119413_GS EW 091002

Important disclosures appear at the back of this document

European Weekly Analyst Issue No: 09/34

October 1, 2009

Goldman Sachs Global Economics, Commodities and Strategy Research

at https://360.gs.com

Budget bills and elections: Contrasting styles in Germany, Spain, France, Greece and Italy September brought us a harvest of 2010 budget discussions in the Euro-zone. Although it may be too soon to exit from exceptionally expansionary policies, Euro-zone countries are already exhibiting contrasting approaches to the delicate timing of the transition back to normality.

The first focus looks at the budget plans put forward by Spain, France and Italy for 2010 and beyond, ranging from tax hikes in Spain, good intentions in Italy despite its debt overhang, and a lax attitude towards existing budget constraints in France. In terms of sovereign long-term debt issuance, no significant reduction is expected for 2010, with Germany, France and Italy at around €230bn-€250bn each, and Spain at ‘only’ €125bn thanks to lower redemptions.

It is also election season. In Germany, our second focus explores the main policy areas on which the new government will need to focus: economic re-balancing, demographics and education. Whether the clear political shift will trigger changes should not be taken for granted.

In Greece, where general elections are to be held on Sunday, the country's endemic budget deficits and rising debt levels have created a challenging fiscal profile for the future government. Our third focus reviews Greece's macroeconomic and fiscal imbalances in this light.

Javier Pérez de Azpillaga [email protected] +44 (0)20 7774 5205 Themistoklis Fiotakis [email protected] +44 (0)20 7552 2901 Dirk Schumacher [email protected] +49 (0)69 7532 1210 Natacha Valla [email protected] +33 1 4212 1343 Nick Kojucharov [email protected] +44 (0)20 7774 1169

Editor Natacha Valla [email protected] +33 1 4212 1343

Euroland: Estimated gross issuance of long-term debt in 2010

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Redemptions

% of GDP (rightscale)

Source: National Treasury Offices, GS Calculations.

Euro-zone: Fiscal balances (% of GDP)

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% of GDP

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Source: Eurostat, GS Forecasts

October 1, 2009 Issue No: 09/34 2

European Weekly Analyst Goldman Sachs Global Economics, Commodities and Strategy Research

Week in review

The flow of sentiment continues to encourage The European Commission’s business survey release this week provided its usual summary of sentiment across the Euro-zone. Confidence in September was up across the industrial (-24.3 after –25.4), construction (–30.5 after –31.6) and services (–9.1 after –10.6) sectors, but ticked down slightly in the retail trade sector (–15.0 after –14.1). The broad-based improvement reflected last week’s strong readings from the German Ifo and the French INSEE surveys, but was likely weighed down by the weakening sentiment reported by Italian industries this week. The headline business climate indicator from the Italian ISAE survey edged down to 74.0 in September from 74.4 in August, as firms reported contractions in both production levels and new orders. We expect this reversal in momentum to be temporary, but there is a risk that ongoing credit constraints in Italian markets will choke off investment and business activity in the medium term.

The final readings from the manufacturing PMIs also surfaced this week, with the headline index coming in at 49.3, marginally better than the Flash estimate of 49.0. Of primary interest was the new regional data beyond the French and German numbers contained in the Flash. On balance, the numbers were encouraging, with the Italian index (47.6 after 44.2) pointing to a slowing pace of contraction, and the Dutch index levelling off at a neutral level of 50 (some give-back after the large rise in August from 46.6 to 50.5). The disappointment, however, was in Spain, where the PMI index fell from 47.2 to 45.8, retracing a large chunk of its gains since June. Volatility

in monthly PMI is inevitable and, at this point, we are inclined to interpret the weak Spanish reading as a sign that manufacturing is lagging the recovery of its peers, as opposed to developing any meaningful negative momentum.

The PMIs and the European Commission indicators have diverged occasionally in the past (most notably during the early part of the current recession), and at this stage in the cycle, we are sometimes forced to place more faith in the signals of one survey than the other. That said, the readings from both surveys over the past few months have been largely in concordance, and collectively suggest a positive trajectory of near-term industrial activity (Chart 1).

On the consumer side, the outlook conveyed by the EC survey was similarly optimistic. The headline consumer confidence indicator has been on a steady climb since March, and surged another 3ppt in September from –22 to –19. Consumer sentiment was upbeat on several dimensions: unemployment fears declined, assessments of the economic and financial landscape improved, and purchasing plans became more bullish. We will be monitoring consumption indicators closely in the coming weeks to gauge whether this consumer optimism will translate into material purchases.

Labour market weakness endures German unemployment posted another surprise decline in September, of 12,000, after falling 5,000 in August and 7,000 in July. At first glance, three consecutive months of declining unemployment would suggest a genuine shift in momentum. But we maintain that government employment schemes continue to distort labour market dynamics in Germany. In this month’s report, the labour office emphasised that "a re-orientation of employment policy has dampened the rise in unemployment," and estimated that, without this change, unemployment would have increased by 10,000 in September and by 13,000 in August. Indeed, employment readings from the rest of the Euro-zone confirm the continued underlying weakness. The area-wide unemployment rate ticked up for the 17th consecutive month in August, rising from 9.5% to 9.6%. Spain, France and the Netherlands registered similar increases, while Italy’s unemployment rate (for which the latest reading is June) remained anchored at 7.4%.

This week provided a further stream of business sentiment data, with the European Commission survey broadly confirming the optimism from last week’s country-level survey indicators. Revised manufacturing PMI readings also suggested continuing positive momentum in the industrial sector, and now point to +0.2%-0.3%qoq growth in Q3. The labour market continues to lag the recovery, however, as is historically the case, and despite surprise declines in unemployment in Germany, we do not expect any substantial employment growth until late 2010. On the monetary policy front, the Polish and Hungarian central banks matched expectations with their rate decisions, but Poland surprised by announcing a new liquidity facility for 2010.

Chart 1: EC Business survey is in broad agreement with the PMI

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Source: Markit, European Commission.



No surprises on the inflation front The flash estimate of September Euro-zone inflation came in at –0.3%yoy, in line with our expectations and a tenth lower than the August reading of –0.2%. There is no breakdown of the underlying components as yet, but the fall in oil prices from €51/bbl to €47/bbl in September is likely to have been a key contributor to the depressed headline reading. We expect energy prices to turn upwards again in the coming weeks, and we forecast that the headline inflation rate will turn positive by November or December.

With regards to core inflation, we have advocated that given the large output gap, there is a risk that consumers’ expectations of deflation may become entrenched to the point where they postpone nonessential purchases and place further downward pressure on prices. But the latest EC survey indicates that after 10 months of expecting disinflation, consumers are finally beginning to tilt their inflation expectations to the upside. As Chart 2 shows, 49% of survey respondents in September expected prices to remain flat or fall in the next 12 months, compared with over 52% in August. We see this as an encouraging sign that any remaining risks of deflation are beginning to ease.

