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  • 1. .Mean S FX & Rates Strategies KBank Economics / Strategy An update of the Eurozone debt problems FX / Rates 23 December 2010 Eurozone’s debt problem continues to be a major concern for the stability of the eurozone economies and a source of financial Nalin Chutchotitham market volatility EU members established three key measures to calm the market’s concerns, as well as to deal with immediate obligations For now, the emergency funds seemed sufficient to cover for the combined obligations of the PIGS governments, without further borrowing from the market Yet, eurozone economies will continue to face liquidity concerns in the short-run and longer-term worries on solvency Disclaimer: This report We think that ultimate solvency involves the eurozone’s political must be read with the decision, something hardly predictable by economic facts Disclaimer on page 8 that forms part of it The euro would continue to fluctuate in value against major currencies, as it provides a mechanism for the market to cross- check the progress made by debt-laden economies KBank Capital Market Research can now be accessed on Bloomberg:Eurozone’s debt problems and measures so far KBCM <GO>The markets has indeed factored in a large amount of information with regards to theextent of eurozone’s debt problems, especially for the maturing debts in the medium termof 3-5 years’ time as well as the amount of fiscal deficit reduction. This information isreflected through the decline in the value of eurozone’s sovereign bonds and thefluctuating value of the euro. However, there remains a large amount of uncertainties,namely, the ability and political will of governments to cut deficits as planned, thecoordination among member countries with regards to speedy agreements over crisismanagement measures and joint commitment to the euro system.Fig 1. EUR/USD fluctuates due to market’s sensitivity of Fig 2. EUR/CHF falls as investors shirted money into aEurozone’s debt problems European economy with stronger balance sheet 1.70 1.70 1.60 1.60 1.50 1.40 1.50 1.30 1.40 1.20 1.30 1.10 1.00 1.20 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 EUR/USD EUR/CHFSource: Bloomberg, KBank Source: Bloomberg, KBank111
  • 2. In any case, the eurozone has established three key measures to calm the market’sconcerns, as well as to deal with immediate obligations, such as repaying maturing debtsin the near-term, meeting deadlines for next fiscal year’s fiscal budget plans and so forth.(Please see details in the table below) The establishment of the facilities wasinstrumental to ameliorating market’s concerns over Greece’s debt back in May of 2010.However, given that the eurozone does not only have a single troubled member butseveral of them, the concerns could no longer be limited to country-by-country conditionsbut the market has turned its attention towards risks of debt contagion and continuity ofeconomic recovery of the whole eurozone in the few years ahead.Table 1. Facts about the three financial support facilities after May 2010 Description Caveats/Concerns • Approved on May 3 with €80 billion facility from euro-area rd • Greece continues to face challenges in trying to achieve members’ contributions and another € 30 billion from the IMF the targeted deficit reduction, among other conditions that would maintain its eligibility for the future • Funds are set up for 3-year period and conditions applied to Greece disbursement of aid funds €110 billion package before each disbursement i.e. Greece must be making sufficient for Greece progress towards cutting deficits down to 3% of GDP by 2014 • There remains a possibility that Greece cannot raise funds in the market after the expiration of the aid package. This will further increase the burden of EU nations • Worth 60 billion euros and administered by European Commission • The size is relatively small compared to debt problems in the eurozone • Backed by EU budget and viewed as good credit European Financial • May be against Article 122.2 of EU Treaty Stabilsation Mechanism (EFSM) • Issue with several guarantee (EU Budget) is that there is no clear collateral guarantee from individual member states • Created by the 16 euro area member states following the decisions • Chance of EFSF’s credit rating being downgraded from taken May 9, 2010 and jointed owned by euro-area member states AAA • Overall rescue package worth €750 billion • Creates moral hazard for the borrowers • Tenure of 3 years - up to June 2013, (or if loans are made, the • Due to the correlation between the Eurozone maturity of the financing instruments) economies, the quality of the collateral are likely to be correlated with the health of the borrowers’ economic European Financial • Capacity to issue bonds guaranteed by EAMS for up to € 440 billion healthStability Facility (EFSF) for on-lending to EAMS in difficulty • Issuance of EFSF debt is only made after a loan by a • Bonds issued by EFSF are guaranteed by member-states based on member stakeholder, a timing which is viewed each member state’s share of ECB capital. Hence, there is negatively by the market and signals that conditions had individual guarantee as opposes to the EFSM worsened • Total amount of guarantee covers up to 120% of total debt issuanceSource: Professor Anne Sibert, University of London and CEPR via and selectively summarized by KBanKNote: There may be opinions added by the author and other facts from Bloomberg and Reuters222
  • 3. Table 2. Contributions by each Euro Area Member State to the EFSF Guarantee commitments Country Share of total (%) (EUR billions) Germany 119.4 27.1 France 89.7 20.4 Italy 78.8 17.9 Spain 52.4 11.9 Netherlands 25.1 5.7 Belgium 15.3 3.5 Greece 12.4 2.8 Austria 12.2 2.8 Portugal 11.0 2.5 Finland 7.9 1.8 Ireland 7.0 1.6 Slovak Republic 4.4 1.0 Slovenia 2.1 0.5 Luxembourg 1.1 0.3 Cyprus 0.9 0.2 Malta 0.4 0.1 TOTAL 750 100Source: www.efsf.europa.euLimitations of mechanismsThere are several limitations with the present mechanisms for solving the debt problems.The most obvious one is being the mismatch between the projected time needed to solvethe problems and the expiration of the mechanisms put in place. For example, the largestpool of funds, the EFSF, is due to expire in June 2011. However, there are many moreproblems than just the expiry date of the fund. Below, we quote Professor Anne Sibertfrom the University of London and Centre for Economic Policy Research (CEPR), whowas requested by the European Parliament’s Committee to analyse the consequences ofthe EFSM and EFSF below in a study paper dated Sep 2010. In any case, the gist of herstatement is that the establishment of emergency funds would result in moral hazardproblems and indicate a transfer of wealth from the funds provider to the funds user. Atthe same time, the dealings of such bail-out measures may also run against thefundamental laws that helped to form the European Union itself. The new facilities were created by European Union policy makers to lower the borrowing costs of financially troubled countries. The idea is that if the euro area borrows as a whole, it can get better rates than a troubled country can and it can pass on these rates to this country. Unfortunately, the lower borrowing costs come with a political problem. If some euro area countries must make good on the euro area’s guarantee as a whole in the case of one or more other euro area countries defaulting, then this is a transfer of wealth from these countries to one or more others. It may be seen as a violation of the so-called “no bailout clause”, Article 125.1 of the Treaty (consolidated version) which says: “The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project.”Indeed, the fiscal austerity measures either announced or adopted by the eurozonegovernments have created dissatisfaction among their people, both in the fund-providingnations and the fund-receiving nations. Hence, the financial and political risks involved in333
  • 4. future measures are likely to be much greater, should the existing ones be insufficient. Atthe same time, the euro-area government continues to run the risk of making insufficientefforts in the eyes of investors and other market players. This problem had been one ofthe key sources of volatility in the financial market in the year 2010 and could potentiallyreduce the effectiveness of the measures taken.Are the emergency funds sufficient?Next, we will consider the impact of debt repayment of Ireland, Spain, and Portugal onthe emergency facilities, excluding the Greece’s debt burden. The government of Greecehad been granted a separate aid package worth €110bn, subject to a set of criteria forreduction of debt levels into the future. This amount should be sufficient to cover forGreece’s repayment obligations over two years. The amount of treasury bills maturing inthe year 2011 is €8.8bn and €9.2bn if all of the bills maturing in 2010 are refinanced. Asfor maturing bonds and interest payments for the years 2011 and 2012, they areseparated into €40.5bn and €41.6bn, respectively. The budget deficit plan passed by theGreek parliament on December 23rd is €17bn for the year 2011 (about 7.4% of GDP). Intotal, this amounts to €108.3bn of financing need for the next two years, excluding thebudget deficit of the year 2012. There is some risks to the funds allocation for Greeceshould government spending gets out of hand. However, given that political pressurefrom Greece’s neighbors would be substantial, the funds allocated should be sufficient forthe next two years.Let’s now take a look at the other three troubled economies – Ireland, Spain, andPortugal. Below is the amount of debt repayment burden plus financing needs fromTreasury bill rollovers and budget deficit borrowing. The total sum of financingrequirement for the three governments comes up to about €313.0bn in the year 2011 and€155.1bn in the year 2012. Assuming that the three governments do not borrow from themarket in the next two years, the EFSF should, by itself, be able to cover for all therequired funds. However, the numbers here are based on many assumptions, includingthe halving of budget deficits in the year 2012 from 2011 and that the troubledgovernments remain within the PIGS group. In any case, the overall burden of thegovernments is immense, as indicated by the financing needs measured against annualnominal GDP.Table 3. Government debt repayment burden in 2011 unit: billion of euros Bond Interest Deficit Treasury bills Total Grand total principal payment Spain 92.7 45.1 18.7 76.9 233.4 Ireland 19.3 4.5 4.2 6.0 34.0 313.0 Portugal 13.3 9.5 4.7 18.1 45.6% of nominal GDP Spain 8.8 4.3 1.8 7.3 22.2 Average Ireland 12.1 2.8 2.6 3.8 21.3 23.5% Portugal 7.9 5.7 2.8 10.8 27.1Government debt repayment burden in 2012 unit: billion of euros Deficit Bond Interest (assuming ½ Treasury bills Total Grand total principal payment of 2011) Spain 46.4 46.4 16.6 6.9 116.3 Ireland 9.7 5.6 4.0 0 19.3 155.1 Portugal 6.7 8.5 4.3 0 19.5% of nominal GDP Spain 4.4 4.40 1.58 0.65 11.03 Average Ireland 6.1 3.51 2.51 - 12.11 11.6% Portugal 3.9 5.06 2.56 - 11.52Source: European Commission ( May forecasts), Bloomberg, nominal deficits are approximated using nominal GDP in 2009 Estimations exclude Ireland’s injection of capital into its banking sector444
  • 5. Fig 3. Financing needs in 2011 - 2012 billion euros 350 300 250 200 150 100 50 0 2011 2012 Spain Ireland PortugalSource: European Commission, Bloomberg, KBankLiquidity vs. solvency problemsThe eurozone debt problem would take many years to solve and its impacts on globalfinancial market would have to be separated into issues of liquidity concerns or solvencyconcerns. Liquidity concerns involve the ability of the government to make timelypayments of their immediate obligations, including maturing bonds and due interestpayments. Liquidity concerns could be potentially lessened with the help from the EUemergency aid packages as well as the governments’ demonstration of a believableeconomic recovery and growth going forward. As for the longer-term solvency concerns,further analysis is needed to determine the ability of the government to repay its debtsafter the aid packages expire. These include concerns for possibility of eventual defaultrisks and member country’s exit from the euro zone and currency devaluation.Table 4. Impacts to the euro-area due to liquidity and solvency conditions of eurozone governments Issues Impacts - Euro currency will weaken and governments have to tap into the Financing of maturing debts in the funding of emergency packages near-term - Raises the problem of moral hazard and leads investors to demand more details of other potential troubled governments - Governments are forced to borrow at higher costs, exacerbating Liquidity their debt problems Refinancing is costly as markets - ECB would come under pressure as the purchaser of eurozone’s drive sovereign bond yields higher sovereign bonds who tries to keep bond yields low - Private sector will have to bare higher costs of borrowing as well as the reference - one announcement of default by a member of the eurozone can send a ripple-effect across the region that could lead to investors’ panic Ability of government to generate sufficient tax revenues to pay for Solvency long-term obligations and - questions are likely to emerge with regards to the effectiveness eventually bring down debt-to- of cooperation among eurozone (and also EU) members in GDP ratio emergency situations - the stability of the euro system and the credibility of the ECB would be at risk as wellSource: KBank555
