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Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
Country risk quarterly report 2 q12
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Country risk quarterly report 2 q12

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International Financial Markets , Global Risk Aversion and Capital Flows …

International Financial Markets , Global Risk Aversion and Capital Flows

Sovereign Markets & Ratings Update

Macroeconomic Vulnerability and In-house assesment of country risk on a Regional basis

Special Topics:Central Bank Balance Expansion in Developed and Emerging Economies: What are the risks?

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  • 1. Country RiskQuarterly ReportCross-Country Emerging Markets – May 2012
  • 2. Country Risk Quaterly Report – May 2012SummaryFinancial • Financial Stress relaxed somehow after the liquidity measures introduced by the ECB (LTRO). However, the impact has been very different across regions and asset classes. The impact in the US and Emerging Markets (EM)Markets & was positive but financial tensions remain high in Europe specially for Sovereign and Bank CDS. On the positiveGlobal Risk side, both USA and Europe Ted Spreads reacted positively to the liquidity measures.Aversion • Capital Flows improved from the sharp drop of the second half of 2011 particularly in EM. Still, inflows to Emerging Europe remained fairly stagnant despite the fact that they were already very low levels last year.Sovereign • Sovereign CD Swaps continued to widen in Europe, reflecting that tensions remain well alive. The Nordic countries and Germany continue to act as safe havens while France’s situation became somewhat tense. As for EM,Markets & sovereign premia increased in Emerging Europe and remained low and stable in Asia and Latam (with theRatings exception of Argentina and Venezuela).Update • With the exception of Spain, the rating downgrade cycle relaxed in Western Europe. In EM Markets, rating agencies downgraded some countries in Emerging Europe. In Latam the upgrade momentum has stabilized.Our own • Our tools and Models for country risk assessment suggest that additional downgrades in Europe could happen. Among the core countries, France is still vulnerable.country riskassessment • Emerging European countries continue to be the riskiest ones among EM, Slovenia and Slovakia were recently downgraded by rating agencies, which is in line with our model expectations. • There were no significant changes in our Latam risk outlook. The main vulnerabilities lie on the institutional framework and inflation although with large heterogeneity across countries. • In Asia, our models call for an upgrade for Australia and confirm the recent upgrade for Indonesia. Japan continues to be under pressure. 2
  • 3. Country Risk Quaterly Report – May 2012SummarySpecial • Not only developed countries but also emerging ones have expanded their Balance Sheet of their CentralTopics Banks. − However the sources of Balance Sheet expansion has been quite different: Net Domestic Assets (NDA) in Developed CBs and mostly Net Foreign assets (NFA) in Emerging Markets. − The risks of balance sheet expansion differ depending on the sources of such expansion. 1. Future inflation may be a risk for the central banks which have allowed to translate the expansion of Balance Sheets to the monetary base and are in a more expansionary mode. The money-inflation link is weaker in developed markets and the output gap much larger but some EM Central Banks should maintain a more prudent attitude towards future inflation. 2. Other risks are related to asset quality for rapidly expanding NDA, sometimes with dubious assets, and exchange rate and interest rate valuation effects on the NFA side. The first risk is, of course, more true for CBs in developed countries and the second for those in emerging economies. 3
  • 4. Country Risk Quaterly Report – May 2012Index1 International Financial Markets , Global Risk Aversion and Capital Flows2 Sovereign Markets & Ratings Update3 Macroeconomic Vulnerability and In-house assesment of country risk on a Regional basis4 Special Topics– Central Bank Balance Expansion in Developed and Emerging Economies: What are the risks?Annex– Methodological appendix 4
