CS European Public Finances 2012

10 January 2012 Economics Research
http://www.credit-suisse.com/researchandanalytics
European Economics
Research Analysts Yiagos Alexopoulos +44 20 7888 7536 yiagos.alexopoulos@credit-suisse.com Christel Aranda-Hassel +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com Steven Bryce 44 20 7883 7360 steven.bryce@credit-suisse.com Violante Di Canossa +44 20 7883 4192 violante.dicanossa@credit-suisse.com Neville Hill +44 20 7888 1334 neville.hill@credit-suisse.com Axel Lang +44 20 7883 3738 axel.lang@credit-suisse.com Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com
European public finances in 2012
The authors of this report wish to acknowledge the contribution made by Maxine Koster of Koster Economics Limited.
The euro area faces a tough 2012. Its economy is in recession; financial conditions have deteriorated; and troubled governments and banks have substantial financing needs, especially in the next few months. A conclusive policy response to the crisis remains lacking. But the ECBs latest unconventional measures are supplying liquidity, so a sovereign or bank funding crisis may well be avoided. And the slowdown is, so far, in no way comparable to the one experienced in 2008-9. A stronger global economy and a weaker euro should support activity going forward. And although pro-cyclical fiscal tightening should prove a drag on growth, we dont think it is self-defeating. Quite the opposite: the euro area should see substantial and successful fiscal consolidation this year. In this publication, we look at these issues and analyse the public finances of most European countries.
ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com.
10 January 2012
Contents
Europe in 2012: Not the end of the world? In fiscal austerity we trust (but dont forget other policies) Can austerity be self-defeating? Policy hurdles Greece Portugal Cyprus Ireland Italy Spain Belgium France Austria Finland The Netherlands UK Germany Sweden Denmark Summary macroeconomic data
Summary macroeconomic indicators IMFs debt sustainability analysis European fiscal indicators European monthly bond redemptions
3 8 11 14 16 20 23 26 29 34 38 42 46 49 52 56 60 64 67 70
70 73 74 74
European Economics
10 January 2012
Europe in 2012: Not the end of the world?

Neville Hill +44 20 7888 1334 neville.hill@credit-suisse.com
The euro area faces daunting challenges in 2012. Not the least of them, the enormous financing needs of governments and banks in the early months of this year. That funding challenge takes place against a backdrop of low market confidence, high government bond yields, and an economy dipping into recession. These challenges posed a risk that the euro area would find itself locked in a vicious cycle of tighter monetary and financial conditions, weaker growth and fiscal slippage. Deteriorating financial conditions would worsen the downturn, limiting governments ability to reduce their deficits, in turn precipitating a further loss of confidence in the debt of some sovereigns in the euro area. And the inability of policymakers to provide a clear and compelling solution to the crisis has raised concerns that the euro area is set to slide into this vicious cycle early this year. However, we think expectations for the euro area may have become unduly pessimistic, and believe the risks of an imminent extremely negative outcome a deep recession and acute financial crisis have diminished considerably in the past month. There are a couple of reasons for this: First of all, the evidence from the first of the ECBs three-year LTROs is that much needed liquidity is being injected into the euro area financial system, which should ease, but not alleviate many of the sovereign and banking funding pressures; and Secondly, the slowdown in the euro area has, so far, been less acute than we and other forecasters have anticipated. And the prospects for growth driven by global developments look, in the near term, to be slightly more promising than a few months ago. Thats not to say that the euro area in 2012 will not be beset by periodic crises. It almost certainly will. But there is scope for euro area developments the economy, public finances, and financial conditions to surprise positively in the early months of this year and the worst outcomes to be avoided. There is also scope for European politicians to build on the summit agreement of last year and begin discussions on the possibility of Eurobonds. But European politicians have, so far, not been characterised by their swift and effective action.
The challenge for the euro area is clear enough. The inability of policymakers to promptly and effectively address the distress in sovereign bond markets especially in Italy led to a severe deterioration in financial conditions and liquidity. For sovereigns especially Italy and Spain facing considerable financing needs this year, that illiquidity raises the risk that they will not be able to issue sufficient amounts of debt in coming months to finance their deficit or redeem the substantial amount of debt maturing. As the chart below shows, between them, both Italy and Spain need to raise around 290bn in the coming six months, with their financing needs most acute in February, March and April. Given the illiquidity in their bond markets, as well as the high level of yields, there is a very real risk of acute financial turbulence if those governments find it increasingly hard to fund themselves. In the very near term, another key sovereign issue for early this year will be the implementation of private sector involvement in Greek government debt. It remains to be seen how deep the cuts in the net present value for private sector bondholders will be. In our view, deep and substantial private sector haircuts at this stage would more effectively remove Greece as a source of market volatility and slowly mitigate market concerns about the possibility of a Greek exit from the euro area.
European Economics
10 January 2012
Exhibit 1: Estimated monthly Italian and Spanish government financing needs in 2012
bn per month
70 Spain 60 50 40 30 20 10 0 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Source: Credit Suisse
Italy
The close association between the sovereign and its banking sector has also led to considerable monetary distress. Inasmuch as the sovereigns face substantial funding problems, so do the banks. As Exhibit 2 shows, there is a considerable amount of bank debt maturing this quarter, much of it in the periphery. That funding need has been exacerbated by deposit flight from peripheral economies. As Exhibit 3 shows, in the six months to November 2011, bank deposits fell by 100bn.
Exhibit 2: Euro area banks bond redemptions in 2012

bn
Exhibit 3: Bank deposit growth in the periphery and Germany

Non-financial private sector bank deposits, 6m flow, bn
140 120 100 80 60 40 20 0 Q1

Source: Credit Suisse, Dealogic
Rest of euro area EAP5 200 150 100 50 0 -50 EAP5 -100 Q2 Q3 Q4 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Credit Suisse, Thomson Reuters DataStream
Germany
That financial distress is having palpably negative effects on the euro area economy. Business surveys are at levels consistent with a recession, especially in the periphery, and broad money is contracting. 4
European Economics
10 January 2012
So the euro area ended 2011 with an illiquid, recessionary economy. Not really one to instil much confidence in sovereigns ability to stabilise their debt-to-GDP ratios. A combination of high bond yields and weak growth does little for debt sustainability. So there are plenty of good reasons to have very low expectations for the euro area in early 2012. But, we would caution against being too pessimistic. We had argued that euro area government bond markets required a significant injection of liquidity if extremely negative outcomes were to be avoided. In our view, there remains a strong case for the ECB to embark on large scale asset purchases similar to the quantitative easing programmes undertaken by the Federal Reserve and the Bank of England. However, we think the ECBs recently announced unconventional policies of unlimited three-year refinancing operations have a reasonable chance of success. Certainly, the take-up of the first LTRO close to 500bn has increased liquidity considerably, with a net increase of just over 200bn. That liquidity will be increased substantially further by the reduction in reserve requirements in late January, perhaps by slightly less than 100bn. And the second refinancing operation at the end of February will take place after the change to collateral requirements has been implemented, meaning that an even larger take-up may occur. As such, its possible that these measures could cumulatively add well over 500bn of liquidity into the euro area banking system. That should alleviate the funding pressures for banks and could help alleviate some of the funding pressures for sovereigns. Of course, that money need not find its way to finance governments, but we think its unrealistically pessimistic to think that none of it will. As the chart below shows, the first period of generous liquidity provision by the ECB in 2009 was associated with banks increasing their holdings of government debt. We expect that there will be significant political pressure on financial institutions in Spain and Italy to invest in their governments debt.
Exhibit 4: LTRO operations and banks' net acquisition of government debt

400 300 200 100 0 -100 -200 07
800 700 600 500 LTROs outstanding, bn, rhs 400 300 200 Banks' net acquisition of govt bonds, 12m sum, bn, lhs 100 0 08 09 10 11 12
Indeed, the evidence so far which, given the time of year, we shouldnt really regard as conclusive is that domestic banks have been solid buyers of government debt. So far, that appetite seems stronger for debt of relatively short duration. As the charts below show, rates at the short end of the Spanish and Italian yield curves have fallen considerably in the past month. So if those governments are prepared to skew their issuance towards the shorter end, they should be able to borrow at rates the market could
European Economics
10 January 2012
regard as sustainable. That would reduce the near-term risk of a funding crisis for the Spanish and Italian governments, but would come at the cost of a shortening of the maturity of their debt stock.
Exhibit 5: Italian yield curve

%
Exhibit 6: Spanish yield curve

%
8 7 6 5 4 3 2 1 0 3m 6m 1y 2y 3y
End-Nov 2011
7 6 End-Nov 2011
Jan 2012
5 4 3 2 1 0 Jan 2012
4y
5y
6y
7y
8y
9y
10y
3m
6m
1y
2y
3y
4y
5y
6y
7y
8y
9y
10y
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
On the basis that the ECBs policy is successful in averting a financial accident, theres good cause to think that the euro area economy could surprise some of the more pessimistic expectations to the upside. It seems clear that the euro area as a whole is in mild recession. We expect output to fall by 1% between Q4 2011 and Q1 2012, and that seems consistent with the mild quarterly declines in euro area GDP signalled by the PMI. But, the weakness in euro area cyclical indicators is not as acute as the distress in financial markets would have suggested. There seem to be several factors at work preventing a more severe deterioration: Firstly, the pass-through to the real economy from the considerable stresses in the banking sector seems to be limited. Although there is growing evidence of banks cutting back on lending, the corporate sector appears fairly resilient. In part, that may be a reflection of the relatively high financial balance that sector has run since the start of the crisis. Secondly, the global economy appears to have started 2012 with a pick-up in momentum. Given that the euro area tends to be a follower, rather than a leader, of global growth trends, we think a stronger global economy will mean the euro area recession will be short and shallow rather than long and deep. And that positive stimulus to euro area growth should be further boosted if the euro continues to weaken. On a trade-weighted basis, the euro is 7% below its level of last May. Such a decline should boost GDP growth by close to 1% over a two-year period. Some degree of resilience in growth should mean that the cyclical deterioration in countries public finances shouldnt be as severe either. Offsetting that, of course, is a risk of a sharp upwards spike in the oil price. That could dampen global growth momentum much as it did early last year.
European Economics
10 January 2012
Exhibit 7: Euro area PMI and GDP growth
Exhibit 8: Euro area non-financial corporate sector financial balance

% GDP
1
60 55 50 45 40 35 30 25 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: Credit Suisse, Thomson Reuters DataStream, Markit Economics
1.0 0.5 0.0 Euro area composite PMI, lhs -0.5 -1.0 -1.5 Euro area GDP, q/q, rhs -2.0 -2.5
-1
-2
-3
-4 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Of course, it is worth reiterating that the prospect for the euro area in coming months is not great. The economy is in recession and the financing needs of banks and sovereigns are considerable. But the apparent success of the ECBs policy measures makes us think that the risks to our euro area GDP forecast for 2012 of a contraction of 0.5% are more balanced than they have been.
Exhibit 9: The global PMI ex-euro area

60 55 50 45 40 35 30 1999 Global ex-euro Euro area 60 55
Exhibit 10: Euro area TWI

115 110 105
50
100
45 40 35 30 2001 2003 2005 2007 2009 2011
95 90 85 80 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Source: Credit Suisse, Markit Economics
European Economics
10 January 2012
In fiscal austerity we trust (but dont forget other policies)

Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com
Deficit reduction is due to continue this year, despite the significant economic slowdown. After a local peak at over 6% in 2009, the aggregate euro area deficit ratio has fallen to around 4% in 2011 and we expect it to fall by a further pp in 2012 and again in 2013 leading to a deficit below 3% in 2013 and also a first fall in the debt ratio that year after five consecutive yearly increases. These figures compare favorably with most other developed economies.
Exhibit 11: General government budget balance

% of GDP
Exhibit 12: General government gross debt

% of GDP
2 0 -2 -4 -6 -8 -10 -12 -14 2001 US Euro area UK 2003 2005 2007 2009 2011 2013
120 100 80 60 40 20 0
US UK Euro area
2001
2011
2013
Source: OECD, Credit Suisse, Thomson Reuters DataStream
Source: OECD, Credit Suisse, Thomson Reuters DataStream
The cyclically adjusted deficit should fall by more than 1.5pp in 2012, having fallen by just under 1.5pp in 2011, on our calculations. The structural adjustment for this year is larger than we penciled in only a few months ago. In light of worsening growth projections, most euro area members have chosen to keep their deficit reduction profile unchanged, taking additional fiscal measures instead.
Exhibit 13: Credit Suisses fiscal projections

As % of GDP General government balance 2010 Austria Belgium Finland France Germany Greece Ireland Italy Netherlands Portugal Spain Euro area
Structural balance 2010E -3.5 -3.2 -0.6 -5.8 -3.5 -8.7 -10.0 -3.3 -3.7 -9.2 -7.0 -4.6 2011E -3.1 -3.8 0.7 -4.5 -2.5 -4.3 -7.6 -2.6 -2.8 -6.1 -5.1 -3.4 2012E -2.4 -1.7 1.7 -2.9 -2.2 1.3 -4.6 0.4 -1.4 -1.6 -1.1 -1.6 2013E -2.2 -1.1 2.5 -2.1 -2.2 3.2 -2.7 1.5 -0.4 -0.3 -0.2 -1.0 -3.0 -2.3 -0.5 -4.0 -1.0 -5.0 -7.5 -0.5 -3.0 -3.0 -4.8 -2.4
Change in structural balance (pp) 2010E -0.5 1.5 0.3 0.4 -1.5 8.3 2.5 0.3 -0.1 0.5 3.0 0.5 2011E 0.4 -0.6 1.3 1.3 1.0 4.4 2.4 0.7 0.9 3.1 1.9 1.2 2012E 0.7 2.1 1.0 1.6 0.3 5.6 3.0 3.0 1.3 4.4 4.0 1.7 2013E 0.3 0.6 0.8 0.7 -0.1 1.8 2.0 1.1 1.0 1.3 1.0 0.7
Debt 2011E 72 97 49 85 82 163 108 120 64 102 70 88
2011E -3.6 -4.2 -1.0 -5.7 -1.3 -9.5 -10.0 -3.9 -4.5 -4.7 -8.0 -4.2
2012E -3.6 -3.0 -1.0 -4.9 -1.5 -6.5 -8.6 -1.8 -4.1 -4.5 -5.4 -3.3
2013E
-4.4 -4.1 -2.5 -7.0 -3.3 -10.6 -11.6 -4.6 -5.4 -9.8 -9.2 -5.6
European Economics
10 January 2012
Fiscal packages are not just about deficit cuts. It is worth noting that key measures in recent packages also address long-term debt sustainability concerns through pension reform, for example. As a consequence, budget improvements do not relate just to the deficit reduction requirements of the current year, but also to the debt profile in the longer run. Secondly, the composition or quality of the measures is important in the context of the current recession: many measures in the adjustment programmes try to be as growth friendly as possible, as we detail below. Finally, institutional changes are accompanying fiscal packages, aimed at addressing enforcement related credibility issues of the Stability and Growth Pact. In particular, constitutional balanced budget rules are being presented and implemented in most countries in the euro area. The deadline for implementation has been fixed for the end of this year, and countries, including Germany, Italy and Spain, have already completed the legal process of approval or at least have started it with a first parliamentary vote in the process. According to the ECB, for example, The agreements following the European Council meeting of 8-9 December 2011 are a further important step (...) a key element of the new fiscal compact is the balanced budget rule formulated in structural terms (debt brake) in an intergovernmental treaty at the European level, to be enshrined in national legislation and combined with an automatic correction mechanism in the event of deviations. Other major elements are the endorsement of quasi-automatic sanctions if budget deficits exceed the 3% of GDP reference value and the decision to enshrine in primary law the numerical benchmark for debt reduction for countries with general government debt in excess of 60% of GDP. Although probably not the final word on the matter, and in many aspects just an incremental improvement of the current imperfect fiscal infrastructure, it is important that the ECB is giving a strong backing to these latest modifications also in light of the role that the ECB has to play in the context of the overall policy strategy, as we discuss below.
Key fiscal measures and strategy A simple strategy of unconsidered deficit reduction will not be enough, and could even prove self-defeating. Structural reforms and other measures to foster growth are needed and in most cases are included in the packages already voted by countries of the so-called periphery. Most packages include a move away from labour and corporate income taxation and into consumption (VAT) or property taxes ideally on less mobile capital (e.g., real estate). An interesting element is also the so called fiscal devaluation, which generally combines an increase in VAT with lower social contributions. This is akin to a devaluation in the sense that the VAT increase affects all products, including imported ones, while the cut in social contributions reduces input costs for the domestic producers only, thereby mimicking the effects of currency depreciation. Portugal is still discussing the measure, Italy is implementing aspects of it, and even France has preannounced it will attempt to implement a similar approach in the coming months, via the TVA sociale. While the impact is likely to be limited, a fiscal devaluation can speed up the process of adjustment from an initial situation characterised by real exchange rate overvaluation. In its latest monthly bulletin, the ECB made its contribution to the debate stating that: Reforms that shift taxation from inputs to consumption are likely to be beneficial from a broader economic perspective. Moving away from taxes on labour income or profits and towards consumption or property taxes could boost growth structurally in addition to the (possibly small) effect from higher net exports. Such a reform would reduce the tax bias against saving and promote labour supply. Moreover, the more attractive tax structure might encourage investment, including by fostering foreign direct investment. There is strong empirical evidence that moving towards taxing consumption or property has a positive impact on growth.
European Economics
10 January 2012
Pension reform is also a key element of the fiscal strategy in most countries, with the increase in the retirement age probably the most effective measure on debt dynamics and generally with positive effects on growth. Privatisations can also help bring down public debt (and deficit, to some extent) without a negative impact on aggregate demand, and as such are attempted in most countries. Finally, liberalisation of closed professions, retail trade and other services, as well as labour market reforms, are actively sought in all peripheral countries. Clearly, not all measures are growth neutral or growth enhancing. Several measures are negative for growth: a freeze of pension indexation or public sector wages can only be negative for aggregate demand, even though it improves public finances directly. Also, Greece has cut investment spending by around 40% last year to try to reach its deficit target, with a negative impact expected on potential growth as well. Finally, social unrest often has consequences over and beyond the strict implications of policy decisions on income and spending. More importantly, other aspects of policy, and not just in the periphery, are key for the adjustment to be successful. Core countries should boost aggregate domestic demand, for example, and monetary policy should accompany the fiscal adjustment with loose monetary conditions. We will discuss all these aspects more in detail in the context of the next section, which tries to address a question we have often heard from clients in recent months: will austerity be self-defeating?
Exhibit 14: Euro area monetary condition indicator

Restrictive 3 2 1
Exhibit 15: German and Spanish domestic demand

Difference between domestic demands annual growth rate and EA average
3 2 1 0
Germany
0 -1 Accommodating -2 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
-1 -2 Spain -3 98 99 00 01 02 03 04 05 06 07 08 09 10 11
European Economics
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10 January 2012
Can austerity be self-defeating?