  • 6. For both of the concerns, there is a need for governments to ensure trustworthy efforts indebt and deficits reduction going forward. Once again, we iterate that this sticking toplans would be difficult across Europe, given the weak economies, higher borrowingcosts, “piggy-backing” of some economies by the others, and limited adjustments in thevalue of the euro. The most obvious evidence of why the market continues to havemistrusts in the governments came from historical experience. From past perspective,countries with more severe debt problem were seemingly less discipline in term ofkeeping budget deficit under 3% of nominal GDP. Hence, it is logical for investors todoubt the success of the austerity plans of these economies as well as the government’scommitment to keep to their promises. Hence, we expect that the euro would continue tofluctuate in value against other major currencies, as it provides a mechanism for themarket to cross-check the progress made by debt-laden economies.Fig 4. Historical budget deficit/GDP ratios Fig 5. Historical budget deficit/GDP ratios % of GDP % of GDP 4 6 2 4 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 Euro area (16) European Union (27) -10 Germany France -12 Euro area (16) Italy Portugal -10 -14 United Kingdom Ireland Greece Spain -12 -16 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Source: Eurostat, KBank Source: Eurostat, KBank666
  • 7. Table 5: Monthly Key Economic Indicators Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10Manufacturing production index (ISIC) 180.0 185.0 194.2 190.1 183.7 201.5 191.6 % YoY 23.4 15.9 14.2 13.1 8.4 8.1 6.2Industrial capacity utilization rate % (ISIC) 58.3 64.3 65.4 64.8 63.6 64.4 64.1Retail sales (% YoY) 12.0 8.1 11.8 12.2 8.5 8.5 8.5Passenger car sales (units) 57,128 62,205 70,557 65,672 65,724 68,261 72,012 78,874Motorcycle sales (units) 143,988 138,558 168,389 175,926 153,256 147,932 145,916Unemployed labor force (000 persons) 451 586 459 346 353 343Commercial car sales (units) 1.2 1.5 1.2 0.9 0.9 0.9Consumer prices (% YoY) 3.0 3.5 3.3 3.4 3.3 3.0 2.8 2.8 core 0.5 1.2 1.1 1.2 1.2 1.1 1.1 1.1Producer prices (% YoY) 8.5 8.0 11.5 11.1 10.7 9.1 6.3 5.9External Accounts (USD mn, unless specified otherwise)Exports 13,832.0 16,436.0 17,878.0 15,475.0 16,292.0 17,955.0 17,046.0 % YoY 34.7 42.5 47.1 21.2 23.6 21.8 16.6Imports 14,022.0 14,137.0 15,342.0 16,266.0 15,440.0 14,712.0 14,604.0 % YoY 44.0 53.5 38.3 36.5 41.8 15.7 13.0Trade balance -190.0 2,299.0 2,536.0 -791.0 852.0 3,243.0 2,442.0Tourist arrivals (000) 1,108 815 953 1,258 1,268 1,220 1,360 % YoY 2.1 -11.8 -0.2 14.7 12.5 1.9 6.3Current account balance -289.0 1,172.0 814.0 -1,001.0 280.0 2,767.0 2,909.0Balance of payments 3,749 -989 2,166 1,412 3,589 4,270 5,822FX reserves (USD bn) 147.6 143.4 147.1 151.5 154.7 163.1 171.1Forward position (USD bn) 11.9 13.0 12.2 11.0 12.1 11.1 12.6Monetary conditions (THB bn, unless specified otherwise)M1 1,182.5 1,261.9 1,180.2 1,173.0 1,181.4 1,175.5 1,202.3 % YoY 11.5 14.4 15.1 15.8 11.4 11.7 11.4M2 10,831.8 11,001.5 10,846.4 10,887.1 10,968.1 11,116.1 11,321.4 % YoY 5.4 6.7 6.9 8.7 8.4 9.8 11.1Bank deposits 9,975.6 10,229.1 9,983.3 9,974.5 10,015.9 10,091.6 10,204.1 % YoY 4.6 7.0 6.2 7.6 6.6 7.8 8.5Bank loans 8,995.4 9,101.2 9,196.7 9,219.7 9,299.8 9,432.7 9,580.5 % YoY 6.0 7.3 8.5 9.1 9.8 10.8 12.1Interest rates (% month end)BOT 1day repo (effective) 1.12 1.12 1.12 1.12 1.12 1.12 1.12 1.12BOT 1 day repo (target) 1.25 1.25 1.25 1.50 1.75 1.75 1.75 1.75Average large banks minimum lending rate 5.86 5.86 5.86 6.00 6.00 6.00 6.00 6.00Average large banks 1 year deposit rate 0.68 0.68 0.68 0.98 0.98 1.11 1.11 1.11Govt bond yield 1yr 1.60 1.52 1.56 1.91 1.99 2.01 1.98 2.11Govt bond yield 5yr 3.12 3.06 2.99 3.08 2.69 2.56 2.83 2.98Govt bond yield 10yr 3.67 3.49 3.33 3.44 3.01 3.12 3.18 3.59Key FX (month end)DXY US dollar index 81.87 86.59 86.02 81.54 83.20 78.72 77.27 81.20USD/THB 32.40 32.52 32.45 32.24 31.27 30.35 29.94 30.21JPY/THB 34.46 35.63 36.62 37.29 37.14 36.34 37.18 36.11EUR/THB 43.07 40.02 39.71 42.08 39.65 41.38 41.76 39.22Source: Bloomberg777
  • 8. 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.888