38856398 European Austerity SocGen (1)

8/8/2019 38856398 European Austerity SocGen (1)

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All you ever wanted to knowabout European austerity plans

(but were afraid to ask)

October 2010

Written by a non-U.S. research analyst not registered/qualified under FINRA rules

THIS RESEARCH REPORT IS THE PRODUCT OF SOCIETE GENERALE (AUTHORIZED IN FRANCEBY THE AMF).PLEASE SEE IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION IN APPENDIX

Daniel Fermon Phone: +33 (1) 42 13 58 81


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Austerity Plans - Kill or Cure?

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010e 2015e

0%

50%

100%

150%

200%

250%

300%

UK Japan

0%

50%

100%

150%

200%

250%

300%

US

Source: SG Cross Asset Research, IMF

Public financesimpacted by WW2

Start of Japanslost decade

Public debt/GDP 1900/2015e


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Question 1Why is it necessary for Europeancountries to deliver austerity plans?

In the middle of every difficulty lies opportunity.Albert Einstein


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European government debt is held by non residents (%)

0

10

20

30

40

50

60

70

80

90

Japan UK Spain US Germany Italy Ireland France Greece Portugal

Source: OECD, IMF, SG Cross Asset Research


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Fears of higher cost of debt fully justi fied

Senior 5-year CDS (bp) and austerity plan annoucements: a limited impact

Doubts on future of

eurozone after S&P

downgraded Greek

debt to junk

Source: SG Cross Asset Research, Datastream


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Debt remain a major threat for developed economies

Question 1Why is it necessary for Europeancountries to deliver austerity plans?

Answer 1Because, if governments do notrapidly address their debtproblems, the cost of debt couldexplode, as in Greece. Thus, fearsof escalating interest rates and the

resulting dire consequences fortheir economies are seen to justifythe need for austerity measures.


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Recap of austerity measures

yCountry Debt toGD P BudgetBalance Austerity plan details2011e 2011e Sizeb n Size, %of GDP Years Spending cuts Pension reform Tax increasesGreece 129.4 -7.0 35 17 3 State salary freeze until 2014Holiday bonuses partly abolished

Pensions freeze until 2012Retirement age extended to 65

VAT raised from 21 to 23%One-off tax on companies

Italy 119.2 -3.9 24 2 3 State salary freeze for 3 years13bn of spending cuts 2011-12

Retirement pushed back by 3 to 6months

New taxes on stock options and bonusesPossible expansion of toll roads

Belgium 97.9 -4.0 22 15 5 Elections and regional divisions are delaying a clear deficit reduction strategyPortugal 86.1 -4.6 11 7 4 5% pay cuts for public sector

Sell 6bn of state assets (e)- VAT increased from 20% to 21% and

then to 23%

Crisis tax created

France 87.7 -6.0 45 3 3 3-year freeze on public spendingState subsidies cut by 10%

Retirement age raised from 60 to

62 by 2018

Top rate income tax to 41%

Taxes raised on capital gains + life insur.

Ireland 92.8 -11.1 4 2 2 3 austerity budgets over a year.Public sector salaries cut by up to15%

- VAT up from 21% to 21.5% 2008

+2% on top income tax rate

Germany 69.3 -3.8 80 4 4 Welfare spending cut by 30bnCut in public sector payrolls

- Taxes on nuclear power plantsFinancial transaction tax

UK 73.4 -7.5 110 9 5 25% cut in government spending Retirement age raised from 65 to66

VAT up from 17.5 to 20%Total of 40bn in tax increases

Spain 68.7 -6.5 15* 1 2 Civil service payrolls cut 5% in20106bn cut in public sector

investment

Pensions freeze VAT up from 16% to 18%, and 8% from7%

Overview of European austerity measures

Source: SG Cross Asset Research*Agreed 15bn cost-saving plan in May on top of an 50bn package in January. So 65bn overall


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Fears of 1937 rerun in the US at the end of economic stimulus

End of economic stimulus: consequences on equity markets

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400

1928

1929

1930

1931

1932

1933

1934

1935

1936

1937

1938

1939

1940

1941

1942

Dow Jones IndustrialAverage

End of

economicstimulus



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End of Bush tax cuts for the US in 2011

European Union =21% of global

GDPRest of the world

USA

Tax Increase

Spending cutPension ref orm

Public lay-off s

Distributionstillunknown

Greece 17%UK 9%

Portugal 7%

Germany 4%

France 3%Ireland 2%

Italy 2%

Spain 1%

Size of austeritymeasures in % of

2009 country GDP

End of Bush Tax cuts inJanuary 2011 ?