A fiscal retrenchment could be defined as self-defeating if it reduces demand so much that the fiscal outlook of a country deteriorates instead of improving. A deficit-increasing fiscal adjustment? It is difficult to imagine that the deficit of a country would increase as a consequence of a tax rise and/or expenditure cuts. Such an event would be quite extreme. Empirical evidence does not point in that direction. Moreover, if that was the case, it would probably make sense to always expand fiscally, as the financial expansion would fully finance itself. This type of policy fallacy has been attempted in the US and in Europe in the past, with poor results. True, fiscal adjustments generally have a negative impact on activity and as a consequence a negative feedback effect on the deficit but generally not so large as to defeat the purpose of the fiscal adjustment. Fiscal adjustments can also be associated with a neutral or even positive impact on growth, through three channels: (i) if they create positive confidence effects and lead to a fall in private sector savings, in accordance with the so-called Ricardian equivalence; (ii) if the measures that cut the deficit dont have a negative impact on GDP (e.g., a pension reform that delays retirement most likely increases potential output; a wealth tax has empirically very little impact on demand); (iii) if the fiscal retrenchment is accompanied (or facilitates) complementary policies easier monetary conditions, both in terms of interest and FX rates, and looser fiscal policies in countries that do not need to adjust fiscally. In technical terms, for austerity to be self-defeating, the fiscal multiplier which is defined as the change in output due to an exogenous change in the fiscal deficit respective to the relative baselines should be clearly higher than 1 and probably close to 2. Estimates of the fiscal multiplier are numerous and far apart. Some suggest it should be higher than 1, consistent with the classic Keynesian multiplier, for example. At the other extreme, others argue that positive confidence effects, for example, more than compensate for a restrictive policy (i.e., the multiplier should be negative instead). The size of the multiplier also clearly depends on the type of measures implemented a cut in investment expenditures would lead to a higher multiplier than, say, a tax on the extremely wealthy or on real estate. Empirical evidence is mixed on the subject. Although some episodes in the 1990s would tend to support some Ricardian effect on confidence (a very low multiplier), the recent crisis would point to the opposite conclusion. The ECB provided a review of the topic last year (ECB monthly bulletin, June 2010) and concluded that, Looking at a broader range of experiences, it is found that around half of the fiscal consolidations in the EU in the last 30 years have been followed by an improved output growth performance in the short term relative to the initial starting position. [...] Fiscal consolidations have had negative but limited short term implications for real output growth in a number of countries. Clearly, other factors beyond the simple relation between fiscal variables and GDP affect growth during the adjustment including other economic policies. Most econometric models used by central banks and governments suggest that a restrictive fiscal policy has a short-term negative impact on growth. They also suggest, however, that the multiplier is significantly lower than 1 and that the negative effect on GDP is only in the short term. The European Commission QUEST model estimates a multiplier of 0.4 in year one, assuming a permanent across-the-board adjustment in spending and taxes proportional to their respective shares in the government budget. The negative impact on GDP disappears over the following years. The Bank of Italy model assumes an even lower number (0.3) in its modeling of the fiscal multiplier for Italy. Other widely used econometric models have fiscal multipliers of just over 0.5 on average (see Fiscal multipliers, an IMF staff position note on the topic published on 20 May 2009 for a broader list of estimates). Overall, a 0.5 coefficient should be seen as a fair approximation in order to assess the impact of the fiscal retrenchment in the euro area. If thats correct, then a fiscal adjustment would rarely be self defeating in the meaning defined above.
European Economics
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10 January 2012
There is, however, a second interpretation for a self defeating austerity drive, linked to the impact of fiscal retrenchment not so much on the deficit, but on the debt ratio. Thats especially true if the debt ratio is large. Lets take the example of Italy, with a debt ratio at 120% and a deficit at 4% in 2011. Lets assume a cut in the deficit by 2pp of GDP that leads to a fall in GDP of 2pp relative to its natural baseline. Lets also assume that potential growth is 3% nominal (2% inflation, 1% real). In that case, the retrenchment would be self defeating as the debt ratio in 2012 would be slightly higher than the debt ratio, which would have been obtained without fiscal adjustment (Exhibit 16).
Exhibit 16: Stylized impact of austerity on the Italian debt ratio

% of GDP
125% No austerity 120% Austerity 115%
110% 2011
2012
2013
2014
2015
2016
2017
However, two other conditions must hold for austerity to be really self-defeating: 1) The multiplier must be relatively large. In the case of Italy, it must be higher than 0.83 (i.e., the inverse of the debt ratio, 1/120%) and as we discussed above, most studies agree on lower multipliers, of around 0.5. Moreover, given the nature of the measures implemented in most countries in Italy (heavy on pension reform and property taxation), it is likely that the fiscal multiplier is lower and not higher than usual. 2) More importantly, even in the case of a self-defeating multiplier, austerity makes sense for the medium run provided the dent on GDP growth is temporary. While some commentators (see Paul Krugmans self-defeating austerity piece, in the New York Times, 7 July 2011) argue that GDP growth could be permanently affected by austerity, through for example, the increase in long-term unemployment, and the reduction of investment expenditure, most econometric models argue that in most cases the loss of output is a one-off event (affecting the level, as opposed to the growth rate, of GDP) and at best, leads to an increase in potential growth in the medium run (with fiscal retrenchment leading to an efficient re-allocation of resources, pension reforms increasing labour inputs ...).
European Economics
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10 January 2012
Taking the middle view and assuming a permanent loss of GDP (in level terms) but no consequences to the GDP growth rate in the following years, the negative impact on the debt ratio will appear only the first year as, similar to what happens with other forms of deleveraging1, the positive impact on the debt will show up in the following years relative to no retrenchment scenario (Exhibit 16). In a recent article (Can austerity be self-defeating, voxeu.org, 29 November 2011), Daniel Gros illustrated these same points concluding that the permanent deficit cut lowers the growth rate of debt, while the permanent impact on GDP is of the pathlowering type, not the growth-lowering type. Thus any initial increase in debt/GDP will be reversed over time. Implementing credible austerity plans constitutes the lesser evil for peripheral countries with high debt, even if this aggravates the cyclical downturn in the short term. Clearly, this does not end the job for the euro area. Other policies and other countries should complement austerity with coordinated actions. Monetary policy should help provide the right conditions for the fiscal adjustment to be successful. This means low rates for longer, and actions to address the loss of confidence and high level of uncertainty, affecting activity and spreads. European politicians, especially from core countries, should also contribute to the latter. There is indeed little question that the confidence channel of austerity is not working at all at the moment one might even argue that the opposite is happening right now. IMFs chief economist has recently argued for a slower pace of fiscal adjustment, to address the risk of too harsh procyclical policies and their negative feedback on growth also through market rates. We share the concern, but believe that a better way of addressing the confidence issue would be through stronger political commitments to the euro area by all member countries governments. Meanwhile, German fiscal policy should probably turn accommodative, while European institutions should present a concrete and ambitious plan for new transnational infrastructure projects to boost economic growth as well as European integration de facto. A contribution from exchange rate depreciation should also be sought more proactively, while addressing the social consequences of the current economic crisis remains a key challenge, no matter how difficult it is to capture it in economic models. We see progress on some of these fronts, but clearly more is needed. Overall, our maybe simplistic conclusion would be that austerity is required but needs to be complemented by other policies of the sort mentioned above. This is the same conclusion we reached nearly two years ago 2 and we believe it remains very actual.
1 2
See on this Leverage up, leverage down, 12/11/2010. See "How to survive in a monetary union", 29/1/2010.
European Economics
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10 January 2012
Policy hurdles
Three key events will influence confidence in the euro area in the coming months. The first concerns the final shape of the private sector involvement (PSI) in Greece's debt restructuring; the second involves the finalisation of the firewall instruments at the EU/IMF level; the third the broader setting of the fiscal compact, for a closer fiscal union for euro area members. We briefly review the current status and likely innovations expected in the coming months on all these fronts. 1. Private sector involvement (PSI): As we write, negotiations on a revised Greek PSI are ongoing and reports suggest that an agreement on the Greek debt swap will be found within days. The involved parties are anyway expected to come up with a proposal by the end of January, after which private bondholders will have roughly a month to decide whether to participate in the debt exchange. A favourable scenario would be a near universal participation of the private bondholders, through which the Greek sovereign would experience a 100bn reduction in its debt, as well as lower financing needs for the following years. Alternatively, if the PSI proves unsuccessful i.e., high voluntary participation is not secured in the debt swap Greece would have to either proceed with an involuntary debt exchange or face the risk of default as soon as March 20, when 14.5bn of bonds come due without a PSI agreement. As a consequence, the 'hard' deadline for any agreement is effectively March. The details of the PSI will be key in forming more general expectations for the euro area, as well as for specifications of the second support programme for Greece. 2. Firewall construction: European leaders have been trying to create a robust firewall to avoid further contagion since the beginning of the crisis, with several amendments, steps back and steps forward along the way and little clear success so far. The current firewall includes: EFSF: The EFSF was created last year on the back of the Greek crisis and has been used so far to support, in a joint venture with the IMF, Portugal and Ireland. The tools of the EFSF have been expanded over the past months and in October, EU leaders have approved the possibility to leverage EFSF resources in an expanded role, yet to become operational. At the time of writing, the EFSF has a AAA-rating and a firepower of 440bn. Leverage could happen in two ways: partially guaranteeing primary issuance of euro area states, and/or through the creation of a SPV, in which private investors could participate and which would purchase bonds in the primary and secondary markets. The loss of confidence in euro area sovereigns, as well as concerns over correlation risks (the guarantors of the structure are essentially the same euro area countries) are limiting the leverage potential. In addition, increasing risk of a downgrade of AAA-rated countries, would mean that the EFSF would likely lose its AAA credit rating as well or see its firepower further reduced. Nevertheless, the fund started a bill issuance programme in December and it is expected to assume its expanded role by the end of January. Operational support granted by the ECB also suggests that the EFSF remains a pillar of the strategy at this stage. ESM: The ESM is expected to replace the EFSF as a permanent, and more flexible, crisis management and rescue mechanism in the euro area. It will have an effective lending capacity of 500bn, although EU leaders agreed to assess whether this is sufficient in March and could decide to increase it. Its introduction was brought forward one year and it is expected to become operational this year. A positive development for confidence would come if the ESM is operational from mid 2012, if its firing power is increased, if it is made as flexible as possible in terms of its capacity to intervene, and finally if indications of seniority and potential private sector involvement are further diluted or outright abandoned.
European Economics
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10 January 2012
IMF: The IMF is already involved through its co-participation in all rescue programmes. On December 19 2011, euro area countries agreed to contribute with an additional 150bn via their central banks, with other countries also expressing their willingness to participate. These resources represent an additional weapon in the arsenal against the financial crisis, whose effect is still to be appreciated with also the firing power likely to increase well beyond the 150bn already committed, especially if the BRICs decide to contribute as well, as they have suggested in recent months. 3. Fiscal compact: On December 9, most EU leaders (with the notable exclusion of the UK) agreed on a new intergovernmental treaty for tighter fiscal rules. These include a balanced budget rule introduced in national constitutions, more automatic rules for sanctions under the stability pact and stronger policy coordination. The agreement will be finalised in March, and will then have to be ratified by national parliaments. It has been decided that fifteen countries will have to approve it before it comes into force, but, importantly, it doesn't need EU, nor euro area, unanimous participation to go ahead. This reduces the risk that some countries might delay the process. As we have stated in the section above, this additional binding commitment is key as it is consistent with requests coming from the ECB. It is also likely to be crucial for the latter, in order to use more fully its capacity, perhaps the only fully credible and ultimate firewall against financial contagion and instability in Europe.
European Economics
15
10 January 2012
Greece
Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com Yiagos Alexopoulos +44 20 7888 7536 yiagos.alexopoulos@credit-suisse.com
The Greek economy contracted by 6% in 2011 worse than expectations and is forecast to enter a fifth consecutive year of recession in 2012, with its GDP falling by around 4%. The extreme fiscal retrenchment continues to cause a decline in domestic demand and labour market conditions have deteriorated, with unemployment reaching 17.5% in September 2011. Significant wage cuts, higher taxes, cuts in benefits and decreasing asset prices are reducing households purchasing power and willingness to spend. At the same time, banks exposure to Greek government bonds, deposit outflow and an increasing number of non-performing loans have intensified pressures on the banking system, leading to a significant credit tightening. On the positive side, exports continue to grow at a strong pace, with balance of payments data showing a clear rebound in tourism revenues. Nevertheless, given the limited size of export-oriented sectors, their impact is yet insufficient to counterbalance the negative effect from depressed domestic demand. Also, despite some correction of external imbalances since 2008, it would take at least another couple of years to meaningfully reduce the current account deficit and see a first reduction in external debt, we reckon. The increased uncertainty over the sustainability of the Greek debt and over the resolution of the euro area debt crisis has prevented investment flowing in the country. A successful PSI and an improvement in sentiment, coupled with more effective and timely implementation of the needed structural reforms, should hopefully provide a floor to economic activity in the second half of the year (and vice versa, clearly). Greek growth could under such conditions turn marginally positive again in 2013.
Financing needs Defining financing needs for Greece remains a complicated exercise at the moment of writing, since a lot will depend on the negotiations over the PSI and the second EU/IMF programme, both due to be finalised over the next few weeks, according to the latest official declarations. While final details are not yet available, the PSI is said to envisage a 50% haircut of the notional value of all Greek government bonds held by the private sector around 200bn and an exchange of the latter with new bonds of longer maturity. In addition, a second EU/IMF financing programme of up to 130bn is negotiated, with 37bn remaining from the first EU/IMF financing programme. If the negotiations go as planned, Greeces financing needs for the next two to three years would be significantly reduced and fully funded by official loans, with short-term paper issuance covering any shortfall. The Greek PSI The private sector involvement (PSI) foresees a voluntary exchange of the bonds held by the private sector, with new ones of different notional value, coupon and maturity. It was originally introduced at the July 21 EU summit and it envisaged a debt swap of all privately held bonds maturing before 2020, with new 15-30y bonds with guaranteed principal, leading to an NPV loss of 21%. This was soon deemed insufficient and at the 26 October EU summit, a bigger PSI was agreed. It involved a 50% face value haircut on all privately held Greek government bonds and 30bn of cash incentives, with the aim to reach a debtto-GDP ratio of 120% by 2020. The negotiations for the PSI proposal are ongoing, as we write. According to reports and our understanding at the time of writing, the debt exchange proposal would involve a face value of 100% being exchanged for 15% in cash and 35% in new 20-30y bonds carrying a coupon of 4-5% and governed under English law. The aim would be for near universal participation. Greek net financing requirements for 2012 amount to around 14bn prior to PSI and 10-11bn after, on our calculations, with the difference arising from lower interest payments. As of now, there are 34bn of bonds maturing in 2012, with March being a key redemption month, with 14.5bn coming due.
European Economics
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10 January 2012
However, the crucial month for Greece is probably the current one, due to the above mentioned negotiations. When (if...) the PSI and the second package will be in place, Greeces debt profile will improve substantially and its financing needs for the next few years will be significantly reduced. Apart from the first two to three years, that would see a full coverage of the funding needs by official loans, we calculate that a successful PSI would mean that annual funding requirements in Greece would be low, as a percentage of GDP, when compared to most developed countries, for a decade at least.
Exhibit 17: Financing needs for the Greek government in 2012: prior PSI
bn per month
Exhibit 18: Financing needs for the Greek government in 2012: post PSI (CS estimations)
bn per month
20
19
Bill redemptions Bond redemptions Monthly deficit 12 Monthly financing need
20
Bill redemptions Bond redemptions Monthly deficit Monthly financing need 9 6
15
15
10
10
4 3
4 2 1 1 0
4 3
3 1
4 1 1 2 0
0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Exhibit 19: Prospective financing needs of Greek government in coming years: prior PSI
bn
Exhibit 20: Prospective financing needs of Greek government in coming years: post PSI (CS estimations)
bn
70 60 50 40 30 20 10 0 2011 Bills stock
Deficit Bills stock
Existing bonds maturing EU/IMF loans
70 60 50
Deficit Bills stock
Existing bonds maturing EU/IMF loans
EU/IMF loans
40 30 20 10 0
2012 2013 2014 2015
EU/IMF loans
Bills stock 2011 2012 2013 2014 2015
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. The post PSI scenario follows IMF guidelines and assumes universal participation in the PSI, with only official holdings remaining. Source: PDMA, IMF, Credit Suisse
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10 January 2012
Public finances outlook Final figures for the 2011 budget deficit are not yet known, but given central government data up to November, we believe that the twice revised target of 9% might be missed again. Therefore, Greece, despite the fiscal effort this year, is likely to show only a slight improvement compared to 2010. A deeper than expected recession, delays in the implementation of the reforms, poorly designed measures and political and social tensions are among the factors that contributed to this outcome. Nevertheless, despite these shortfalls, the original target for the 2012 deficit remains unchanged and it might be even lower due to the interest savings from the PSI. The exact deficit target will depend on the specifics of the PSI agreement, i.e., the notional of the new bonds, the coupon rate and whether there will be a grace period or not. At the same time, the government expects to achieve a primary surplus for the first time after many years, after an estimated primary deficit of around 2% in 2011. In order for this to happen, the pace of the structural reforms has to be accelerated and additional austerity measures might be needed. So far, the austerity package includes tax increases and special levies, such as VAT increases and extraordinary taxes on income and property, large cuts in public sector wages and in pension entitlements. Additional measures will likely focus on privatisations and on expenditure cuts, including public sector layoffs in addition to reinforced tax evasion actions. The general government debt ratio probably topped 162% of GDP at the end of 2011 according to the IMF and will decrease in 2012, to around 150%, only thanks to the PSI (it is forecast to reach almost 190% of GDP without PSI). It is expected to continue in its downward path thereafter, with the goal of reaching 120% of GDP by 2020. For this to happen, the Greek economy will have to return to growth and it will have to engineer a substantial and sustainable primary surplus in the coming years. At the same time, privatisations and asset sales should also contribute to the reduction of the debt. With little confidence, given developments over the past two years, that reforms can be implemented and targets can indeed be reached, we believe it will take some time before confidence in the country is restored, unless some new positive innovations in Greek or European polices pop up in the coming months.
Exhibit 21: Medium-term fiscal consolidation plan IMF projections (assuming a PSI along the lines of the October 26 2011 agreement)
% of GDP General government balance General government debt
Source: IMF, Credit Suisse
2011 -9.0 162
2012 -4.7 151
2013 -3.9 149
2014 -1.4 141
2015 -1.1 133
Risks Greeces situation remains extremely fragile and risks abound. In terms of economic activity, there are now few signs of strength in the economy, to say the least. If a recovery does not materialise in the next year and delays in structural reform implementation continue, reaching the public finances objectives will again be very difficult. In addition, the outcome of the PSI negotiations represents a key risk for Greece. It is still uncertain, as we write, whether the PSI will be voluntary and if it will have wide participation. An involuntary debt exchange will have unknown implications both for Greece and the rest of the euro area. At the same time, the escalation of the debt crisis to the euro area level, creates risks as to whether Greece will be in a position to secure the needed funding from the European instruments and whether it will be able to go ahead with the privatisations in a recessionary environment.
European Economics
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10 January 2012
Finally, political tensions although contained for the moment are likely, following the forthcoming elections and the possibility that no party will secure an absolute majority. Elections, originally planned for February 19, will most likely be postponed to April, in order to give time to the interim government to finalise the negotiations on the PSI and the second financing programme. The risk that a newly elected government will want to renegotiate the agreement with the EU/IMF and pursue a different policy mix exists, although it has been contained following the written commitment from the major political parties. Nevertheless, the likely scenario that no party secures an absolute majority bears the risk that it might lead the country to prolonged political uncertainty, causing further delays in the reforms.
Rating Greece is rated below investment grade by all three rating agencies. The rating agencies have also indicated that if the PSI goes ahead, Greece might be downgraded to a default rating, albeit briefly.
Exhibit 22: Greeces current ratings

