Deutsche Bank                                         Corporate & Investment BankThe Markets in 2011Foresight with Insight...
ForewordChallenges and opportunities in 2011As the world economy slowly recovers from the mostfar-reaching dislocation in ...
Markets in 2011—Foresight with Insight   Deutsche Bank
ContentsLeaders                                   Markets                                    Risk Management1.1 Global Eco...
1                               Leaders                               Global Economy                               Corpora...
Deutsche Bank   Markets in 2011—Foresight with Insight
1.1                                                      David Folkerts-LandauLeaders                                     ...
has already begun to decelerate as           very low bond yields. The inflows          Figure 1: Widening gap betweenthe ...
1.2                                                                                  Jacques BrandLeaders                 ...
How and when to deploy record               How to manage currency and interestamounts of low yielding cash?              ...
1.3                                                                                   Marc BalstonLeaders                 ...
premium over developed markets,                                                                                           ...
1.3LeadersWhat are the policy options for taming                                                 In practice, countries ha...
Deutsche Bank   Markets in 2011—Foresight with Insight
1.4                                                                                    Henrik AslaksenLeaders             ...
deals as long as they are disciplined        these countries in the near-term. Lack   Deal volume in the near-term willon ...
1.5                                                                                  Colin FanLeaders                     ...
usually state-owned. There are well           to be enormously important. A series          We may see greater activity fr...
1.6                                                                                  Ram NayakLeaders                     ...
1. Eurozone Sovereign Default              4. Commodity Price Rises                    8. LongevityI do not believe that a...
1.7                                                                                   Ivor DunbarLeaders                  ...
Equity investors are proving they        to credit research and assessment.        However, they should not preventare rea...
1.8                                                                                 Jim ReidLeaders                       ...
issues for the foreseeable future as                                                                    in December 2007, ...
2                               Economics                               EMU Crisis                               China    ...
Deutsche Bank   Markets in 2011—Foresight with Insight
2.1                                                                                     Gilles MoecEconomics              ...
unlike Ireland, Portugal’s economy         Portugal, the ECB knows that Spain is       What about Portugal?requires extens...
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  1. 1. Deutsche Bank Corporate & Investment BankThe Markets in 2011Foresight with Insight Deutsche Bank Markets in 2011—Foresight with Insight
  2. 2. ForewordChallenges and opportunities in 2011As the world economy slowly recovers from the mostfar-reaching dislocation in living memory, the outlook formarkets in 2011 will continue to be uncertain.Even so, we do expect to see three themes Having long been active in emerging markets,continuing to drive our clients’ investment we will continue to facilitate capital flowsdecisions: between developed and emerging markets for our clients, and to support the development ofThe global economic recovery is set to continue, the local EM markets.albeit at an uneven pace. Growth in the matureeconomies will be anaemic despite central banks In this guide, we have attempted to provideflooding markets with liquidity. some clarity on the outlook for the year ahead by bringing together insight and analysis from ourSovereign debt markets in peripheral Europe will most experienced market experts.remain under pressure, although we do not thinka default in 2011 is likely. As you determine where to invest and how to mitigate risk in 2011, we aim to distinguishThe seismic move in the balance of power from ourselves through the breadth and depth of ourWest to East will continue, as demographic analysis and our willingness to take a view.trends ensure that emerging markets continue tooffer superior long-term growth potential. We hope you find this guide valuable. Anshu Jain Head of the Corporate & Investment Bank Member of the Management Board Deutsche Bank Markets in 2011—Foresight with Insight
  3. 3. Markets in 2011—Foresight with Insight Deutsche Bank
  4. 4. ContentsLeaders Markets Risk Management1.1 Global Economic Outlook 3.1 Regulatory Change 5.1 Equity Hedging Prospects and worries for 2011 What’s coming up Look beyond the put1.2 Corporate Multinationals 3.2 Asian Equities 5.2 Credit Risk Management Strategies in 2011 Signs of euphoria Getting easier1.3 Emerging Market Capital Flows 3.3 European Equities 5.3 Rate Hedging Will the wave continue? Price rises ahead Key risks for 20111.4 Mergers & Acquisitions 3.4 US Equities 5.4 FX Risk Management Outlook for the year ahead Strategic case is compelling Going super-sized1.5 Chinese and Indian Multinationals 3.5 EM Equities 5.5 Longevity Risk Companies to watch out for Watch out for FX Live long and prosper1.6 Risk Management 3.6 Foreign Exchange 5.6 Inflation 10 key risks to hedge in 2011 Don’t get complacent No need for panic but1.7 Capital Raising 3.7 Commodities take precautions How easy will it be to raise Outlook for 2011 5.7 Commodity Risk Management money? 3.8 Rates What risks are worth hedging?1.8 Credit Rising in Q2 The final hoorah 3.9 US Real Estate Financing Outlook for 2011Economics 3.10 Asset Backed Securities 6.1 Bond Market Outlook Investor demand returns Uncertainties need resolving2.1 The EMU Crisis 3.11 Art 6.2 IPO Market Outlook Will Portugal and Spain Four artists to watch in 2011 Encouraging trends follow Ireland? 6.3 Trade Finance in Asia Pacific2.2 China Trading Embracing the old Japanese ghosts, and the outlook 6.4 Bank Recapitalisation for 2011 4.1 High Yield Credit Possible responses2.3 United States Ten high yield trades for 2011 6.5 Bail-Ins: Pros and Cons What’s different this time? 4.2 Investment Grade Credit A fast-track option2.4 Germany Trading ideas for the year 6.6 Infrastructure Outlook for 2011 4.3 Foreign Exchange Privatisation rises up the agenda2.5 Emerging Markets Ten FX trades for 2011 Another good year but not for all 4.4 Commodities Investing2.6 ASEAN and North Asia Ten commodity trades for 2011 Still attached to the G3? 4.5 Rates 7.1 Asset Allocation Ten rates trades for 2011 A model portfolio for 2011 4.6 Asset Backed securities 7.2 Stock Picking Strategies Ten ABS trades for 2011 What value analysis tells us 4.7 Carry Trading 7.3 Exchange Traded Funds Is the FX carry trade dead? On the march 7.4 Hedge Funds: EU Directive Impact of the new rules 7.5 Managed Accounts Good news for investors and hedge fund managers 7.6 Asset and Liability Management New rules for European insurers 7.7 Portfolio Theory Binary outcomes, bimodal returns 7.8 Green Investing Opportunities ahead Deutsche Bank Markets in 2011—Foresight with Insight
  5. 5. 1 Leaders Global Economy Corporate Multinationals Emerging Market Flows Mergers & Acquisitions Asia on the March Risk Outlook Financing CreditMarkets in 2011—Foresight with Insight Deutsche Bank