Rates decisions in Central Europe There were two notable monetary policy meetings in the Euro-zone periphery this week:

In Poland, the NBP kept rates at 3.50% as expected. The committee maintained its informal 'easing bias', but qualified it by adding a new statement that “the probability that inflation runs below the target has lessened in recent months”. Governor Skrzypek also announced that the NPB would introduce a new 12-month repo program beginning in January 2010. Given the recent improvements in the economic data and increasingly dovish tone of the committee, the provision of a new liquidity facility at this stage is somewhat puzzling. Nevertheless, we remain confident that the NPB sees the economy improving, and will not change rates for the remainder of the year.

In Hungary, the NBH cut its base rate by 50bp to 7.50%, in line with our expectations. As expected, a larger 75bp cut was discussed, but an "overwhelming majority" supported a 50bp move. The NBH is clearly maintaining its dovish bias, and we expect two more 50bp cuts this year, bringing rates to 6.5% by the year-end. We then foresee the NBH lowering rates by another 100bp to 5.5% by mid-2010.

Nick Kojucharov

Chart 2: Expectations of deflation are beginning to ease

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Year ahead expectations (lhs)

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Source: European Commission

% of respondents



State budget season: Different approaches across the Euro-zone

Most of the draft finance bills in the Euro-zone (except perhaps in Spain) would fit with the view that it is too soon to abandon crisis-response mode. Yet, country approaches with respect to public finances in 2010 are, to say the least, very diverse. While Germany had carved its commitment to a balanced budget into its constitution before last week’s elections, France has maintained its phlegmatic attitude towards existing budget constraints, with yet further announcements of extra-budget spending “for long-term purposes”. Spain is introducing tax hikes, whereas Italy has announced flat taxes while at the same time sticking to a discretionary fiscal stance that is as lean as possible.

This diversity to some extent reflects the strengths and weaknesses specific to each EMU member state. Charts 1

to 4 illustrate the heterogeneity in fiscal fundamentals across countries using variables such as the trajectories of fiscal balances, the level of tax revenues and the burden resulting from interest rate repayments.

Yet, in all countries, the phasing-out of exceptional fiscal stances will have to be discussed, if not in 2010, at least within the time-span of the triennial public finance plans that each country has to submit to the European Commission. This may be a reminder that some countries entered the crisis with very unfavourable structural balances, and may have to show at least as strong a commitment to fiscal consolidation as their more disciplined neighbours. We review the fiscal plans in turn in the following pages.

Most Euro-zone governments have now prepared draft budget bills for debate in national parliaments, spelling out the prospects for public finances in 2010. We take stock of the budget plans here and provide rough estimates of sovereign issuance for the year to come. Overall, heterogeneity is high across countries in terms of how the transition back to normality will be tackled, ranging from tax hikes in Spain, good intentions in Italy (although it is struggling with a large debt), and a lax attitude towards existing budget constraints in France. Looking at sovereign long-term debt issuance in 2010, we do not expect a significant reduction, with Germany, France and Italy expected to issue some €230-250bn each (10.3%, 12.4% and 15.0% of GDP, respectively), while Spain should sell ‘only’ €125bn (11.5% of GDP) thanks to lower redemptions.

Chart 1: Fiscal balances (% of GDP)

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% of GDP

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Source: Eurostat, GS Forecasts

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1991 1993 1995 1997 1999 2001 2003 2005 2007Source: Eurostat

% of GDP

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Chart 2: Contrast in tax revenues…(% of GDP)

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Chart 4: Spread with 10-year German Bund (bp)

Source: Bundesbank, Bancad'Italia, Banque de France, Banco de España

Chart 3: …and in interest repayment burden (% of GDP)

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1980 1983 1986 1989 1992 1995 1998 2001 2004 2007Source: Eurostat

% of GDP

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The Spanish 2010 Budget raises taxes (income tax and VAT) by 1.0% of GDP and envisages a 4% decline in spending, with non infrastructure investment losing out. The aim is to bring the general government deficit from an expected 9.5% of GDP in 2009 to 8.1% in 2010, delivering a 1.5-2.0 p.p. negative fiscal impulse that will dampen GDP growth by at least 1%. However, our key concern remains that, in the absence of structural reforms in the labour market, the consolidation drive is bound to be lopsided and its impact limited. We maintain our deficit forecasts: 10% of GDP in 2009 and 9.5% in 2010.

Going into the detail of the draft:

The outstanding element of the draft is the tax hikes: the €400 income tax benefit that the government instituted in 2008 will disappear; the tax rate on capital income (interest, dividends) will rise from 18% to 19% for the first €6000 and to 21% thereafter; and the general VAT rate will be raised from 16% to 18% from July 2010. There is also a small tax cut: small companies and non-incorporated businesses will have their profits taxed at 20%, instead of the current 25%, as long as they do not reduce their payrolls. The tax increases are not a surprise, PM Zapatero having announced tem in early September.

We see two reasons for this attempt at fiscal discipline even as the economy is still in recession. First, the fear that, absent some consolidation effort, Spain’s fiscal credibility would suffer, especially if the macroeconomic context surprises again on the downside. Second, the government is sending a message of austerity to the country so as to facilitate wage cost containment, both in the public and the private sector.

The tax increases will accrue an extra €11bn (1.0% of GDP) per annum for the central government, although the effect for 2010 will be lower (0.6%).

Total tax revenues rise some 8%, the result of tax rises but also of some calendar effects on tax inflows.

Overall spending is budgeted to fall 3.9%yoy to €185bn. The government is keen on highlighting that welfare payments, together with infrastructure and R+D spending, will be broadly maintained - they are considered “spending priorities”. Despite the effort on infrastructures, overall investment is still set to fall by 9.5%, ministers being asked to economise on all replacement investment that can be postponed. The budget also envisages a 0.3% increase in wages in the public sector and stricter limits on hiring.

The negative fiscal impulse that the Budget delivers will in our view dampen 2010 GDP growth by at least 1.0% - that would bring our 2010 forecast to -0.3%, in line with the government’s expectation. In addition, the 2.0 p.p. increase in the VAT rate since July 2010 may prompt some frontloading of consumer spending to Q2 (at the expense of spending in the second half of the year). It will also affect CPI inflation: we will be raising our prices some 1 p.p. from July.

Some of the Budget projections appear somewhat optimistic (revenues) or vaguely defined (spending). Moreover, the fiscal tightening delivered can backfire and prolong fiscal difficulties if it is not accompanied by reforms (mainly in the labour market) conducive to create the conditions in which GDP can grow back to its potential as fast as possible. We therefore stick to our deficit forecasts of 10% in 2009 and 9.5% next year.

The draft proposal is now in Parliament. The Socialist party lacks a sufficient majority and will have to negotiate with smaller parties for it to be passed before year-end. This should not present much of a problem even if negotiations look deadlocked from time to time.

