K bank capital market perspectives jul 22 greece


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K bank capital market perspectives jul 22 greece

  1. 1. KBank Capital Market Perspectives Market Updates Macro / FX / Rates Why should Germany and France save Greece? 22 July 2011 Euro-area leaders recently annouced that the eurozone and the IMF would provide additional EUR 159bn (USD 229bn) to Greece Amonthep Chawla, Ph.D. - Greece is seen to benefit more from staying in the eurozone than Kasikornbank amonthep.c@kasikornbank.com leaving it Germany and France are likely to protect their interest by keeping Greece inside the eurozone so as to reduce financial volatility Thai economy will need to prepare for another round of economic turmoil because the recent negotiation will last only temporarily while the fundamental problems are not yet resolved. Disclaimer: This report must be read with the Disclaimer on page 7 that forms part of itSome doctors save a life of a patient by cutting off his legDebt crisis in the eurozone has been spreading from Greece to Ireland and Portugal.These three countries requested financial aid from the IMF and the ECB in exchange oftheir fiscal reform, which could guarantee that they could pay back loans and service theirbond interest payments. However, sluggish tax increase and spending cut has led toseries of bail-out, which deteriorate the credibility of the eurozone. Euro-area leadersrecently annouced that the eurozone and the IMF would provide additional EUR159bn (USD 229bn) to Greece. The region is likely to increase rescue fund to othercountries that have trouble servicing their debt as well. Greece is going into “selectivedefault”, which includes a voluntary extension of the bond maturity and lower the bondyields. Investors will need to accept haircut. Enormous debt in Spain and Italy triggeredthe market to question the sustainability of the region. Why can’t the core countries, i.e.Germany and France, just get rid of some bad apples before they ruin the whole basket?Is it possible to kick Greece out of the eurozone?Fig 1. Budget deficit to GDP Fig 2. Current account balance to GDP % GDP % GDP 5 10 5 0 0 -5 -5 -10 -10 -15 -15 -20 -20 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Germany Greece Italy Spain US Germany Greece Italy Spain USSource: Bloomberg, KBank Source: Bloomberg, KBankJust like any other political or economic settings, the eurozone started with hope that itwill reduce price volatility, subside social instability and promote economic prosperity. Astime goes by, the eurozone is being challenged by global economic crisis as well as fiscalsolvency. It has been originally formed to coordinate regional monetary policy so as everycountry uses common interest rate and currency. Meanwhile, each country maintains111
  2. 2. independence of fiscal policy. In order to avoid inconsistency between these two policies,the eurozone members promised, as stated in the Lisbon Treaty, that they wouldmaintain fiscal discipline in their countries, i.e. keeping fiscal deficit under 3% of GDP andpublic debt below 60% of GDP. However, significant number of members are not able tokeep their promise that they gave before joining the eurozone. There are some rules topunish countries that do follow fiscal discipline, yet there is no rule stating that thesecountries could be expelled from the group. It is understandable that they would not draftany plan to break up the eurozone; similarly there is no part in the US constitution on theprocedure to break up the United States. On the other hand, it is possible for any countryto voluntarily withdraw from the eurozone. That means Greece could simply leave thecurrency union, start its weaker national currency to gain competitiveness and solve itseconomic crisis. However, Greece decided to stay regardless of several politicaldemonstration against the austerity measures. Meanwhile, Germany and France areseen to try very hard to keep Greece inside the eurozone. What do Greece, France andGermany mutually benefit from the eurozone?Fig 3. Twin deficits Fig 4. Debt to GDP % GDP % GDP 180 US 160 Spain 140 120 Portugal 100 Italy 80 60 Ireland 40 20 Greece 0 -35 -30 -25 -20 -15 -10 -5 0 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 