Source: SG Cross Asset Research

Many European countries on the road to austerity


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Still plenty of fog

Question 2What do we really know about thedifferent austerity measures?

Answer 2At present all we know is that theausterity plans in Europe willrepresent more than 350bn or 3%of European GDP for the next four

years.
http://blog.athos99.com/arbre-dans-le-brouillard/


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Question 3Do past examples fully justifythese austerity measures?

Keep your eyes on the stars, and your feet on theground.Theodore Roosevelt.


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Fiscal adjustements take an average 8 years to succeed

Country & period of consolidation Duration ofthe plan General government debt Structural primary balance Real GDPgrowth InflationRate Interestrates UnemploymentrateStart Peak End Swing Start End Average over the period

In years As a percentage of GDP In per cent

Short durationDenmark (1983-86) 3 65 77 72 13.4 -6.4 7.0 3.9 5.4 11.8 6.8

Sweden (1981-87) 6 47 71 62 8.6 -5.7 2.9 2.2 7.6 9.0 3.7

United Kingdom (1994-2000) 6 49 53 45 7.7 -4.4 3.3 3.5 1.8 7.0 7.3

Sweden (1994-2000) 6 78 84 64 11.8 -7.1 4.7 3.7 1.0 6.1 10.1Long durationWestern Germany (1980-89) 9 29 41 40 5.2 -3.7 1.5 1.9 2.9 7.8 5.2

Ireland (1980-89) 9 68 114 100 11.8 -7.0 4.8 3.1 9.3 10.5 14.5

Japan (1979-90) 11 41 77 64 7.0 -4.9 2.1 4.6 2.7 6.6 2.4

Italy (1986-97) 11 89 130 130 10.2 -3.4 6.7 2.1 5.0 10.6 10.2

Canada (1986-99) 13 67 102 91 11.1 -5.4 5.7 2.8 2.8 11.1 9.2Belgium (1984-98) 14 107 141 123 10.3 -3.6 6.7 2.3 2.6 8.3 8.9

Examples of successful large fiscal adjustments

Source: European Commission AMECO database; OECD; BIS; Datastream; national data; SG Cross Asset Research


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First di fference: interest rates already very low

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Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99

Canada Benchmark bond 10yr US Benchmark bond 10yr

Announcement&

establishmentof

austeritymeasure

s

3

5

7

9

11

Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99Sw edish Benchmark bond 10yr Germany Benchmark bond 10yr

UK Benchmark bond 10yr US Benchmark bond 10yr

Announcemen

t

&establishmen

t

ofausterity

measures

Long-term interest rates: same pattern observed in Canada and Sweden



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Second difference: austerity measures much larger with 21% of globalGDP


Current economic cycle

Governmentdebt

increasing

CapexM&A

EmergingMarkets IPOs

4 2012-2013e

Economies slow

1 2007- 2009

Crisis in developedeconomies

Interest ratecuts

2 2009- 2010e

Recovery in emergingmarkets and rise incommodity prices

3 2011-2012e

Rise in consumptionand investment

Improvingconsumerconfidence

Inflation/Interest ratehikes

Marketstress

Yuanrevaluation?

Previous economic cycle

1 2001-2003

US EconomicSlowdown

2 2003-.2004

Start of recovery

3 2004-2006

Recovery andGrowth

4 2006-2007

Growth stabilising

Corporatedebt

reduction

MarketStress

Capex

LBO andM&A

Interestrate drop

Low interest rates:consumer borrows

Interestrates rising

Highconsumerspendingand risinginflation


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Third difference: further depreciation of western currencies takestime to materialize



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All countries cannot win at the same time

Question 3Do past examples fully justify theseausterity measures?