Spain: Raising taxes while maintaining infrastructure spending

Chart A1: Revenues, expenditures and fiscal deficit of Spanish government

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Deficit (rhs) General Government Expend (lhs) General Government Revenue (lhs)

Source: Eurostat

GS Forecasts

% GDP % GDP Chart A2: Structure of Spain's consolidated gross debt

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92 94 96 98 00 02 04 06 08Source: Eurostat / HaverAnalytics

LT loansST loans LT Sec Oth than Shares, ex Finl DerivST Sec Oth than Shares, ex Finl DerivCurrency and deposits

Eur bn



France’s 2010 Budget law, reviewed by the Council of Ministers on Wednesday, pushes fiscal consolidation way into the future (if at all). The budget deficit is expected to remain above 8% of GDP this year and next (8.5% in 2009 and 8.2% in 2010), leading to an increase in the debt-to-GDP ratio to 83% and 88%, respectively, mostly on account of worse-than-expected corporate tax collection. This is good news for ‘automatic stabilisers’, which should act as a buffer for cyclical fluctuations, but is bad news for fiscal balances. The debt burden is expected to deteriorate despite the low level of interest rates, at a cost of €42.5bn in 2010 (some €10bn above 2009). Overall, our key concern would be that the repeated absence of a consolidation drive, in particular in light of the discipline exhibited by neighbouring Germany, could trigger a sudden wake-up call in markets, with the ensuing impact on sovereign spreads—a phenomenon that has been absent so far. We are downgrading our deficit forecasts to -8.4% of GDP in 2009 and -9.0% in 2010.

2009 particularly unfavourable. The gap between the initial 2009 budget plan and the new estimates is particularly spectacular this year. The deficit, initially planned at €67bn, is now expected to be around €141bn (falling back towards €116bn in 2010). Overall, the adverse impact of the crisis on public accounts, and in particular on corporate tax receipts, has turned out to be much worse than expected. Looking further ahead, even under an optimistic view on real GDP growth (2.5% from 2011 onwards), the debt ratio is expected to be in excess of 90% by 2013. In other words, while the trajectory of French debt remains manageable, the country is accumulating a handicap that will weigh on public accounts for many years to come.

Tax reforms under way. Despite (or thanks to) the crisis, a number of structural tax reforms are being pushed through. The partial withdrawal of the Taxe Professionnelle (TP), a local tax levied on businesses’ fixed investment, is probably the boldest step in

President Sarkozy’s tax policy. It will have a substantial one-off adverse impact of €11.6bn on the 2010 budget (and about half of that henceforth), but should at the same time foster the competitiveness of French businesses. However, the TP will be partially replaced by two local taxes, to be levied from 2011 onwards. A second important innovation in tax policy is the introduction of the ‘Carbon tax’ on CO2 emissions. While it is meant to be neutralised by a complex system of subsidies for households, it will fall fully on businesses (€2bn), albeit only partially compensating for the removal of the TP.

No rush to phase out the stimulus. Nothing in the budget law suggests that France is in a rush to return to normal mode. A few measures in the stimulus package will be continued in 2009 (e.g., reductions in social charges for very small firms). That said, the bulk of the stimulus package has been concentrated in 2009, so a drag on growth stemming from the stimulus withdrawal should still be expected by mid-2009 despite the plan to spend about €7bn in discretionary measures over 2010.

Vagueness about fiscal consolidation. Beyond 2010, the law remains extremely vague as to how the country will return to Maastricht limits. In this context, it is worth recalling that the next triennial plan to be submitted to Brussels will also reflect the impact of the Grand Emprunt (public borrowing to be subscribed by the public at large, at least partially), to be launched early next year, on deficit and debt figures. Current plans do not take it into account. While details of the emprunt are still to be clarified (a commission led by former PMs Rocard and Juppé is still debating the modalities), a very skilful government communication will be necessary early in 2010 to reassure markets that France still deserves to stand next to Germany among the safest and best-rated sovereigns in Europe.

France: No fiscal consolidation in sight

Chart B1: Revenues, expenditures and fiscal deficit of French government

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% GDP % GDP Chart B2: Structure of French consolidated gross debt

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LT loansST loans LT Sec Oth than Shares, ex Finl Deriv ST Sec Oth than Shares, ex Finl DerivCurrency and deposits

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The budget bill approved last week has confirmed the 2010 public finance targets set by the Italian government in its Economic and Financial Planning Document (DPEF)—the blueprint for the years 2010-2013 that was approved in the Summer. The 2010 bill foresees an increase in general government net borrowing to 5.3% of GDP in 2009 and 5% in 2010. Overall, we remain confident in the government’s willingness to keep public finances in check, as far as is feasible under the current circumstances. Given the drag on revenues as a result of the crisis and the boost to public spending, our current deficit estimates stand at 5.4% of GDP for 2009 and 5.2% for 2010.

Taxes at a standstill. The bill approved last week confirmed that there would be no tax hikes, but it remained vague on spending targets. As we have argued in the past, Italy’s discretionary fiscal stimulus has remained quite meagre in light of the large debt overhang and the resulting limited room for manoeuvre. The most recent measures, which look marginal when compared with the stimulus implemented in neighbouring countries, have focused on businesses and

bank credit support measures. In parallel, the government offered a tax amnesty on repatriated assets.

Restated commitment to stability. When presented in the Summer, the DPEF included a triple commitment to “budget stability, sustainable employment and credit to business”. The government’s goal remains to converge towards a balanced budget in structural terms, and “towards a gradual but substantial reduction in the debt as soon as the recovery has consolidated”. In this spirit, the government has changed its views on the macroeconomic environment in light of the improved data released since the Summer. Estimates for public finances beyond 2010 have been raised relative to previous numbers, with a gradual decline in the deficit towards 2.2% of GDP in 2013 (against a previous estimate of 3.5%).

Debt likely to be sticky at high levels. The debt-to-GDP ratio is currently expected to rise discretely, from €105.7bn in 2008 to €115.1bn in 2009 and €117.3bn in 2010. However, the government aims to bring public debt back to a downward trajectory from 2011 onwards, with a 2013 objective of €112.7bn.

Italy: Struggling with debt, but with good intentions

Chart C2: Structure of Italian consolidated gross debt

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92 94 96 98 00 02 04 06Source: Eurostat / HaverAnalytics

LT loansST loansLT Sec Oth than Shares, ex Finl Deriv ST Sec Oth than Shares, ex Finl DerivCurrency and deposits

Eur bnChart C1: Revenues, expenditures and

fiscal deficit of Italian government

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In Germany, the timing of budget discussions is peculiar this year, owing to the recent General Elections, which put Angela Merkel back in the driving seat. We will have to wait until the beginning of December for a

clearer idea about the new government’s priorities. For more details about the fiscal challenges facing them, see the focus article on Germany in this issue.