Rating agency S&P Moodys Fitch
Rating CC Ca CCC
Outlook Negative Not specified Not specified
European Economics
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10 January 2012
Portugal
Axel Lang +44 20 7883 3738 axel.lang@credit-suisse.com Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com
The Portuguese economy contracted in 2011, but less severely than expected in its EU/IMF adjustment programme. The outcome yet poor was largely supported by a strong performance of the export sector but the upside surprise mainly occurred during the first half of the year, before the euro area crisis escalated to a new level. There are few reasons to be optimistic for 2012 either. We expect the economy to contract in 2012 by 2.7% after a fall of 1.3% in 2011. The worsening of the outlook mainly stems from a very large fiscal retrenchment planned for this year, compounded by a sharp loss of private agents' confidence. Additionally, exporters could experience more challenging conditions this year and might be unable to match the very good performance of 2011.
It is worth nothing that although external imbalances have started their long overdue correction, the Portuguese current account deficit remains large and requires several more years of deleveraging to put the external debt of the country on a sustainable debt reduction path.
Financing needs Portuguese net financing requirements for 2012 amount to around 8bn and gross borrowing needs excluding T-bills to around 20bn. This year, both should be taken care of by EU/IMF funds and privatisation receipts. Thus, Portugal will not need to tap the government bond market this year; it is also assumed it will continue to roll over Tbills (8.5bn). The key redemption month is June but clearly, the important dates for Portugal will be those of the quarterly reviews of its adjustment programme when the decision on the release of the funds by the official creditors is taken February, May, August and November.
Exhibit 23: Financing needs for the Portuguese government in 2012

bn per month
14 12 10 8 6 4 2 0 -2 Jan Feb Mar Apr May 3 4
12
Bill redemptions Bond redemptions Monthly deficit Monthly financing need
3 2 -1
2 0 0
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: IGCP, IMF, European Commission, Credit Suisse
2011 financing needs were unusually high as the EU/IMF programme notably intended to halve the outstanding amount of T-bills. In the coming years, financing needs will remain elevated and Portugal is expected to come back to the bond market in 2013 with the issuance of 10bn of medium-to long-term bonds. 2012 will be crucial to gauge as to whether Portugal will be able to do that at an affordable rate.
European Economics
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10 January 2012
Exhibit 24: Prospective financing needs for Portugal in coming years

bn
45 40 35 30 25 20 15 10 5 0 Bills stock Bonds issued 2011 2012 2013 EU/IMF funds
Bills stock Existing bonds maturing Deficit
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: IGCP, IMF, Credit Suisse
Repayment of IMF loans will only start in 2015 (0.6bn) while EFSF/EFSM loans will not have to be repaid within the next fifteen years.
Public finances outlook The Portuguese government has continued to show a strong commitment to meet the deficit targets set under the EU/IMF programme. We currently estimate that the final deficit for 2011 could be between 4.5% and 5.0% (lower than the 5.9% official target) after 9.8% in 2010. However, excluding the transfer of commercial banks pension funds to the social security accounts, the deficit would have been higher3. Other additional one-off expenditure and revenue measures taken last year blur the underlying picture and the true deficit actually ended 2011 just above 7% of GDP, according to our calculation. The government passed a budget worth 5.3pp of GDP of fiscal consolidation measures for this year after 3.4pp last year to reach this years target of 4.5%. Still, the latter will be hard to achieve in the context of a shrinking economy. However, if most of the measures deliver the expected results, the fiscal effort beyond 2012 should not impact growth significantly. The main measures for this year are a sharp reduction in civil servants wages and pensions (around 10%) as well as a broadening of the tax base. Structural reforms are advancing at a satisfactory pace according to the latest EU/IMF review of the adjustment programme although the fiscal devaluation strategy first envisioned has been put aside for now and is being replaced by an increase in the regulatory working time, less bank holidays and more flexible working conditions with the aim of lowering overall unit labour costs.
The fiscal slippage mainly stems from elements outside the central government which was broadly on track and are, to a certain extent, non-recurrent items such as the downward revision of concession revenues, the cost of selling the bank BPN or the realisation of PPP and SOE costs by the local government of Madeira.
European Economics
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10 January 2012
Public debt should rise further this year and next, mostly driven by the fall in GDP the country should post a primary surplus this year. The speed of economic expansion in the following years will be key to gauge debt sustainability.
Exhibit 25: Medium-term fiscal consolidation plan government projections

% of GDP
2011 General government balance General government debt

*CS calculation. Source: Credit Suisse, IMF
2012 -4.5 116
2013 -3.0 118
2014 -2.3 116
2015 -1.9 114
-4.7* 107
Risks As with other countries, a deeper than expected recession would put the deficit and debt targets at risk. Additionally, the large number of state-owned enterprises (SOEs) and Public-Private-Partnerships (PPPs) pose a risk of fiscal slippages as they face acute difficulty to roll over their debts from private sources and might have to be reintegrated in the general government perimeter. Also, commercial banks may require more funds than earmarked under the EU/IMF programme (12bn) although the capital shortfall highlighted in the latest stress test only amounts to 7bn. Political risks appear non-existent at the moment since the government has a large majority in parliament (and the main opposition party agreed on the EU/IMF adjustment plan). Additional measures, if required, would be passed without any problem although social discomfort is gradually rising. One concern to keep in mind relates to next year and beyond. If uncertainty were to remain high and markets remained closed for the country, Portugal could face a similar issue that Greece faced last year: the IMF would ask financing needs over the next 12 months to be fully covered before it can disburse its part of the funds. The enhanced flexibility of the EFSF/ESM could help in that regard but ultimately, the issue to involve the private sector in Portugal would potentially arise unless EU officials state vey clearly, again, that Greece is a unique case and more importantly, explain how they would deal with Portugal if the need of continued official financing were to manifest itself in the coming months.
Rating Portugal has been downgraded several times in 2011. S&P is now the only rating agency that gives Portugal a credit rating in the investment grade category. Further downgrades are clearly a possibility and we would expect the credit rating assigned by all three agencies to finish lower than it is now.
Exhibit 26: Portugals current ratings

Rating agency S&P Moody's Fitch
Rating BBBBa2 BB+
Outlook Negative Negative Negative
European Economics
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10 January 2012
Cyprus
Yiagos Alexopoulos +44 20 7888 7536 yiagos.alexopoulos@credit-suisse.com
Cyprus GDP marginally increased by 0.2% in 2011 and is expected to fall by 0.6% in 2012. The large exposure of the countrys banks to Greece, weaker external demand and the destruction of a key power plant, which supplied half of the islands power, have deepened the sense of economic uncertainty and have deteriorated growth prospects. At the same time, the construction sector continues to face a decline in output, following the burst of the real estate bubble. On the positive side, tourism is performing very well, with its revenues increasing close to pre-crisis levels, and potentially profitable gas exploration is proceeding with no benefits, however, expected in the near future. Tighter financial conditions and fiscal consolidation measures taken are expected to have a negative impact on growth this year. The Cypriot economy is likely to return to growth in 2013.
Financing needs Cypruss net financing requirements for 2012 amount to around 0.53bn and gross borrowing needs to around 1.7bn, excluding bills (worth 1.5bn at the end of 2011). As of now, Cyprus is effectively shut out of international sovereign bond markets. However, it has secured a loan of 2.5bn from Russia that will help the country finance most of its needs for 2012. The first tranche of the loan, amounting 0.6bn, was disbursed at the end of December. Any remaining shortfall is expected to be covered by issuance of bills and/or long-term domestic debt, giving time to the country to restore confidence in the markets through the fiscal consolidation efforts and a resolution of the euro area debt crisis. Key redemption months are January and February, with a total of 1.1bn of bonds maturing.
Exhibit 27: Financing needs for the Cypriot government in 2012

mn per month
900 700 500 300 100 -100
820 697 727
Loans Bill redemptions Bond redemptions Monthly deficit Monthly financing need
218
256 98 111 -4 -21 Sep -6 Oct 43
298
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: PDMO, Credit Suisse
European Economics
23
10 January 2012
Exhibit 28: Prospective financing needs of Cypriot government in coming years

bn
Existing loans maturing Bills stock Existing bonds maturing Deficit

Russian loan
Bills stock
1
Bonds issued
0 2011
Source: PDMO, Credit Suisse
2012
2013
2014
Note: We assume the bill stock remains constant at the end of 2011 levels.
Public finances outlook The latest figures point to a 2011 budget deficit of around 6.5%, substantially higher than the original forecast of 4%. This was due to some one-off factors, but also due to delays in the implementation of corrective measures. For 2012, the government announced two sets of measures, primarily focused on the expenditure side and addressing wage dynamics. The measures are mostly of a structural and permanent nature and are estimated to reduce the deficit by approximately 4% of GDP. Therefore, if they are implemented in full, the 2012 budget deficit target of 2.8% is within reach. The general government debt probably ended 2011 at around 66% of GDP below the euro area average. It is expected to stabilise around this level for the next few years before it starts falling.
Exhibit 29: Medium-term fiscal consolidation plan government projections

% of GDP
2011 General government balance General government debt

Source: Ministry of Finance, Credit Suisse
2012 -2.8 67
2013 -2.1 67
2014 -2.0 66
-6.5 66
Risks The Cypriot economy faces significant risks in 2012. Its large banking system with its heavy exposure to Greece Greek government bond holdings and loans to Greek residents total 29bn, or 160% of GDP is a major vulnerability, especially if there is a deterioration in the Greek debt crisis. Having effectively lost access from international bond markets, Cyprus might not be in a position to support its banking system in case it is needed. In addition, the fiscal measures taken might not be enough to reduce the deficit and restore confidence in the economy, which means that in the absence of any other form of financing the country could be forced to ask for support from the EFSF.
European Economics
24
10 January 2012
Rating Cyprus has faced a series of downgrades by all rating agencies in 2011. Its credit rating is borderline investment grade, however, further downgrades in the next few months are likely. The main reason behind these rating downgrades is the countrys exposure to the Greek economy.
Exhibit 30: Cyprus current ratings

Rating BBBBaa3 BBB
European Economics
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10 January 2012
Ireland
Steven Bryce 44 20 7883 7360 steven.bryce@credit-suisse.com Neville Hill +44 20 7888 1334 neville.hill@credit-suisse.com
The outlook for the Irish economy and public finances is still highly uncertain. Irelands economy had a promising start to 2011, with average Q1 and Q2 GDP growth of 1.6%, but was followed by a surprising large contraction of 1.9% in Q3. Nonetheless, it seems probable that Ireland will reach its current IMF deficit/GDP target of 10.6% for 2011; the governments current forecast is 10.1%. The most recent data for the Irish 2011 central government primary deficit suggest that, after adjusting for bank recapitalisation costs, the Irish central government primary deficit is 1.3bn better than the programme target. Following the December budget, Ireland is in a stronger position to reach its 2012 target of 8.6%. But this will be put under serious pressure if our 2012 GDP forecast of 0.3% growth is correct. The Irish public finances have also benefited by the decision in July to reduce interest charges and increase the maturity profile of loans made as part of the EU segment of the Irish bailout. As a result of these decisions, Ireland is expected to save 6.7 bn on the EFSM loans, and around 5.5bn on the EFSF loans over their lifetime. The heads of state of government and European institutions also agreed to continue supporting Ireland until it regained market access. In the governments December budget, the Finance Minister gave several proposals to reduce the deficit. On the revenue side, from the start of 2012, VAT will be increased from 21% to 23%, and the government will introduce a housing charge, which together should increase revenues by 720mn. On the expenditure side, the government has planned for a broad-based series of savings, including cutting the size of the public sector by about 6000 people. Ireland maintained its corporate tax rate at 12.5%. The programme of bank recapitalisation, initiated following stress tests in March, has largely been completed this year, leaving Irish banks with high tier 1 capital levels relative to the rest of Europe. Some weakness remains in the credit union sector, and the planned sale of the insurance arm of one Irish bank, Irish Life and Permanent, fell through in November. This is likely to impose around 1bn worth of recapitalisation costs on the government in early 2012.
Financing needs in 2011 The central government deficit this year is likely to be around 19bn. This includes the 1bn recapitalisation costs mentioned above. In addition, there is a bond redemption worth 5.6bn in March, putting the total year financing needs at 24.4bn. Total financing from the EU/IMF programme and bilateral loans from Sweden, Denmark and the UK were given as 23.2bn in the last IMF review. The gap in financing occurs due to the unforeseen recapitalisation costs, but could be covered by Irish cash reserves, and the lower than expected deficit this year.
European Economics
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10 January 2012
Exhibit 31: Irish government financing needs in 2012

bn
7 6 5 4 3 2 1 0 -1 -2 -3 Jan Feb Mar Apr May Jun Jul 0 1 1 7 4 2 1
Bond redemptions Monthly deficit Monthly financing need 5
2 1
-2 Aug Sep Oct Nov Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Source: Credit Suisse, Irish Department of Finance, NTMA
The chart below shows that financing needs were substantially elevated in 2011 compared to the forecast horizon. About 15bn of this was driven by bank recapitalisation requirements, most of which were funded by an Irish contribution from the national pension fund reserve and Treasury cash reserves. The chart shows that there is a slight funding hump in 2014, driven by substantial bond redemptions, but that this drops away in 2015. However, requirements for bond and loan repayments will be elevated after this point.
Exhibit 32: Prospective financing needs of Irish government in coming years

bn
50 45 40 35 30 25 20 15 10 5 0 2011 2012 2013

EU/IMF loan Irish funds
EU/IMF loan repayment Bills stock Existing bonds maturing Deficit Gvnt retail savings scheme
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. However, it is suggested that the government will potentially reenter the short term market in 2012. Source: Credit Suisse, IMF, Irish Department of Finance, NTMA
European Economics
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10 January 2012
Public finances outlook Forecasts suggest that the Irish government deficit is continuing on a downward path from the exceptional levels in 2010. From a projected general government deficit of 15.6bn in 2011, the deficit is expected to fall again to 13.7bn in 2012. However, the forecast has worsened somewhat over the year, with the 2011 deficit increasing by 0.7% of GDP, and the 2012 deficit increasing by 1.3% of GDP compared with the outlook at the beginning of 2011. The 2012 budget made adjustments worth 3.8bn to ensure that the deficit target in 2012 is met, with the burden lying on expenditure cuts (around 60% of the consolidation) rather than revenue increases.
Exhibit 33: Irish public finances government projections

% GDP General government balance Primary balance Interest expenditure Government gross debt
Source: Credit Suisse, Irish Department of Finance
2011 -10.1 -6.7 3.3 107
2012 -8.6 -4.4 4.2 115
2013 -7.5 -1.9 5.6 119
2014 -5 0.8 5.8 118
2015 -2.9 2.8 5.7 115
Risks There are several major risks to the outlook for Ireland. The most substantial is the prospect for growth. Irish domestic demand is expected to make a negative contribution to GDP growth in 2012, at close to 1%. The government forecast is for this to be offset by a 4% contribution from exports. The EU (excluding Great Britain and Northern Ireland) comprises 42% of Irish exports according to 2010 data. As a result of this, any shock that reduces the desire or ability of other euro area countries to import could have a substantial pass-through effect into the Irish debt-to-GDP ratio. Another key area of concern is the problem of mortgage arrears. Central Bank data for September 2011 showed that 8.1% of private residential mortgage accounts were in arrears for more than 90 days, and this number has been trending upwards since 2009. The risk that this poses to the banking sector is to some extent offset by banks relatively strong position post-recapitalisation. However, the mortgage arrears situation is suggestive of weaknesses in the household sector that may constrain future demand and, of course, any future negative shock could amplify the situation further. The Keane Report on mortgage arrears, published earlier in the year, resolutely opposed any substantial role for debt forgiveness, and instead focused on the role that could be played by bank forbearance.
Rating At present, Ireland is rated BBB+ by S&P, Ba1 by Moodys and BBB+ by Fitch. The outlooks are negative, driven by concerns about the European situation and the feedthrough effect this could have on the Irish public finances.
Exhibit 34: Irelands current ratings

Rating BBB+ Ba1 BBB+
European Economics
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10 January 2012
Italy
Violante Di Canossa +44 20 7883 4192 violante.dicanossa@credit-suisse.com Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com
The Italian economy entered recession in Q3 11 and should experience another couple of negative quarters at least, judging from the latest business surveys and consistent with our own forecasts. We expect real GDP to contract by around 2% from peak to trough. Significant headwinds from tight fiscal policy and a severe confidence crisis brought to a halt the mild recovery seen in 2010 and in the first half of 2011. On the positive side, Italy is now on track to reach a close to balanced budget by 2013 with the measures already voted in Parliament so far. Confidence (and lower rates) might return as a consequence of the implementation of the measures or, more broadly, if and when Europe deals once and for all with its fundamental confidence crisis at the political level, monetary conditions continue being more expansionary and ideally, fiscal policy in Germany becomes looser too. The negative shock to growth due to the large fiscal adjustment this year is partly compensated by the quality of the measures, which include taxation of the wealthiest (with generally a small impact on consumption), a pension reform (positive for growth, if anything) and by a policy mix that is turning more supportive thanks to ECB decisions in recent months and exchange rate developments. Finally, VIX developments over the past few months, for example, suggest that broad uncertainty is receding. If that latter trend is confirmed, growth could resume later this year. Corporate spending and exports would drive the recovery. A key concern is also related to the Italian banking sector. As we write, official statistics are reporting only a mild slowdown in lending growth but banks, which have already tightened credit standards, anticipate significantly further tightening this year. It is yet to be seen if the measures announced by the ECB will suffice to turn things around in the coming months.
Financing needs Excluding bills, the Italian government faces just over 220bn of financing needs this year, just a touch higher than 2011s issuance of 210bn. Bond redemptions account for 194bn and the government deficit for just under 30bn, on our estimates. Financing needs are higher in H1, with significant bond redemptions. As Exhibit 35 shows, in February, the Italian government will need around 60bn and around 50bn in March and April including bills (42bn, 36bn and 35bn, respectively, excluding them). Given tensions in financial markets and the relatively high yield on Italian bonds, a key question is how Italy will go through next months large redemptions (26bn of a ten-year bond at the beginning of the month and 11bn of a two-year bond at the end of the month). The Treasury is planning to introduce retail bonds from this year, as an alternative to alleviate some of the pressure on medium-to-long-term bond issuances. Moreover, the government has some cash buffers available (over 23bn at the end of last year in the cash account at the Bank of Italy, for instance), but if financial markets remain severely impaired, Italy will have to work on some financial repression move pushing domestic banks to fund the government or count on external help. With the IMF already in Rome, officially to certify the implementation of reforms, it seems that things are being prepared for a more significant involvement of that institution, if needed. It is worth noting in this context, the recent decisions by euro area countries to increase IMFs firing power with 150bn via their central banks in December, as well as the creation of a new lending facility. The new IMFs Precautionary and Liquidity Line (PLL), has been designed for countries with sound economic fundamentals in a liquidity crisis and has light conditionality attached to it. As such, we would see any involvement of the IMF to be quite different from the one in Greece, Portugal and Ireland.
European Economics
29
10 January 2012
That said, bills and bond auctions at the end of last year were encouraging. The average yield on bills halved, to 3.2%, compared to similar auctions held in mid November, while the yield on ten-year bond issuance dropped a little bit as well.
Exhibit 35: Italian governments funding requirement in 2012

bn
59 60 50 40 30 20 10 0 -10 Jan Feb Mar Apr May Jun 15 0 30 53 52
Bill redemptions Bond redemptions Monthly deficit Monthly financing needs 31 23 20 25 20 35
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government , monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: Credit Suisse, Tesoro.it
As for now, from 2013 onwards, the governments financing needs should decrease significantly, thanks to stronger public finances and lower redemptions. As Exhibit 36 shows, assuming the amount of bills is kept constant at the 2011 stock, the Italian government will face financing needs of around 160bn next year and around 120bn in 2014.
Exhibit 36: Prospective financing needs of the Italian government