  6. 6. Deutsche Bank Markets in 2011—Foresight with Insight
  7. 7. 1.1 David Folkerts-LandauLeaders Global Head of ResearchOutlook for Global Economy 2011Prospects and worries for 2011The coming year is likely to prove challenging The world economy is looking for a recovery in private demand to takefor the world economy and policy makers over the baton from government spending, which is likely to be cut inalike. After a strong bounce from the worst many countries now facing recordrecession in decades during 2009 and early peace-time budget deficits and looking to repair public finances battered by2010, thanks to unprecedented monetary the recession. Interest rates in the US, Europe and Japan are at recordand fiscal stimulus, 2011 is likely to be slower low levels and are likely to remain soand more difficult for much of the world, throughout the year as central banks try to keep economies growing in theespecially developed economies such as the face of this fiscal retrenchment.US, Japan and the Eurozone. Many emerging We see the world economy growingeconomies will continue to perform relatively by a modest 3.9% in 2011, down from 4.7% this year. We think a double-dipstrongly, however, as the shift in global is unlikely and, while we agree with the US Federal Reserve that deflationeconomic power continues apace. But they is a threat, we think this, too, will bewill not be immune to slower growth in the avoided. But much of the world will see lacklustre growth by historic standardsdeveloped world. next year, and slower than 2010. We expect the US economy to expand at a similar modest pace to 2010 in 2011. We’re anticipating growth of around 2.5% after the Fed, disappointed at the lack of strong growth in the US economy and stubbornly high unemployment, in early November 2010 launched a second round of quantitative easing, or QE2. We think this was necessary, particularly because further fiscal support is unlikely after the mid-term elections, and it should modestly boost growth and inflation next year. But the country’s weak housing market and continued debt reduction by households remain major downside risks to our forecast. The Eurozone, hampered by the ongoing sovereign debt crisis, should only manage to expand by around 1%, down from 1.5% this year. Indeed, the bloc’s economyMarkets in 2011—Foresight with Insight Deutsche Bank
  8. 8. has already begun to decelerate as very low bond yields. The inflows Figure 1: Widening gap betweenthe peripheral economies are cutting into emerging markets are tending to EM and G3spending sharply and raising taxes to depress yields there at a time when Source: IMF G3 EMtry to bring their huge budget deficits many countries’ authorities are looking 10 GDP growth % yoy DB Forecastback under control. Growth for the for higher interest rates, not lower. 8area slowed sharply to 0.4% in the China has announced a series of policy 6third quarter of 2010 from 1% in the tightening measures in the recent past 4previous three months. designed to prevent inflation in some 2 parts of its economy. 0We are likely to continue to see a two- -2speed Europe with core countries such International discord is a major -4as Germany continuing to perform concern for next year. The unity shown -6strongly but many of the peripheral by the G20 nations during the worsteconomies remaining in recession. of the financial crisis in 2008 and 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11The recent problems surrounding 2009 has, unfortunately, dissipated.Ireland and, to a lesser extent, Many countries, in particular GermanyPortugal, highlight the vulnerability and Brazil, have been critical of theof the European economy should Fed’s QE2, arguing that the US ismarkets continue to test various intentionally trying to drive down its Figure 2: Global growthgovernments’ resolve. In response currency and thus risks igniting a Source: IMFto the recent volatility, the European global currency war. We think that 6 % yoy DB ForecastCentral Bank has postponed its exit these fears are totally misplaced as the 5from its emergency liquidity support principal aims of QE2 are to avoid the 4for the continent’s banking system. very real threat of deflation as well as 3We do not see it raising interest rates to spur economic growth. 2from the current 1% level before Q3 12011 at the earliest. We also believe that China’s policy 0 on the yuan: of real appreciation via -1Japan, recently overtaken by China as domestic inflation, while gradually 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11the world’s second largest economy, adjusting the band within which itswe see barely expanding at all in 2011, currency can fluctuate, is the rightafter a reasonable showing of over 3% one. This should result in gradualin 2010. The country remains mired yuan appreciation and allow domesticin recession and deflation. China and demand to expand and help reduceIndia we expect to grow robustly the global imbalances that wereat 8.7% and 8.1% respectively, but partly to blame for the financialthose rates are down slightly because crisis. November’s G20 summit inneither will be able to entirely shrug off Seoul made little progress on thethe slowdown in Western economies. fundamental issue of economic imbalances. As the year draws to aIndeed, in many Asian countries, close, there is a real risk of furtherinflation remains more of a concern tension in 2011 if emerging economiesthan deflation. The situation has not continue to restrict capital inflows,been helped by inflows of capital from the dollar continues to weaken orthe developing world as investors if US Congress backs protectionistseek higher returns in emerging measures against China andmarkets (EM) than they are able to others it considers to be ‘currencyget in the US, for example, with its manipulators’. Deutsche Bank Markets in 2011—Foresight with Insight
  9. 9. 1.2 Jacques BrandLeaders Co-Head of Investment Banking Coverage & Advisory Edward Chandler Chariman, Global Corporate Finance Stephan LeithnerCorporate Multinationals Co-Head of Investment BankingStrategies in 2011 Coverage & Advisory2010 has been an extraordinary year: record low interest rates,massive currency swings and rising stock markets juxtaposedwith faltering western economies, banks failing stress tests,funds seized by regulators and, of course, several countries inactual or impending financial crisis prompting social unrest andassociated shifts in political regimes.Yet corporate multinationals have The fiscal impasse in the United States counterparts and, above all, defendingnavigated these unprecedented times is unresolved. While the flexibility their own home markets.with apparent equanimity, by and and resilience of the US economy islarge delivering on their forecasted undoubtedly without parallel, moves All these factors will continue to haverecovery in earnings. Some have to resume sustained consumer led a profound impact on companies ofcapitalised on the crisis by completing growth seem likely to impose stresses all sizes and in virtually all sectors inmergers or acquisitions. Others have on the international financial system 2011. The key issues that multinationalopted to wait out the storm, tightening which many outside the US will find boards will need to confront are:their belts wherever possible, investing unpalatable.in research and development, How to weigh the near-term risks ofstrengthening their balance sheets The banking sector will continue to emerging markets against their long-and adapting their risk management absorb resources. Even as we move term rewards?procedures