  • 5. Country Risk Quaterly Report – May 2012Section 1Financial Markets Stress& Global Risk AversionFinancial Stress Map • Developed Markets Financial Stress relaxed during theSource: BBVA first quarter of the year driven by LTRO supporting liquidity measures. The effects of the liquidity measures were uneven with special positive effects on equity, currency and Ted spreads components and more muted effects on Banks CD Swaps and Sovereign. • More specifically, sovereign bonds in Europe remained in the high tension area in the 1Q with some worrisome revival at the beginning of 2Q-2012. Credit markets somehow improved but banks CDS remains tense reaffirming the sovereign-banks connection. On the positive side equity response was clearly positive and although still tense, the interbank spreads (Ted Spread) relaxed somehow. • .US Financial Stress relaxed but some tensions remain. Most of the segments went back to neutral although interest rates and Banks CDS remain linked to European volatility • Emerging Markets have been the most benefitted from Developed Markets Central Bank activism with a relatively better relative performance. The VIX returned to normal levels and both debt and currency markets benefitted by the relaxation in the developed markets during most of the 1Q. Eurozone’s problems revival at the beginning of Q2 have triggered new volatility in FX markets. 5
  • 6. Country Risk Quaterly Report – May 2012Section 1Capital Flows Update Equity & Bonds Net Inflows ReversalEquity & Bonds Net Inflows (change between Oct-Dec 2011 to Jan-April 2012 in standardized units over(in standardized units over the 2006-2012 period) the 2006-2012)Source: EPFR and BBVA Research Source: EPFR and BBVA Research 3.5 2.8 2.6 3.0 Developed markets Emerging Markets 2.4 2.5 2.2 2.0 2.0 1.8 1.5 1.6 1.0 1.4 0.5 1.2 1.0 0.0 0.8 -0.5 0.6 -1.0 0.4 0.2 -1.5 0.0 -2.0 Japan Middle East Asia GCC Turkey Switzerland Balkans Russia&CIS Australia&N.Zealand USA&Canada Developed Emerging Baltics S.Saharan Africa Latin America Nordics North Africa East Europe West Europe Periphery Europe -2.5 -3.0 -3.5 7 7 7 0 7 8 8 8 8 9 9 9 9 0 1 0 1 0 0 1 1 1 1 / 1 1 / 1 1 / 1 2 1 1 / / 0 / 0 / / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0 / / 1 / / / 1 4 7 0 1 1 4 7 0 1 4 7 0 1 4 7 0 0 4 7 1 0 0 0 0 1 0 0 0 0 1 0 0 0 1 0 0 0 1 0 0• Capital Flows (Bond & Equity) picked up sharply during the first quarter of 2012 with EM markets outperforming. Developed markets’ capital flows have been uneven. Commodity exporters experience the highest inflows followed by USA• The positive reversal in capital flows towards emerging markets was specially important in EM Europe with Eastern Europe. The Balkans and Russia benefiting the most followed by Turkey 6
  • 7. Country Risk Quaterly Report – May 2012Section 2Sovereign Markets UpdateSovereign CDS spreads April 2012Source: Datastream and BBVA Research Monthly average • Europe’s CD Swap spreads continued to widen in a diverging way. Only Norway remained below 50bp 23 as Austria and Germany finally increased almost 51 reaching 100bp, showing some contagion from EU 77 78 periphery. In the periphery, Italy and Spain 185 experienced increasing country risk levels. Greece, 429 Portugal and Ireland CD Swaps have remained at 474 critical levels despite bailout programs 248 13300 7773 • Some of the Eastern Europe sovereign CD Swaps 1105 1177 experienced sharp hikes during 4Q 2011. Hungary’s 583 236 730 situation deteriorated very fast driven by economic 196 and political uncertainty. Bulgaria, Romania 198 surpassed the 400 bp mark and Croatia’s 114 deterioration is also noteworthy. Turkey, Poland and 557 681 Russia did relatively better. 281 332 • Latin America sovereign CD Swaps remained at 418 relatively safe levels in the Emerging Markets 123 126 group. Chile continued to be the outperformer and 98 Mexico and Brazil stayed near 130 bp. Argentina and 115 Venezuela remained the outliers in the region with 127 CDS spreads at very high levels. 924 771 883 • Asian CDS spreads have experienced some 933 112 contagion. Still, China, Korea and Malaysia stayed 122 135 near 150 pb while Indonesia and Philippines reached 169 200 bp. 109 147 0 50 100 150 200 250 300 350 400 450 500 550 600Sovereign CD Swaps Map: It shows a color map with 6 different ranges of CD Swaps quotes(darker >500, 300 to 500, 200 to 300, 100 to 200, 50 to 100 and the lighter below 50 bp) 7
  • 8. Country Risk Quaterly Report – May 2012Section 2Sovereign Credit Ratings UpdateSovereign Rating Index 2007-2012Source: BBVA Research by using S&P, Moodys and Fitch Data AAA20 AAA20 AAA AA+19 AA+19 20 AA+ AA 18 AA 18 AA 19 AA- 17 AA- 17 18 AA- A+ 16 A+ 16 A+ 17 A 15 A 15 A 16 A- 14 A- 14 A- 15 BBB+13 BBB+13 14 BBB+ BBB 12 BBB 12 BBB 13 BBB-11 BBB-11 12 BBB- BB+10 BB+10 BB+ 11 BB 9 BB 9 BB 10 BB- 8 BB- 8 BB- 9 B+ 7 B+ 7 B+ 8 B 6 B 6 B 7 B- 5 B- 5 B- 6 CCC+4 5 CCC 3 CCC+ 4 CCC+ 4 CCC 3 CCC CCC- 2 CCC- 3 CC 1 CCC-2 2 CC 1 CC D 0 D 1 D 0 0 Core 20 AAA 20 AAA AA+19 20 AAA AA+19 AA 18 AA+19 AA18 17 AA 18 AA- AA-17 A+ 16 AA-17 A+16 A+16 A 15 A 15 A- 14 A 15 A- 14 13 BBB+ A- 14 13 BBB+ 13 BBB+ BBB12 BBB12 BBB12 BBB-11 11 BBB- BBB-11 BB+10 10 BB+ BB+10 BB 9 BB 9 BB 9 BB- 8 BB- 8 BB- 8 B+ 7 B+ 7 B+ 7 B 6 B 6 B 6 B- 5 B- 5 B- 5 CCC+4 CCC+4 CCC+4 CCC 3 CCC3 CCC3 CCC-2 CCC-2 CCC-2 CC 1 CC 1 CC 1 D 0 D 0 D 0Sovereign Rating Index: An index that translates the three important rating agencies ratings letters codes (Moody´s, Standard & Poor´s and Fitch) to numerical positions from 20 (AAA) to default (0) . The index shows the average of the threerescaled numerical ratings.• Developed Europe: The Sovereign Rating downgrade cycle came to a halt after the general downgrades in Europe in January. However, some of the EU periphery are still under the downgrade cycle (Portugal and Spain). On the positive side some agencies removed the negative outlook for Ireland• Some Emerging markets have also experienced downgrades since our last report, in particular Hungary, Slovakia and Slovenia. In Asia, Indonesia’s sovereign rating was upgraded reaching the investment grade category. In Latam the upgrade trend stabilized with no significant movements during the quarter. 8