Germany Greece Ireland Current account deficit Budget deficit Italy Portugal SpainSource: Bloomberg, KBank Source: Bloomberg, KBankHigh cost of stayingCould Greece recover from its ailing economy by leaving the eurozone? Greece lostcontrol of its monetary policy after it joined the eurozone in 2001. Consequently, Greecehas been using the interest rate set by the ECB to control regional price volatility, yet it isnot dependent on Greece’s labor market condition. Higher interest rate is likely to deterlabor market recovery, leading to higher unemployment rate, poverty and recession.Further, Greece has adopted the euro as its national currency, preventing it fromchanging the exchange rate to rebalance the current account deficit. Greece’s poorexport performance could have been improved by allowing the exchange rate to beweaker against neighboring countries so as to gain competitiveness. At the same time,Greece has to cut budget deficit and lower public debt. Greece has recently passed theausterity measures to raise taxes and cut spendings. The plan is seen to slowly createfiscal strength to the Greek government in expense of its citizens. Some publicemployees will lose their jobs. Salaries, pensions and other public benefits will be cut.Domestic consumption will subsequently fall, leading to an economic recession.Privatization of state enterprises will be implemented to reduce fiscal pressure and togain enough capital to pay off debt, which will reduce national assets and increasedependency on foreign companies.222
  3. 3. Fig 5. Greece’s export by product 2010 Fig 6. Percent of world export % world export Food 6 Manufactured Goods 23% and Articles 5 33% 4 Crude Materials ex cl 3 Fuels 2 7% Greeces ex port by product 2010 1 Mineral Fuels 9% 0 Machinery and 1990 1994 1998 2002 2006 2010 Transport Equipment Chemicals 13% 15% Portugal Ireland Italy Greece SpainSource: CEIC, KBank Source: World Trade Organization, KBankFrom the point of view of taxpayers in France and Germany, the bail-out plans are seento incur losses to them, either by extending bond maturity or shifting financial burden toinvestors. Costs of rescuing Greece and other indebted nations will surge, which willtrigger demonstration in the lending countries. It is likely that Greece cannot reform itsfiscal stance, then taxpayers in Germany and France could stop their government frombailing out Greece, or even could threaten these founding countries to leave theeurozone.Fig 7. Current account Fig 8. Number of Visitors 16,000 0 Millions 14,000 18 -10,000 16 12,000 14 -20,000 10,000 12 8,000 -30,000 10 6,000 8 -40,000 6 4,000 -50,000 4 2,000 2 0 -60,000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 Current Account: Serv ices: Trav el (left, USD mn) Current Account (right, USD mn) Visitor Arriv als: Europe Visitor Arriv als: non-EuropeSource: CEIC, KBank Source: CEIC, KBankHigher cost of exitingLet’s say Greece wants to leave the eurozone, abandon the euro and revive its drachma.Is it going to benefit Greece? For sure, Greece could gain control of its monetary policy.Greece’s central bank could set a policy rate that is in line with its macroeconomicconditions so as to promote employment and lower price fluctuation. Greece could set itsdrachma weaker than the euro in order to gain competitiveness in exports, which willsolve its long-lasting current account deficits. Main sources of foreign income aretourism and exports of food and vegetable product. Increase in exports and thenumber of tourists from Europe will favor Greece’s economy. However, the cost ofexiting the euro could be excruciating to its economy.First, Greece will have to re-denominate its existing euro to the national currency, whichwill inevitably encounter technical difficulties. For example, banks will need to re-denominate mortgage loans, credit card debt, bank deposit in all electronic system intothe national currency. The government will need to pass a law to re-denominate taxes,government employees’ salary, public pension and other measurement as well. Second,Greece will need to prevent capital flight after depositors or investors anticipate thatGreece will re-denominate their claims from the euro to the national currency. Thechange to national currency is likely to reduce their asset values, which will rush people333
