1. Views on Sovereign Risk Nantes, 16 mars 2012
Natacha Valla
March 2012
Goldman Sachs Global Economics, Commodities and Strategy Research 1

2. Sovereign risk is intertwined in an adverse feedback loop4 3 1 2

3. PLAN
I – THE MACRO / BANKING FEEDBACK LOOP AND IMPLICATIONS FOR SOVEREIGN RISH
I I– THE ROLE OF THE CENTRAL BANK
I II– THE 2012 FRENCH ELECTIONS AND SOVEREIGN RISK IN THE EURO AREA
Source: ECB

4. PART I THE MACRO / BANKING FEEDBACK LOOP AND IMPLICATIONS FOR SOV. RISK
Source: ECB

5. Bank loan flows are very modest …
Source: ECB

6. ... and credit conditions are tightening ...
Source: ECB

7. ... with loan rates increasing, especially in peripheral countries
... and credit conditions are tightening, especially for smaller firms ...
... with loan rates increasing, especially in peripheral countries
Source: ECB

8. Government bond yields are diverging …
Source: Datastream

9. ... destabilising sovereign markets ...
Source: GS Global ECS Research

10. … with a spillover into the area-wide banking sector …
Source: GS Global ECS Research, Bloomberg, Haver Analytics

11. … in a context of high funding needs of both banks and sovereigns
Governments
Source: Dealogic

12. PART II THE ROLE OF THE CENTRAL BANK
Source: ECB

13. The ECB has provided extensive financing to banks ...
Source: ECB

14. ECB has also eased in the face of weakness, but less on interest rate dimension …
Source: GS Global ECS Research

15. … and more via balance sheet measures
As of end of January 2012 (using 2011 GDP figures)
Source: GS Global ECS Research

16. Outstanding ECB monetary policy operations have increased
Source: GS Global ECS Research

17. … building banks’ dependence on the ECB …
Source: National Central Banks

18. … and resulting in growing intra-Eurosystem cross-country (im)balances
Source: National Central Banks

19. Debt of programme countries is migrating onto public balance sheets …
Note: Includes second Greek package
Source: IMF, GS Global ECS Research

20. … as banks have sold government debt …
Source: ECB

21. ... in large part to the ECB
Source: ECB

22. In principle there is remaining capacity at the euro area level to address fiscal issues …
Source: GS Global ECS Research

23. ... given the consolidated euro area fiscal position ...
Source: GS Global ECS Research

24. ... but cross-country diversity in the fiscal situation is great ...)
Note: Column for Ireland excludes impact of state support to banking sector (unadjusted figure = -32.4% of GDP
Source: IMF, GS Global ECS Research

25. ... and governance weaknesses make consolidation difficult
Source: Eurostat

26. Case study for sovereign risk: the 2012 French elections takeaways
Long term: no major difference on
Fiscal consolidation: will get there (late)
Europe (on safe grounds)
Short term, a couple of challenges
Headwinds: Cycle + « inertia » in policies will mean fiscal consolidation slower than thought
Europe: Hollande insisting on Treaty renegotiation
Overall
Renewed episode of market discipline likely in H2:2012

27. PART III CASE STUDY: THE 2012 FRENCH ELECTIONS AND SOVEREIGN RISK IN THE EURO AREA
Source: ECB

28. First-round polls suggest four candidates have a chance of winning

29. Second-round polls: in the event of a Sarkozy/Hollande run-off , Hollande more likely to win

30. Similar horizon for a balanced budget

31. Past: both right- and left-wing governments have consolidated budgets…

32. …but counter-cyclical consolidation has been rare in France (1978-2011)...

33. Required gov. primary balance from 2014 as a function of nominal interest rate and nominal growth

34. Short-term: tax policy will be a key ‘divider’

35. France uncompetitive on a number of taxes

36. But proposals on expenditure cuts are scarce

37. Transfers matter for households’ real disposable income - not a campaign theme

38. Macroeconomic outlook: we foresee weak domestic demand (Contributions to quarterly GDP growth)

39. Background slides Total government spending suggests larger public sector in France than in the Euro area, the US or Japan...

40. The same holds for government consumption…

41. …and for the share of government employment

42. Northern 'core' - southern 'periphery' duality in the quality of institutions...

43. ...which is less evident in other key indicators

44. BACKGROUND SLIDES

45. Global growth momentum has turned …
Source: GS Global ECS Research

46. … resulting in some upward revision to our global forecasts
Source: GS Global ECS Research

47. But marked deterioration in Euro area data through the year …
Source: GS Global ECS Research

48. … reflected also in PMI business surveys …
Manufacturing
Services
Euro-zone previous in (): Man PMI:xx (xx), Service:xx (xx), Composite PMI: xx (xx). Man. PMI: Germany xx (xx), France xx (xx), Italy xx (xx), Spain xx (xx).
Source: Markit 1

49. ... has led us to revise real activity down, but with a recent uptick …
Source: GS Global ECS Research

50. … resulting in a growth forecast for 2012 of -0.4%yoy…
Source: GS Global ECS Research

51. … with the Euro area standing half way through a ‘lost decade’ by end-2013
Source: GS Global ECS Research

52. Headline inflation is expected to moderate …
Source: GS Global ECS Research

53. … while money and credit have rebounded, but remain subdued
Source: ECB

54. General government deficit, revenue and expenditure

55. General government debt-to-GDP ratios

56. Unit labour costs remain divergent …
Source: Eurostat

57. Cross-country comparisons of recovery
Source: Eurostat

58. Disclaimer
I, Natacha Valla, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships. 1