  • 9. Country Risk Quaterly Report – May 2012Section 2Sovereign downgrade Pressures MapRating Agencies Downgrade Pressure Map • Financial Markets implicit ratings ( by Sovereign(actual minus CDS-implied sovereign rating, in notches) April 2012 Credit Default Swaps) continue to reflect aSource: BBVA Research End of Month divergent outlook with the EU periphery (and some core countries as France). Norway Sweden • The downgrade pressure continued to be intense in Austria the EU periphery with CD Swaps quoting 6 to 9 Germany France notches below the actual ratings. This pattern is Italy specially intense in Spain, Belgium, Italy and Spain Belgium Ireland. Besides, France’s sovereign rating remains Greece under pressure. Portugal Ireland • Pressure for downgrades in Emerging Europe is Turkey Russia specially in Hungary and Croatia, less so in Poland. Poland Turkey remain the safest. Czech Republic Hungary • Latam region remains uneven with some of the Bulgaria countries discounting a few upgrades of sovereign Romania Croatia ratings (in particular for Colombia, Mexico and Brazil) Mexico and Argentina and Venezuela still signaling Brazil Chile downgrade pressure Colombia Peru • Asia, remains in the neutral area, although some Argentina tensions have appeared in China and Korea. Venezuela China Philippines continued to signal some upgrade Korea potential, meanwhile Indonesia and Malaysia Thailand maintain near neutral levels Indonesia Malaysia Philippines -6 -3 0 3 6 9 12Downgrade Pressure Map: The map shows the difference of the current ratings index (numerically scaled from default (0) to AAA (20)) and the implicit ratings according to the Credit Default Swaps. We calculate implicit probabilities ofdefault (PDs) from the observed CDS and the estimated equilibrium spread. For the computation of these PDs we follow a standard methodology as the described in Chan-Lau (2006) and we assume a constant Loss Given Default of 0.6(Recovery Rate equal to 0.4) for all the countries in the sample. We use the resulting PDs in a cluster analysis to classify each country at every point in time in one of 20 different categories (ratings) to emulate the same 20 categories usedby the Rating Agencies.. 9
  • 10. Country Risk Quaterly Report – May 2012Section 3World Vulnerability MapMacroeconomic Vulnerability Map • Vulnerability in Europe´s Core Countries (Central Western(scaled through principal components of several vulnerability variables.) Europe and the Nordics) remains high relative to historicalSource: BBVA Research levels although lower than periphery countries. There were some deterioration in the fiscal during 2Q-2012 as public debt increased. • EU Periphery Countries (Belgium, Italy, Spain) risk continue to be concentrated in the fiscal dimension. Beyond this, liquidity and external risks remain important despite the external adjustment in some of the countries. The macroeconomic vulnerability index stays high as economic activity and unemployment deteriorated.. • Vulnerability in EU Bailed Out Countries (Greece, Ireland and Portugal) remains extremely high with liquidity, fiscal and external weaknesses at maximum levels • Emerging Europe continued to underperform the rest of EM countries with the reserve adequacy and macroeconomic dimensions still in negative area.. • Latinamerica’s vulnerability remains relatively low with most of the components below neutral levels.. The institutional index remain the main drag for the region. • Emerging Asia continues to be the less risky area. Most of vulnerability dimensions remain at neutral or low vulnerability. 10