EUR bn
400 350 300 250 200 150 100 50 0 2011 2012

Bonds issued Bills stock
Deficit
Existing bonds maturing
Bills stock
2013
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: Credit Suisse, Tesoro.it
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10 January 2012
Public finance outlook The Italian parliament passed its third austerity package after the two summer measures just before Christmas. The new package is worth around additional net 20bn (1% of GDP), confirming the strong commitment to reach a balanced budget by 2013. Combined, the measures are worth around net 80bn (5% of GDP) over three years. Below, we present a table summarizing these measures.
Exhibit 37: Fiscal measures taken since mid 2011

bn
2011 Total net amounts Extra revenues Income tax Reduction in tax benefits Solidarity contribution Tax evasion Tax on fuel VAT hike Capital gain tax Energy tax and Tax on luxury goods Games and lotteries Tax on real estate (IMU) Other Lower spending Transfers to local administrations Pensions Civil servants Cut to ministries expenditure Health sector Other Higher spending Infrastructure projects Public local transport Other Lower revenues Regional tax (IRAP) Other
Source: Credit Suisse, lavoce.info
2012 48.5 42.2 2.2 4.0 0.4 1.3 7.0 4.2 4.9 2.3 2.0 11.0 3.0 19.6 7.0 3.5 0.4 8.2 0.0 0.3 9.6 1.6 1.2 6.8 3.7 1.6 2.1
2013 76.0 59.0 2.2 16.0 0.6 2.6 6.6 4.2 7.4 1.3 2.0 11.0 5.0 29.0 9.2 7.1 2.1 7.2 2.6 0.3 4.0 2.0 1.2 0.8 8.0 3.6 4.4
2014 81.5 62.7 2.2 20.0 0.8 2.6 6.7 4.2 4.9 1.4 2.0 11.0 6.9 33.4 9.2 10.0 2.1 6.0 5.1 0.3 4.4 2.4 1.2 0.9 10.5 3.0 7.5
2.9 2.8 0.0 0.0 0.0 0.0 0.0 0.7 0.7 0.0 0.4 0.0 0.9 2.4 0.0 0.0 0.0 1.9 0.4 0.1 2.1 0.0 0.4 1.7 0.2 0.0 0.2
The difference between the government and our public finance outlooks mainly lies on our gloomier view on growth. The government is expecting a GDP contraction of around 0.5% vs. our 1.5% forecast for this year. Despite the poorer growth outlook, 2013 should see a close to balanced budget nevertheless. The two summer packages, the save Italy December decree, and some additional savings from the upcoming spending review should be sufficient to at least approach the target next year. Government gross debt, thanks to the fairly solid structural fiscal stance, should be on a descending path from 2013 onwards.
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10 January 2012
Exhibit 38: General government fiscal forecasts Credit Suisse forecasts

As % of GDP
2010 Government balance Gross debt

2011 -3.9 121
2012 -1.8 121
2013 -0.5 119
-4.6 118
Risks As mentioned above, a slippage in the public finance numbers due to even lower than expected growth is a clear risk. This risk would be even more acute in a state of the world where financial markets remained severely impaired. Italian ten-year yields at 7% are not sustainable in the medium-to-long-term. A more aggressive action from European policymakers will be needed if confidence does not return. Contingent liabilities are increasing, although they represent a limited source of risk, in our view. Italian banks have already made good use of the state guarantee scheme announced at the October Euro summit. At the end of last year, news reports suggested that the Italian government already underwrote around 50bn of new banks issuances, with a maturity from three months to five years. That said, the scheme is designed so that only solvent banks should have access, with a fairly low level of risks for the government, in our view. State guarantees and unlimited liquidity by the central banks, with the threeyear LTRO in particular, should allow banks to manage their high re-financing needs as shown in Exhibit 39.
Exhibit 39: Italian commercial banks financing needs

bn; Mediumto-long-term bond redemptions per quarter
20 18 16 14 12 10 8 6 4 2 0 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013
Source: Credit Suisse, Dealogic
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10 January 2012
Rating Italy remains under negative watch by all the three major rating agencies and a Exhibit 40: Italys current ratings Rating Outlook downgrade at the beginning of this year is Rating agency S&P A Negative likely. S&P has put Italy, together with A2 Negative other 14 euro area member states, under Moodys Fitch A+ Negative negative watch in early December and Source: Credit Suisse said that future actions will take into account the December summits conclusions. Moodys also stated that it will review ratings early this year, again on the back of the mentioned summit. No agency has, however, reacted so far the deadline for a decision being late February.
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10 January 2012
Spain
Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com Axel Lang +44 20 7883 3738 axel.lang@credit-suisse.com
Spains weak growth performance last year (we estimate GDP was up around 0.6%) was the result of a dynamic export sector and lacklustre domestic demand, the latter leading to a further increase in unemployment to a record 23% rate. The silver lining is possibly that the economy carried on its adjustment: the size of the construction sector has now shrunk to pre-boom levels as a share of GDP, while Spains current account deficit, which reached 10% of GDP in 2008, appears to have dropped to zero in late 2011 for the first time in 15 years. The growth outlook is, if anything, grimmer this year. The latest business surveys signal renewed weakness, consistent with a shrinking economy in Q4/Q1 and we believe that the economy will contract by 0.8% overall in 2012, posting positive albeit mild growth only in the second half of the year. It is unlikely that the export sector will be as supportive as it was last year, although maybe the latest developments on the currency front provide some support at least in terms of market shares. Furthermore, the current financial stress remains extremely severe and the situation appears unstable, leaving little room for a significant confidence boost, even though the most recent acute phase has been addressed by ECB intervention. As elsewhere in Europe, credit will likely be scarce partly due to demand considerations, but also through stricter lending conditions, as highlighted by banking surveys. Finally, the significant fiscal consolidation effort will continue and even accelerate this year, likely dragging domestic demand down.
Financing needs We estimate that Spains central government has roughly a 40bn net financing requirement in 2012 while 50bn of bonds will mature this year. Excluding T-bills, total gross financing needs should be 90bn this year. Additionally, the Treasury is expected to roll over 75bn of bills. Revenues from privatisations could lower the financing needs to a certain extent although it is unclear whether the sale of the national lottery, for example, (8bn) will go ahead.
Exhibit 41: Prospective financing needs for the Spanish government in 2012
bn per month
40 35 30 25 20 15 10 5 0 -5 -10 Jan Feb Mar Apr May 14 9 16 16 14
Monthly deficit Bill redemptions 25
Bond redemptions Monthly financing need 20
16
14 9 5
17
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: Ministerio de Economia y Hacienda Tesoro Publico, Credit Suisse
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Key bond redemptions this year are concentrated on April, July and October and broadly coincide with the months of largest tax revenue intake. Redemptions of bonds and bills in each of those three months top 20bn vs. redemptions of 10bn or less in the remaining months of the year. Financing requirements for 2012 are slightly lower than last year and should continue to decline marginally over the coming years, as the budget deficit moves towards balance.
Exhibit 42: Prospective financing needs of Spains government in coming years

bn
200 180 160 140 120 100 80 60 40 20 0 2011 2012 2013 2014 Bonds issued Bills stock
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: Ministerio de Economia y Hacienda Tesoro Publico, Credit Suisse
Public finances outlook Final figures for the 2011 budget deficit are not yet known, but the incoming government warned that it would be slightly higher than 8% of GDP compared with a target of 6%. Although the government has not yet detailed the reasons and the nature (structural or one-off) of that large slippage, it appears to be due to the social security accounts and the regional governments to a large extent (the issuance of government bonds, which finance the central government, should not be revised significantly upward as a consequence). Following the announcement, the government immediately unveiled austerity measures worth about 15bn (1.4pp of GDP). Additional fiscal measures will need to be taken later in the year to reach this years 4.4% deficit target the 2012 budget will only be voted in March (due to elections late last year). A large fiscal consolidation retrenchment worth around 40/50bn (4/5pp of GDP) will be required this year to respect the annual target, in our view. Nevertheless, it is worth noting that several tools to enforce budget discipline both at the central and regional levels have been introduced over the last year. A golden rule enshrined into the constitution is the main instrument of course, but a new spending rule to link spending to economic growth should also prove useful. Additionally, the new conservative government will not rely on regional parties support as much as the previous government, also making fiscal enforcement easier (most regions are now headed by the ruling PP party). Finally, regions with high deficits are required to detail and report to the central government for approval of their rebalancing plans. Failure to comply allows the central government not to authorise debt issuance until corrective measures are taken.
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10 January 2012
Spains public debt remains one of the lowest of the euro area and the previous government expected it to peak just below 70% of GDP in 2013. We forecast that debt-toGDP will peak in 2015 at around 80%.
Exhibit 43: Spanish public finances government projections

% of GDP Government balance Gross government debt 2011 -6.0* 68 2012 -4.4 69 2013 -3.0 69 2014 -2.1 69
The incoming government believes the 2011 deficit will be around 8.2% of GDP. Source: Ministerio de Economia y Hacienda, Credit Suisse
Risks As for other countries, the economic performance may come in even weaker than our forecast of minus 0.8%. In this environment, reducing the deficit as planned will prove extremely challenging, and could create a backlash in terms of confidence in case of more target misses. There are no significant political risks on the radar screen, after the government won a very large majority in the parliament. As such, additional measures, if needed, will likely be passed easily by Parliament although social unrest cannot be ruled out, especially in light of the extremely high unemployment rate. For now, social opposition has been contained, however. The restructuring of the Spanish financial sector continues apace. Spanish financial institutions still have large exposures to the real estate sector (16% of GDP): just over 50% of the total exposure of banks to property are problem assets and coverage for these stands at just over 30%. The government seemed to have favoured an increase in the banks provision of doubtful loans over several years thus dropping the idea of setting a bad-banks. Such a move would generate up to a 40-60bn shortfall (4pp to 6pp of GDP) and accelerate the restructuring process. While the biggest banks could well be able to face by themselves this additional requirement, several cajas will struggle and more mergers could occur as a result. The government-backed restructuring fund FROB or the EFSF/ESM could ultimately step in but, in both cases, that will add some pressure to the public debt. Funding risks: as we write, yields on the secondary market are low enough for the sovereign to fund itself without jeopardising the long-term sustainability of its debt, we estimate. However, market conditions remain fragile. Even if market conditions were to deteriorate again, we believe that funding needs could be covered with existing tools and or with new tools been created as we write. A combination of credit lines from the EFSF(ESM)/IMF could be envisioned, if market financing were to dry up. But Spain could also continue to rely on private funding, especially through domestic banks. Indeed, the ECB could as we expect keep a lid on yields by engaging in QE or as a second best option, continue its bond buying programme, leaving yields somewhat elevated but affordable for the country. The EFSF(ESM) could also intervene in the primary and secondary markets. Last but not least, some kind of financial repression in particular supported by the ECBs three-year LTROs should help to put a lid on the funding risk to some extent this year.
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10 January 2012
Rating Spains credit rating was downgraded last year by all rating agencies. Further pressure on the credit rating is expected and it would not come as a surprise if Spains credit rating was downgraded further.
Exhibit 44: Spains current ratings

Rating Agencies S&P Moody's Fitch
Rating AAA1 AA-
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Belgium
Axel Lang +44 20 7883 3738 axel.lang@credit-suisse.com The authors of this report wish to acknowledge the contribution made by Maxine Koster of Koster Economics Limited.
After 541 days without an active government, a coalition of six parties crossing the linguistic and political spectrum formed a new government in December. The agreements on state reform and the 2012 budget were in place before the government was sworn in. The budget is expected to be passed by parliament at the end of this month. It was sent to parliament before the end of last year and so Belgium should avoid, following an additional 1.3bn spending freeze announced over the weekend, any fines from the European Commission. While the political negotiations were ongoing, a bank had to be bailed out and the euro area debt crisis intensified. As a result, the market became more concerned about Belgium and its high debt ratio and ten-year bond spreads with Germany blew out to over 350bp in November. Two rating agencies downgraded the sovereign. We expect a mild recession in 2012 with growth contracting 0.3%, whereas the central bank is assuming mild growth of 0.5%. The recession may have already begun in the third quarter of last year when output fell 0.1% q/q. Private consumption and investment should remain weak in the first half of this year, before the former receives some support from higher nominal wages due to Belgiums indexation system. But unemployment is set to rise over the year. Exports should continue to face headwinds related to the euro area debt crisis but drive the recovery in the second half. Both business and consumer confidence rose in December, suggesting the recession should only be mild. The new government has stated it is committed to a 2.8% budget deficit in 2012, set under the Excessive Deficit Procedure, and a structural balance in 2015. As a result, 12.5bn of fiscal consolidation is planned to take place this year to bring the deficit down from the 4.2% estimated by the central bank for 2011. The debt ratio should have peaked last year at around 98%. It was boosted by support for the financial sector.
Financing needs Belgiums financing need for 2012 is planned to fall to 35bn from 46bn last year, excluding the 35bn of outstanding Treasury Certificates euro area denominated T-bills that will be rolled over. The reduction is driven by a 4bn drop in the central government deficit and an assumption that no direct intervention in the financial sector and other sovereigns will take place. Long- and medium-term debt maturing this year will be 28bn, which is higher than last year. The debt agency again plans to buy back some debt (3.4bn) but slightly less than in 2011. March and September look to be the heaviest financing months for the year. The agency expects to issue 36bn in bonds and other long- and medium-term funding vehicles (26bn in OLOs), which is down on 2011s 49bn (OLOs 41bn). It finally plans to issue a further 6.0bn to retail investors after the successful event last year.
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10 January 2012
Exhibit 45: Belgian government financing needs in 2012

bn per month; shows expiries for current bills but not possible future issues
20.0 15.0 10.0 5.0 0.0 -5.0 Jan Feb Mar Apr 9 9 14
Bill redemptions Bond redemptions Monthly deficit Monthly financing need 7 4 4 2 0 4 1 2 15
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: Belgian Debt Agency, Credit Suisse
Exhibit 46: Prospective financing needs of the Belgian central government

bn
90 80 70 60 50 40 30 20 10 0 2011 2012 2013

2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. For 2012, existing bonds maturing include EUR 3.4bn of debt buyback targeted at bonds maturing in 2013. Existing bonds maturing in 2013 are thus equally reduced by EUR 3.4bn. Source: Belgian Debt Agency, High Council of Finance, Credit Suisse
Public finances outlook In the 2012 budget, the government is assuming that last years deficit was 3.6% of GDP but the central bank now believes it was 4.2%, which is 0.1pp more than 2010. This revision is worth around 2bn and is due to lower tax revenues related to slower growth and measures to support Holding Communal, which being a large shareholder, faced difficulties after the Dexia bailout. Support to financial institutions and sovereigns added 5.2bn to the federal state budget in 2011 (1.4pp of GDP). These expenses are unlikely to recur in 2012. 39
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10 January 2012
The new government is maintaining the previous administrations commitment to the European Commission to achieve a 2.8% deficit in 2012. It had first planned to hike taxes and cut spending by 11.3bn to accomplish this. 42% of the savings were to come from cuts, 34% from tax increases and 24% from other measures, such as efficiency gains and fraud reduction. However, after the European Commission believed that the growth assumptions were too optimistic and that the current savings plan was rather consistent with a deficit of 3.25%, the new government decided to freeze spending by an additional 1.3bn to avoid a 0.7bn fine from the European Commission. The final decision on sanctions should be made this Wednesday and is now expected to be positive. The new prime minister emphasised in the budget agreement that the focus remains achieving a balanced structural budget by 2015. The public debt ratio probably rose around 1.5pp in 2011 to 98%, whereas in September it was expected to fall slightly. The government bailed out troubled-bank Dexia in October, and while this had a minimal impact on the deficit, it added around 1pp to the public debt ratio. The government believes that the additional interest payments on this debt should be offset by associated guarantee premiums and dividends it will receive. The debt ratio is likely to peak at 98% and the government expects it to decline over the forecast horizon towards 90%.
Exhibit 47: Belgian public finances government projections

% of GDP
2011* Government balance Cyclical factors Structural Government gross debt

Source: Belgian Federal Government, Credit Suisse
2012 -2.8 -0.9 -1.9 97
2013 -1.8 -0.6 -1.2 95
2014 -0.8 -0.3 -0.5 92
2015
-3.6 -1.2 -2.4 98
0.0
Note: 2011 government balance estimate is from budget 2012 plan, as government yet to adopt central banks 4.2% estimate
Risks We expect growth to be weaker than assumed by Belgian officials and so the 2.8% deficit could be difficult to achieve despite the latest austerity measures. There have already been strikes over the austerity measures. Therefore, policymakers may not have the resolve for further savings in the face of public opposition. Thus, we could see a higher deficit and debt ratio. Or even worse, the coalition could collapse over disagreement on the mix of further spending cuts and tax rises. Belgium could still face fines from the European Commission if it is not seen to be reacting sufficiently in the context of deteriorating economic conditions. There is a significant risk that Belgium could face higher borrowing costs this year if there is an escalation of the euro area debt crisis, given its relatively high debt ratio. It could also occur if the market loses confidence in the stability of the new government or its ability to reduce the deficit. In this regard, the coalition does not include the Flemish nationalists, who received the largest share of the vote in the last elections and has increased its support. There is the risk that they could destabilise the coalition. The European Banking Authority has estimated that only one Belgian Bank, Dexia, has a capital shortfall (6.3bn or 1.7% of 2011 GDP). There are still uncertainties surrounding the bank and liabilities connected with a unit of the bank. The government has also provided guarantees for Dexia funding, which if realised, pose risks to the public finances. On this front, the European Commission agreed to only half the guarantees proposed by the French and Belgians under the state-aid rules and gave the governments three months to submit proposals for the restructuring or sale of the bank.
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Rating Recently, Moodys downgraded Belgium two notches and S&P one notch and both kept them on negative outlook. Fitch hasnt downgraded Belgium but said that it may. The agencies cited uncertainties regarding the funding, growth and political outlook and the high government debt level as continued causes for concern.
Exhibit 48: Belgiums current ratings