Answer 3No. Three major differences withthe situations observed in Canadaand Sweden in the 1990s suggestthat not all the austerity plans willbe successful and point to a major

risk on economic growth ifgovernments implement austerityplans in an uncoordinated manner.


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Question 4Which variable should you look at toanalyze the success of these austerityplans?

In matters of style, swim with the current; inmatters of principle, stand like a rock.Thomas Jefferson

.


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Unemployment rate jumped in many countries during the 2009recession

Unemployment rate in major countries2008 2010e Increase over the recession

Germany 7.40% 8.01% 8.24%

France 7.90% 9.50% 20.25%

Italy 6.80% 8.30% 22.06%

Portugal 7.60% 9.45% 24.34%

Greece 7.60% 9.50% 25.00%

UK 5.20% 7.80% 50.00%

USA 5.80% 9.30% 60.34%

Spain 11.30% 18.20% 61.06%

Ireland 6.10% 12.00% 96.72%



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Property bubble reveals the risk associated to austerity plans

1996 2001 2006 2011 2016 2021 2026

50

150

250

350

450

50

150

250

350

450

1980 1985 1990 1995 2000 2005 2010Japan lost decade UK Ireland Spain

OECD officialdata with2009 and

2010estimates

1996 2001 2006 2011 2016 2021 2026

50

150

250

350

50

150

250

350

1980 1985 1990 1995 2000 2005 2010Japan lost decade Italy

France Germany

OECD officialdata w ith2009 and

2010estimates

Nominal residential home price

Source: SG Cross Asset Research, Datastream, OECD


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Unemployment rise and saving rates major variables to analyzethe success of austerity plans

Austerity plans and social risk



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Confidence in the future is essential

Question 4Which variable should you look atto analyze the success of theseausterity plans?

Answer 4Unemployment trends, savingrates, social movements andproperty markets are the keyvariables that can be analysed to

forecast the chances of successof the austerity plans. Dependingon the country, the austerityplans could be devastating.


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Question 5How to invest under an austerityplan scenario

You only have to do a very few things right in yourlife so long as you dont do too many things wrong.Warren Buffett

.


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What is discounted by these plan so far

Successes (bp)

Failures (bp)



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Worried about inflation? Austerity plans suggest deflation moreof a risk for 2011

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72003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023

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1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949

US Government Bond Yields from 1929

Prime bankers' acceptances, 90 days f rom 1929

US Government Bond Yields from 2004

US FED FUNDS MIDDLE RATE from 2004

End of f iscalstimulus

10

40

70

100

2000 2002 2004 2006 2008 2010 2012 2014 2016

10

40

70

100

1930 1932 1934 1936 1938 1940 1942 1944 1946S&P Composite Real (Inflation-adjusted) Price - 1929 peak through 1945S&P Composite Real (Inflation-adjusted) Price - 2000 peak to the present

Comparing 1929-1950 period with todays US 10YRbond yields

Comparing the S&P today and the S&P in the 30s



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Key recommendations summary

Recommendations from a European austerity standpointAsset class Impact

- = +Fixed income overall positive Spain USA Portugal

UK France Greece

Ireland Germany Italy

Equities overall negative

Spain UK Portugal

Ireland FranceGermany

Italy

Greece

USA

Currencies overall neutral Expect emerging market currencies to continue torevaluate



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UK and Spain: r isk not pr iced in

Question 5How to invest under an austerityplan scenario

Answer 5Risk-reward is positive for theGreek, Italian and Portuguesebond markets. The executionrisks inherent in austerity plansmake us more cautious on bondmarkets in Ireland, Spain and the

UK. The UK could benefit fromrenewed currency depreciation ifits austerity measures have anoverall negative impact on theeconomy.


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APPENDIX -- DISCLAIMERANALYST CERTIFICATION: Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and

all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this

report: Daniel Fermon

This research report was written by a non-US research analyst who is not an associated person of a FINRA member, who is not registered/qualified as a research analyst under FINRA Rulesand who may not be subject to the FINRA restrictions on communications with a subject company, public appearances and trading securities held in the research analyst (s) account (s).


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38856398 European Austerity SocGen (1)

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