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Market Economics 17 February 2012

Eurozone: Fiscal Update

www.GlobalMarkets.bnpparibas.com Please refer to important information found at the end of the report.

The most recent fiscal news from the eurozone…

News on Greece turned positive yesterday, strengthening our expectations that a last-minutedeal will be struck at the 20 February eurozone finance ministers meeting. There is, however,a risk that a final decision will be taken at the EU summit on 1-2 March.

Following written assurances from the leaders of the Greek coalition parties, the draft lawimplementing further austerity measures to plug Greece’s EUR 325mn financing gap couldbe put before parliament as early as today, so it can be passed by Sunday night ahead of the

Eurogroup meeting on Monday. This morning, Ekathimerini reported that the deadline forvoting on all of the bills spanning the agreement with the Troika is 29 February.

Reportedly, to bridge the EUR 325mn funding gap, Greece will take the following measures:(i) a cut of EUR 100mn in the operating expenses of the defence ministry; (ii) salaryreductions in certain civil-servant categories, including teachers and military personnel, twomonths earlier than originally scheduled, saving some EUR 90mn; (iii) a 10-12% cut inprimary pensions in excess of EUR 1,300 per month, saving the state about EUR 45mn; (iv)the abolition of children’s allowances to families with four or more children and with an annualincome of more than EUR 40,000-45,000, saving EUR 40-42mn; (v) a further EUR 20-30mncut to supplementary pensions, on top of the already announced EUR 200mn annual cut,although the details of how this will be done have not yet been decided and (vi) and aEUR 6mn cut in the operating expenses of a number of state companies and corporations.

Small cuts to other state expenditure items will also be included in the bill, bringing the total tothe desired figure of EUR 325mn.

German sources have suggested that the plan reportedly advanced by some eurozonecountries to delay the overall deal by providing Greece with a bridging loan in order to repayits March 12 bond redemption have been dropped. Political leaders, however, are still mullingways to strengthen the monitoring of programme implementation, as suggested by the headof the Eurogroup, Jean-Claude Juncker, on Wednesday. Among the proposals are thecreation of an escrow account into which part of the bailout funds for Greece would befunnelled to specifically service interest on Greek debt. This would guarantee payments toGreek creditors, while keeping pressure on Greece to deliver.

Press reports also suggest that the ECB is ready to swap the Greek bonds purchased underits securities markets programme (SMP) for new Greek bonds. The swap will reportedlyhappen at par and not at the purchase price, as previously suggested. According to a numberof press reports, the swap could start this weekend. But the ECB would then distribute theprofits to the national governments via the national central banks. These profits could then beused to provide additional debt relief for Greece, helping to plug the funding gap that the latestdebt sustainability analysis is likely to highlight. The outcome of the analysis is not yet known.By making the ECB immune to the eventual use of CACs, the swap should also encourageparticipation in the PSI. Additional debt relief could also eventually come in the form of lowerinterest payments on the loans provided to Greece, according to press speculation.

Overall, the latest press reports point to a more constructive debate ahead of the eurozonefinance ministers meeting on Monday, following heightened political tensions over the pastfew days.

Uncertainty persists, however. Recent opinion polls suggest that Greek political party NewDemocracy would not win an absolute majority at the April elections. This would open the wayfor a coalition government, which could include political parties that oppose the austeritymeasures. New Democracy is still leading the opinion polls by a wide margin, but left-leaning



IMPORTANT NOTICE. Please refer to important disclosures found at the end of this report.www.GlobalMarkets.bnpparibas.com

parties are also scoring highly in the most recent polls (the Democratic Left has polled 16%support, the Communist Party 14% and the Radical Left 13.5%). As the parliamentary groupleader of the Greek far-right LAOS party confirmed yesterday that his party will not commit tothe austerity package passed by the Greek parliament, such numbers could fuel concernamong EU officials about the commitment of Greece’s political leadership to fiscal

consolidation.

Against this backdrop, an alternative that has been recently floated is that the currentcaretaker government led by Lucas Papademos remains in place for longer, allowing theimplementation of some of the measures set out in the programme with a wider politicalconsensus. The proposal, made by former Prime Minister Georgios Papandreou, amongothers, is similar to the solution adopted by Italy, whose technocratic government is led byMario Monti, and could prevent a populist drift, assuring a more effective implementation ofthe programme. It is unlikely, however, that Mr Samaras would ever agree. Such an optionwould also very likely fuel the already high level of discontent among the population.

Today’s meeting between Italian Prime Minister Mario Monti and German ChancellorAngela Merkel has been cancelled at the last minute, as the German president, Christian

Wulff, is to give a statement today at 10.00 GMT. The president has been accused ofaccepting illicit payments and gifts from industry. While embarrassing, the role of the Germanpresident is largely ceremonial, so any developments will not affect Germany’s political stanceon the eurozone. Note that today’s get-together was supposed to replace the postponedmeeting initially scheduled for 20 January between the Italian prime minister, the Germanchancellor and French President Nicolas Sarkozy. Chancellor Merkel will give a statement at10.30 GMT.