Rating AA Aa3 AA+
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10 January 2012
France
The French economy grew at around 1.5% in 2011, in our view. A decent 0.3% q/q increase in Q3 was likely followed by negative growth in Q4, as highlighted by business surveys and hard data since September. Some less negative indications from surveys, in the last few weeks, suggest that the recession might be shallow, even though the significant fiscal consolidation still ahead suggests that activity is likely to remain particularly subdued in the coming months. We expect a broadly flat outcome for GDP this year, with some rebound in 2013 on the back of looser monetary conditions, an improving global growth framework and, in our central scenario, also some reduction in uncertainty at the euro area level. Conversely, domestic political uncertainties could weigh on activity and on financial markets this year.
Financing needs The French Treasury 2012 net financing requirements amount to around 80bn, with gross financing needs of just over 180bn, excluding Tbills. Existing bills amount to 170bn at the end of 2011 and should remain broadly unchanged in 2012. Overall, this implies total financing needs in the order of 350bn. Key French bond redemption months this year are, as usual, January, April, July, September and October. Funding requirements are expected to decline slightly over the coming years, mainly as a consequence of a decreasing budget deficit embedded in the projections.
Exhibit 49: French government financing needs in 2012

bn per month
65 55 45 35 25 15 5 -5 -15
Bill redemptions 56 53 54 55 Bond redemptions Monthly deficit Monthly financing need 33 25 22 14 1 9 1 29
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: French Treasury, Credit Suisse
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10 January 2012
Exhibit 50: Prospective financing needs of the French central government

bn
400 350 300 250 200 150 100 50 0 2011

Deficit
Bills stock
2012
2013
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: French Treasury, High Council of Finance, Credit Suisse
Public finances outlook The French government announced in November last year a new round of austerity measures on the back of downwardly revised GDP growth forecast for 2012, to 1.0% from 1.75% (still higher than our latest estimate), to comply with the 2012 deficit target, as well as some additional adjustments for the next several years. The latter outline the main measures leading to a balanced budget in 2016. Aside from the new measures announced, it is worth recalling that France has in place a rule of limiting expenditure, by capping most expenditures to zero growth in value terms. This reduces expenditures relative to what would be implied by GDP trends by over 10bn (0.5pp of GDP) per year for the foreseeable future. That is respected, notably, by not replacing one out of two retiring civil servants. New measures are worth 7bn (or about 0.35pp of GDP) and come on top of 10.4bn (or 0.5pp of GDP) worth of savings presented in August. Most of the measures are recurrent. Exhibit 51 shows the latest measures announced and their expected impact for 2012, 2016 the last year of the multi-annual plan and their cumulated impact over the period.
Exhibit 51: Fiscal measures announced on November 7

Annual and cumulated savings, bn
Main measures De-indexation of the income, solidarity and inheritance tax thresholds for 2012 and 2013 A 5% rise in corporate tax for companies with turnover exceeding 250mn for 2012 and 2013 A tax increase on dividends and interests earned to 24% from 19% Additional savings of ministries' operating budget and health insurance A speed-up in the reform of the mandatory retirement age A further closing of tax loopholes A partial de-indexation of social benefits, i.e., 1% increase instead of forecast inflation in 2012 An increase of the reduced VAT rate to 7% from 5.5% for several sectors (catering, transport) Total
Source: Credit Suisse, Ministre du Budget
2012 1.7 1.1 0.6 1.2 0.1 0.0 0.4 1.8 7.0
2016 2012-16 3.4 0.0 0.6 7.2 1.3 2.6 0.5 1.8 17.4 15.3 2.2 3.0 21.1 4.4 7.2 2.5 9.0 64.7
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The measures now in place for the period 2012-16 represent a large part of the fiscal effort required to achieve a balanced budget in 2016. According to our calculations, the programmed fiscal consolidation for the period 2012-16 effort represents around 4pp of GDP (Exhibit 52). If growth was to come in line with the government forecast, an additional 30-40bn (1.5/2pp of GDP) over the period 2013-16 would be required to balance the budget by 2016.
Exhibit 52: Total measures

Annual savings, bn
2011 Measures programmed before August Measures announced since August Planned closure of tax loopholes Total Annual fiscal consolidation (% of GDP)
2012 33.9 17.4 0.0 51.3 1.4
2013 43.4 21.5 3.0 67.9 0.8
2014 52.4 22.7 6.0 81.1 0.6
2015 62.8 24.0 9.0 95.8 0.6
2016 76.5 26.1 12.0 114.6 0.8
20.8 1.2 0.0 22.0 1.1
Exhibit 53: French public finances government projections

As % of GDP
2011 Government balance Gross government debt

2012 -4.5 88
2013 -3.0 88
2014 -2.0 87
2015 -1.0 85
2016 0.0 82
-5.7 85
The direct impact of the fiscal retrenchment on growth in 2012 should be somewhat contained, because the composition of the measures should have a limited impact on low-income households but nonetheless negative. The French government has announced it could freeze 6bn of expenditures in order to deal with a lower growth scenario possibly 0.5/0.6% instead of 1%. Should growth be in line with our forecast next year (-0.2%), around 8bn of additional measures (or another 0.4pp of GDP) would likely be required to meet the 4.5% fiscal target for this year.
Risks As we have highlighted above, risks come mainly from a weaker GDP profile although latest business surveys seem to limit the risk on that front and from uncertainties linked to French elections this year. A key additional risk (opportunity?) is what happens at the euro area level Greek PSI decisions, EU/IMF firewalls and building of the institutional fiscal compact. Finally, Frances AAA rating is under close scrutiny, as we discuss below. Although a cut is largely discounted already, the risk of somewhat higher borrowing costs going forward cannot be excluded. France will hold general elections in April 22 (first round) and May 6 (second round). UMP's centre-right President Sarkozy is running for a second five-year mandate and will be opposed by centre-left Socialist Party's Mr Hollande. Other relevant candidates include Front Nationals Marine Le Pen and centrist Franois Bayrou. Marine Le Pen is unlikely to have any real chances of getting elected, while Mr Bayrou would see his chances increase significantly if he were to reach the second round, in our view. However, the two main candidates are the clear contenders as we write. Mr Hollande's programme will be unveiled progressively over the next several months, while Mr Sarkozy has started to announce some ideas such as the social VAT, a fiscal devaluation (see main section in this publication for more details) that he intends to put
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forward next month. In any case, both parties agree to continue with the country's fiscal consolidation effort electorate's awareness toward deficit reduction is broad based. But as elsewhere in Europe, the policy mix to achieve such targets is different. The two main parties in particular have clashed on the so-called golden rule of fiscal policy. The center-right party pushed for the rule to be enshrined into the constitution before the election and also made commitments at the European level for the implementation of such a rule by the end of 2012 but the Socialist party did not like the version presented by the center-right. Discussion on this topic will clearly be part of the electoral campaign, we believe. Currently, Mr Hollande is leading in the poll by a significant margin. However, we believe the outcome of the election remains uncertain and impossible to call at this time.
Rating All three rating agencies assign France a AAA credit rating. Nevertheless, risks are Exhibit 54: Frances current ratings Rating Outlook elevated, as highlighted by the negative Rating agency S&P AAA Negative outlook assigned by two of the agencies. Aaa Stable We expect the credit rating to be lowered Moody's Fitch AAA Negative notably on the back of the euro area issues and a deeper economic contraction Source: Credit Suisse than currently foreseen. Whether the rating will be lowered by one or two notches remains to be seen, but we would expect at first, a one-notch downgrade
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10 January 2012
Austria
Christel Aranda-Hassel +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com The authors of this report wish to acknowledge the contribution made by Maxine Koster of Koster Economics Limited
Austria saw robust growth in the first half of 2011 driven by investment and net exports. The economy continued to benefit from its strong links with Germany. Domestically, household consumption was only moderately positive as high inflation reduced real incomes. However, we expect a brief recession began last quarter. It should end by H1. As a result, 2012 growth should be a weak 0.3% after posting a 3.1% increase in 2011. The effects of the debt crisis in the periphery appear to have spread to the core through a tightening of financial conditions and a confidence shock. Austria should be supported by the domestic German economy and its own low rates of private debt and unemployment. Austrias debt and deficit ratios remain below the euro area average. The 2011 deficit is likely to be lower than expected in the Stability and Growth Programme (SGP). The government expects it to fall to 3.2% in 2012 before falling below 3% the following year. There is 1.1% of GDP worth of savings measures for 2012 in the 2011 budget but no new measures were included in the 2012 plan. The debt ratio is expected to peak at just over 75% next year.
Financing needs 2011s funding requirement was 22% lower than the previous years. However, the Austrian Federal Financing Agency is projecting a rise in total financing requirements for 2012 to between 27bn and 30bn, with 20-24bn being issued in bonds. This is around a 30% increase on 2011 due to higher redemptions. 2012 bond redemptions should be around 10bn and take place in July. The redemption profile rises over the forecast horizon with 2014 being a particularly heavy year. Austrias issuance is only 2% of the euro areas total. Austria has a very low refinancing risk. The average maturity of the debt portfolio is 8.2 years. Also, the debt rollover ratio (short-term debt stock that needs to be rolled over plus maturing medium- and long-term debt as a percentage of GDP) was 4.9% in 2010 compared with the euro area average of 10% and 8.6% in Germany.
Exhibit 55: Austrian government financing needs in 2012

bn per month
15 13 11 9 7 5 3 1 -1 -3 -5 Jan Feb Mar Apr May Jun 1 -1 6 3 3 1
13
Bill redemptions Bond redemptions Monthly deficit Monthly financing need
1 0 -2
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: Credit Suisse
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Exhibit 56: Prospective financing needs of the Austrian central government

bn
35 30 25 20 15 10 5 0
Deficit
Bills stock
Bills stock
Bonds issued
2011
2012
2013
2014
2015
Note: other includes loans and federal obligations. We assume the bill stock remains constant at the end of 2011 levels. Source: Austrian Federal Financing Agency, OeKB, Credit Suisse
Public finances outlook The general government deficit in 2011 is likely to have improved 1pp to 3.6% of GDP. This is better than projected in the SGP (3.9%) but not as good as in the 2011 budget estimations (3.2%). In 2012, the improvement is expected to continue with the deficit falling to 3.2% as a result of continuing fiscal consolidation. The 2011 budget plan contained 1.1% of GDP of consolidation measures for 2012. There were no additional plans in the 2012 budget but given the new debt break, further measures are likely to be announced. The growth supporting measures are to include increased investment in research, education, science, infrastructure and the environment. Austria should meet the Maastricht criteria in 2013, which is a year later than expected in last years budget. The debt ratio has been revised up for 2011 due to statistical revisions. The ratio is expected to continue rising until it peaks in 2013 at 76%, which is about 15pp below the euro area average. The Austrian government has passed a debt break into law but failed to get the two-thirds majority required for it to become part of the constitution. However, negotiations with opposition parties are continuing and the government hopes that it will pass early in 2012. The bill states that the structural deficit should not exceed 0.35% of GDP from 2017 and from 2020, the debt should be below the Maastricht criterias 60%. To achieve this, structural savings of 2bn per year have been agreed, which would likely include a rise in the retirement age. But while it is not in the constitution, it remains a goal and is non-binding.
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Exhibit 57: Austrian public finances government projections

% of GDP
2011 Government balance Cyclical factors Structural Government gross debt

Source: Bundesministerium fuer Finanzen, Credit Suisse
2012 -3.2 -1.0 -2.2 75
2013 -2.9 -0.8 -2.1 76
2014 -2.4 -0.6 -1.9 75
2015 -2.0 -0.4 -1.6 74
-3.6 -0.9 -2.7 72
Risks There is currently a high degree of uncertainty surrounding forecasts. The governments growth forecasts are around 0.5pp higher than ours and if the crisis spreads to the core or central and eastern Europe (CEE), growth is likely to be even weaker. It has said it will allow the automatic stabilisers to operate freely according to the budget law and so there is a risk it wont meet its deficit targets and the Maastricht criteria in 2013. If this is the case, then theres a good chance of further budgetary measures being announced through the year. The government has said that even with the automatic stabilisers, it will still meet its targets. Austrias 10-year yield spread over Germany widened significantly in November, to around 180bp at the recent height of the euro debt crisis fears. It has since narrowed but has not returned to its usual level. As doubts over a sustainable solution to the debt crisis persist, there is a risk that Austrian spreads will widen again at some point throughout the year, thus adding to the countrys refinancing cost and the deficit. For instance, the government has said that a one-notch ratings downgrade would cost 3bln a year in higher debtinterest payments. The European Banking Authority has estimated that three Austrian banks have a capital shortfall of 3.9bln or 1.3% of 2011 GDP. And the IMF has said that capital quality also needs to improve. The capital-raising plans of all three banks state that they wont need state aid and they will achieve their targets through retained earnings and restructuring. Austrian banks have a high exposure to CEE, with around 60% of total bank claims on this region. Changes by the Hungarian government to the exchange rate at which households paid back foreign currency mortgages and increased taxes have hurt Austrian banks earnings. The sector continues to face growth and political risks from the region, which could hamper recapitalisation efforts. There is a fear that the large exposure of Austrias banks to CEE could result in the government having to provide support to the financial sector again, thus putting pressure on public finances. It is worth noting that Austrian banking exposure to the troubled periphery is only around 7% of total claims.
Rating There has been ample discussion that Austria is at risk of being downgraded. The Exhibit 58: Austria's current ratings Rating Outlook country was put on negative credit watch Rating Agencies S&P AAA Negative by S&P in December with all the other Aaa Stable AAA rated countries due to credit risk Moody's Fitch AAA Stable stemming from the euro area debt crisis. Source: Credit Suisse Moodys confirmed Austrias Aaa rating with a stable outlook in December due to its competitiveness and low interest-to-revenue ratio.
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10 January 2012
Finland
Violante Di Canossa +44 20 7883 4192 violante.dicanossa@credit-suisse.com
Finlands growth will outperform the euro area average this year and next, in our view, thanks to no fiscal headwinds, fairly strong domestic demand and a resilient global economy, supporting net trade. However, risks, as elsewhere, remain on the downside. The Finnish economy is relatively sensitive to external demand conditions. In this respect, a sharper downturn in Finnish main trade partners and the global economy, more in general, would have a significant impact on this economy.
Financing needs Gross financing needs for this year should be just below 15bn, excluding Tbills. The government is expecting net financing needs amounting to 7.3bn for the central government (around 3.7% of GDP). Given the seasonality of the monthly figures and the bonds and bills redemptions, we estimate that January, September and December will be the most demanding months from a financing point of view. Needs would amount to around 10bn per month.
Exhibit 59: Finnish central governments funding requirement in 2012

bn per month
12 10 8 6 4 2 0 -2 -4 -6
10
Bill redemptions Bond redemptions Monthly deficit Monthly refinancing needs 2
10 9
-1 -2 -1 Jan Feb Mar Apr -2 -3 May Jun Jul Aug Sep Oct Nov Dec -2
Financing needs from 2013 onwards are likely to be fairly similar to this years. Assuming the stock of bills remains constant at last years level (7.5bn), financing needs will be around 20bn, or a fifth of the outstanding debt, per year until 2015.
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Exhibit 60: Prospective financing needs of the Finnish government

bn
25 20 15 10 5 0 2011
Deficit Bills stock
Bills stock
Bonds issued
2012
2013
2014
2015
Public finance outlook Finland enjoys a stable fiscal position, as shown in the table below. General government finances, after having significantly deteriorated on the back of the 2008-09 crisis, have recovered. The government is expecting a general government deficit of less than 1% for this year. However, this reflects a significant surplus in the employment pension scheme. In fact, the central government deficit is larger and is unlikely to fall much below 3% during the forecasting period. So much so that, according to the central bank, to put the debt on a sustainable path would require a contraction of the central government deficit relative to GDP by around 2.5%.
Exhibit 61: General government fiscal stance government projections

As % of GDP
2010 Government balance Central gov. balance Gross debt

Source: Ministry of finance, Credit Suisse
2011 -1.1 -3.8 50.4
2012 -1.0 -3.7 53.1
2013 -0.5 -3.5 55.3
2014 -0.5 -2.8 56.5
2015 -0.5 -2.8 57.5
-2.8 -5.5 48.4
Risks The government has based its fiscal policy on a better outlook for growth than what we are expecting. As such, it is likely that we will see some fiscal slippage, albeit from a favourable position. If downside risks were to materialize, the general government deficit may well go back to 3%.
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Rating Finland is one of the few European countries still enjoying a AAA rating by all three major rating agencies. S&P, however, has placed Finlands rating under negative review, concerned about the potential adverse impact of deepening political, financial, and monetary problems in the euro area.
Exhibit 62: Finlands current ratings

Rating AAA Aaa AAA
Outlook Negative Stable Stable
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10 January 2012
The Netherlands
Christel Aranda-Hassel +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com The authors of this report wish to acknowledge the contribution made by Maxine Koster of Koster Economics Limited
We believe that the Netherlands entered a recession in the third quarter of last year but should again see moderate growth around the middle of 2012. Investment and net exports supported economic growth in 2011, as the economy is closely tied to Germany. Government consumption was weak due to consolidation measures taken. Data are only available to Q3 of 2011 but private consumption fell in every quarter, as real wages contracted over one percent and government austerity hit private purses. The level of net exports of goods and services has continued to hold up and while it is likely to weaken in 2012, it should remain stronger than domestic demand. Public cuts are to continue this year and may be even more severe than originally planned to keep the deficit from exceeding the one percentage point deviation from target. Unemployment has begun to rise and a recent survey showed that the top 20 Dutch employers plan to make significant job cuts. The public sector is a large share of this and the ministry of defence is expected to make large cuts. The unemployment rate is projected to reach 6.5% by the end of the year from the current 5.8%. Soft wages, rising joblessness and government austerity are likely to mean that private consumption continues to contract. Financing requirements this year should be similar to last year but more than originally published in the Dutch Treasurys 2012 Outlook, as a result of a sharp upward revision to the deficit forecast. The Treasury hopes to issue less in bills to improve its debt management flexibility. The 2012 general government deficit should improve to 4.1% but this is disappointing compared to earlier projections. The debt ratio is now expected to peak in 2014 at around 69%, which is two years later than expected a year ago. Dutch public finances remain in a better position than for most of the euro area.
Financing needs The Dutch Treasury at the beginning of December projected a 2012 funding need of 100bn, which is about 10bn lower than last year. However, the funding need was published using the governments September forecasts and so the Treasury emphasised that there was a high degree of uncertainty surrounding the estimate. Soon afterwards, the governments independent forecasting body (CPB) published its updated projections. It now expects the economy to contract 0.5% in 2012 compared with 1% growth expected in September. The 2011 central government deficit has been revised up 0.4pp and 2012 over a percentage point from the September projections. This means that already the financing need for this year is about 10bn higher than estimated in the 2012 Outlook and thus little changed from last year. The Dutch Treasury made clear in its Outlook that it wants to lower money market issuance to increase flexibility and to have a buffer for unexpected events. The goal is to reduce the reliance on the money market to around 30bn by 2015. As a result, funding in the bond market should creep up. The additional 2012 funding mentioned above is likely to be sourced from the money market and so we expect around 50bn of shortterm financing rather than the 40bn planned. Bill redemptions are likely to be higher than this amount and the difference should be financed with bonds, in line with the strategy. Total 2012 bond issuance is expected to be around 60bn, up from 53bn last year. January and July should be the heaviest financing months for the year.
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Exhibit 63: Dutch government financing needs in 2012

bn per month
30 25 20 15 10 5 0 -5
Bill redemptions 26 26 Bond redemptions Monthly deficit Monthly financing need 12 8 3 5 5 6 4 5 2 -4 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Note: Monthly deficit estimated using seasonal patterns from government , monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Bond redemptions also include 4.5bn of private loans maturing in October. Source: Ministerie van Financien, Credit Suisse
Exhibit 64: Prospective financing needs of the Dutch central government

bn
100 90 80 70 60 50 40 30 20 10 0 2011 2012 Bonds issued Bills stock
Deficit
Bills stock
2013
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Bond redemptions for 2012 also include 4.5bn of private loans. Source: Ministerie van Financien, Credit Suisse
Public finances outlook The 2011 budget deficit is likely to be around 4.5%, which is a 0.6pp improvement on the previous year. However, it is just under a percentage point worse than expected in the 2011 stability programme due to a 1.5bn tax revenue shortfall related to the euro area debt crisis and higher social security spending. Lower-than-expected interest costs saved the government around 1bn. The 2012 deficit should be significantly worse than originally projected principally due to the expected recession. The CPB now expects the deficit to be 4.1% compared with expectations of 2.9% in September. The current austerity plans for 2012 involve a cut in expenditure of 0.8% of GDP and include a reduction in government employment, the end to a number of subsidies and cuts in health and child care allowances. Consolidation is to continue in 2013.
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The government remains obliged under the Excessive Deficit Procedure to reduce the deficit below the 3% threshold by 2013. To achieve this, a large improvement will need to be made in 2013. It also has its own rules and the forecast 2012 deficit exceeds its signal margin. This margin requires the government to make further consolidation measures in the following year if the current deficit projection is one percentage point worse than projected in the coalition agreement of November 2010. Thus, the government has begun to talk of the need to make further budgetary adjustments on top of the already planned 18bn of savings over the forecast horizon. A decision is to be made in February once forecasts are updated but the mortgage interest relief scheme, unemployment benefits and the retirement age could all be affected. Last years debt ratio is expected to have risen to 65.2% from 62.9% this is worse than forecast in the 2011 Stability Programme. In 2012, it should rise to 68.2%, which is around three percentage points higher than expected in September. The ratio doesnt begin to fall until 2015. Despite this, the Netherlands has the second lowest debt ratio in the euro area.
Exhibit 65: Dutch public finances government projections