to the new environment. towards industry stability, banks It is clear that Asian consumptionAll, however, have been alive to the remain under-capitalised and exposed will drive global growth, and thatchanging growth patterns in the global to risky assets. Balance sheets will companies which can continue toeconomy and to the opportunities – need to be buttressed as institutions strengthen their market positionsand challenges – this presents for their exit the period of state ownership and in China and India, in particular, willstakeholders. support. Adding to this uncertainty is benefit in terms of the way they are the daunting amount of new regulation valued by the investment community.As we look to 2011, the road ahead which is set to place additional But emerging market economicappears uncertain. The sovereign debt restrictions on lending capacity. growth and capital inflows appear tocrisis is entering a new and potentially be on an unsustainable trajectory. Themore dangerous phase which will test Meanwhile, a new world order is risk of a bubble – coupled with socio-the limits of international coordination continuing to develop as the fast economic and environmental fragilityas the IMF, ECB, central banks, national growing economies in the eastern and – reminds us that growth cannot begovernments and supranationals seek southern hemispheres spawn major taken for granted.to tread the narrow line between multinationals of their own, competingpolitical practicalities and capital for human resources, technologies andmarkets reassurance. markets head on with their westernMarkets in 2011—Foresight with Insight Deutsche Bank
  10. 10. How and when to deploy record How to manage currency and interestamounts of low yielding cash? rate volatility and the headwinds ofWith corporate liquidity nearing regionalised inflation?levels last seen in 2007, we expect We expect higher currency andcompanies to come under increasing interest rate volatility to be a featurepressure to spend their cash or of markets for the foreseeable future,return it to shareholders. Emerging causing added volatility in corporatemarket M&A present risks: valuations earnings and complicating capitalare expensive and execution more investment decisions. In addition,complex. We therefore expect EM- ‘managed inflation’ will be one of theoriented M&A to be balanced by an principal tools used by some of theincreasing number of European and more exposed economies to addressUS market transactions, as companies the aftershock of the credit crisis,seek to enhance their product and with consequences for commodityservice offerings better to tackle the and food prices and, in turn, foropportunities in third markets. Small the management of pension fundand medium sized companies will also liabilities. Finally, additional capitalembrace M&A as never before. constraints imposed on banks will force up the cost of traditional hedgingWill funding be available to support techniques and favour the adoptionexternal growth? of alternative approaches. All of theseThe answer to this question is a factors will force renewed attention onresounding ‘yes’. At least for the time risk management and hedging policiesbeing, shareholders would much around the board table.rather trust corporate managementteams to deploy cash resources than Will shareholder structures change?making those judgements themselves. We think so, gradually. For example,And they will express this view via a we detect a noticeable increasetolerance for longer pay-back periods in focus by the major sovereignon acquisitions than the traditional two wealth funds on European and USto three years, as well as a willingness companies (as opposed to financials),to support M&A with fresh equity if especially those that are the globalcircumstances require. As for the debt leaders in their sectors, or have strongmarkets, the continued compression exposure to so-called ‘secular growth’in corporate spreads in recent months sectors such as natural resources,points to high levels of liquidity and energy efficiency and certain sub-the availability of extraordinary funding segments of the food and healthcareopportunities – hybrids, long dated industries. Moreover, the lure of highissues and low coupon convertibles valuations on IPOs in Asia and Brazilto mention a few. The predominant will encourage many companiestheme, however, will continue to be to monetise parts of their business‘bonds rather than banks’. portfolios in those regions. Deutsche Bank Markets in 2011—Foresight with Insight
  11. 11. 1.3 Marc BalstonLeaders Head of EM Quantitative Research Robert Burgess EMEA Chief Economist, ResearchEmerging Market Flows: Will the Wave Continue?Is a bubble coming? How will central banks stop one?Private capital flows into emerging market (EM)economies have rebounded strongly over the pastyear. Continued strong inflows will stretch theability of EM economies to productively absorbthem. In this environment, there is a risk thatasset price bubbles will start to form.While foreign direct investment (FDI) 2010, with over $50 billion of flowsremained relatively stable through the over the last quarter alone (figure 2).crisis, bank lending and investments inbond and equity markets were much The direction of investment hasmore volatile. These shorter-term also shifted, away from EMEA andflows recovered to an estimated $450 towards Asia and Latin America.billion in 2010, still some way off their Led by a sharp reduction in bankextraordinary pre-crisis peak of almost credit lines, shorter-term investments$800 billion but well up from their into Hungary, Romania, Russia,crisis-low of less than $100 billion in and Ukraine are expected to reach2008 (figure 1). barely 20% of their peak 2007 levels in 2010 (figure 3). Flows into Brazil,Bank lending accounted for much of Chile, China, Indonesia, and Thailand,the run up in inflows during the last however, look set to rebound above orwave of inflows into EMs, but has close to their recent peaks.been largely absent during the pastyear as major financial institutions Will capital continue to flow intoin advanced economies continue to emerging markets in 2011?rebuild their balance sheets. Instead, The flows are motivated by a variety ofthe current wave of inflows is more factors, many of which are long termconcentrated on debt and equity in nature and should continue to drivemarkets. Inflows into EM equity and inflows well into 2011. Fundamentalsdebt funds have been running at are supportive: EM economies arerecord levels in the second half of likely to enjoy a sustained growthMarkets in 2011—Foresight with Insight Deutsche Bank