  • 11. Country Risk Quaterly Report – May 2012Section 3Regional Risk Update: Western EuropeWest Europe: Vulnerability Radar 2012 • The Western Europe vulnerability position remains high mainly((all data for 2012, Relative position for the Developed Economies) due to EU Periphery countries. Although core countries positionSource: BBVA Research (Nordics and Central Europe) remain below the average of advanced Ciclically Adjusted Deficit (% GDP) countries, most of EU periphery vulnerability indicators remains Unemployment 1,0 Interest rate-GDP relatively high, with fiscal sustainability and external positions clearly Growth Diferential (%) 0,8 2012-16 above the average of advanced countries. 0,6 • Despite the high vulnerability relative to historical levels, theConsumer Prices Gross Public Debt (%yoy) (% GDP) relative position of Europe Core countries (Nordics & Central 0,4 Europe) remain below the advanced economies (mainly due to 0,2 even higher risk positions in USA, UK, and Japan). Fiscal vulnerability is lower than average due to safest debt levels and lower structural Current Account GDP (%yoy) 0,0 Deficit (%GDP) budget deficits. External vulnerability is also supportive. France continue to be the exception with external and liquidity vulnerability well above this group.Debt Held by Non Residents (% External Debt (% • The weaknesses in Europe Periphery I ( Belgium, Italy and Spain) GDP) total) remain challenging. Fiscal consolidation have brought some improvements in the cyclically adjusted deficits. However, both interest Short T. Debt Pressure* External Debt (% Exports) rate GDP growth differentials and debt levels remain vulnerable. Gross Fin. Needs External vulnerability is in better position than bailed out countries but (% GDP) Advanced Economies 2012 liquidity is still challenging (high gross financing needs). Europe Core 2012 Europe Periphery I 2012 • The weaknesses of Europe Periphery II (“Bailed out countries”) Europe Periphery II 2012 continues to be extremely high, Debt sustainability indicators remain •Developed: (ST Public Debt/ Total Public Debt) at risk despite improvements in cyclically adjustment deficits and •Emerging : (Reserves to ST External Debt) 1: High vulnerability external vulnerability is also high. Short term pressure improved after the 0: Low vulnerability bail outs as relatively high Gross financing needs will be covered by official credits. The Greek elections pose immediate risks.Vulnerability Radar: Shows a static and comparative vulnerability for different countries. For this we assigned several solvency , liquidity and macro variables and we reorder in percentiles from 0(lower ratio among the countries to 1 maximum vulnerabilities.) Furthermore Inner positions in the radar shows lower vulnerability meanwhile outer positions stands for higher vulnerability. 11
  • 12. Country Risk Quaterly Report – May 2012Section 3Inside Europe:Alert Imbalances Mechanism (AIM)Eurozone: Alert Imbalances Mechanism (AIM) The European Commission implemented the Alert ImbalancesSources: National sources, ECB, Eurostat, OECD, IFS and BBVA Research Mechanism (AIM) for the early detection of imbalances and to helpNote: Standard deviation with respect the normalized eurozone average in on thelatest available data in 2011 on a quarterly basis execute the subsequent adjustment. The divergence across European countries for some variables is relatively large, specially those related General Government with the external position and competitiveness. Debt (%GDP) 2.5 General Government 2 Private sector debt Debt The scoreboard includes the following indicators: Deficit (% of GDP) 1.5 (% of GDP) 1 • Current account: 0.5 % change on credit to the 3y average between +6%/-4% of GDP Unit Labor costs growth 0 private sector (% of GDP) -0.5 Spain and Portugal are converging rapidly, while Greece is proving -1 -1.5 more persistent. -2 Housing market • International Investment position:Export Market share loss developments The threshold is clearly surpassed by the periphery. The adjustment will be slow. REER growth Unemployment rate • External competitiveness: Net International Debtor Current Account (% of Measured through unit labor costs, export market shares and real Position (% of GDP) GDP) effective exchange rates developments. ULC are declining in peripherals. DEU FRA ITA ESP Ez avg. 2.5: High vulnerability -1.5: Low vulnerability 12
  • 13. Country Risk Quaterly Report – May 2012Section 3Regional Risk Update: Emerging EuropeEmerging Europe: Vulnerability Radar 2012 • The weaknesses of Emerging Europe remain above the(all data for 2012, Relative position for the Emerging Market countries) average of EM with some of the countries showing Trade andSource: BBVA Research Ciclically banking contagion channels from Western Europe. Adjusted Deficit (% GDP) • Fiscal vulnerability remains at neutral levels with cyclically Interest rate- Unemployment 1,0 GDP Growth adjusted deficits and public debt levels around emerging market (%) 0,8 Diferential levels, but high vulnerability arising from relatively higher interest 2012-16 rates, GDP growth differential. Fiscal problems are larger in Poland, Consumer 0,6 Gross Public Hungary and Croatia relative their peers. Prices (%yoy) Debt (% GDP) 0,4 • External sustainability continue to be the main challenge as 0,2 external debt levels remain above the EMs’ average and current Current account deficits are challenging in some countries. Except Russia,GDP (%yoy) 0,0 Account Deficit most of the countries present high