% of GDP
2011 Government balance Cyclical factors Structural Government gross debt -4.5 -0.9 -3.6 65.2
2012 -4.1 -1.7 -2.4 68.2
2013 -2.9 -1.1 -1.8 68.8
2014 -2.5 -0.9 -1.6 69.0
2015 -2.0 -0.7 -1.3 68.8
Note: Unlike the 2011 Outlook, the 2012 Outlook does not contain forecasts beyond 2012. So, we have estimated 2013-2015 using the information available. Source: Ministerie van Financien, Stability Programme of the Netherlands, Credit Suisse estimates.
Risks The minority coalition government relies on support from Geert Wilders Freedom Party (PVV) for economic-related legislation and the Labour Party for European-related legislation. However, the PVV has said it will not support further budgetary measures unless 4bn is cut from the development aid budget. The government stated at the end of November that aid would remain at 0.7% of GDP. The PVV has also said that it wont vote for any changes to the mortgage interest relief scheme but other parties may do so. There is a risk that the coalition could fail over the austerity issue and that there are early elections, a change of government and budgetary uncertainty. Given the worse fiscal prognosis for 2012 and high degree of uncertainty due to the debt crisis, there is a strong chance that the government wont be able to reduce the deficit below the required 3% in 2013 and wont be able to keep its obligation to the European Commission. The consolation is that the Dutch would unlikely be the only ones. The Netherlands has a high mortgage debt worth 128% of GDP. This has been a direct consequence of the mortgage interest relief scheme, which allows for interest payments to be fully deducted for 30 years. Thus, people are encouraged to maximise the mortgage they take out (maximum mortgage/property value allowed is 106%) and minimise their repayments. The system has been criticised by both the Dutch central bank and the financial services watchdog, as they see it as a serious risk to financial stability. Over 400k households are believed to be overstretched. House prices are down 8% from their 2008 peak and further falls could test lenders and pose a serious risk to public finances. The government appears likely to announce changes to the scheme this year.
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As a result of the low interest rates and market volatility associated with the financial and euro area debt crises, the Dutch pension system is facing significant strains. Relative to GDP, Dutch pension assets are the largest globally. The central bank published a report that said two-thirds of pension funds dont meet the official 105% coverage ratio. In Q3:11, the ratio had fallen to 94%. Some major funds have already announced, and others are likely to follow, increases in premiums, reductions in payouts or limits to indexation, which will be an additional burden on businesses and consumers. The three largest Dutch banks passed the European Banking Authoritys latest capital test. One bank had a relatively small shortfall of 159mln. The government had to bail out the financial sector in 2008. Much of this assistance has either expired or been repaid but there continues to be a risk that there is a delay to the governments exit strategy and that even further intervention may be required.
Rating The relative good performance of the Dutch fiscal position means that it remains Exhibit 66: Dutch current ratings Rating Outlook AAA rated by all three major agencies. Rating agency AAA Negative S&P put the Netherlands along with all S&P Aaa Stable AAA rated countries in the euro area on Moodys AAA Stable negative credit watch in December. The Fitch agency cited five interrelated factors for Source: Credit Suisse the move (i) tightening credit conditions, (ii) higher risk premiums on a growing number of countries, (iii) continuing disagreements among European policy makers, (iv) high levels of government and household indebtedness and (v) rising risk of recession in 2012.
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10 January 2012
UK
Neville Hill +44 20 7888 1334 neville.hill@credit-suisse.com Steven Bryce 44 20 7883 7360 steven.bryce@credit-suisse.com
UK growth has disappointed significantly in the past year. Aside from volatile factors, output largely stagnated in the first half of 2011 before declining towards the end of the year. It appears that a slowdown driven by higher energy prices and fiscal tightening has been exacerbated by worsening cyclical and financial conditions in the euro area. As such, growth in the first half of 2012 is likely to be insipid at best. But some moderation in the pace of fiscal tightening part structural, part cyclical and an increasingly expansive stance of monetary policy should provide the platform for an improvement in growth later in the year. In particular, an easing of the squeeze on household real incomes should support a modest recovery in consumer spending. We expect GDP growth of 0.7% this year. And the resilience of growth outside the euro area should also prove supportive for UK growth. Unlike many euro area countries, the government has not responded to weaker growth and consequent relative weakness in the public finances by tightening fiscal policy pro-cyclically. That means that although the governments structural fiscal consolidation programme is ongoing, cyclical pressures mean that the pace of deficit reduction will slow considerably in 2012. As such, the gross government debt-to-GDP ratio is now likely to peak in 2014, and at well above 90% of GDP.
Financing needs The governments gross financing need is unlikely to change significantly in 201213. The current financial year (which comes to an end in March) will have seen total gilt sales of 179bn and 63bn of bill stock rolled over. In 2012-13, the financing need is likely slightly greater. The deficit is only likely to fall marginally next year, as the effects of weaker growth offset the governments fiscal consolidation, and bond redemptions are slightly higher. The bill stock is likely to rise marginally, meaning that gross gilt issuance in 2012-13 will be only slightly higher than in 2011-12, at 182bn.
Exhibit 67: Illustrative financing arithmetic for 2012-13 OBR projections

bn Central government net cash requirement Gilt redemptions Financing for the official reserves Planned short-term financing adjustment Gross financing requirement Less assumed net contribution from NS&I Net financing requirement Financed by Treasury bills Changes in ways and means Unplanned rise in DMO cash reserve (-) Gilts Memo: Bill stock (end FY)
Source: DMO, HM Treasury, Credit Suisse
2011-12 135 49 6 -9 182 3 179
2012-13 130 53 6 0 189 2 187
0 0 0 179 63
5 0 0 182 68
The 2012-13 financing needs will be confirmed in the March budget. The chart below shows the prospective financing need over the coming few years. In general, annual gilt redemptions will remain in the 50-60bn range, meaning that the decline in the governments financing need from 2013-14 onwards is largely achieved through reductions in the deficit.
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10 January 2012
Exhibit 68: UK governments funding requirements in 2012

bn per month
50 40 30 20 10 0 -10 Jan Feb 6
50 43
Bill redemptions Bond redemptions Monthly deficit Monthly financing need 34 20 23 11 4
14
14 8
-3 Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Note: Monthly deficit estimated using seasonal patterns from government , monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: DMO, ONS, Credit Suisse
Exhibit 69: Prospective financing needs of UK government in coming years

bn
250 200 150 100 50 0 2011-12

Source: DMO, Credit Suisse
Bill stock Existing bonds maturing Deficit
2012-13
2013-14
2014-15
2015-16
Of course, one significant factor alleviating the governments substantial issuance needs in the near-term is the Bank of Englands gilt purchases under its quantitative easing programme. On the basis that the MPC extends its asset purchase programme further in February, possibly by a further 50bn, then gilt issuance net of Bank of England purchases in the 2011-12 financial year would have been around 80bn. On the basis that the programme ends early in the 2012-13 financial year, will imply a substantial increase in the net supply of gilts absent QE. That may mean the demand-supply dynamics for UK government debt are less stable than the static financing needs chart above would suggest.
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Public finance outlook Last year saw a substantial structural tightening of fiscal policy, largely in the form of higher tax receipts. That fiscal consolidation continues in coming years, but it will increasingly take the form of lower public spending, rather than higher taxes. That should mean a steady decline in both the actual and structural deficit in coming years. In terms of GDP growth, though, it should shift the burden of tightening from household spending to government spending. As we noted above, as the automatic stabilisers have been allowed to take effect during the current slowdown, the decline in the deficit in 2012-13 is smaller than was projected in early 2011. The deficit is expected to start falling rapidly again from 2013-14 onwards, but this stall in the deficits drop means that debt is now expected to peak higher, and later, than before. Indeed, gross government debt is now expected to peak at just below 95% of GDP in 2014-15. That is concerningly close to a debt ratio of 100%. Net debt, however, should peak just short of 80% of GDP.
Exhibit 70: UK public finances Office for Budget Responsibility projections

% GDP Public sector net lending Structural factors Cyclical General government gross debt Public sector net debt
Source: OBR, Credit Suisse
2011-12 -8.4 -6.4 -2.0 84.2 67.5
2012-13 -7.6 -5.5 -2.1 90.1 73.3
2013-14 -6.0 -4.0 -2.0 93.1 76.6
2014-15 -4.5 -2.8 -1.7 93.9 78.0
2015-16 -2.9 -1.7 -1.2 92.6 77.7
Risks The government appears to remain committed to its programme of fiscal consolidation and, for now, the governing coalition looks remarkably stable. Near-term political risk therefore seems low. We would also note that, so far, the institutional framework for the public finances has worked remarkably well. The Office for Budget Responsibilitys latest fiscal projections suggested that the structural deficit was larger than previously estimated and, as a consequence, the government announced further tightening measures to take effect from 2015 onwards. So an independent budgetary watchdog has been shown to be capable of affecting changes in fiscal policy. So the risks to the public finances do not come from implementation. In reality, they are likely to come from growth and financial market pressures. As we have seen, the recent slowdown has led to a significant slippage in the pace of deficit reduction and a consequent significant increase in where government debt will peak. As such, a severe deterioration in financial and economic conditions in the euro area poses the greatest risk to UK growth and, consequently, its public finances. As well as the cyclical influences on taxes and spending, another risk a euro area crisis could pose to the UK public finances would be through the banking sector. The governments latest SME financing scheme could leave it with contingent liabilities in the banking sector of around 20bn, in the form of bank bond guarantees. However, a serious financial crisis could also lead to a further capital need for UK banks, which may in turn lead to that capital being injected by the government. That said, a positive outcome to the euro area crisis may also prove problematic to the UK inasmuch as there has been a significant inflow of foreign funds into the gilt market in the past couple of years, which may reverse if investor appetite returns to the euro area bond market. At the same time, that may mean markets could become a little more
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concerned about the UKs recent poor inflation performance, especially in the context of an extremely stimulative monetary policy stance. In our view, a sell-off in sterling could be problematic for the UK authorities.
Rating The UK is rated AAA with a stable outlook by all three ratings agencies. In 2010, S&P revised the UK outlook to stable from negative.
Exhibit 71: UK current ratings

Rating AAA Aaa AAA
Outlook Stable Stable Stable
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10 January 2012
Germany
Christel Aranda-Hassel +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com
German public finances benefited from stronger economic activity than envisaged by the government in 2011, but the economys fortunes have turned. Economic activity enters this year with a considerable loss of momentum on the back of the sovereign debt crisis and we expect Germany to stagnate after growing by nearly 3% last year. The mounting uncertainty has dampened both business and consumer confidence although the decline has been more moderate in Germany compared to the rest of the euro area. At 0.5 standard deviations above their long-term averages, business and consumer confidence compare favourably to the euro area measures which, excluding Germany, stand at 0.5 and 2 standard deviations below long-term averages, respectively. This, combined with the decline in orders and production data, is likely to see Germany experiencing a technical recession with declines in activity in both the fourth and first quarter but with growth remaining above the euro area average. German exports are around 40% to the rest of the euro area, but if the fallout from the sovereign debt crisis does not worsen further and growth outside the euro area remains more resilient, we expect the interruption to German growth to be temporary. German economic fundamentals remain sound. Competitiveness was restored on the back of structural adjustments ahead of the financial crisis and corporate balance sheets are strong. Also, the economy is not held back by the need to repair private and public balance sheets. With jobs still being created, although at a slower pace than in early 2011, we expect domestic demand to be the main contributor to growth this year.
Financing needs in 2012 Parliament approved the 2012 federal budget and the medium-term plan until 2015, at the end of November. The federal governments net borrowing requirement is expected to decline to 26.1 bn (1% of GDP), more than 5bn below that envisaged in the medium-term plan presented in the spring last year. The new medium-term plan adopted by parliament envisages the net borrowing requirement of the federal government to decline to 25bn in 2013 reaching, 15bn by 2015. The German finance agency has announced that the Federal government financing needs for 2012 amount to 250bn, up around 5% from 2011. In the 2011 issuance preview, the government estimated a financing need of 302bn and actually only issued 239bn. This assumes around 160bn of bond redemptions and a Federal deficit of 26bln. Interest payments are projected to be 35bn and so the Federal government is expected to run a primary surplus this year.
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10 January 2012
Exhibit 72: German government financing needs in 2012

bn per month
50 40 30 20 10 0 -10
44 37 27 17 7 5 26
23
9 4
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government , monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues. Source: Bundesrepublik Deutschland Finanzagentur, Credit Suisse
Exhibit 73: Prospective financing needs of the Federal German government in coming years
bn
250 200 150 100 50 0 2011 2012 2013 Bonds issued Bills stock
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: Bundesrepublik Deutschland Finanzagentur, Credit Suisse
Public finance outlook The general government deficit is estimated to have dropped to 1.3% of GDP in 2011. This is considerably lower than the 2.5% of GDP target pencilled in by the German government in its stability programme in April last year and the 2% predicted by the European Commission in last years spring forecast. The deficit has thus fallen below the Maastricht reference value of 3% two years earlier than required under the excessive deficit proceedings.
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The better outturn came on the back of stronger growth, which boosted tax and social contribution revenues. But the decline was also helped by the government phasing out fiscal stimulus measures adopted after the breakout of the financial crisis. In 2010, the government laid the foundation for a growth-oriented consolidation strategy that puts the budget rule into practice. Germanys budget rule sets a constitutional limit on borrowing for the federal government and the federal states, anchoring the medium-term objective of having a structural general government deficit of 0.5% of GDP. As a result, since 2010 fiscal consolidation has been pursued under the so called future package (Zukunftspaket), which includes on the revenue side: increased unemployment insurance, increased health care contribution, taxes on aviation and nuclear fuel and reduced energy tax exemptions. On the expenditure side, lower long-term unemployment benefits have been combined with cuts in the federal administration and cuts to the employment agency. The approved federal budget for 2012 envisages a nominal expenditure increase of a mere 0.1%. On the income side, the government is optimistic, penciling in an increase of nearly 9%. The pace on the income side is not expected to be maintained. In 2013, a nominal increase of a mere 2% has been penciled in on the back of the tax relief of 6bn (0.2% of GDP) agreed by Chancellor Merkels cabinet at the end of 2011. The tax free allowance will be increased by 4.4% to 8,354 and progression into higher tax brackets will be inflation adjusted in two steps in 2013 and 2014.
Exhibit 74: Federal government net borrowing requirement projections

2011 estimate, 2012-15 government projections
320 300 282.3 280 260 240 220 200 2004 212.1 2005 2006 2007 2008 2009 251.6 259.8 261 270.4 292.3
303.7
305.8
306.2
311.5 309.9
315
14.7 26.1 24.9

286.6
18.7
291.2 300.3
11.5
270.8
44.0 34.1
258.2 259.7
48.4
280.1 257.4
14.3
256.1
27.9 31.2 39.5

228.6 233.1
Expenditure Income
2010
2011
2012
2013
2014
2015
Source: Bundesfinanzministerium, Credit Suisse
With the ESM anticipated to be brought forward into mid-2012, a supplementary budget is likely. Germany will participate with 21.5 bn in the 80 bn capital of the ESM. The intention was to transfer this in five 4.3 bn installments starting from 2013. The first tranche is now likely to be brought forward into this year, but the government has announced that it is not intending to revise the net borrowing requirement, which would mean the increased funding need has to be neutralised through further revenue raising or expenditure cutting measures. There is a risk, however, that the net borrowing requirement will be raised if pressure to deliver the 80 bn in one installment continues to grow.
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As a result of stagnant economic activity, we expect the general government deficit to deteriorate slightly from 1.3% to 1.5% of GDP this year. The government slashed its 2012 GDP growth forecast from 1.8% to 1% but this is well above our forecast. As a result, the downward move seen in gross debt, which fell from over 83% of GDP in 2010 to an estimate of just below 82% in 2011, is likely to be reversed and we expect an increase to 82% this year before starting to decline again in forthcoming years.
Exhibit 75: Germany public finances Government projections

% of GDP
2011 Government balance Government gross debt -1.3 82
2012 -1.5 82
2013 -1.0 80
2014 -0.5 78
2015 -0.5 76
Source: Federal Ministry of Finance, European Commission, Credit Suisse
Risks The main risk stems from the sovereign debt crisis resulting in further dislocations and a deeper recession as a result. Although the government remains committed to continue consolidating the fiscal balances, the improvement is likely to be derailed if the economic weakness persists and deepens. The constitutional debt brake started being phased in from 2011 but the federal structural deficit ceiling of 0.35% of GDP only needs to be reached as of 2016, which provides some margin. Market dislocations and the need for banks to raise capital to comply with the EBA ruling is another risk. The transfer of impaired assets from ailing banks to related bad banks was a key reason for the rise of the debt-to-GDP ratio from 74% in 2009 to just over 83% in 2010. The ongoing financial market turmoil could require new state intervention and thus poses downside risks to Germanys indebtedness. The EBA estimated a capital shortfall of 13bn in six German banks, with one of the larger German banks accounting for nearly half of that amount. As a result, in mid-December the German government approved plans to revive its state-backed bank rescue fund SoFFin, which had been wound down at the end of 2010. In similar fashion to the first one, SoFFin II is envisaged to be able to disburse up to 80bn (3.3% of GDP) in capital and an additional 400bn in credit guarantees. For the first time, the plan also includes a provision to accept portfolios of euro area government bonds, thus potentially raising SoFFins exposure to sovereign debt risk.
Rating The December EU summit failed to impress rating agencies. They warned that the European sovereign debt crisis remained at a critical stage. Moodys and Fitch stated that the gradualist approach to forging a fiscal union was imposing additional economic and financial costs. Following S&P, which put all AAA rated core euro countries on negative credit watch in December, Moodys stated that it would review country ratings in the first quarter of this year.
Exhibit 76: Germanys current ratings