  12. 12. premium over developed markets, sustainable inflows into new markets markets (as opposed to foreignwhile also exhibiting a lower level of that ended abruptly and painfully are currency lending) will make for lessindebtedness compared to mature well known, from the Latin American painful and disruptive burden sharing.markets. International investors debt crisis of the 1980s through to Central banks also have much largerremain underweight exposure to the Asian crises of the late 1990s. cushions of foreign exchange reservesEM, certainly in comparison to their Most recently, we saw credit booms on which to draw.share of global GDP (33%) and also in central and eastern Europe turn torelative to their share of world stock bust as the foreign bank lending that Nevertheless, there is inevitably amarket capitalisation (also 33%) and fuelled them dried up. risk that the volume of inflows willtheir share of world government debt start to stretch the ability of emergingoutstanding (16%). Anecdotal evidence Will it be different this time? economies to productively absorbindicates that many major developed Much of the emerging world is a them. In this environment, the riskmarket institutional investors hold fundamentally less risky place for that inflation accelerates and assetless than 5% in EM equities and less investors than it was 10–15 years ago. price bubbles form is substantial. Earlythan 2% in EM debt. And if these Public and private sector balance warning signs are already appearingfactors were not sufficient, the sheets are less leveraged than before among countries that have receivedcurrent exceptionally easy monetary and indeed much less leveraged than the largest capital inflows. Inflationconditions in the US, Europe, and their mature market counterparts. has started to drift upwards in Brazil,Japan are a further motivation to move Financial sectors are more developed Turkey, and parts of Asia. And policycapital from advanced to EMs. and better able to intermediate flows. makers in Hong Kong, China, and And, should things go wrong, the Israel, have taken steps to curb rapidWe have, of course, been here many relatively high share of investments growth in local property markets.times before. Episodes of seemingly into equity and local currency debtFigure 1: Figure 2:Private (non-FDI) capital flows to emerging markets by year ($ billion) Cumulative inflows to emergingSource: IIF Portfolio and other Bank credit markets mutual funds since the start of 2008 ($ billion) EM Equity funds (lhs)800 $ billion EM Debt funds (rhs) Source: EPFR700600 100 $ billion 40500 75 30400300 50 20200 25 10100 0 0 0-100 -25 -10 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 -50 -20 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11Figure 3:Private (non-FDI) capital flows to EM by country ($ billion)Source: IIF 2007 2010F160 $ billion140120100 80 60 40 20 0 Korea India China Indonesia Phillipines Malaysia Thailand Russia Polan Turkey Romania Sth Africa Ukraine Hungary Brazil Mexico Argentina Venezuela Peru Chhile Colombia Asia EMEA Lat Am Deutsche Bank Markets in 2011—Foresight with Insight
  13. 13. 1.3LeadersWhat are the policy options for taming In practice, countries have adopted a big rise in the value of the realthese extremes? different combinations of these and large interest rate differentialsGiven this, a key question is how approaches depending on their which push up the costs of sterilisedcentral banks in EMs will respond particular circumstances. Central intervention, has twice raised its taxto continued flows. Their first banks in Latin America, emerging on foreign bond inflows.option is simply to allow currencies Europe, and Africa, for example, haveto appreciate. However, with past typically been more comfortable Where does this leave investors?crises still fresh in their minds, EM with currency flexibility whereas The anticipated continued asset-policymakers are acutely aware that those in Asia have intervened more allocation shift towards higher weightsthe loss of competitiveness associated aggressively in the foreign exchange for EM in global portfolios is likelywith even transitory currency strength markets (figure 4). In Latin America, to underpin the performance of EMcan take time to recoup. an increase in reserves equivalent to assets for the coming year. While about 6% of GDP between January ongoing measures to stem inflowsA second option is to limit appreciation 2006 and August 2008 coincided with will likely reduce the attractiveness ofby intervening. However, the resulting a 25% real exchange rate appreciation, some specific investments – notablyaccumulation of foreign reserves can whereas in Asia, much larger reserve domestic fixed income in countriesexacerbate overheating in already accumulation of 20% of GDP helped willing to impose controls, such asfast-growing economies, causing to limit real exchange rate appreciation Brazil and Taiwan – they are unlikelycredit growth, inflation, and possible to 7%. to change the overall attractiveness ofasset price bubbles. Sterilising the the asset class.intervention can help to prevent More recently, we have seen centralmoney and credit growth. But by banks step up their foreign exchange The extent of the inflows does raisekeeping interest differentials high, it purchases in Colombia, Israel, Peru, the risk of inflation and asset bubblesalso encourages even further inflows. South Africa, and Turkey. Others have within EM which argues for a bias implemented more direct controls on towards real assets. The extent ofAnother option is to try to stem inflows, though these vary widely in the flows also presents a real risk ininflows directly via capital controls or nature. Indonesia, for example, has that if it were to reverse it could beother forms of prudential limits. Their introduced minimum holding periods destabilising. However, we fail to seeaim is to curb flows of so-called ‘hot for some forms of debt. Thailand has any catalyst for such a reversal andmoney’ while prioritising the ‘stickier’ imposed a withholding tax on returns are confident that this is a risk whichcategories of overseas capital, such as on bond holdings, a measure also is unlikely to materialise before 2012 atforeign direct investment. being considered by South Korea. the earliest. Meanwhile Brazil, concerned aboutFigure 4: Different approaches to dealing with capital flowsFigure 4: Different approaches to dealing with capital flowsFour data points for each region shows: Latin AmericaSource: INF(i) Jan 06; (ii) crisis peak in REER and reserves; Latin America EMEA(iii) post crisis trougheach region shows: andFour data points for REER and reserves; EMEA Asia(iv)Jan 06;observation(i) latest (ii) crisis peak in REER and reserves; Asia Asia (ex China)(iii) post crisis trough REER and reserves; and Asia (ex China)(iv) latest observationSource: Deutsche Bank135 Reserves (% 2006-08)130 (iv) (ii)125120115110105 (iii) (i)100 95 90 85 REER (2005=100) 0.0 10.0 20.0 30.0 40.0 50.0 60.0Markets in 2011—Foresight with Insight Deutsche Bank
  14. 14. Deutsche Bank Markets in 2011—Foresight with Insight
  15. 15. 1.4 Henrik AslaksenLeaders Global Head of Mergers and AcquisitionsOutlook for Mergers & Acquisitions in 2011Cheap debt and strong cash levels will turn corporates to M&AUnderneath the overhang of fiscal deficits,currency swings and sluggish macroeconomicgrowth, the ground appears fertile for mergerand acquisition (M&A) activity.With access to cheap debt and high As we look to 2011, what remains the after tax cost of debt). The latestlevels of corporate cash levels1, as the most telling indicator during 12-month P/E of the S&P 500 is aboutboardrooms are faced with a choice: the upturn is where the pools of 14.7x, which gives the index a value ofreturn capital to shareholders or capital are. The most robust capital 27, about the highest it has ever been.fund growth. markets are found in highly developed By comparison, during the peak of the countries– like the United States up cycle in 2007, the index stood atFor corporates struggling with and western Europe. These markets circa 13.anaemic growth in their home also play host to some of the world’smarkets, the choice will be easier to largest companies with the strongest Underpinning this is an arbitragemake. Expect deal making to continue appetites for growth. Since capital is opportunity: low interest rates havesteadily increasing in 2011 as a result. mobile, it is fair to assume the deal significantly reduced the costs of flow will follow the money. funding a transaction using debtPools of capital providing an alternative source forPrevious upswings in deal activity We recently developed an ‘affordability corporates to fund growth.focused on particular sectors