external vulnerability problems. (%GDP) In Turkey external debt levels are manageable but the current account deficit is still high. Debt Held by External Debt Non Residents (% GDP) • International Reserve adequacy remains poor relative to the (% total) emerging markets which pose some risks if Eurozone Debt crisis Short T. Debt External Debt deteriorates. Pressure* (% Exports) • Still poor relative economic growth performance and higher Gross Fin. Emerging Europe 2012 Needs (% GDP) unemployment drag the region. Turkey’s economic growth is outstanding but inflation disappoints. Emerging Europe 2011 •Developed: (ST Public Debt/ Total Public Debt) •Emerging : (Reserves to ST External Debt) 1: High vulnerability 0: Low vulnerabilityVulnerability Radar: Shows a static and comparative vulnerability for different countries. For this we assigned several solvency , liquidity and macro variables and we reorder in percentiles from 0 (lower ratioamong the countries to 1 maximum vulnerabilities.) Furthermore Inner positions in the radar shows lower vulnerability meanwhile outer positions stands for higher vulnerability. 13
  • 14. Country Risk Quaterly Report – May 2012Section 3Regional Risk Update: LatamLatam: Vulnerability Radar 2012 • Vulnerability position in Latam stays at relatively sound levels(all data for 2012, Relative position for the Emerging Market countries) with the main exceptions being Argentina and Venezuela. TheSource: BBVA Research Ciclically significant improvement of fiscal and external ratios during the last Adjusted Deficit (% GDP) decade provide the region with a much better position to cope Interest rate- Unemployment 1,0 GDP Growth with potential crisis episodes (%) Diferential 0,8 2012-16 • Fiscal vulnerability remains near average EM levels. Both actual 0,6 and cyclically adjusted fiscal deficits remains at safe area and Consumer Gross Public Prices (%yoy) Debt (% GDP) relatively low public debt ratios support. However, not so high long 0,4 term growth, and a high real interest rate pose some challenges 0,2 for public debt dynamics in some of the countries and in particular Current Brazil. Brazil should, therefore, increase efforts to improve fiscalGDP (%yoy) 0,0 Account Deficit variables. Finally, Venezuela still remains very vulnerable. (%GDP) • External vulnerability is near EM average, with current account Debt Held by deficits being the only variable EM averages. However, external External Debt Non Residents (% GDP) debt levels (both relative to GDP and exports) provide low levels of (% total) vulnerability Short T. Debt External Debt • Liquidity pressures are relatively low. Reserve adequacy ratios Pressure* (% Exports) remains in the safest levels and gross financing needs and debt Gross Fin. Latam 2012 Needs (% GDP) held by non residents stay at relatively low levels. This will provide some cushion in an hypothetical capital flows sudden stop Latam 2011 Developed: (ST Public Debt/ Total Public Debt) • Inflation remains the main source of risk. I has improved in Emerging : (Reserves to ST External Debt) 1: High vulnerability Brazil but remains very high in Argentina and Venezuela. 0: Low vulnerabilityVulnerability Radar: Shows a static and comparative vulnerability for different countries. For this we assigned several solvency , liquidity and macro variables and we reorder in percentiles from 0 (lower ratioamong the countries to 1 maximum vulnerabilities.) Furthermore Inner positions in the radar shows lower vulnerability meanwhile outer positions stands for higher vulnerability. 14
  • 15. Country Risk Quaterly Report – May 2012Section 3Regional Risk Update: AsiaEmerging Asia: Vulnerability Radar 2012 • Emerging Asia’s vulnerability remains the safest among the(all data for 2012, Relative position for the Emerging Market countries) EM. This is the result of very low levels of fiscal and externalSource: BBVA Research vulnerability and strong reserve adequacy after years of Ciclically Adjusted international reserves accumulation. India is still the most Deficit (% GDP) Interest rate- vulnerable within the region. Unemployment 1,0 GDP Growth (%) Diferential • A sound fiscal situation remains an asset for the region with 0,8 2012-16 very low fiscal deficits (current and cyclically adjusted) as well as Consumer 0,6 Gross Public low public debt levels. India is the exception with a relatively high Prices (%yoy) Debt (% GDP) structural deficit. 