  4. 4. to take money out of Greece to other eurozone countries and lead to bank run or collapsein Greece’s financial system. Third, financial uncertainty will lead to another round ofcredit-rating downgrade, which will result in greater sovereign spreads and higher interestcosts. Higher interest costs and weakening national currency will increase the amountedof debt, which is originally denominated in the euro. Despite gains in exportcompetitiveness and increase in employment, higher inflation from weakening currencycould outweigh gains in higher wage, leading to lower real income of Greek people.Greece could implement capital control temporarily to force its citizen and investors tosurrender their euro to the new national currency. However, such policy will greaterisolate Greece economically from the region.Why Germany and France need to help Greece? Greece’s economy is relatively small inthe eurozone. However, Germany and France are heavily exposed to Greece’s debt.Failure to pay off debt and continual decline in the bond market prices could severelyaffect the financial sector in the lending countries. Therefore, it is an act of self-interest forGermany and France to save Greece and prevent this contagious effect to spread toother borrowing countries.Fig 9. Percentage of gold in foreign reserve Fig 10. Exposure of Greece’s debt by other countries USD bn % 60 90 383 112 80 8,134 50 3,401 2,452 70 2,435 40 60 50 30 228 40 20 30 20 10 10 109 1,054 0 0 Spain Japan Belgium Sw itzerland Italy US UK Germany France Portugal Greece USA Germany Italy France Spain Thailand China % of reserv es Public sector Banks&priv ate lendingNote: the numbers above the bar graph indicate tonnes of gold Source: BIS Quarterly Review June 2011, KBankSource: World Gold Council, KBankWhat’s next for Greece and the eurozone?The latest attempt to bail out Greece and perhaps other indebted nations are likely to bejust a short-term scheme to gain confidence back to the eurozone. Greece may havereceived money to pay off debt; however, it needs to generate new money to financeinterest payment as well as the principal of the debt. How can Greece generate newmoney? One thing for sure is to extract income from its citizen by raising taxes andcutting spending so as to generate budget surplus. One major difficulty is that taxrevenue will be unavoidably lower after Greece’s economy is going toward recession.People will have lower income. Consumption will decline. Subsequently, taxes levied onincome and consumption will fall. What about privatization? Yes, Greece can earn a greatdeal of revenue by selling off national property to foreign investors. However, Greece willneed to bear the consequence that it is likely to pay higher price for using the stateutilities. How about selling gold? Greece’s central bank holds a great deal of gold over112 tonnes, or nearly USD 6bn. Greece could easily service its debt payment. What hasrestrained Greece from not selling off gold? One reason is that the IMF has set aregulation to prevent a country’s central bank to sell gold, which could intervene the goldprices in the market. However, Greece could sell gold directly to the IMF for certainamount. What if Greece increases its exports and boost tourism? Sure, it does sound likea great idea, but how? Greece cannot simply lower price of its export products becauseits currency is fixed by the euro. Export of food product is seen favorable as it relies lesson import of oil, capital goods and intermediary products. Food export is accounted forabout 20% of total export, yet it is unlikely to generate enough revenue.444