Next week, on 23 February, Spanish Prime Minister Mariano Rajoy will meet with ItalianPrime Minister Monti. According to Spanish newspaper El Pais , the choice of date is “notrandom”, as it is the day on which the European Commission will release its new economicforecasts. According to the paper, Mr Rajoy could use the fact that Italy is facing the samegrowth headwinds as Spain to start garnering support for the European Commission to

change Spain’s deficit targets.

The Spanish parliament yesterday approved with a wide majority (303 out of 337 seats) thegovernment’s proposed overhaul of the financial sector. The final result is broadly in line withthe initial proposal. Banks will be required to set aside extra provisions by the end of the yearfor possible losses on toxic and non-toxic real-estate assets. Total provisions are expected toincrease EUR 52bn. The government estimates that EUR 25bn will be required for specificprovisioning and EUR 10bn for generic provisioning, with an extra buffer of close toEUR 17bn to increase the cover on real-estate assets.

The government will also incentivise mergers, particularly between smaller financialinstitutions, subject to the approval of plans to be submitted by May. Funding from the FROBat an interest rate in line with its usual funding rates will be provided for this purpose. Thebanks that intend to fuse will then have until the end of June to finalise their mergers and willhave until December 2013 to meet the provisioning requirements. The remainder of thebanks will have to increase their provisions by the end of this year.

The implications of this reform are positive, in our view. This plan seems to be a step in theright direction, considering the clarity it should bring to the financial sector going forward. But itis definitely worth keeping an eye on the rationale behind the smaller bank mergers to assessif the impact of the linkups will, in fact, be positive.

The president of the autonomous regional government of Catalunya, Artur Mas, said in ainterview with French newspaper Le Monde that his administration plans to submit to theSpanish government by the end of this year or early 2013 a “fiscal pact”, whereby the regionalgovernment would have to transfer less of its revenue to the central government and “reducethe region’s deficit by half”. Mr Mas added that if the pact is not approved by the Spanish

government, he might propose a regional referendum.

The Portuguese statistical institute (INE) yesterday released the unemployment numbersfor Q4 2011. The unemployment rate rose to 14%, its highest level ever, from 12.4% in Q3.



IMPORTANT NOTICE. Please refer to important disclosures found at the end of this report.www.GlobalMarkets.bnpparibas.com

Employment decreased 2.4% q/q and the participation rate fell by 0.4pp to 51.7%.

On top of these very negative numbers, it was evident that job destruction was broad based.The youth unemployment rate now stands at 35%. Half of the unemployed have been out ofa job for more than a year and one-third for more than two years. If those out of the workforce

but willing to work were taken into account, the rate would top 19%.

The deterioration was above both our and market expectations and contrasts with the lastGDP number for Q4, which, despite showing a marked fall of 1.3% q/q, is consistent with aless pronounced fall in employment.

Given Portugal’s bleak growth prospects, we expect the unemployment rate to continue totrend higher, reaching 15% at the end of this year. The contraction in activity, mostly as aresult of falling domestic demand, should continue to damp employment.

Yesterday, the biggest Portuguese union, CGTP, which is linked to the Communist Party,called for a general strike on 22 March. However, the other union, UGT, which recentlysigned an agreement on labour-market reform with the government and businessassociations, refused to support the strike, saying it was “not the time for this kind of protest”.

Gizem KaraTel: 44 20 7595 8783Email: [email protected]

Luigi SperanzaTel: 44 20 7595 8322Email: [email protected]

Ricardo Santos

Tel: 44 20 7595 8369Email: [email protected]




Fiscal Monitor www.GlobalMarkets.bnpparibas.com

Ratings MonitorChart 1: Sovereign 5yr CDS & Credit Ratings

0

200

400

600

800

1000

1200

AA+ AA- A BBB+ BBB- BB B+

Rating (Avg. of Moody's, S&P, Fitch)

5 y r S o v e r e i g n

C D S ( b

p )

Philippines

Romania

Colombia

Indonesia

TurkeyIceland

Bulgaria

Brazil

Kazakhstan

Hungary

Russia

Mexico

Thailand

Poland

Bahrain

Portugal

Ireland

ItalySpain

S. Korea

Belgium

Slovenia

JapanAustralia

UK

US

France

Chile

China

Slovakia

Switz.Norway

SwedenAustria

0

200

400

600

800

1000

1200

AA+ AA- A BBB+ BBB- BB B+

Rating (Avg. of Moody's, S&P, Fitch)

5 y r S o v e r e i g n

C D S ( b

p )

Philippines

Romania

Colombia

Indonesia

TurkeyIceland

Bulgaria

Brazil

Kazakhstan

Hungary

Russia

Mexico

Thailand

Poland

Bahrain

Portugal

Ireland

ItalySpain

S. Korea

Belgium

Slovenia

JapanAustralia

UK

US

France

Chile

China

Slovakia

Switz.Norway

SwedenAustria

Source: Bloomberg, BNP Paribas, Note: the chart does not include Greece

The chart above plots the relationship between sovereign ratingsand CDS spreads. Portugal, for example, is still trading at levelsconsistent with further downgrades.