or deal index’, which tracks the gap betweenstructures – the technology boom in the implied P/E multiple of single A Disciplined approach to deal makingthe late 1990s/2000 and leverage in rated debt and the P/E multiples of In the early stage of this recovery,2007 – but the upturn in this deal cycle broad market indices such as the S&P companies kept an inward focusis spread quite broadly across various 500 and Euro Stoxx 50. The greater by streamlining assets and pruningsectors and transaction types. the index value, the more ‘affordable’ it portfolios. As M&A activity is for a company that can raise single continued, we saw the market forAt the turn of this past year, some A rated debt to fund the acquisition of leveraged buyouts trickle back,predicted certain sectors such as a target trading at levels comparable especially in the US.financial institutions and oil and gas to that of the broader market.as the hotbeds for M&A activity. In With greater stabilisation in the capitalretrospect, the market hardly followed To illustrate, the composite yield on markets and corporate cash pilesthis trend. The top 20 deals of the year 10-year single A rated corporate debt increasing, the boardroom moodspan almost every sector and included in the US is currently approximately appears to have shifted from reactivecorporate reorganisations, strategic 4%. For an acquirer whose marginal to proactive.deals, asset disposals and emerging tax rate is 40%, the implied P/E of newmarket activity2. debt is therefore 41.7x (the inverse of Since funding growth is cheap, boards have a strong argument to pursueMarkets in 2011—Foresight with Insight Deutsche Bank
  16. 16. deals as long as they are disciplined these countries in the near-term. Lack Deal volume in the near-term willon price. This strategy is likely to drive of developed capital markets outside likely follow a similar pattern ofmedium-sized transactions in the China and little knowledge of how to growth relative to their respectiverange of $1–5 billon, large enough to navigate new regulatory schemes, like regions, however the majority ofprovide meaningful synergies and/or Brazil’s, will continue to make deal activity will continue to come fromgrowth in emerging markets. making challenging, though developed economies. Regardless not impossible. of where the deals are, the upswingWhen BHP’s $43 billion offer for looks set to continue.Potash Corporation was rebuffed by Until these channels are betterregulators, we were reminded that developed, the BRIC deals that 1. Cash/market capitalisation ratios for S&P of 11.6% as of Q3 2010, and 12.2% for Euro Stoxxstakeholders will play a role in deal- crop up will be sporadic. For this 2010E; Source: Compustat and Deutsche Bankmaking that is equal to or greater than reason, the ‘bread and butter’ deals estimatesthat of shareholders. should continue to originate from 2. Source: Thomson Reuters the developed economies, where 3. Source: Deutsche Bank Economic ResearchThis stakeholder influence is a factor gross domestic products arethat will continue to be a characteristic growing at stable rates and capitalof deal activity. is readily available.BRICs Towards stable growthEvery corner of the market has focused Economic growth is undeniable inon how to invest in the BRIC countries emerging markets. Real GDP forecastof Brazil, Russia, India and China. for 2011, for example, is estimated to be 7.4% for Asia (excluding Japan),Though these markets present long- and 4.5% for both Brazil and Russia3.term growth potential, we believe Real GDP for G7 economies ischallenges remain for deal activity in projected to grow 2.2% in 2011. Deutsche Bank Markets in 2011—Foresight with Insight
  17. 17. 1.5 Colin FanLeaders Head of Global Credit Trading and Emerging MarketsThe Rise and Rise of Chinese and Indian MultinationalsWhat companies to watch out forIt tells you a lot about the strength of China’s domesticeconomy that Industrial and Commercial Bank ofChina (ICBC) is the world’s largest bank by marketcapitalisation despite barely having started to ventureoffshore. It’s not alone: all of China’s top lenders, despitehaving done little more than build a few branchesoverseas, rank among the world leaders by marketvalue. When companies that are so powerful at homedecide it is time to expand overseas in earnest, there arealmost no limits to how big they could become.At multinationals across the region, purchases, like China Petrochemical current acquisition boom andthat’s exactly what is starting Corp’s $8.83 billion purchase of Addax Japan’s in the 1980s is that Chineseto happen. Chinese and Indian Petrolum in 2009. Indian companies companies are state-owned and makecompanies, having built vast customer have also been active: Bharti acquisitions for geopolitical reasonsbases and balance sheets at home, are Airtel’s $9 billion purchase of Zain’s as well as for profit.increasingly seeking to acquire and telecommunication assets in Africaexpand overseas. Everything is in their this year showing the scale of this new There are, though, challenges forfavour. They have cash at a time when found ambition. Indian companies in going overseas.potential targets elsewhere in the world International capital flows into India canare cheap, they are buoyed by fast Many Indian companies deleveraged slow very quickly if market sentimentexpanding domestic economies and during the expansion in the Indian turns, and domestic liquidity, thoughthey now have the confidence to grow. equity markets and now have ready plentiful, comes with a caveat: debt access to debt finance. Chinese raised onshore can’t be used forThere were more than 100 merger companies, meanwhile, are in many acquisitions, just for working capital.and acquisition transactions with cases even more cash-rich and enjoyChinese acquirers each year from almost unfettered access to capital Availability of domestic capital is not a2007 to 2009, compared to less than from banks as well as debt and equity problem in China. League tables of top30 in each of the first four years of markets on and offshore. equity and debt bookrunners in Asiathe decade1. Meanwhile, the value are packed with home grown Chineseof foreign acquisitions by Chinese Chinese and Indian businesses have names, but Chinese companiescompanies increased more than various reasons for buying offshore, seeking to acquire overseas attract30 times between 2003 and 2008. chiefly market access, technology a great deal of suspicion from theirChinese companies have also begun and resources they lack at home. targets’ governments and electorates,to make jumbo cross-border The big difference between China’s because the bidding companies areMarkets in 2011—Foresight with Insight Deutsche Bank