Rating AAA Aaa AAA
Outlook Negative Stable Stable
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Sweden
The Swedish economy is likely to be impacted by the slowdown we expect to see elsewhere in Europe and, in particular, by the recession in the euro area. Even if it may skirt a recession itself, Sweden is likely to experience a significant slowdown in growth. Such weakness should be concentrated around the turn of the year and we do not exclude a negative quarter, particularly following the surprisingly strong Q3 GDP reading. Transmission mechanisms between Sweden and its weaker neighbors are multiple. Trade is likely to suffer. Contagion is also happening through confidence, leading businesses and consumers to postpone spending decisions on the backdrop of a highly uncertain environment. And the banking sector, despite being well-capitalised, enjoying good access to market funding, having low sovereign risk and limited direct exposure to peripheral Europe, has not been left unscathed. Wholesale funding costs have increased in Sweden too and accessibility has become more limited. We expect, however, a relatively strong rebound from H2, thanks to a resilient global economy and some support from the monetary and fiscal policy fronts. In this respect, we expect the Riksbank to cut rates further in the next few months. On the fiscal front, the government has ample room to maneuver. Some has already been done in the 2012 budget. The government announced extra measures to support the economy for SEK 15bn this year and SEK 17.3bn in 2013 (around 1% of GDP cumulatively).
Financing needs Given the solid fiscal position, Swedens financing needs, being from redemptions or government net borrowing, are generally contained. October is the most challenging month with a ten-year bond, worth SEK 64bn, and a foreign currency bond maturing. Other than that, the rest of the redemptions are from treasury bills and amounting to around 0.5% of GDP per month. We expect the central government to record a balanced budget this year.
Exhibit 77: Swedish central governments funding requirement in 2012

SEK bn per month
80 70 60 50 40 30 20 10 0 -10 -20 -30 Jan Feb Mar Apr -21 May -4 34 35 14
-1
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Note: Monthly deficit estimated using seasonal patterns from government , monthly cash balances in previous years. Moreover, the chart shows expiries for current bill stock, not possible future issues Source: Credit Suisse
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For the full year, we estimate SEK 183bn of refinancing needs in 2012, with SEK 123bn worth of maturing bonds and the rest from maturing bills (we assume the bill stock to remain constant as of the end of December 2011). Our annual figure embeds a balanced government budget this year and surpluses from 2013 onwards, in line with the forecasts presented by the government. As such, our forecasts of the governments financing needs are higher than that presented by the Swedish debt office, the Riksgalden. The latter has pencilled in a small government budget surplus for this year, too. Overall, Swedish financing needs will fall sharply from 2013, thanks to fewer bonds maturing and the government budget in surplus.
Exhibit 78: Prospective financing needs of the Swedish government

SEK bn
200 150 100 50 0 -50 -100 -150 2011

Bills stock Bond issued Bills stock Existing bonds Deficit
2012
2013
2014
2015
Public finance outlook The table below shows the governments fiscal forecasts, as presented in the 2012 budget. Given the extremely favourable starting point, gross government debt, currently at 37% of GDP should be on a downward trend and should fall below 30% by 2015.
Exhibit 79: General government fiscal forecasts government projections

As % of GDP
2010 Government balance Government gross debt -0.2 40
2011 0.1 37
2012 0.0 36
2013 0.7 34
2014 2.1 30
2015 3.3 26
Source: Swedish finance ministry, Credit Suisse
Risks Risks are on the downside and mainly stem from any sharper deterioration in the economic prospects of the euro area the key trade partner of Sweden. Any slippage in growth would lead to a slippage in the fiscal numbers. However, given the favourable starting point, we think this should not be an issue and, if anything, the government is likely to further actively use fiscal policy to support the economy.
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The banking sector is also exposed to risks. For now, Swedish banks have good access to market funding, but as they are dependent on market funding in foreign currencies, they are sensitive to disruptions in the financial markets. So much so, that the central bank is suggesting that Swedish banks should be subject to a binding minimum requirement for the Basel III Tier 1 capital ratio of at least 10% from 2013, and of at least 12% from 2015.
Rating Sweden is one of the few European countries still enjoying a stable AAA rating by all three major rating agencies. We see little risk for this to change considering the fiscal position of the country, even in the context of a more severe economic downturn.
Exhibit 80: Swedens current ratings

Rating AAA Aaa AAA
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Denmark
Denmark is likely to continue seeing sluggish growth this year, particularly in the first half, following relatively mild growth in 2011. GDP should continue to contract at the turn of the year, weighing on this years average growth: We expect growth to slow to 0.3% this year from just below 1% last year. The slowdown in Germany and Sweden, Denmarks main trade partners, is dampening exports, while domestic demand is likely to remain subdued. Private consumption, affected by stagnant labour market prospects and a high debt burden, will barely contribute to growth this year. And we expect corporates to start the new year on a cautions footing. Volatility, uncertainty and tightening credit conditions should push businesses to postpone further spending decisions. Fiscal policy should come to the rescue, at least partially. The government estimated that the fiscal stimulus should be around 0.4pp in 2012. The kick-start package brings forward public investments by around DKK 10bn (0.6% of GDP) this year and slightly less in 2013. A planned reimbursement of early retirement pension contributions this year should also somewhat support private consumption.
Financing needs With the backdrop of high demand for Danish government securities and low funding costs, the Danish government issued in excess of its financing needs last year for around DKK 100bn. Despite this, the government is planning to keep bill issuance at a similar level than last year, at around DKK 44bn and to issue more than the DKK 30bn in bonds needed to cover this years needs. This years bond redemptions account for around DKK 90bn, two-thirds of which are domestic bonds and the rest international bonds. The central government net borrowing requirement should amount to DKK 80bn (4.6% of GDP). Accounting for the deficits seasonality, March, July and November appear to be the two most challenging months in terms of financing needs, as shown in Exhibit 81.
Exhibit 81: Danish central governments funding requirement in 2012

DKK bn
80 60 40 20 0 -20 -40 -60 -80 Jan 13 -8
70
69 34 35 15 -7
33
24
Bill redemptions Bond redemptions Monthly deficit Monthly financing needs Feb Mar Apr May Jun Jul Aug -36
-24
Sep
Oct
Nov
Dec
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Exhibit 82: Prospective financing needs of Denmarks government in coming years

DKK bn
250 200 150 100 50 0 2011

Bonds issued
Deficit
Bills stock
Bills stock
2012
2013
2014
2015
Note: We assume the bill stock remains constant at the end of 2011 levels. Source: Credit Suisse
Financial prospects The government is loosening fiscal policy this year, bringing forward some expenditures to support the economy. Higher spending and one-off measures (estimated to be worth around 1.0% of GDP) imply that the general government deficit is expected to rise to 5.5% of GDP from 4.0% of GDP last year. The government, however, expects to bring the deficit down below 3% in 2013, in absence of the oneoff measures and thanks to lower social transfers. Government debt remains low relative to other European economies. It should have reached its peak last year at 46% of GDP.
Exhibit 83: General government fiscal forecasts government projections

As % of GDP
2010 Net lending Gross debt

Source: Denmarks Finance Ministry, Credit Suisse
2011 -4.0 47
2012 -5.5 42
2013 -2.6 N.A.
-2.7 43
Risks As for the other Nordic countries, risks to growth stem mainly from the euro area debt crisis and, consequently, the depth of the recession for Danish main trade partners. Domestically, nevertheless, there are some source of potential troubles. First, a tight control to avoid recurrent spending overruns at local and regional government levels is important to achieve budgetary targets, given that public spending has continuously been above budgetary targets in the past. Second, households are highly indebted. This may create potential risks for the economy and financial stability, although it is mitigated by the high level of wealth of the household sector itself.
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So far, Denmark has been relatively spared by the markets and government yields have remained low, actually among the lowest of the sovereigns we have discussed n this note. However, the banking sector has been impacted by the loss of confidence and financial market disruption. The Danish central bank announced the possibility for banks to raise three-year loans to offset the funding crisis, following the decision of the ECB. That said, the banking sector, dominated by a few large banks, is fairly solid and well capitalized. The stress test conducted in December showed that all the four participating banks have high level of core capital and that they are not exposed to peripheral sovereigns to any large extent.
Rating Denmark remains one of the few European countries enjoying a AAA rating by all three major rating agencies with a stable outlook.
Exhibit 84: Denmarks current ratings

Rating AAA Aaa AAA
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Summary macroeconomic data

GDP Credit Suisse projections Real GDP, y/y%
2001 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro area Norway Sweden United Kingdom 0.9 0.7 4.0 6.3 2.3 1.8 1.6 4.2 4.8 1.8 2.5 -1.6 2.0 2.0 3.5 3.3 3.7 2.0 1.8 1.4 3.2 2002 1.6 1.4 2.1 6.6 1.8 0.9 0.0 3.4 5.9 0.4 4.1 2.6 0.1 0.8 4.6 3.7 2.7 0.9 1.8 2.5 2.7 2003 0.9 0.8 1.9 7.8 2.0 0.9 -0.4 5.9 4.2 0.0 1.5 -0.3 0.3 -0.9 4.8 2.8 3.1 0.7 1.3 2.5 3.5 2004 2.4 3.1 4.2 6.3 4.1 2.3 0.7 4.4 4.5 1.6 4.4 1.0 2.0 1.6 5.1 3.8 3.3 2.0 4.1 3.7 3.0 2005 2.6 1.9 3.9 8.9 2.9 1.9 0.8 2.3 5.3 1.1 5.4 4.0 2.2 0.8 6.7 4.5 3.6 1.7 3.8 3.2 2.1 2006 3.6 2.7 4.1 10.1 4.4 2.7 3.9 5.2 5.3 2.3 5.0 3.3 3.5 1.4 8.3 6.2 4.1 3.3 4.6 4.6 2.6 2007 3.7 2.8 5.1 7.5 5.3 2.2 3.4 4.3 5.2 1.6 6.6 3.7 3.9 2.4 10.5 7.0 3.5 2.9 6.8 3.4 3.5 2008 1.2 0.9 3.6 -3.7 1.0 -0.2 0.8 1.0 -3.0 -1.2 0.8 5.6 1.8 0.0 5.9 3.2 0.9 0.2 1.4 -0.8 -1.1 2009 -3.7 -2.7 -1.9 -14.3 -8.2 -2.6 -5.1 -2.3 -7.0 -5.1 -5.3 -3.0 -3.5 -2.9 -4.9 -8.1 -3.7 -4.2 -1.6 -5.1 -4.4 2010 2.4 2.3 1.1 2.3 3.6 1.4 3.6 -4.4 -0.4 1.4 2.7 2.7 1.6 1.4 4.2 1.3 -0.1 1.8 1.8 5.3 2.1 2011E 3.1 1.9 0.2 8.0 2.8 1.5 2.9 -6.0 2.0 0.3 1.8 1.7 1.4 -1.3 2.8 1.1 0.6 1.5 2.6 4.5 0.9 2012E 0.3 -0.3 -0.6 2.5 0.4 -0.2 0.0 -4.0 0.3 -1.6 0.5 0.5 -0.3 -2.7 0.5 0.0 -0.8 -0.5 1.8 1.5 0.7 2013E 2.3 1.8 1.0 3.3 1.8 1.8 2.3 1.0 1.8 0.8 2.3 1.5 1.8 1.0 2.5 1.5 1.3 1.7 2.8 2.5 2.3
Inflation Credit Suisse projections

HICP/CPI, y/y%, annual average 2001 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro area Norway Sweden United Kingdom 2.3 2.4 2.0 5.6 2.7 1.8 1.9 3.6 4.0 2.3 2.4 2.5 5.1 4.4 7.2 8.6 2.8 2.4 3.0 2.4 1.2 2002 1.7 1.6 2.8 3.6 2.0 1.9 1.4 3.9 4.7 2.6 2.1 2.6 3.9 3.7 3.5 7.5 3.6 2.3 1.3 2.2 1.3 2003 1.3 1.5 4.0 1.4 1.3 2.2 1.0 3.4 4.0 2.8 2.5 1.9 2.2 3.3 8.4 5.7 3.1 2.1 2.5 1.9 1.4 2004 1.9 1.9 1.9 3.0 0.1 2.3 1.8 3.0 2.3 2.3 3.2 2.7 1.4 2.5 7.5 3.7 3.1 2.1 0.5 0.4 1.3 2005 2.1 2.5 2.0 4.1 0.8 1.9 1.9 3.5 2.2 2.2 3.8 2.5 1.5 2.1 2.8 2.5 3.4 2.2 1.5 0.5 2.1 2006 1.7 2.3 2.2 4.4 1.3 1.9 1.8 3.3 2.7 2.2 3.0 2.6 1.7 3.0 4.3 2.5 3.6 2.2 2.3 1.4 2.3 2007 2.2 1.8 2.2 6.7 1.6 1.6 2.3 3.0 2.9 2.0 2.7 0.7 1.6 2.4 1.9 3.8 2.8 2.1 0.7 2.2 2.3 2008 3.2 4.5 4.4 10.6 3.9 3.2 2.7 4.2 3.1 3.5 4.1 4.7 2.2 2.7 3.9 5.5 4.1 3.3 3.8 3.5 3.6 2009 0.4 0.0 0.2 0.2 1.6 0.1 0.2 1.3 -1.7 0.8 0.0 1.8 1.0 -0.9 0.9 0.9 -0.2 0.3 2.2 -0.3 2.2 2010 1.7 2.3 2.6 2.7 1.7 1.7 1.2 4.7 -1.6 1.6 2.8 2.0 0.9 1.4 0.7 2.1 2.0 1.6 2.4 1.3 3.3 2011 3.5 3.6 3.5 5.3 3.3 2.3 2.5 3.1 1.2 2.8 3.7 2.7 2.6 3.6 4.1 2.0 3.1 2.7 1.3 3.0 4.5 2012E 2.7 2.5 3.3 3.8 3.1 2.0 2.2 1.3 1.2 2.5 2.6 2.7 2.4 3.5 2.2 1.8 1.6 2.2 1.0 1.7 3.0 2013E 3.0 3.0 3.4 3.9 2.9 2.5 2.5 1.9 2.3 3.0 3.5 3.4 2.4 2.6 3.2 2.3 2.4 2.7 1.9 2.0 2.5
Source: Thomson Reuters DataStream, European Commission, Credit Suisse
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Current account balance European Commission projections

As % of GDP 2001 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro area Norway Sweden United Kingdom -0.8 3.4 -3.3 -5.2 8.4 1.8 0.0 -7.2 -0.6 0.3 8.8 -3.8 2.6 -10.3 -8.3 0.2 -3.9 -0.4 16.1 5.0 -2.1 2002 2.7 4.6 -3.8 -10.6 8.5 1.2 2.0 -6.5 -1.0 -0.4 10.5 2.4 2.6 -8.2 -7.9 1.1 -3.3 0.6 12.6 4.7 -1.7 2003 1.7 4.1 -2.3 -11.3 4.8 0.7 1.9 -6.5 0.0 -0.8 8.1 -3.0 5.5 -6.4 -5.9 -0.8 -3.5 0.3 12.3 7.0 -1.6 2004 2.2 3.5 -5.0 -11.3 6.2 0.5 4.7 -5.8 -0.6 -0.3 11.9 -5.9 7.6 -8.3 -7.8 -2.7 -5.2 0.8 12.6 6.6 -2.1 2005 2.2 2.6 -5.9 -10.0 3.4 -0.5 5.1 -7.6 -3.5 -0.9 11.5 -8.7 7.4 -10.3 -8.5 -1.7 -7.4 0.1 16.1 6.8 -2.6 2006 2.8 2.0 -7.0 -15.3 4.2 -0.6 6.3 -11.2 -3.5 -1.5 10.4 -9.8 9.3 -10.7 -7.8 -2.5 -9.0 -0.1 16.4 8.4 -3.2 2007 3.5 1.6 -11.8 -15.9 4.3 -1.0 7.4 -14.4 -5.3 -1.3 10.1 -6.3 6.7 -10.1 -5.3 -4.7 -10.0 0.1 12.5 9.2 -2.5 2008 4.9 -1.8 -16.9 -9.7 2.5 -1.7 6.3 -14.7 -5.7 -2.9 5.1 -5.1 4.3 -12.6 -6.6 -6.9 -9.6 -1.6 16.0 8.8 -1.4 2009 2.7 0.0 -7.8 3.7 1.9 -1.5 5.6 -11.0 -2.9 -2.0 6.5 -7.3 4.2 -10.9 -2.6 -1.3 -5.2 -0.3 10.8 7.1 -1.5 2010 3.0 1.5 -7.8 3.6 1.8 -1.7 5.7 -10.0 0.5 -3.5 7.7 -3.7 6.6 -10.0 -2.5 -0.8 -4.6 -0.5 13.6 7.0 -3.3 2011E 2.7 2.4 -7.3 3.1 -0.1 -3.2 5.1 -9.9 0.7 -3.6 5.3 -3.1 5.5 -7.6 -0.7 0.1 -3.4 -0.1 12.2 6.4 -2.5 2012E 2.8 2.1 -6.7 1.5 0.0 -3.3 4.4 -7.9 1.5 -3.0 3.4 -2.9 7.0 -5.0 -1.2 0.3 -3.0 0.0 12.1 6.3 -0.9 2013E 2.9 2.4 -6.1 0.7 0.1 -3.0 4.2 -6.9 1.8 -2.3 2.9 -2.6 6.9 -3.8 -1.9 0.5 -3.0 0.2 -6.4 -0.2
General government balance Credit Suisse projections