  5. 5. In the short-run, Greece is unlikely to acquire enough money to pay off debt. ShouldGreece ask for another round of bail out? Or should investors just accept haircut andbanks start to increase their capital to rebalance their balance sheet? Debt crisis in theeurozone is likely to come back to haunt investors again in the near future. Apart fromGreece, the eurozone is full of indebted countries, which are unlikely to meet the target offiscal discipline set by the region. The problems of regional insolvency is likely to growbigger when big economies, such as Spain and Italy, annouce default. Thai economywill need to prepare for another round of economic turmoil because the recentnegotiation will last only temporarily while the fundamental problems are not yetresolved. The amount of international trade between Thailand and Greece or othereurozone countries are small. However, volatility in exchange rate will affectcapital flows, which will subsequently result in an increase in the volatility of Thaibaht.So what could be a long-term solution? One possibility is to plan for an exit strategy forcountries that could no longer integrate in the region. An exit strategy should prevent boththe exiting members and the existing members from economic crisis. Countries may beallowed to temporarily adopt the euro as their national currency in order to insulate pricevolatility during the transition until they pay off their foreign debt or regain strength toovercome economic difficulties. Apart from looking a way to break up the eurozone,countries in the eurozone could increase integration in fiscal policy and politicalindentities so as to increase power of the central planner to solve the regional economicproblems. This could be an ideal solution to reduce diversity of the region in terms ofeconomic development and fiscal policy. We could experience the revival of the RomanEmpire or the European version of the United States. In such case, price volatility willreduce, which will greater increase economic growth and international trade. Thaieconomy is likely to benefit from the global economic stability as fund flows andexchange rate will be less volatile.555
  6. 6. Table 1. Monthly Key Economic Indicators Nov 10 Dec 10 Jan-11 Feb-11 Mar 11 Apr 11 May 11 Jun-11Manufacturing index (ISIC) 189.1 189.6 189.5 188.2 186.7 180.1 181.3 % YoY 5.7 -3.4 4.1 -3.0 -6.7 -8.1 -3.9Industrial capacity utilization rate (%) (ISIC) 63.6 62.4 62.3 59.5 66.1 54.4 58.7Retail sales (% YoY) 8.3 8.4 9.6 9.0 4.1 7.9 n.a.Total vehicle sales (units) 78,874 93,122 68,398 77,213 93,008 67,283 55,851Motorcycle sales (units) 152,767 167,707 165,152 188,248 191,437 174,244 163,411Unemployed labor force (000 persons) 389 268 268 374 268 276 n.a.Unemployment rate (%) 1.0 0.7 0.7 1.0 0.7 0.7 n.a.Consumer prices (% YoY) 2.80 3.00 3.03 2.87 3.14 4.04 4.19 4.06 core 1.10 1.40 1.32 1.45 1.62 2.07 2.48 2.55Producer prices (% YoY) 7.1 4.7 6.0 7.4 5.9 6.6 6.2 4.5External Accounts (USD mn, unless specified otherwise)Exports 17,584.0 17,220.0 16,523.0 18,406.0 21,072.0 17,243.0 19,284.0 % YoY 28.7 18.6 21.4 29.1 31.0 24.7 17.3Imports 17,094.0 15,911.0 17,111.0 16,375.0 19,180.0 17,720.0 19,010.0 % YoY 35.0 8.8 31.2 18.6 27.2 26.3 34.4Trade balance 490.0 1,309.0 -588.0 2,031.0 1,892.0 -477.0 274.0Tourist arrivals (000) 1,500 1,840 1,810 1,822 1,765 1,506 1,376 % YoY 10.3 9.5 12.8 12.8 22.7 35.9 68.8Current account balance 1,019.0 1,750.0 1,090.0 3,823.0 1,881.0 -165.0 -511.0Balance of payments 820 2,263 1,689 4,271 1,365 3,570 -2,600FX reserves (USD bn) 168.2 172.1 174.0 179.2 181.5 189.9 186.2Forward position (USD bn) 15.3 19.6 19.0 17.7 20.8 21.4 23.5Monetary conditions (THB bn, unless specified otherwise)M1 1,235.4 1,302.4 1,326.2 1,346.4 1,345.6 1,347.6 1,396.4 % YoY 10.8 10.9 15.5 13.4 13.8 14.0 10.7M2 11,497.6 11,776.4 11,817.2 12,152.9 12,280.3 12,481.0 12,563.0 % YoY 11.1 10.9 11.5 13.7 13.1 15.2 14.2Bank deposits 10,387.9 10,584.9 10,606.3 10,834.2 10,891.3 10,966.1 11,084.4 % YoY 8.1 8.7 8.8 10.3 9.0 9.9 8.4Bank loans 9,751.1 9,947.0 10,064.5 10,209.7 10,308.2 10,376.2 10,516.8 % YoY 12.3 12.6 14.5 15.1 14.9 15.3 15.6Interest rates (% month end)BOT 1 day repo (target) 1.75 2.00 2.25 2.25 2.50 2.75 2.75 3.00Average large banks minimum lending rate 6.00 6.12 6.37 6.37 6.62 6.75 6.75 6.87Average large banks 1 year deposit rate 1.11 1.32 1.51 1.51 1.67 1.86 1.86 2.03Govt bond yield 1yr 2.11 2.38 2.54 2.68 2.83 3.00 3.15 3.50Govt bond yield 5yr 2.98 3.26 3.40 3.48 3.41 3.38 3.50 3.78Govt bond yield 10yr 3.59 3.77 3.85 3.89 3.75 3.70 3.79 3.91Key FX (month end)DXY US dollar index 81.20 79.03 77.74 76.89 75.86 72.93 74.64 74.30USD/THB 30.21 30.06 30.93 30.60 30.28 29.88 30.32 30.73JPY/THB 36.11 37.01 37.60 37.47 36.42 36.80 37.17 38.13EUR/THB 39.22 40.23 42.35 42.25 42.86 44.24 43.64 44.56Source: Bloomberg666
  7. 7. Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request.777