0,4 0,2 • External vulnerability is even lower with very low levels of Current current account deficits (or even surplus) and historically low levels GDP (%yoy) 0,0 Account Deficit of external debt, providing an important buffer for potential capital (%GDP) flow reversals Debt Held by • Reserve adequacy ratios remain in the safest levels . This is External Debt Non Residents (% GDP) particularly the case of reserves in months of import covered but (% total) also the external short term debt to reserves ratios. A very strong position in international reserves provides an additional cushion for Short T. Debt External Debt Pressure* (% Exports) potential capital flow reversals Gross Fin. Emerging Asia Needs (% GDP) 2012 • Economic growth and unemployment stay robust despite the Emerging Asia economic activity deceleration. Inflation figures have relaxed 2011 particularly in China 1: High vulnerability 0: Low vulnerabilityVulnerability Radar: Shows a static and comparative vulnerability for different countries. For this we assigned several solvency , liquidity and macro variables and we reorder in percentiles from 0 (lower ratioamong the countries to 1 maximum vulnerabilities.) Furthermore Inner positions in the radar shows lower vulnerability meanwhile outer positions stands for higher vulnerability. 15
  • 16. Country Risk Quaterly Report – May 2012Section 3Regional Risk Update: Western EuropeEurope Core: Sovereign Rating Europe Periphery I: Sovereign Rating Europe Periphery II: Sovereign Rating(Rating agencies and BBVA scores +-1std dev) (Rating agencies and BBVA scores +-1 std dev) (Rating agencies and BBVA scores +.1 std dev)Source: Standard & Poors, Moody´s, Fitch and BBVA Research Source: Standard & Poors, Moody´s, Fitch and BBVA Research Source: Standard & Poors, Moody´s, Fitch and BBVA Research 21 AAA 20 21 21 AA+19 AAA 20 AAA 20 AA 18 AA+19 AA+19 AA- 17 AA 18 AA 18 A+ 16 AA- 17 AA- 17 A 15 A+ 16 A+ 16 A- 14 A 15 A 15 BBB+13 A- 14 A- 14 BBB12 BBB+13 BBB+13 BBB-11 BBB12 BBB12 BB+10 BBB-11 BBB-11 BB 9 BB+ 10 BB+ 10 BB- 8 BB 9 BB 9 B+ 7 BB- 8 BB- 8 B 6 B+ 7 B+ 7 B- 5 B 6 B 6 CCC+ 4 B- 5 B- 5 CCC 3 Rating Agencies CCC+ 4 CCC+ CCC 3 Rating Agencies 4 Rating Agencies CCC-2 CCC 3 CC 1 BBVA Models Average CCC-2 CCC-2 0 CC 1 BBVA Models Average CC 1 BBVA Models Average 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012Europe Core: CD Swap Europe Periphery I: CD Swap Europe Periphery II: CD Swap(Actual and Equilibrium CDSwap) (Actual and Equilibrium CDSwap) (Actual and Equilibrium CDSwap)Source: BBVA Research Source: BBVA Research Source: BBVA Research140 500 1800 CDSwap CDSwap CDSwap 450 1600 CDS Swap Equilibrium CDS Swap Equilibrium CDS Swap Equilibrium120 400 1400100 350 1200 30080 1000 250 80060 200 600 15040 400 10020 50 200 0 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 2012 16
  • 17. Country Risk Quaterly Report – May 2012Section 3Sovereign Ratings: Emerging MarketsEM Europe: Sovereign Rating Latam: Sovereign Rating Emerging Asia: Sovereign Rating(Rating agencies and BBVA scores) (Rating agencies and BBVA scores) (Rating agencies and BBVA scores)Source: Standard & Poors, Moody´s, Fitch and BBVA Research Source: Standard & Poors, Moody´s, Fitch and BBVA Research Source: Standard & Poors, Moody´s, Fitch and BBVA Research 21 21 21AAA 20 AAA 20 AAA 20AA+19 AA+19 AA+19AA 18 AA 18 AA 18AA- 17 AA- 17 AA- 17A+ 16 A+ 16 A+ 16A 15 A 15 A 15A- 14 A- 14 A- 14BBB+13 BBB+13 BBB+13BBB12 BBB12 BBB12BBB-11 BBB-11 BBB-11BB+ 10 BB+ 10 BB+ 10BB 9 BB 9 BB 9BB- 8 BB- 8 BB- 8B+ 7 B+ 7 B+ 7B 6 B 6 B 6B- 5 B- 5 B- 5CCC+ 4 CCC+ 4 CCC+ 4CCC 3 Rating Agencies CCC 3 Rating Agencies CCC 3 Rating AgenciesCCC-2 CCC-2 CCC-2CC 1 BBVA Models Average CC 1 BBVA Models Average CC 1 BBVA Models Average 0 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 2012Emerging Europe: CD Swap Latam: CD Swap Emerging Asia: CD Swap(Actual and Equilibrium CDSwap) (Actual and Equilibrium CDSwap) (Actual and Equilibrium CDSwap)Source: BBVA Research Source: BBVA Research Source: BBVA Research500 600 350 CDSwap CDSwap CDSwap450 CDS Swap Equilibrium CDS Swap Equilibrium CDS Swap Equilibrium 500 300400350 250 400300 200250 300 150200 200150 100100 100 50 50 0 0 0 2004 2005 2006 2007 2008 2009 2010 2011 2004 2005 2006 2007 2008 2009 2010 2011 2012 2004 2005 2006 2007 2008 2009 2010 2011 17
  • 18. Country Risk Quaterly Report – May 2012Special Topic: Central Banks BalanceSheet In Developed & EM Markets • A significant increase of central bank (CB) balance sheets is aCentral Balance Sheet and Money Expansion (2007-2011) distinctive feature of the world economy since the global crisis The(Change 2011-2007 in percentage of GDP) balance sheet of CBs virtually doubled in EM countries in the periodSource: BBVA Research and IMF (IFS and WEO/Apr12) between 2006 and 2011 while it actually tripled in G7 economies. 20.0 CB Assets 15.0 Monetary Base • However, since emerging market economies have been growing Monetary Circulation much faster than G7 ones, the relative size of their CB balance sheets 10.0 (that is over GDP) increased only 3 percentage points as opposed to as much as 10 percentage points in the developed world. 