As % of GDP 2001 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro area Norway Sweden United Kingdom 0.0 0.4 -2.2 -0.1 5.1 -1.5 -3.1 -4.5 0.9 -3.1 6.1 -6.4 -0.2 -4.3 -6.5 -4.0 -0.5 -1.9 13.5 1.5 0.5 2002 -0.7 -0.1 -4.4 0.3 4.1 -3.1 -3.8 -4.8 -0.4 -3.1 2.1 -5.8 -2.1 -2.9 -8.2 -2.4 -0.2 -2.6 9.3 -1.3 -2.1 2003 -1.5 -0.1 -6.6 1.7 2.6 -4.1 -4.2 -5.6 0.4 -3.6 0.5 -9.2 -3.1 -3.0 -2.8 -2.7 -0.3 -3.1 7.3 -1.0 -3.4 2004 -4.4 -0.3 -4.1 1.6 2.5 -3.6 -3.8 -7.5 1.4 -3.5 -1.1 -4.7 -1.7 -3.4 -2.4 -2.3 -0.1 -2.9 11.1 0.6 -3.5 2005 -1.7 -2.7 -2.4 1.6 2.8 -2.9 -3.3 -5.2 1.7 -4.4 0.0 -2.9 -0.3 -5.9 -2.8 -1.5 1.3 -2.5 15.1 2.2 -3.4 2006 -1.5 0.1 -1.2 2.5 4.1 -2.3 -1.6 -5.7 2.9 -3.4 1.4 -2.8 0.5 -4.1 -3.2 -1.4 2.4 -1.4 18.5 2.3 -2.7 2007 -0.9 -0.3 3.5 2.4 5.3 -2.7 0.2 -6.5 0.1 -1.6 3.7 -2.4 0.2 -3.1 -1.8 0.0 1.9 -0.7 17.5 3.6 -2.7 2008 -0.9 -1.3 0.9 -2.9 4.3 -3.3 -0.1 -9.8 -7.3 -2.7 3.0 -4.6 0.5 -3.6 -2.1 -1.9 -4.5 -2.1 19.1 2.2 -5.0 2009 -4.1 -5.8 -6.1 -2.0 -2.5 -7.5 -3.2 -15.8 -14.2 -5.4 -0.9 -3.7 -5.6 -10.1 -8.0 -6.1 -11.2 -6.4 10.5 -0.7 -11.5 2010 -4.4 -4.1 -5.3 0.2 -2.5 -7.0 -3.3 -10.6 -31.3 -4.6 -1.1 -3.6 -5.4 -9.8 -7.7 -5.8 -9.2 -5.6 10.6 0.2 -10.3 2011E -3.6 -4.2 -6.5 1.3 -1.0 -5.7 -1.3 -9.5 -10.0 -3.9 0.5* -3.0* -4.3 -4.7 -5.7* -4.1* -8.0 -4.2 -0.9* -8.4 2012E -3.6 -3.3 -4.1* -1.7 -1.0 -4.9 -1.5 -6.5 -8.6 -1.8 0* -3.5* -3.8 -4.5 -4.4* -3.8* -5.4 -3.3 -0.7* -7.6 2013E -3.0 -3.0 -4.2* -1.1 -0.5 -4.0 -1.0 -5.0 -7.5 -0.5 -0.2* -3.8* -3.0 -3.0 -4.6* -4.7* -4.8 -2.5 -0.9* -6.0
* European Commission estimates. Source: Thomson Reuters DataStream, European Commission, Credit Suisse
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General gross government debt European Commission projections

As % of GDP 2001 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro area Norway Sweden United Kingdom 67 107 61 5 43 57 59 104 35 108 6 61 51 51 49 27 56 68 29 55 38 2002 66 103 65 6 42 59 61 102 32 105 6 59 51 54 43 28 53 68 36 53 38 2003 65 98 70 6 45 63 64 97 31 104 6 68 52 56 42 27 49 69 44 52 39 2004 65 94 71 5 44 65 66 99 29 103 6 72 52 58 42 27 46 70 46 50 41 2005 64 92 69 5 42 66 69 100 27 105 6 70 52 63 34 27 43 70 45 50 43 2006 62 88 65 4 40 64 68 106 25 106 7 64 47 64 31 26 40 69 55 45 43 2007 60 84 59 4 35 64 65 107 25 103 7 62 45 68 30 23 36 66 52 40 44 2008 64 89 49 5 34 68 67 113 44 106 14 62 59 72 28 22 40 70 49 39 55 2009 70 96 59 7 43 79 74 129 65 116 15 68 61 83 36 35 54 80 43 43 70 2010 72 96 62 7 48 82 83 145 93 118 19 69 63 93 41 39 61 86 44 40 80 2011E 72 97 65 6 49 85 82 163 108 121 20 70 64 102 45 46 70 86 -36 84 2012E 73 99 68 6 52 89 81 198 118 121 20 71 65 111 48 50 74 88 -35 85 2013E 74 100 71 6 54 92 80 199 121 119 20 72 66 112 51 55 78 89 -32 85
Source: Thomson Reuters DataStream, European Commission, Credit Suisse
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IMFs debt sustainability analysis

% of GDP
2010 Cyclically adjusted Gross Debt Austria Belgium Denmark Finland France Germany Greece Ireland Italy Japan Netherlands Portugal Spain Sweden Switzerland United Kingdom United States Average G-20 advanced 72.2 96.7 43.7 48.4 82.4 84.0 142.8 94.9 119 220 63.7 92.9 60.1 39.7 54.5 75.5 94.4 98.1 104.4 Primary Balance 2.5 0.9 2.4 3.2 4.9 1.2 4.9 28.9 0.3 8.1 3.9 6.3 7.8 1.1 1 7.7 8.4 5.7 6.2 primary balance 1.6 0.3 1.1 0.7 3.1 0.4 5.7 6.4 1.2 6.6 3.1 5.3 6.3 0.6 0.9 5.8 5.4 3.8 4.1
Illustrative Fiscal Adjustment Strategy to Achieve Debt Target in 2030 Required adjustment Cyclically adjusted 1.8 3.1 1 0.4 3.1 2 9.8 5.6 4.3 7 1.3 4.3 2 0.2 0.2 3.4 5.4 4 4.3 Required adjustment 3.4 2.8 2 1.1 6.3 2.3 15.5 12 3.1 13.6 4.4 9.6 8.3 0.5 0.7 9.1 10.8 7.8 8.4 and age-related spending 2010-30 7.7 8.4 4 6.8 7.9 4.6 19 13.5 4.1 14.3 9.7 13.8 10.4 0.1 13.3 17 11.7 12.5 primary balance in 2030 between 2010 and 2020
Note: Averages are weighted by GDP at PPP. The table reports gross debt; cyclically adjusted primary balance (CAPB) is reported in percent of nominal GDP (in contrast to the conventional definition in percent of potential GDP). General government data are used where available. In the illustrative fiscal adjustment strategy, the CAPB is assumed to improve in line with Fiscal Monitor projections in 201112 and gradually from 2013 until 2020; thereafter, it is maintained constant until 2030. The fifth column shows the CAPB adjustment needed between 2010 and 2020 to bring down the debt ratio to 60 percent in 2030 (shaded entries, higher debt) or to stabilize debt at the end-2012 level by 2030 if the country debt-to-GDP ratio is less than 60 percent. The analysis is illustrative and makes some simplifying assumptions: in particular, up to 2015, an interest rategrowth differential of 0 percentage points is assumed, broadly in line with WEO assumptions, and 1 percentage point afterward, regardless of country-specific circumstances. The last column adds the projected increase in health care and pension spending between 2010 and 2030, which will require offsetting measures. Illustrative scenarios for Japan are based on its net debt ratio, with a net debt target of 80 percent of GDP assumed, which corresponds to a target of 200 percent of GDP for gross debt. For the United States, the CAPB excludes financial sector support recorded above the line. For countries not reporting CAPB or output gap, a Hodrick-Prescott filter is used to estimate potential output, and the CAPB is estimated assuming growth elasticities of 1 and 0 for revenues and expenditures, respectively. Source: IMF, Credit Suisse
In its latest Fiscal monitor, published late last year, the IMF provided updates of its long-term fiscal scenarios. In the euro area as a whole, the overall fiscal adjustment needed is smaller than in other large economic areas, such as the US, the UK and Japan, but clearly with some countries within the euro area having to do special efforts as we are witnessing; The necessary additional fiscal effort needed if the aim is to get to a debt/GDP ratio of 60% of GDP by 2030 is also quite revealing. The adjustment required in the 201120 period is particularly large for Greece, Japan, Ireland, the US, the UK, Portugal and Spain (see the footnote to the table for more details on the figures). Italy's required adjustment is relatively small. Moreover, it is worth noting that several additional measures have been taken since the IMF published its numbers, most of them going into reducing some of the gaps highlighted above.
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10 January 2012
European fiscal indicators

Government Nominal GDP (bn, 2012) debt (bn, 2012) Government debt (% of GDP, 2012) Average Gov. financial Residual Life (Years) assets as % GDP (2010) Ownership of government debt (%, 2010) Domestic banks Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain Euro Area Norway Sweden UK 308.1 377.1 18.3 16.9 196.6 2013.5 2603.0 210.6 157.7 1592.5 42.7 6.6 617.7 169.1 71.2 36.2 1078.1 9522.3 354.9 393.2 1799.8 227.3 378.7 12.7 1.0 102.7 1808.1 2131.5 420.6 186.6 1948.5 8.7 4.7 403.9 187.0 34.0 18.3 807.7 8682.1 137.3 144.0 1587.5 73.8 100.4 69.4 5.9 52.2 89.8 81.9 199.7 118.4 122.4 20.3 72.0 65.4 110.6 47.8 50.6 74.9 91.2 38.7 36.6 88.2 8.2 6.7 6.0 11.5 5.0 7.0 5.6 6.9 6.2 7.2 5.4 7.0 7.0 6.0 5.5 6.1 6.2 -2.5 5.8 13.9 34.9 20.0 23.1 47.3 121.2 37.4 36.8 33.1 43.3 27.6 67.7 30.5 36.9 34.3 24.1 40.3 25.9 34.7 ---12.4 24.9 36.5 57.0 12.5 -32.7 27.1 -30.6 47.5 45.7 18.5 23.2 62.4 28.7 31.8 28.2 ---Other domestic Non-domestic 11.2 18.8 13.8 5.3 16.4 -19.3 3.4 -24.7 22.4 48.7 13.2 13.5 0.6 13.6 26.7 19.7 ---76.4 56.3 49.7 37.9 71.1 -49.0 69.6 -44.6 30.1 5.6 68.3 63.3 37.0 57.7 41.5 52.1 ---428.5 463.1 50.1 25.2 279.4 3071.0 2768.4 282.1 532.5 1951.9 81.2 13.0 1306.4 387.1 45.6 45.4 2248.8 15077.0 714.3 873.2 3594.8 165.7 232.7 289.2 176.1 177.7 159.8 128.1 124.1 341.3 126.4 253.9 212 223.4 248.5 69 128.8 227.3 : 220.8 236.9 212.2 Private debt (bn, 2010) Private debt (% of GDP, 2010)
Note: Domestic banks includes national central banks. Source: Credit Suisse, ECB
European monthly bond redemptions

Greece Portugal bn Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Total 0.0 0.0 14.4 0.1 8.5 0.6 0.1 7.7 0.1 0.0 0.0 2.0 33.5 bn 0.0 0.0 0.0 0.0 0.0 10.2 1.0 0.0 0.0 0.0 0.0 1.3 12.5 Cyprus mn 543 556 0 0 0 45 0 0 0 0 0 0 1144.5 Ireland bn 0.0 0.0 5.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.6 Italy bn 0.0 36.4 27.1 27.8 0.0 0.0 17.1 11.5 11.5 18.4 13.5 30.5 193.7 Spain Belgium bn 0.0 1.3 0.8 12.5 0.0 0.0 12.9 0.0 2.0 20.3 0.0 0.0 49.8 bn 0.4 0.5 4.5 1.7 0.4 0.6 0.4 1.70 10.05 0.5 0.1 6.7 27.7 France bn 14.8 0.0 0.0 17.8 0.0 0.0 29.4 0.0 12.4 18.8 0.0 5.5 98.7 Austria bn 0.9 0.5 0.9 0.2 0.3 0.0 10.2 0.0 0.0 0.0 1.2 0.0 14.1 Finland bn 0.0 0.3 0.0 0.0 0.0 0.0 0.0 0.0 6.0 0.0 0.0 0.0 6.3 Nether. bn 14.4 0.0 0.0 0.0 0.0 0.0 15.3 0.0 0.0 4.5 0.0 0.0 34.2 UK Germany Sweden Denmark bn 0.3 0.0 20.0 0.0 0.0 23.0 0.0 0.2 0.0 0.0 0.0 0.0 43.5 bn 25.0 0.0 19.0 16.0 0.0 19.0 27.0 0.0 21.0 16.0 0.0 17.0 160.0 kr bn 0.0 0.0 16.8 28.2 0.0 0.0 11.0 0.0 0.0 70.5 3.4 0.0 129.9 kr bn 0.0 0.0 16.1 0.0 18.7 0.0 0.0 0.0 0.0 0.0 58.2 0.0 93.0
European Economics
74
European Economics
European Economics team: Coverage of regions, institutions, themes and countries

HEAD OF EUROPEAN ECONOMICS
REGION Euro area
neville.hill@credit-suisse.com
Neville Hill
COUNTRY Austria
christel.aranda-hassel@credit-suisse.com
THEME Cyclical outlook

Greece
giovanni.zanni@credit-suisse.com
Portugal
axel.lang@credit-suisse.com
+44 20 7888 1334 Northern euro area

+44 20 7888 1334

violante.dicanossa@credit-suisse.com
+44 20 7888 1383 Belgium

+33 1 70 39 0132
yiagos.alexopoulos@credit-suisse.com
+44 20 7883 3738

+44 20 7883 4192 Inflation

+44 20 7883 7536 Ireland

steven.bryce@credit-suisse.com
+33 1 70 39 0132 Spain

+44 20 7888 1383 Southern euro area

+44 20 7883 3738 Cyprus

yiagos.alexopoulos@credit-suisse.com
+44 20 7883 4192

+44 20 7883 7360

+33 1 70 39 0132
+33 1 70 39 0132 Scandinavia

+44 20 7888 1334 Fiscal policy

+44 20 7883 7536 Denmark

+44 20 7888 1334 Italy

+44 20 7888 1383 Sweden

+44 20 7883 4192 INSTITUTION European Central Bank

+33 1 70 39 0132 Monetary policy

+44 20 7883 4192 Finland

+44 20 7883 4192

+44 20 7883 4192 Switzerland

+33 1 70 39 0132 Netherlands

+44 20 7888 1383

+44 20 7883 4192 France

+44 20 7883 4192 UK

+44 20 7888 1383 European Commission/EFSF/ESM

+44 20 7888 1334 "The periphery"

+44 20 7888 1383 Norway

+33 1 70 39 0132
gergely.hudecz@credit-suisse.com
+44 20 7888 1334

steven.bryce@credit-suisse.com
+33 1 70 39 0132 Bank of England

+44 20 7883 3738

+44 20 7883 9589 Germany

+44 20 7883 4192
+44 20 7883 7360
+33 1 70 39 0132
10 January 2012
+44 20 7888 1334
+44 20 7888 1383
75
FIXED INCOME RESEARCH > ECONOMICS RESEARCH > DEVELOPED COUNTRIES

Dr. Neal Soss, Managing Director Chief Economist and Global Head of Economics +1 212 325 3335 Eric Miller, Managing Director Global Head of Fixed Income and Economic Research +1 212 538 6480
EURO AREA AND UK ECONOMICS

Neville Hill, Director Head of European Economics +44 20 7888 1334 neville.hill@credit-suisse.com Violante di Canossa, Vice President +44 20 7883 4192 violante.dicanossa@credit-suisse.com Yiagos Alexopoulos, Analyst +44 20 7883 7536 yiagos.alexopoulos@credit-suisse.com Christel Aranda-Hassel, Director +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com Axel Lang, Analyst +44 20 7883 3738 axel.lang@credit-suisse.com Giovanni Zanni, Director European Economics Paris +33 1 70 39 0132 giovanni.zanni@credit-suisse.com Steven Bryce, Analyst +44 20 7883 7360 steven.bryce@credit-suisse.com
US ECONOMICS
Dr. Neal Soss, Managing Director Head of US Economics +1 212 325 3335 neal.soss@credit-suisse.com Dana Saporta, Director +1 212 538 3163 dana.saporta@credit-suisse.com Isaac Lebwohl, Associate +1 212 538 1906 isaac.lebwohl@credit-suisse.com Jonathan Basile, Director +1 212 538 1436 jonathan.basile@credit-suisse.com Jill Brown, Vice President +1 212 325 1578 jill.brown@credit-suisse.com Peggy Riordan, Assistant Vice President +1 212 325 7525 peggy.riordan@credit-suisse.com Jay Feldman, Director +1 212 325 7634 jay.feldman@credit-suisse.com Henry Mo, Director +1 212 538 0327 henry.mo@credit-suisse.com
ASIA
JAPAN ECONOMICS Hiromichi Shirakawa, Managing Director +81 3 4550 7117 hiromichi.shrirakawa@credit-suisse.com NON-JAPAN ECONOMICS Dong Tao, Managing Director Head of Non-Japan Asia Economics +852 2101 7469 dong.tao@credit-suisse.com Takashi Shiono, Associate +81 3 4550 7189 takashi.shiono@credit-suisse.com
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10 January 2012 Economics Research

European public finances in 2012

Europe in 2012: Not the end of the world?

Exhibit 2: Euro area banks bond redemptions in 2012

Exhibit 3: Bank deposit growth in the periphery and Germany

140 120 100 80 60 40 20 0 Q1

Exhibit 4: LTRO operations and banks' net acquisition of government debt

Exhibit 5: Italian yield curve

Exhibit 6: Spanish yield curve

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service

Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service

Exhibit 7: Euro area PMI and GDP growth

Exhibit 8: Euro area non-financial corporate sector financial balance

Exhibit 9: The global PMI ex-euro area

Exhibit 10: Euro area TWI

Source: Credit Suisse, Markit Economics

In fiscal austerity we trust (but dont forget other policies)

Exhibit 11: General government budget balance

Exhibit 12: General government gross debt

Source: OECD, Credit Suisse, Thomson Reuters DataStream

Source: OECD, Credit Suisse, Thomson Reuters DataStream

Exhibit 13: Credit Suisses fiscal projections

Debt 2011E 72 97 49 85 82 163 108 120 64 102 70 88

Exhibit 14: Euro area monetary condition indicator

Exhibit 15: German and Spanish domestic demand

Can austerity be self-defeating?

Exhibit 16: Stylized impact of austerity on the Italian debt ratio

125% No austerity 120% Austerity 115%

Bill redemptions Bond redemptions Monthly deficit 12 Monthly financing need

Bill redemptions Bond redemptions Monthly deficit Monthly financing need 9 6

70 60 50 40 30 20 10 0 2011 Bills stock

Deficit Bills stock

Existing bonds maturing EU/IMF loans

Deficit Bills stock

Existing bonds maturing EU/IMF loans

Bills stock 2011 2012 2013 2014 2015

2011 -9.0 162

2012 -4.7 151

2013 -3.9 149

2014 -1.4 141

2015 -1.1 133

Exhibit 22: Greeces current ratings

Outlook Negative Not specified Not specified

Exhibit 23: Financing needs for the Portuguese government in 2012

14 12 10 8 6 4 2 0 -2 Jan Feb Mar Apr May 3 4

Bill redemptions Bond redemptions Monthly deficit Monthly financing need

Exhibit 24: Prospective financing needs for Portugal in coming years

45 40 35 30 25 20 15 10 5 0 Bills stock Bonds issued 2011 2012 2013 EU/IMF funds

Bills stock Existing bonds maturing Deficit

Exhibit 25: Medium-term fiscal consolidation plan government projections

2011 General government balance General government debt

2012 -4.5 116

2013 -3.0 118

2014 -2.3 116

2015 -1.9 114

Exhibit 26: Portugals current ratings

Rating BBBBa2 BB+

Outlook Negative Negative Negative

Exhibit 27: Financing needs for the Cypriot government in 2012

900 700 500 300 100 -100

820 697 727

256 98 111 -4 -21 Sep -6 Oct 43