  18. 18. usually state-owned. There are well to be enormously important. A series We may see greater activity fromknown examples of this, such as of liberalisations over the last year have Chinese banks, who despiteCNOOC’s failed bid for Unocal, and it set up Hong Kong as a proving ground accounting for 26% of all Chineseis unlikely to get any easier. for RMB liberalisation in a host of M&A over the last 10 years2, have so areas from trade finance to investment far only taken tentative steps towardsPrivate sector Chinese companies products, foreign exchange and local international expansion, such asface less interference. Look at Ping currency bonds. All of these will, in time, ICBC’s purchase of 20% of SouthAn Insurance’s acquisition of assets help to open up the onshore market Africa’s Standard Bank. The mostfrom Fortis or Huawei Technologies’ to foreign players, and in turn give active acquirers will be firms thatpurchase of parts of IBM. domestic champions more flexibility to import and export rather than firms in use their profits should they choose to sectors such as property and retailingBut no matter how genuinely go overseas. where domestic growth should becommercial a company’s aspirations, sufficient for years to come.the spectre of state ownership causes Outlook for 2011problems in other countries (although Expect to see further expansion There are a host of companies tonot, notably, in Africa, where many by Asian multinationals in 2011. watch: Chalco, which may buy bauxiteof the energy acquisitions have taken Companies in India will focus on mines for alumina refining; Jiangxiplace). In Europe and the Americas, natural resources. Coal India, which Copper, seeking foreign mines; Chinahowever, Chinese companies should recently completed the largest IPO Mobile, which is targeting developingcontinue to expect interference with in Indian history, has $8.4 billion on market telecommunications operators;their bids. its balance sheet and is looking for port operators China Merchants acquisitions in Indonesia, South Africa, and Cosco Pacific, again targetingIn India, where buyers are more Australia and the US. Oil and gas emerging markets; internet-relatedfrequently pure private sector rather assets are also likely to be in demand groups like Tencent and Alibaba, railthan state-owned, politics is less of a among Indian companies, although equipment companies such as CSR,problem. Names like Tata, whose most areas of previous activity – telecoms, coal companies seeking coking coalrecent acquisitions include Jaguar financial services, pharmaceuticals, exposure and buyers from otherLand Rover and Corus, or Reliance automotive – may be quieter. sectors including healthcare, steel andIndustries, which has been buying utilities.shale assets in North America, are For Chinese companies, resourcesconsidered credible partners who will also be a key target, but China Whatever happens, prepare forbring expertise to the table without the is also keen to secure infrastructure expansion both next year and for aagenda of a state mandate. assets in order to participate in the long while to come. real economy of foreign countries.FX is an issue in both countries. It’s less Despite potential political opposition 1 & 2. Source: Thomson Reutersof a problem in India, where the rupee is to such bids, China is unlikely torelatively liberalised, but the FX regime privatise state-owned companies tostill creates challenges such as the facilitate foreign acquisitions. Instead,ability of Indian companies to provide it will wait to see if the European crisiscorporate guarantees. It’s much more of develops to make Chinese capitalan issue in China, but here the gradual more attractive.internationalisation of the RMB is going Deutsche Bank Markets in 2011—Foresight with Insight
  19. 19. 1.6 Ram NayakLeaders Global Head of Structuring10 Key Risks of 2011What to hedge against and howThe range of risks faced by borrowers andinvestors in 2011 is perhaps greater than at anytime since World War 2: an economic slowdown,sovereign defaults, inflation, rate hikes it isa formidable list.The good news is that nearly all Against this difficult background, thethese risks can be hedged thanks to best approach will be to identify andthe growth and development of the prioritise the risks that really matter,global derivatives market over the past and then to examine the differentdecade. options available. A top-down view on risk will also be helpful not onlyThe bad news is that it is likely to be to reduce correlation risk but to findexpensive – using plain vanilla options ways to bring hedging costs down byat least – because of huge uncertainty linking risks together.among dealers about where themarkets are heading. With this in mind, here are the ten risks that I believe cannot be ignoredSome companies will take the view this year (not in order of severity orthat the cost of hedging outweighs probability) and some suggestions onthe benefit. We believe this would be which to hedge and how.unwise given the scale of the potentialdownside.Others will prefer not to take anyrisk at all until the outlook becomesclearer. This, too, is a strategy wewould not recommend given theseismic changes underway in theglobal economy.Markets in 2011—Foresight with Insight Deutsche Bank
  20. 20. 1. Eurozone Sovereign Default 4. Commodity Price Rises 8. LongevityI do not believe that a major Eurozone Commodity prices are expected An absolute must for insurancesovereign will default in 2011 but if by Deutsche Bank Research to rise companies and pension funds withone does, the results would be so significantly during the first half of policy holders living longer than ever.catastrophic that it does seem a risk 2011 as supply remains constrained The old approach was to buy long-worth hedging. Buying CDS protection and investors and consumers demand dated bonds but longevity swaps offeron a euro sovereign index may for commodity price participation greater precision and are much morecost you 400 basis points or more. increases. Risk management liquid than they used to be.Alternatives are to go short the euro strategies include extendible forwards,or wideners on the EUR/$ cross options and hybrids. 9. Regulatory Changecurrency basis. We may not know the details yet but 5. Rate Hikes it looks certain that within the next 182. Capital Markets Freeze Deutsche Bank Research expects months, many users of derivatives willTwice in 2010, we saw the bond rates to start rising in the US in Q2 and have to clear their trades via a centralmarkets close down to most forms for the European Central Bank to begin exchange rather than on an OTC basis.of new debt issuance. The issue – tightening earlier than expected. For We strongly advise all companiesEurozone sovereign risk – is still live. investors, front end payers would be a to get their back offices up to speedSolutions include front loading your good solution for both. ahead of time and do a full evaluationissuance calendar, private placements on how the changes will impactand loans secured by equity stakes. In 6. US Dollar Weakness profitability and infrastructure.the event of an equity capital markets Deutsche Bank FX Research’s view isshutdown, OTC structured alternatives that the US dollar may surprise on the 10. Borrowing Cost Risesare available. Another related risk upside this year. But for companies With banks cutting back for Baselis the emergence of a backlog in with extensive US assets, the risk may 3 and bond investors focusing onIPOs. Remedies for this include be too great to leave unhedged. Going emerging markets or safe havens, apre-IPO macro hedging and pre-IPO short the dollar via a forward is the rise in funding costs cannot be ruledconvertibles. obvious choice but comes with a stiff out for many firms. Asset backed opportunity cost price tag. Purchased finance and loans linked to proprietary3. EM Equity Bubble options could offer better value. trading indices can bring costs downIf Asian central banks fail to control to manageable proportions.inflation or take too aggressive 7. Inflationaction against it (thereby provoking Not an immediate risk for US anda slowdown), we may start to see European investors but one withthe flow of funds from the US and the potential to cause havoc in theEurope into Asia slow significantly medium-term given rising inflation inand perhaps start to flow the other Asia and the long-term effects of QE.way. We would look to go short Asian We recommend getting in early whilecurrencies. Investors can protect hedging levels remain attractive viathemselves against both using equity collars, swaps, inflation linked bondsput options (expensive) or put options and swaps.linked to volatility (cheaper). Deutsche Bank Markets in 2011—Foresight with Insight