Germany: Wait until December

Chart D2: Structure of German consolidated gross debt

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Eur bnChart D1: Revenues, expenditures and fiscal deficit of German government

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Sovereign issuance in 2010 We take the opportunity provided by this helicopter view of draft budget bills to arrive at early estimates of EMU government issuance for 2010. Our views on the years to come are summarised in Table 11. Overall, we do not expect a meaningful reduction in issuance next year (or in 2011) compared with the already inflated issuance calendar in 2009.

Looking at gross debt issuance in 2010 (excluding T-bills, see Chart 5), Germany, France and Italy will issue some €230-250bn each (10.3%, 12.4% and 15.0% of GDP, respectively). Spain benefits from lower redemptions in 2010 and will have to sell some €125bn (11.5% of GDP).

Beyond the heavy issuance calendar, investors will focus on the fundamental soundness of public finances: the credibility of fiscal consolidation plans, the overall level of debt and the prospects for a return to the economies’ potential. For example, despite the marked deterioration in Spain’s deficits in 2009 and 2010, and the lack of progress in labour market reform, it should keep overall debt levels (as a percentage of GDP) below those of the other countries throughout 2009-2014. In a similar vein, Italy may well be able to keep the trajectory of its debt in check. By contrast, the dynamics of French balances do not provide the same degree of comfort. As for Germany, it had carved its commitment to a broadly-balanced budget by 2016 into its constitution before last week’s elections. Whether Germany will keep this commitment

remains to be seen, but historical evidence is reassuring: we would expect the government to embark on a more serious consolidation course around 2012 so as to get the structural deficit down to 0.35% by 2016.

Natacha Valla and Javier Pérez de Azpillaga

Chart 5: Estimated gross issuance of long-term debt in 2010

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Source: National Treasury Off ices, GS Calculations.

1. Note that GDP and deficit projections for 2011-2014 are not forecasts but figures based on working assumptions. The same applies to distribution of net issuance between long-term debt and T-bills.



Table 1: Long-term government debt issuance estimates (€ bn)

Germany France Italy Spain Netherlands Eurozone % of GDP

Gross debt issuance 2009 200 206 220 116 48 965 10.7estimate 2010 251 243 234 125 52 1102 12.0(excl. t-bills) 2011 229 176 202 119 46 954 10.1

2012 173 161 183 103 41 814 8.42013 164 136 148 75 32 699 7.02014 138 93 129 62 29 577 5.6

Debt redemptions 2009 138 110 162 30 35 598 6.6(excl. t-bills) 2010 137 92 172 35 23 587 6.4

2011 120 52 143 46 28 525 5.62012 84 59 128 47 24 469 4.82013 88 56 98 32 15 389 3.92014 75 38 83 33 13 335 3.2

Net debt issuance 2009 62 96 58 86 13 437 4.8estimate 2010 115 151 62 90 29 515 5.6(excl. t-bills) 2011 109 124 59 73 18 429 4.5

2012 89 102 55 56 18 345 3.62013 76 79 51 43 17 310 3.12014 63 55 46 29 16 243 2.3

Increase in circulating tbills 2009 94 69 41 37 -19 250 2.8

2010 14 30 8 23 5 73 0.82011 13 27 8 19 5 85 0.92012 12 23 7 16 5 90 0.92013 10 18 7 12 4 59 0.62014 9 12 6 8 4 56 0.5

Source: National Treasury Offices, GS Calculations



A new government, but not necessarily a new direction

A new government—but a new policy too? Last Sunday’s general election brought a clear majority for a centre-right coalition between Chancellor Merkel’s CDU/CSU and the liberal FDP led by Guido Westerwelle. Coalition talks between both parties will start next Monday and are expected to last until the end of October.

At the end of these talks both sides will agree on a so-called ‘coalition contract’, which will set out the government’s main platform for this parliament and will give a clear indication of how much of a change in policy we can expect from the new government.

At least for now, our view remains that the new government, despite a strong outcome for the FDP (which won almost 15% of the votes), will embark on a very cautious reform approach. Statements by Chancellor Merkel since the election are clearly aimed at downplaying expectations of a radical shift in gear with respect to reforms.

No shift to the left despite crisis At least when seen in the context of the financial crisis, the victory of the centre-right parties may appear unexpected.1 In particular, the strong showing of the FDP, arguably the most market-friendly party in the German political spectrum, seems surprising. Given the depth of the crisis, one could have expected a majority of voters to move towards the left.

We can only speculate about what is behind the relative strength of the centre-right parties but it would appear that voters were less willing than some on the left had hoped to turn the crisis into a general vote of no-confidence in a market-based economy. The election platforms of the SPD, Greens and Left Party were certainly written in the spirit that the crisis not only demands a better regulation of the financial system and banks—but also questions the structural reforms of the past (such as the labour market reforms and the increase in the retirement age), regardless of whether they played any role in the lead-up to the crisis or not.

Judging from the election result, it appears that voters were more willing to differentiate between the causes of the financial crisis and the more general issue of structural reforms. It is interesting in that respect to look at the shift in the number of votes polled for the various parties. An analysis by polling institute infratest dimap shows that the FDP was able to attract, on a net basis, voters from all other parties. While only a few voters ‘deserted’ either the Greens or the Left party for the FDP, the SPD lost some 430,000 votes to the FDP. Moreover, some 620,000 voters shifted from the SPD to the CDU/CSU. Consequently, the SPD lost a tenth of its votes to the centre-right parties compared with a loss of around 15% to either the Left Party or the Greens.

The result is likely to have an interesting long-term consequence. Some have argued that once the SPD was willing to form a coalition with the Left Party (together with the Greens), there would be a clear majority of the parties on the left of the political spectrum. But last Sunday’s election has shown that this is not necessarily the case; in fact—as the analysis of the shift among the parties makes clear—the further the SPD moves to the left, the more voters it may lose to either the CDU/CSU or FDP. Thus, the size of the ‘left camp’ may not increase as the SPD is trying to regroup in opposition.

How much of an appetite for reform? What can we expect from the new government in light of the relative strength of the FPD, and how much of their fairly ambitious program will the FDP be able to push through in the coalition talks?

The past four years have shown that the CDU/CSU’s appetite for reforms is much smaller. To some extent, this was due to the constraints of having to form a coalition with the Social Democrats. However, the CDU’s vagueness with respect to the structural reforms persisted during the election campaign, and their election platform was rather thin on specifics—and in her speeches, Chancellor Merkel preferred to talk about her intentions in a rather general tone.

Last Sunday’s general election brought a clear majority for a centre-right, CDU/CSU and FDP coalition government led by Chancellor Merkel. However, a change in government will not necessarily lead to a meaningful change in German politics.

Coalition talks between the two sides are due to start next week and a general agreement on the main platform for the new government will probably be reached by the end of October. We do not expect the coalition talks to result in a significant change of course. The strong result for the FDP, possibly the most market-friendly party in the German political spectrum, would argue for a bigger reform appetite in the new government, but Chancellor Merkel has already made clear that she is not willing to implement a genuine shift in her policy as this could scare off important segments of her voters.

