITA

SPA

BEL

80%

POR

GER FRA

Source: Bloomberg, Intesa Sanpaolo 13

ITA

SP

NE

BE

PT

AT

FIN

SKK Euro area

A high cost of debt would easily derail the Greek programme With average cost of debt peaking at 6.5% in 2016-18, a stable primary surplus of 45% would cause debt peaking at 165% in 2018, and then drop gradually from 2020.

But is a major drop of yields achievable with rising debt/GDP ratios?

Assuming a trend growth of 2%, if debt servicing costs peak at 7.8% in 2020-25, the consolidation plan will fail even if the primary surplus exceeds 5% of GDP. How to ensure sustainable borrowing costs? (i) Through extension of the support programme and (ii) Through major debt restructuring once Greece is back to a primary surplus.

Greece – Favourable scenario 10% 5% 0% -5% -10% -15%

Greece – Adverse scenario 180% 160% 140% 120% 100% 80% 60% 40% 20% 0%

-20% 1981 1991 2001 2011 2021 2031 2041 Deficit primary balance Debt (rhs)

10%

250%

5%

200%

0%

150%

-5% 100%

-10% -15%

50%

-20% 1981 1991 2001 2011 2021 2031 2041

0%

Deficit

Primary balance

Source: Intesa Sanpaolo

Source: Intesa Sanpaolo 14

Debt (rhs)

Portugal’s financial situation remains fragile Portugal presents debt rollover risks. Gross bond issues in 2011 will be 218% of bonds reaching maturity vs. 135% for Germany and 160% for Italy. Rollover levels are also high for France (203%) and Spain (202%).

Supply-side pressure will ease in 2H11 with gross issues in line with maturities and 46% of the issue program has already been implemented.

Early elections called for June 5th. New government in place not earlier than the end of June.

Spain’s redemptions are better distributed and prefunding will be easier.

Portugal: financing requirement (EUR Bn) Cash deficit

Bond redemptions

Spain: financing requirement (EUR Bn)

Tbill redemptions

Cash deficit

14 12 10 8 6 4

40 35 30 25 20 15 10 5 0 -5 -10

``

2 0 -2 Jan

Mar

May

Bond redemptions

Jul

Sep

Nov

``

Jan

Source: Bloomberg, Intesa Sanpaolo

Mar

May

Jul

Source: Bloomberg, Intesa Sanpaolo 15

Tbill redemptions

Sep

Nov

Euro spreads should be lower Italy-Germany spread (bps)

Spain-Germany spread (bps)

210

300 10Y BTP BUND

180

2Y BTP BUND

10Y SPG BBUND

250

150

2Y SPG BBUND

200

120

150

90 60

100

30

50

0

0 '07

'08

'09

'10

'11

'08

Belgium-Germany spread (bps) 140 120 100

10Y BE Bund

450 400 350 300 250 200 150 100 50 0 -50

2Y BE Bund

0 -20 -40 '08

'09

'10

'10

'11

Portugal-Germany spread (bps)

80 60 40 20

'07

'09

10Y OT BUND 2Y OT BUND

'08

'11

Source: Bloomberg, Intesa Sanpaolo 16

'09

'10

'11