5.0 Furthermore, central banks from emerging markets seem to have tamed their balance sheet expansion since 2009 while those in developed 0.0 countries have not. CB assets over GDP have declined on average for the EAGLEs1/ since 2009, especially in China and Russia, where the strong -5.0 expansion clearly started before the crisis. Brazil and Turkey, however, Usa Jap Emu Uk Chi Ind Kor Bra Mex Rus Tur follow the pattern of the developed world, continuously increasing CBSources of Monetary Base Expansion (2007-2011) balance sheets.(Change 2011-2007 in percentage of GDP)Source: BBVA Research and IMF (IFS and WEO/Apr12) •.Drivers of CB balance sheet growth differ massively: domestic assets20 are behind the growth of developed CBs and reserve accumulation Net Foreign Assets is the key determinant for emerging markets. Quantitative easing 15 Net Domestic Assets through securities purchase and liquidity injections has been behind the 10 FED’s balance sheet expansion as well as that of the ECB and the Bank of 5 England. Foreign assets have been the driver in the EAGLEs, growing above GDP especially in China, followed by Brazil and Turkey. 0 -5 1/ Group of largest contributors to global growth with EM for the next 10 years, according to BBVA Research forecasts.-10 For more info see http://www.bbvaresearch.com/KETD/ketd/ing/nav/eagles.jsp Usa Jap Emu Uk Chi Ind Kor Bra Mex Rus Tur 18
  • 19. Country Risk Quaterly Report – May 2012 Special Topic: Central Banks Balance Sheet In Developed & EM Markets Money Velocity Gaps (2007-2011) • Rapid growth in CB balance sheets does entail some risks. The most (M2/Nominal GDP, relative to 2000-11 trend in %) obvious one is inflation if we believe inflation is a monetary Source: BBVA Research and IMF (IFS and WEO/Apr12) phenomenon in the long run. Looking at the correlation between the 2% expansion of the monetary base and inflation, we find it is quite high for many countries in our sample, especially in the EMs’ universe but 1% the correlation breaks for the Developed Economies, 0% • This is because the money inflation link will be also influenced by -1% economic conditions. In this sense output and money velocity are -2% also key to influence the final link between money and inflation: -3% – Still negative output gaps in developed economies will prevent money to feed inflation but closing or positive gaps in EM´s -4% 2011 poses more risk. Developed economies activity is still running 2006 2008 2009 2010 2005 2007 below potential and this will to contain inflationary pressure. However, economic activity has recovered very fast in EM economies Developed Economies Emerging Economies – The sharp drop in money velocity during 2008-2009 crisis Money and inflation pressures (2007-2011) helped to buffer inflationary pressures but now is reversing. (average annual change in percentage) This is especially true in the case of the EM markets where velocity Source: BBVA Research and IMF (IFS and WEO/Apr12) gaps are now positive and similar in size of the pre crisis levels. 16 Velocity gaps are also recovering in industrial countries although toAnnual average CPI inflation (2001- Annual average CPI Inflation (2001-2011) 14 a slower pace and still below pre-crisis levels Russia 12 Turkey . 10 Indonesia 8 • The two factors above indicate that the margin to keep CB balance sheet expansion without feeding inflation is larger for Developed 2011) Brazil India 6 Markets. Korea Mexico 4 Canada USA UK • Other risks are related to CB asset quality for rapidly expanding 2 China NDA, sometimes with dubious assets, and exchange rate and EMU 0 interest rate valuation effects on the NFA side. The first risk is, of Japan course, more true for CBs in developed countries and the second for -2 0 5 10 15 20 25 30 35 those in emerging economies. 19 Annual average monetary base change (2001-2011)
  • 20. Country Risk Quaterly Report – May 2012AnnexMethodology : Indicators and Maps• Financial Stress Map: It stress levels of according to the normalized time series movements. Higher positive standard units (1.5 or higher) stands for high levels of stress (dark blue) and lower standard deviations (-1.5 or below) stands for lower level of market stress (lighter colors)• Sovereign Rating Index: An index that translates the three important rating agencies ratings letters codes (Moody´s, Standard & Poor´s and Fitch) to numerical positions from 20 (AAA) to default (0) . The index shows the average of the three rescaled numerical ratings.• Sovereign CD Swaps Map: It shows a color map with 6 different ranges of CD Swaps quotes (darker >500, 300 to 500, 200 to 300, 100 to 200, 50 to 100 and the lighter below 50 bps)• Downgrade Pressure Map: The map shows the difference of the current ratings index (numerically scaled from default (0) to AAA (20)) and the implicit ratings according to the Credit Default Swaps. We calculate implicit probabilities of default (PDs) from the observed CDS and the estimated equilibrium spread. For the computation of these PDs we follow a standard methodology as the described in Chan-Lau (2006) and we assume a constant Loss Given Default of 0.6 (Recovery Rate equal to 0.4) for all the countries in the sample. We use the resulting PDs in a cluster analysis to classify each country at every point in time in one of 20 different categories (ratings) to emulate the same 20 categories used by the Rating Agencies..