1. This is not to say that the election result was surprising based on the latest polls. In fact, the result was surprisingly close to the latest published polls.



Given this deliberate vagueness and the experience of the past four years, the crucial question is whether it reflected tactical considerations, or a more general unwillingness to pursue structural reforms.2

We will be able to judge reform prospects only after the coalition talks have taken place. It is important to note, however, that the fact that past reforms will not be reversed is already good news compared with what might have happened under another grand coalition.

The German labour market, for example, has already become more flexible in recent years and unit labour costs had declined dramatically before the crisis started. Thus, the need for labour market reforms is now much less urgent than it was five years ago.

Three challenges This is not to say that the new government can, or should, be idle. We see three policy areas on which the new government will need to focus:

Re-balancing the economy. Spurring consumption, which has more or less stagnated in the past ten years, should be a main focus for the new government. We have written extensively about the imbalances in the German economy in the past and will not reiterate the causes behind this development here (for a detailed discussion, see for example our Global Economics Paper 189 “Re-balancing the Euro-zone: No easy task”). But a rising tax burden has clearly been a major factor behind the lack of growth seen in private consumption.

The current fiscal package already includes tax relief and lower social security contribution rates, and this will support consumption going forward. However, more is needed, in our view, and this Sunday’s election outcome means that there is now a good chance we will see further rate cuts, not least as the FDP has made tax cuts a cornerstone of its campaign.

Managing the demographic challenge. Another big challenge is the sustainability of the pension system. The previous government had already initiated an important change by increasing the retirement age gradually from 2012 onwards, from the current 65 to 67 by 2029. Again it is a positive that this necessary step undertaken by the old government will not be reversed under the new government. There had been growing unease within the SPD about the rise in the retirement age, and there would have been a clear risk that another Grand Coalition might have watered down the status quo.

The planned increase, however, may not be enough. The fact that the federal government is transferring some €80bn this year into the public pension scheme—the biggest single item of the federal budget—shows that the system is already highly dependent on outside funding and the retirement age would need to increase much faster than currently planned if the system had to stand on its own.

Given that the debt level will increase significantly in the coming years on the back of the fiscal packages and the recession, transfers into the pension system will increasingly be seen as a major risk factor to the fiscal outlook. Only a more ambitious increase in the retirement age would allow a reduction of these transfers, freeing up money that the government could use, for example, for a reduction in the tax burden of households.

Education, education, education. Improving the educational system is a task every government has to face up to and this is no different for this new government. But this task is sometimes more urgent than usual. Comparative studies undertaken by the OECD show that a reform of the educational system, on all levels, should be a paramount objective for the new government. A particular focus should be to assure better access to higher levels of education for children from disadvantaged families. Several studies suggest that, at least compared with many European peers, the German educational system is more ‘segregated’ than it should be.

Whatever plans the new government has in this area, it may take a long time before any visible results will emerge. However, this is no reason to be timid or to delay action—but rather an argument to start now.

How much room for manoeuvre on the fiscal front? Many commentators warned before the election that there is no room for tax cuts and that the next government would need to raise taxes in order to prevent the fiscal situation spinning out of control.

While we would agree that the fiscal outlook looks challenging, we are not convinced that things would get out of control without tax hikes any time soon.

Chart 1: Germany: Total governmentdebt as % of GDP

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% of GDP

2. Süddeutsche Zeitung had an interesting quote in that respect on Monday. SZ cited “one of Merkel’s most important ministers” as saying “We do not have any commodities of note, we do not have nuclear weapons, the world does not need us and won’t wait for us”.



The relevant factor to watch when it comes to debt sustainability is the debt to GDP ratio. This ratio will increase, on our estimates, by some 10 percentage points from 65% in 2008 to 75% by 2010—an increase roughly similar to what we saw after unification. However, a sufficient condition for a stabilisation of this ratio in the following years is simply that nominal GDP will eventually grow by at least as much as the size of the deficit.

Chart 2, for example, assumes that the deficit will still be 5% in 2011, 4% in 2012 and 3% thereafter. Such a scenario, assuming nominal GDP growth of 4% from 2011 onwards, would still lead to a stabilisation of debt at 80% of GDP. Thus, unlike as sometimes portrayed, the fiscal situation is not inevitably on an unstable trajectory unless taxes are increased.

All this is not to say that the situation is comfortable. First, interest payments will make up an increasing share of government spending, leaving less room for alternative spending such as investments. Moreover, a rise in interest rates may reduce the room for manoeuvre even further, and potentially significantly so, depending on the size of the increase in interest rates.

But tax hikes could also be very damaging in the current situation. Moreover, a revitalisation of private consumption is necessary for the reasons discussed above. Weighing up the different aspects of a tax hike or cut, we think that a cut in the income tax is possible and indeed needed. Given that the FDP has made tax cuts a cornerstone of its campaign, we are quite confident that the coalition contract will include cuts, although it remains to be seen how big these will be and when they will become effective.

Dirk Schumacher

Chart 2: Debt/GDP to stabilise without tax hikes

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1991 1994 1997 2000 2003 2006 2009 2012 2015Source: Haver Analytics, GS calculations

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Greece: Tough times ahead for the next government

Against a backdrop of political uncertainty… Greece will hold one of the most important general elections of its recent history on Sunday, October 4. Against a backdrop of political uncertainty, a rapid deterioration of macroeconomic conditions has brought chronic structural imbalances to the surface. Brave and deep reforms will be required for the Hellenic Republic to continue on a path of fast convergence towards the EU average over the next few years. But neither of the two parties competing in the election has credibly signalled its ability or willingness to proceed with such reforms.

Caught between a rapidly deteriorating economic situation and a largely unfavourable political backdrop, Prime Minister Karamanlis has called for early elections only two years after his centre-right party, New Democracy (ND), won a second term in power. Both of the ND’s successful election campaigns were based on the promise of structural reform. However, the government failed to deliver the expected reforms, and the public’s disillusion with this failure has translated into a large decline in public approval ratings.

The latest polls have shown PASOK, the centre-left party, largely in the lead. PASOK is no stranger to power—it was the governing party for 19 of the last 30 years. But although it has been credited with the Euro accession, it has also been linked to the persistence of Greece’s chronic economic imbalances. In addition, even if PASOK were willing to deliver the desired policy mix this time around, it is not certain that it would secure the necessary parliamentary majority.

...Macroeconomic challenges raise the stakes for the next government In this unpromising political environment, any new government would be called upon to manage a severe economic downturn as well as the challenges that the chronic imbalances of the economy are once again bringing to the surface.

A large fiscal adjustment ahead. The most daunting task of the new government will be to consolidate the massive fiscal deficit, which the European Commission expects to reach 5.1% of GDP in 2009. For 2010, the Commission has forecast an even larger deficit of about 5.7% of GDP.

Recent statements from government officials point to significant upside risks to these deficit estimates.