  21. 21. 1.7 Ivor DunbarLeaders Global Head of Capital MarketsFinancing OutlookHow easy will it be to raise money in 2011?2011 should provide among the most favourablefinancing conditions for companies in years,despite headwinds buffeting the global economyand the volatility disrupting capital markets.The outlook is highly attractive for opportunities for infrequent orcompanies looking to lock in low debut borrowers.rates for their bonds. There is a wallof cash looking for exciting equity We saw large numbers of debut issuesstories, and the market has shown it in Europe in 2010 and this trend willwill be supportive of well-considered, continue as European companies learnstrategic mergers & acquisitions. to master the post-crisis environment by reducing their reliance on bankFor companies seeking to tap bond lending as a preferred method ofmarkets, borrowing rates are at an financing. With banks continuing toall-time low and should remain so as deleverage in the wake of tough newcash-rich credit investors hunt capital requirements such as Basel 3,for yield. this theme of disintermediation should continue, with more companies going2010 saw a glut of sovereign straight to the capital markets for theirissuance, but 2011 should provide an financing needs.opportunity for corporate borrowers,particularly those that tapped the At the same time, the crisis and themarkets in 2009 when rates were ensuing regulatory climate has sparkedhigh, to take advantage of the low-rate innovation in financing, with banksenvironment, and push back the wall seeking to issue contingent capital – anof debt maturing in 2012 to lock in instrument that is at once a relativelynew funding at attractive rates. cheap form of financing and also a capital buffer. However, before theyIt is not just big names that are become a mainstream funding methodattracting investor attention. Record for banks in 2011, there remains alow interest rates of close to zero are question mark over the regulatoryforcing investors to hunt lower down status of tier one capital.the ratings chain for yield, providingMarkets in 2011—Foresight with Insight Deutsche Bank
  22. 22. Equity investors are proving they to credit research and assessment. However, they should not preventare ready to support initial public Recent events indicate that large cap company boards from executingofferings. In 2010, there was a companies have generally done better strategic plans for which funding isscramble for growth stories such in IPOs than smaller, lesser known available. The ability with which BHPas the $20.5 billion flotation of AIA, companies. The difference between a Billiton was able to raise $45 billionthe Asian operation of AIG, which successful equity or bond issue and a for its ultimately unsuccessful bid forwas the third biggest IPO in history failure will lie in whether the company Potash proved there was life in theby volume and which was multiple has a strong story to tell and can syndicated loans market, and well-times over-subscribed. In the US, communicate it to investors. run companies with strong balanceinvestors showed a similar hunger sheets should find that marketsfor GM, whose $18.1 billion IPO was The challenges of 2010 should will be supportive of M&A deals ofalso heavily oversubscribed. Since continue into 2011 and beyond. strategic importance. With growth inSeptember, the majority of IPOs in the The shape of the global economic emerging markets outstripping thatUS have priced above or within the recovery remains uncertain, while in developed western economies, wefiling range and outperformed in we expect volatility to continue to expect companies to look increasinglythe aftermarket. be a feature of the capital markets towards financing M&A deals to gain as investors maintain a hawkish an edge.However, the apparent ‘perfect stance on sovereign and credit risk.storm’ of pent-up investor demand Crises such as those experienced The losers in 2011 will likely be thoseand borrowers’ increasing use of the by Greece and Ireland in 2010 are unable to come firing out of the blockscapital markets for their financing disruptive influences on markets that because their balance sheets are stillneeds is tempered by a more can temporarily prevent companies being repaired. But for the winners,discerning investor base taking a more accessing the capital markets. 2011 should be a year when they candiligent and sophisticated approach put rivals to the sword. Deutsche Bank Markets in 2011—Foresight with Insight
  23. 23. 1.8 Jim ReidLeaders Chief Credit Strategist, ResearchIs 2011 the Last Year of the Credit Cycle?The final hoorahOne of our main secular views is that post thefinancial crisis, the world will return to the shorterlength of business/credit cycles that prevailedthrough history before the 25-year ‘goldenage’ that came to an end with the 2007 greatrecession. If we are correct, then 2011 could seeus entering the last full year of expansion, albeita year of expansion where there are plenty ofpotential flash points given the legacy of the debtsuper-cycle that the developed world has enduredsince the early 1980s.The more optimistic analyst might complacency as investors and policyconclude that while the developed makers extrapolated out the extremelyworld has problems, globalisation benign pre-crisis economic conditionsand once in a generation levels of as far as the eye could see. The lackemerging market (EM) growth could of inflation also allowed policy makersallow smoother and longer business to ‘fix’ every problem during thiscycles to prevail over the next few period, thus preventing the creativeyears. However we feel there is an destruction process that arguablyargument that globalisation has allows a reasonably efficient allocationdestabilised the economic system of resources. This also allowed afor the developed world. The secular tolerance of debt from investors,30-year reduction in inflation and consumers and policymakers alike,the ‘great moderation’ that have had that would have been unthinkable atheir roots in globalisation, reduced decade or two earlier.the number and severity of businesscycles in the developed world during The debt-burdened developed worldthe ‘golden age’. This arguably led to will now likely have periodic fundingMarkets in 2011—Foresight with Insight Deutsche Bank
  24. 24. issues for the foreseeable future as in December 2007, then statistically it looks to fund a colossal amount of – if we are correct – the start of the private and public debt. With interest next US recession could be between rates now constrained by the zero August 2011 (median) and August bound and high historical levels of 2012 (average). public debt, the hands of governments are collectively tied, leaving policy This means that, again if we are makers with much less flexibility than correct, we could be entering the last they have had for at least 30 years. few quarters of the credit/business This means that recessions are likely cycle. We can’t know what will cause to happen more naturally over the next it to end but we suspect that policy few years and given the complete lack makers will be more powerless to of policy flexibility they may occur prevent it than they have been for with a higher frequency than the long- several decades. The dilemma for term average. investors is that while the business cycle is ongoing, then all risk assets Figure 1 shows that the last three (including credit) will likely perform complete US economic expansions fairly well. However be warned that were three of the five longest in the we are nearer to the end of the cycle 33 we’ve experienced since 1854, than the beginning and 2011 may be likely due to the complete flexibility the final hoorah. the authorities had to manage the business cycle. The average length of the completed cycle (expansion and recession) over the entire period is 4.7 years, with the median length being 3.7 years. Given that the last recession started Figure 1: US economic expansion lengths (months) since 1854 Source: Deutsche Bank, NBER 120 100 Average Median 80months 60 40 20 0 Dec 1854 Jun 1861 Dec 1870 May 1885 May 1891 Jun 1897 Aug 1904 Jan 1912 Mar 1919 Jul 1924 Mar 1933 Oct 1945 May 1954 Feb 1961 Mar 1975 Nov 1982 Nov 2001 Deutsche Bank Markets in 2011—Foresight with Insight