• Macroeconomic Vulnerability Map: Using Principal Component Analysis we construct five different vulnerability indicators that summarize information coming from 17 different variables in several dimensions of economic vulnerability: : Liquidity management (Reserves to Short Term Debt, Reserves to M2, Reserves to Imports for EM countries and Short term public debt relative to total Public Debt for developed countries), External Vulnerability (Current Account Balance, External Debt to Exports and External Debt to GDP),Fiscal Vulnerability (Fiscal Balance and Public Debt to GDP), Macroeconomic Strength (GDP Growth, Unemployment and Inflation) and Institutional Strength: (Rule of Law, Control of Corruption, Government Effectiveness, Political Stability and Absence of Violence, Investor Protection, Number of Days to start a business). Once principal components are calculated we assign colors according to the percentiles position with higher vulnerability scores assigned to the darker blue ranges.• Vulnerability Radar: Shows a static and comparative vulnerability for different countries. For this we assigned several solvency , liquidity management and macro variables relative to the group of the Developed or Emerging countries depending on the country. Finally, we reorder in percentiles from 0 (lower ratio among the countries) to 1 (maximum vulnerabilities) Furthermore Inner positions in the radar shows lower vulnerability meanwhile outer positions stands for higher vulnerability. 20
  • 21. Country Risk Quaterly Report – May 2012AnnexMethodology: Models and BBVA country risk• GVAR Model: The approach uses a dynamic multi-country framework for the analysis of the international transmission of shocks and is based on the GVAR toolbox, launched in December 2010, and sponsored by the ECB. The toolbox is based on work by Dees, di Mauro, Pesaran adn Smith (2007) and has been developed by Centre for Financial Analysis & Policy at Cambridge University. It comprises 26 economies, with the EA as one of the economies covered. The model is constructed by combining separate models for each of the 26 economies linking core variables within each economy with corresponding trade-weighted foreign variables. EA variables are GDP-weighted aggregates of eight countries (Austria, Belgium, Finland, France, Germany, Italy, Netherlands and Spain). The model has both real and financial variables: real GDP, inflation, the real equity price, the real exchange rate, short and long-term interest rates, and the oil price. All the data are observed at the quarterly frequency. More information about the model and the toolbox can downloaded at http://www-cfap.jbs.cam.ac.uk/research/gvartoolbox/index.html.• BBVA Research Sovereign Ratings Methodology: We compute our sovereigns ratings by averaging four alternatives sovereign rating models developed at BBVA research:- Credit Default Swaps Panel Data Error Correction Model: This model forecasts actual and equilibrium levels of CD Swaps for 40 developed and emerging markets. The model allows for dynamic and long run equilibrium deviation of CD Swaps including Global Risk Aversion and Idiosyncratic fundamental variables. The long run equilibrium CD Swaps are the result of equilibrium global risk aversion and idiosyncratic fundamental variables are finally converted to a 20 scale sovereign rating scale.- Sovereign Rating Panel Data Ordered Probit with Fixed Effects Model: The model estimates a sovereign rating index (a 20 numerical scale index of the three sovereign rating agencies) through ordered probit panel data techniques. This model takes into account idiosyncratic fundamental stock and flows sustainability ratios allowing for fixed effects , thus including idiosyncratic country specific effects- Sovereign Rating Panel Data Ordered Probit without Fixed Effects Model: The model estimates a sovereign rating index (a 20 numerical scale index of the three sovereign rating agencies) through ordered probit panel data techniques. This model takes into account idiosyncratic fundamental stock and flows sustainability but fixed effects are not included, thus all countries are treated symmetrically without including the country specific long run fixed effects.- Sovereign Rating Individual OLS models: These models estimates the sovereign rating index (a 20 numerical scale index of the three sovereign rating agencies) individually. Furthermore , parameters for the different vulnerability indicators are estimated taken into account the own history of the country independent of the rest of the countries. 21

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