At a first glance, one could argue that Greece is no different to other developed nations, where fiscal deficits have mounted in the face of declining activity. However, Greece’s problems are not just linked to the decline in output. Its fiscal deficits are chronic. The Commission’s estimates for the cyclically-adjusted government deficit stand at about 5% for 2009 and 4.7% in 2010. With the exception of 1999 and 2006, Greece has never come even close to posting a budget deficit of 3% of GDP since the early 1980s.

And the cycle is not likely to provide substantial support to the fiscal consolidation effort. Consensus expectations are for a decline in output of about 1.6% in 2009 (pretty close to the average annualised GDP decline in H1) and for flat growth in 2010. In absolute terms, the contraction in Greece’s GDP may not look that large relative to the Euro-zone average. However, the Greek economy is also very likely to fail to pick up as swiftly as the rest of Euro-zone. For example, although we have seen some signs of a revival in PMIs and exports, domestic demand indicators (such as confidence in the construction sector, services and consumer confidence surveys) still point to very soft activity ahead and are underperforming the rest of Euro-zone.

In addition, external political pressure is mounting for Greece to consolidate its budget deficits within the next two years. The European Commission placed Greece (for the second time) under excessive deficit procedures in April 2009. As a result, Greece is required to bring the deficit down to 3% of GDP by the end of 2010. The government has tried to negotiate an extension of the deadline to the end of 2012, but although the deadline is likely to be extended, we think that overall the Commission may well be less lenient on Greece than in the past.

Debt to GDP has been declining since 1995, but is still hovering at very high levels of about 98% of GDP in 2008 (see Chart 1). And, according to the European Commission’s forecasts, it is projected to rise to 103% of GDP in 2009 and 108% of GDP in 2010—levels not seen since 1997.

Against a backdrop of political uncertainty, Greece is holding general elections on Sunday October 4. Thirty years of large budget deficits and rising debt levels have created a challenging fiscal profile for the Hellenic Republic. With most of its old GDP growth drivers no longer in place, Greece cannot rely on strong revenue growth to adjust its public finances this time around. Moreover, the European Commission will likely be less lenient on the country going forward.

The challenges ahead also offer a unique opportunity for the next government to promote a set of structural reforms to reduce structural unemployment and the size of the public sector, and increase revenues. However, neither of the two major parties competing in the election has credibly signalled its ability or willingness to proceed with such reforms.



The high and rising level of debt poses two challenges. On the one hand, all else equal, it implies a larger cost of debt servicing. Greece is already paying a large interest payment of 5% of GDP in 2008. Should debt increase according to the Commission’s forecasts, the coupon payment could increase to 5.5% of GDP, all else equal. Even if the next government achieves a balanced primary budget, it would still have to cover debt servicing costs of about €13bn.

A decline in financing costs could offset part of that increase. However, markets have not allowed financing conditions for the Greek government to ease significantly as Greek spreads have remained wide relative to core Europe. Since mid-2007, German 10yr yields have declined by more than 120bp. Over the same period, Greek 10yr yields have declined only marginally. Greek 5y CDS spreads have fallen from their 2008 highs of 300bp to levels of 125 but are still wide historically. The fact that Greek spreads have failed to consolidate further recently is even more interesting, considering the high levels of global risk appetite and the strong performance of other risky assets. The persistence of wide Greek spreads is mainly due to the high levels of debt. The potential for a significant increase in debt stock over the next two years creates upside risks for Greek spreads going forward.

Furthermore, on top of the current challenges, Greece’s fiscal prospects will be further undermined by rising social security and healthcare costs, and unfavourable demographics over the next few years. Social security and welfare fund revenues fell short by an average €6bn per annum in 2003-2007 and this gap is projected to rise to €11bn in 2009. For the most part, this revenue shortfall will be covered by government grants, but the expected net borrowing costs will likely be in the order of 0.5% of GDP in 2009 (about €1.2bn).

Demographics will likely make these pressures more pronounced after 2010. According to UN projections, Greece’s working age population will start to decline on an outright basis from 2011 onwards.

New growth drivers are required. Until now, strong nominal growth in Greece has masked the deterioration in fiscal dynamics to a significant extent. Greece has grown by an average nominal 7.5% for the last 10 years without much cyclical volatility. As a result, the average revenue growth over this period was 7% on average.

However, many of the factors that drove this strong growth in the past are no longer present in Greece. For example, prior to 2004, growth was underpinned by falling inflation and interest rates (a result of EMU accession), as well as infrastructure spending for the Olympic Games.

In the 2004-2007 period, strong consumption was driven by increasing credit penetration and rising levels of household debt (see Chart 2). However, the higher the levels of household debt, the slower the expected pace of credit growth is likely to be. Credit has already started to show signs of peaking as a share of income since mid-2007. As a result, private consumption has collapsed. Chart 2 illustrates these trends.

Investment spending has been strong, averaging 4% over the past six years. However, about 50% of investment growth was linked to the housing and construction boom during the 2004-2007 period. In part, the pick-up in construction activity was a result of various one-off tax incentives over that period and rapid growth in mortgage loans. Going forward, it is hard to imagine construction spending maintaining the levels of growth observed in the recent past.

The external sector has been a drag on growth, with large and widening current account deficits reflecting the overextension of domestic demand relative to external demand and highlighting the imbalances of the Greek economy. The external deficit peaked at about 16% of GDP in Q3 2008 to slightly below 11.5% of GDP in Q2 2009. This adjustment is only moderate relative to the current account shift that has taken place in Spain, Italy and Portugal on average. We think there is room for further CA correction in Greece (see Chart 3). There are

Chart 1: Persistent fiscal deficits have supported high levels of debt

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Sources: National Statistical Service, Bank of Greece, Eurostat.

% of GDP % of GDP Chart 2: As credit penetration peaks, private consumption growth rates collapse

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Source: National Statistical Service, Bank of Greece, Eurostat.

% GDP %yoy



signs that Greek exports are picking up again as the global cycle gains momentum. However, domestic demand will likely bear the brunt of a considerable portion of the external rebalancing ahead.

This could be an opportunity for structural reforms The next two to three years will be testing for Greece. A significant fiscal adjustment needs to take place against a backdrop of weak domestic demand. This implies a narrowing of the current account through domestic demand underperformance and declining relative real wages.

But there is also room for upside surprise in the long run. In our view, the most important new development in Greece is that, for the first time, the public pre-election debate is focusing on the path to fiscal adjustment and debt reduction. Candidates are competing on their policies for the consolidation of deficits and the introduction of reforms, to an extent seldom seen in Greece. Unfortunately, the visibility of the full set of measures they intend to apply to achieve this consolidation is limited.

For a new government focused on reforms, there is a lot of untapped potential in the Greek economy. One source of untapped potential is the very high structural unemployment rate. Labour market rigidities have sustained unemployment rates in the order of 10% on average for the last 10 years. However, the EU is now pushing for a withdrawal of entry barriers in what is known as ‘closed professions’ in Greece. If the EU directives were broadly and deeply applied, they could provide a new boost to private employment.