  25. 25. 2 Economics EMU Crisis China United States Germany Emerging Markets ASEANMarkets in 2011—Foresight with Insight Deutsche Bank
  26. 26. Deutsche Bank Markets in 2011—Foresight with Insight
  27. 27. 2.1 Gilles MoecEconomics Co-Head European Economics Research Mark Wall Co-Head European Economics ResearchThe EMU CrisisWill Portugal and Spain follow Ireland?A key question for the Eurozone as the new ‘permanent crisis mechanism’ to August peak, is still at around EUR40end of a turbulent year approaches replace the EFSF when it expires in billion – or 7.1% of total bank assets, ais whether Portugal, and even Spain, 2013, spooked investors, especially similar level to Ireland’s 7.6%.will be forced to follow Greece and when German Chancellor AngelaIreland into seeking a rescue package Merkel said bond holders would have Meanwhile, Portugal’s governmentfrom the European Union and IMF. to share any losses in a sovereign has failed to make sufficient progressAnd a longer-term question for all default. That, unsurprisingly, led to on spending cuts. In 2010, its budgetfour countries is whether they will be a sell-off in the bonds of peripheral deficit actually increased. It also hasable to reduce their budget deficits economies and pushed government a persistently high current accountsufficiently to return their public borrowing costs up to record highs – deficit of around 10% of GDP,finances to a sustainable position, with in turn, threatening the ability of those indicative of a deeply entrenched lackor without external help, or will they countries to service their enormous of competitiveness.end up with no choice other than a debts.debt default? The government has to refinance Will Portugal follow? EUR10 billion of debt in the first threeWhy did the Irish crisis happen? At the time of writing, these two months of 2011, while banks willIn asking what may happen to external factors are still valid, so it is have EUR5 billion to roll over, so it isPortugal and Spain, it is instructive not surprising that Portugal is coming probably rational for the Portugueseto consider the fate that befell under marked pressure. Is Portugal government to call for rescue soonerIreland. During 2010, Ireland’s budget Ireland? Well, the liquidity position rather than later. This is especially thedeficit continued to widen despite of Portuguese banks is very fragile. case as the negotiation process withunprecedented austerity measures. ECB lending to the country’s banking the IMF/EU could be long because,At the same time, over-indebted system, although down from itsbanks were unable to shake off theimpact of the ongoing property slump,forcing the government, which hadagreed to underwrite the country’sentire banking system, to dramaticallyincrease its support to the point ofjeopardising its own finances.November’s crisis, however, was dueto external developments. First, theEuropean Central Bank made it clearit wished to begin withdrawing theextraordinary support to banks that ithad given at the height of the financialcrisis, since the European FinancialStability Fund – the support systemset up in the wake of the Greek crisisin May – was now in place. Ireland’sbroken banks were heavily dependenton ECB funding and so the entirebanking system came under strain.Second, the initiatives by Germanyand France in October to create aMarkets in 2011—Foresight with Insight Deutsche Bank
  28. 28. unlike Ireland, Portugal’s economy Portugal, the ECB knows that Spain is What about Portugal?requires extensive structural reform so much bigger that it would represent As regards a future debt restructuringto boost its competitiveness. The a systemic risk for the euro. mechanism, nothing is yet certaingovernment is also a minority one, although reports indicate that ameaning the opposition will have to Will debt restructuring be necessary? permanent crisis mechanism wouldbe involved in negotiations to change Many investors argue that debt include changes in sovereign bondsthings such as the country’s pension restructuring (e.g. via maturity issued after 2013 to include ‘collectiveor welfare systems. lengthening or ‘haircuts’) is action clauses’, extensions in the unavoidable for some euro member duration of debt and ‘haircuts’ asIs Spain at risk? countries, especially Greece. The a last resort. This could, of course,Market concern that Spain will need argument goes that even the three raise risk premiums on the bondsto be bailed out has been a consistent years the rescue package buys the and so raise the cost of financefeature of the markets for nearly country to reform its finances and to governments, but that woulda year. Fortunately, the country’s enable it to get in a position to service depend on the existence of otherfiscal and economic developments its debts on the open market will support arrangements too, such ashave gone in the right direction, simply not be enough. the continuation of an EFSF-typemaking the country fundamentally mechanism.different from Ireland and Portugal. Greece’s public debt-to-GDP ratioThe budget deficit is falling, as is the could reach 170% by 2013 if growthcurrent account deficit, and banks is only slightly weaker than the IMFare enjoying easy access to money currently expects. This would make itmarkets for funding, making them very difficult, although not impossible,less dependent on ECB lending (which to service that debt on the openonly accounted for 1.9% of total bank markets from 2013. We continue toassets in October 2010). believe, however, that given enough time and external support, a unilateralWe think that the cuts made thus far restructuring of sovereign Greek debtand the budget for 2011 are enough to can be avoided.get Spanish public finances back on asounder footing. This being the case, We think Ireland should be able towe don’t think Spain should engage in return to market financing of itsfurther austerity for fear of damaging deficit by 2013, even including thegrowth and thus worry markets about enormous cost of bailing out its banks.the speed of the country’s private Spain and Portugal may yet havesector debt adjustment. But we believe to recapitalise their banks if marketthe country does need to speed up the pressure persists. In this regard, Spainrestructuring and recapitalisation of looks safer than Portugal. Public debtits banking sector to address market there should reach only 73% of GDPconcerns on this point. by 2013, thanks to a very low initial level (53%). This gives it a margin toEven if markets do continue to pay for recapitalisation, especially aspush Spanish interest rates up, we its recapitalisation vehicle (the ‘FROB’)think the ECB could provide a crucial can issue up to EUR90 billion, or 9%circuit-breaker by providing lots of of GDP.liquidity to Spain’s banks. Althoughit has proved unwilling to providemeaningful support to Ireland or Deutsche Bank Markets in 2011—Foresight with Insight

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