There is a lot of space to increase government revenues in Greece, either by further taxation or by reducing tax evasion. Government revenues as a percentage of GDP in Greece have averaged about 39.5% relative to an EU average of 46%. The problem of tax evasion is especially pronounced in Greece and a broader dialogue is currently taking place across parties for utilising various interesting resources and measures to reduce tax evasion to some extent. Again, there is no way of verifying whether a new government would succeed in a task many previous governments have failed to succeed in.

Lastly, reductions in public spending could also mean a reduction of the size of the public relative to private sector. That said, there is no indication at the moment that a meaningful reduction of the public sector is a top priority for any party.

Overall, at times of large economic adjustments, opportunities tend to emerge as well. Greece can take this opportunity and change the long-term trends in its fiscal accounts. It could use this conjuncture to apply reforms that promote long-term competitiveness and productivity growth. Or it can resort to temporary measures with uncertain results and postpone the implementation of more structural solutions.

The voters appear ready for structural reforms, the political consensus is in place and the public debate is revolving around the right issues. But whether the new government will also have the political will to apply the optimal policies is still highly uncertain.

Themistoklis Fiotakis

Chart 3: Still space for Greek currentaccount deficit to correct

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Chart 4: Greek CDS spreads have remained wide relative to Germany

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October 1, 2009 Issue No: 09/34

Weekly Indicators

The GS Euroland Financial Conditions Index has eased significantly and is hovering near its lowest level since the financial crisis began in September last year. More than half of this is explained by the fall in corporate bond yields and another quarter by the currency. The fall in short-term rates as a result of easing by the ECB has also helped, but is offset to some extent by declines in inflation expectations.

The Euroland surprise index has ticked up over the past two months, reflecting several positive surprises in the August data.

Real Euro TWI

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105

110

99 00 01 02 03 04 05 06 07 08 09

Source: GS Global ECS Research

Euro/US$

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99 00 01 02 03 04 05 06 07 08 09

Source:GS Global ECS Research

Euroland Surprise Index* (weighted)

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Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09

avg std. dev.

Surprise Index

3-Mth mov Avg

*excluding US non-farm payrollsSource: GS Global ECS Research

Indicator Latest Reading Month Consistent with

(qoq) growth of:

Services PMI 50.6 Sep 0.2Composite PMI 50.8 Sep 0.3German IFO 91.3 Sep 0.3Manufacturing PMI 49.3 Sep 0.3French INSEE 85.0 Sep 0.0Belgian Manufacturing -19.8 Sep 0.0EC Cons. Confidence -19.0 Sep 0.1EC Bus. Confidence -24.3 Sep -0.1Italian ISAE 74.0 Sep -0.1

Weighted* Average 0.2

* Weights based on relative correlation co-effecients

Euro-zone financial conditions

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103

99 00 01 02 03 04 05 06 07 08 09

Index, 1999=100

Source: GS Global ECS

Easier conditions

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GS Leading Indicators

Our capital expenditure indicator points to an improvement in investment.

Our consumption indicator suggests strong consumption growth in Q3.

The GS trimmed index points to a fairly sharp easing in Euro-zone core CPI.

Our labour market model is showing improving employment prospects in Q3.

Our leading indicator, calibrated on IP, continues to signal positive production momentum.

Our coincident GDP indicator is now pointing to a +0.2-0.3%qoq expansion in Q3.

Euro-zone Industrial Production and our leading indicator

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% qoq

IP, 3m/3m

Leading indicator

Source: Eurostat, Ifo, Markit, GS Global ECS Research

Euro-zone GDP and Coincident lndicator

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%, qoq

Actual GDP

Coincident Indicator

Source: Eurostat, GS Global ECS Research

Euro-zone private consumption and coincident indicator

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Actual priv consumption Coincident indicator


Euro-zone employment and coincident indicator

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Coincident indicator

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Euro-zone CPI core and trimmed index

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Euro-zone fixed investment and coincident indicator

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Actual Capex Coincident indicator


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Main Economic Forecasts GDP Consumer Prices Current Account Budget Balance

(Annual % change) (Annual % change) (% of GDP) (% of GDP)2008 2009(f) 2010(f) 2008 2009(f) 2010(f) 2008 2009(f) 2010(f) 2008 2009(f) 2010(f)

Euroland 0.6 -3.8 1.2 3.3 0.2 1.0 -1.1 -1.4 -2.3 -1.9 -5.8 -6.1Germany 1.0 -4.9 1.6 2.8 0.1 0.9 6.6 2.0 2.0 -0.1 -4.9 -5.2France 0.3 -2.1 0.9 3.2 0.0 0.8 -1.5 -3.2 -2.9 -3.4 -8.4 -9.0Italy -1.0 -5.0 0.5 3.5 0.6 1.2 -3.4 -4.4 -4.3 -2.6 -5.4 -5.2Spain 1.2 -3.4 0.7 4.1 -0.4 1.5 -9.5 -6.5 -6.6 -3.8 -10.0 -9.5Netherlands 2.0 -3.6 1.5 2.2 1.0 0.9 7.1 5.8 5.5 1.0 -3.9 -4.0UK 0.7 -4.2 1.9 3.6 2.0 2.0 -1.7 -0.9 0.0 -5.3 -10.5 -11.7Switzerland 1.8 -1.5 0.5 2.4 -0.4 0.5 8.7 3.7 3.8 0.0 -1.8 -1.1Sweden* -0.4 -4.7 2.0 2.5 1.5 1.8 7.8 6.8 7.6 2.5 -2.7 -3.8Denmark -1.2 -3.4 0.8 3.6 1.2 1.7 2.3 3.1 3.1 2.9 -2.1 -3.8Norway** 2.5 -1.5 1.6 3.8 2.4 1.0 17.9 17.6 15.8 — — —Poland 4.9 1.0 2.5 4.2 3.5 2.2 -5.3 0.0 -3.5 -3.9 -6.0 -4.0Czech Republic 2.8 -3.7 1.6 6.4 1.3 2.1 -3.1 -2.5 -2.3 -1.5 -5.0 -5.1Hungary 0.6 -6.5 -0.2 6.1 5.1 4.5 -8.4 -3.8 -3.2 -3.4 -3.9 -3.8

*CPIX **Mainland GDP growth, CPI-ATE

Quarterly GDP Forecasts% Change onPrevious Quarter Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Euroland 0.7 -0.3 -0.4 -1.8 -2.5 -0.1 0.5 0.2 0.2 0.3 0.4 0.5Germany 1.6 -0.6 -0.3 -2.4 -3.5 0.3 1.0 0.2 0.2 0.4 0.4 0.5France 0.4 -0.4 -0.2 -1.4 -1.2 0.3 0.3 0.1 0.1 0.3 0.4 0.5Italy 0.5 -0.6 -0.8 -2.1 -2.6 -0.5 0.1 0.0 0.2 0.3 0.4 0.4Spain 0.4 0.1 -0.3 -1.0 -1.9 -1.0 0.0 0.2 0.3 0.3 0.3 0.4Netherlands 0.7 -0.2 -0.4 -1.0 -2.7 -0.9 1.2 0.2 0.2 0.4 0.5 0.5UK 0.8 -0.1 -0.7 -1.8 -2.4 -0.8 0.6 0.6 0.4 0.7 0.6 0.7Switzerland 0.5 0.2 -0.4 -0.6 -0.9 -0.3 0.2 0.1 0.1 0.2 0.2 0.3Sweden 0.4 -0.1 -0.5 -5.0 -0.9 0.0 0.4 0.6 0.6 0.5 0.5 0.5Denmark -0.5 -0.4 -0.9 -2.0 -1.1 -0.6 0.1 0.3 0.3 0.3 0.3 0.3Norway* 0.5 0.3 0.1 -0.8 -1.0 -0.1 0.4 0.8 0.6 0.7 0.7 0.9Poland 1.1 0.7 0.7 0.0 0.4 0.9 0.5 0.5 0.5 0.6 0.7 1.0Czech Republic -0.1 1.2 0.6 -1.8 -3.4 0.3 0.2 0.2 0.4 0.5 0.6 0.7Hungary 0.9 -0.3 -0.9 -1.8 -2.5 -1.2 -0.5 0.0 0.2 0.4 0.5 0.6*Mainland GDP

20102008 2009

Interest Rate Forecasts% 3-Month Horizon 6-Month Horizon 12-Month Horizon

Current* Forward Forecast Forward Forecast Forward ForecastEuroland 3M 0.8 0.8 0.7 0.9 0.7 1.5 1.5

10Y** 3.2 3.3 3.0 3.3 3.1 3.5 3.4UK 3M 0.6 0.6 0.7 0.8 1.7 1.7 2.8

10Y 3.7 3.8 3.6 3.9 3.5 4.1 4.1Denmark 3M 1.7 1.9 1.1 1.9 1.2 2.5 1.7

10Y 3.5 3.7 3.5 3.8 3.4 4.0 3.7Sweden 3M 0.5 0.6 0.8 0.7 0.7 1.3 1.2

10Y 3.1 3.2 3.0 3.4 3.3 3.6 3.8Norway 3M 1.9 1.9 2.2 3.5 2.7 3.5 3.7

10Y 4.4 4.5 3.9 4.6 4.0 4.7 4.4Switzerland 3M 0.3 0.3 0.25 0.3 0.25 0.5 0.25

10Y 2.0 2.1 1.9 2.2 2.1 2.3 2.3Poland 3M 4.2 4.4 4.1 4.6 4.2 5.0 4.4

5Y 5.8 5.9 6.1 6.0 6.3 6.3 6.3Czech 3M 1.9 2.4 2.1 2.7 1.9 2.5 1.8Republic 5Y 3.9 4.1 4.2 4.2 4.3 4.6 4.6Hungary 3M 7.4 7.2 6.4 6.9 6.1 6.4 6.0

5Y 1.4 1.5 7.6 1.6 7.4 1.8 7.1Euroland**-US 10Y -9 -16 -12 -22 8 -34 37

Close 29 September 09, mid-rates for major markets. We are currently using December 2009, March 2010 and September 2010 contracts for 3-month forward rates.

19



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US Economics Research

20 October 1, 2009 Issue No: 09/34

European Calendar

Economic Releases and Other Events

Focus for the Week Ahead

Industrial production poised for further gains. Industrial production readings across the Euro-zone were quite mixed in July. With business sentiment indicators showing improving momentum throughout August and September, however, we expect IP to follow suit and to have registered strong gains in August. German IP comes in first on Thursday (we expect 1.2%mom), followed by French and Italian IP on Friday.

ECB Meeting (Thursday). The meeting should pass with little fanfare and we expect the ECB to keep rates on hold at 1.00%.

-8

-6

-4

-2

0

2

4

97 98 99 00 01 02 03 04 05 06 07 08 09

3m/3m

22

27

32

37

42

47

52

57

62

index

IP

Manufacturing PMI

Source: Eurostat, Goldman Sachs

PMI points to a pickup in production

Country Time Economic Statistic/Indicator Period Consensus1

(UK) mom/qoq yoy mom/qoq yoy

Friday 2ndCzech Republic 14:00 Minutes of MPC Meeting Sep-24 — — — — —USA 08:30 Non-Farm Payroll Employment Sep -200,000 — -216,000 — -180,000USA 08:30 Civilian Unemployment Rate Sep 9.8% — 9.7% — 9.8%USA 08:30 Average Earnings Sep 0.1% — 0.3% — 0.2%Norway 09:00 PMI Manufacturing Sep 45 — 42 — 47USA 10:00 Factory Orders Aug -1.0% — 1.3% — 1.0%

Monday 5thEuroland 10:00 PMI - Services Sep - F 50.6 — 49.9 — —USA 10:00 ISM Non-Manufacturing Survey Sep — — 48.4 — —Euroland 11:00 Retail Sales Aug -0.4% — — — —

Tuesday 6thHungary 09:00 Industrial Output Aug P — — — -19.4% —

Wednesday 7thCzech Republic 09:00 Trade Balance Aug — — — +CZK12.25bn —Sweden 09:30 Budget Balance Sep — — +SKr11.8bn — —Norway 10:00 Manufacturing Production Aug -0.5% — +0.5% -8.9% —Euroland 11:00 GDP Q2 - F -0.1% — — — —USA 14:00 Federal Budget Balance — — — +$45.7bn — —Hungary 14:00 Minutes of MPC Meeting Sep-28 — — — — —USA 15:00 Consumer Credit Aug — — $21.6bn — —

Thursday 8thUSA 08:30 Initial Jobless Claims — — — — — —Hungary 09:00 Trade Balance Aug P — — +EUR547.9m — —Sweden 09:30 Industrial Production Aug — — -0.5% -19.9% —Sweden 09:30 Activity Index Aug — — -4.6% annl — —USA 10:00 Wholesale Trade Aug — — — — —Germany 12:00 Industrial Production Aug 1.2% -16.9% -0.9% -16.9% —Euroland 14:45 ECB Meeting — 1.0% — — — —

Friday 9thUSA 08:30 Trade Balance Aug — — -$32.0bn — —France 08:45 Industrial Production Aug 0.1% -13.2% (3m/3m) 0.1% -13.0% (3m/3m) —Czech Republic 09:00 Consumer Prices Sep — 0.1% — 0.2% —Norway 10:00 Consumer Prices (CPI-ATE) Aug — 2.1% — 2.3% —Italy 10:00 Industrial Production Aug flat — 1.0% -18.2% —

Forecast Previous

Economic data releases are subject to change at short notice in calendar. 1 Consensus from Bloomberg. Complete calendar available via the Portal — https://360.gs.com/gs/portal/events/econevents/.

119413_GS EW 091002

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