Chart 2: Greece – Credit Ratings

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA

Jan-09 Jul-09 Jan-10 Ju l-10 Jan-11 Jul-11 Jan-12

Moody's

FitchS&P

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA


Moody's

FitchS&P

Source: Bloomberg, BNP Paribas

Chart 4: Portugal – Credit Ratings

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA


Moody's

Fitch

S&P

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA


Moody's

Fitch

S&P


Table 1: Eurozone Credit Ratings

Moody’s S&P Fitch

Rating Last Chg Rating Last Chg Rating Last Chg

AT Aaa (-) - AA+ (-) 13/1/12 AAA -

BE Aa3 (-) 16/12/11 AAu (-) 25/11/11 AA (-) 27/01/12

FI Aaa - AAA (-) - AAA -

FR Aaa (-) - AA+ (-) 13/1/12 AAA -

GE Aaa - AAAu - AAA -

GR Ca* 25/7/11 CC (-) 27/7/11 CCC 13/7/11

IR Ba1 (-) 12/7/11 BBB+ (-) 1/4/11 BBB+ (-) 14/4/11

IT A3 (-) 13/2/12 BBB+ (-) 13/1/12 A- (-) 27/01/12

ND Aaa - AAAu (-) - AAA -

PT Ba3 (-) 13/2/12 BB (-) 13/1/12 BB+ (-) 24/11/11

SP A3 (-) 13/2/12 A (-) 13/1/12 A (-) 27/01/12


Note: u: unsolicited

(-): negative outlook

* : developing outlook

Chart 3: Ireland – Credit Ratings

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA

Jan-09 Ju l-09 Jan-10 Ju l-10 Jan-11 Ju l-11 Jan-12

Moody's

FitchS&P

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA

Jan-09 Ju l-09 Jan-10 Ju l-10 Jan-11 Ju l-11 Jan-12

Moody's

FitchS&P


Chart 5: Spain – Credit Ratings

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Moody'sFitch

S&P

C

CCC-

CCC+

B

BB-

BB+

BBB

A-

A+

AA

AAA

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Moody'sFitch

S&P






Growth MonitorChart 1: Industrial Production (% y/y)

Source: Reuters EcoWin Pro

Among the so-called ‘peripherals’, industrial production continuesto contract in Greece. In Portugal and Spain, production has beenbroadly flat over the last year, but is now trending lower.

Chart 3: Manufacturing Sentiment


Manufacturing sentiment in the peripherals remains well below theeurozone average.

Chart 5: Consumer Sentiment


Consumer confidence for the eurozone overall is below its long-term average. Sentiment indices in the peripherals remain wellbelow their historical averages. In Portugal, sentiment is trendinglower, which is unsupportive of consumer spending.

Chart 2: Retail Sales (% y/y)


Consumer spending is weakening in Portugal and Spain.

Chart 4: Services Sentiment


Services sentiment is generally weaker.

Chart 6: Current Account (% GDP)


In Portugal and Greece, the current account deficit remains wide,reflecting persistent imbalances between domestic savings andinvestment. In contrast, Spain’s current account deficit narrowedfrom 10% of GDP in 2008 to 4.5% last year. In Ireland, the current

account has returned to a surplus.





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IMPORTANT DISCLOSURES: Please see important disclosures in the text of this report.

The information and opinions contained in this report have been obtained from, or are based on, public sources believed to bereliable, but no representation or warranty, express or implied, is made that such information is accurate, complete or up to dateand it should not be relied upon as such. This report does not constitute an offer or solicitation to buy or sell any securities orother investment. Information and opinions contained in the report are published for the assistance of recipients, but are not tobe relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, are subject to changewithout notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference topast performance should not be taken as an indication of future performance. To the fullest extent permitted by law, no BNPParibas group company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arisingfrom any use of or reliance on material contained in this report. All estimates and opinions included in this report are made as ofthe date of this report. Unless otherwise indicated in this report there is no intention to update this report. BNP Paribas SA andits affiliates (collectively “BNP Paribas”) may make a market in, or may, as principal or agent, buy or sell securities of any issueror person mentioned in this report or derivatives thereon. BNP Paribas may have a financial interest in any issuer or personmentioned in this report, including a long or short position in their securities and/or options, futures or other derivativeinstruments based thereon, or vice versa. BNP Paribas, including its officers and employees may serve or have served as anofficer, director or in an advisory capacity for any person mentioned in this report. BNP Paribas may, from time to time, solicit,perform or have performed investment banking, underwriting or other services (including acting as adviser, manager,underwriter or lender) within the last 12 months for any person referred to in this report. BNP Paribas may be a party to anagreement with any person relating to the production of this report. BNP Paribas, may to the extent permitted by law, haveacted upon or used the information contained herein, or the research or analysis on which it was based, before its publication.BNP Paribas may receive or intend to seek compensation for investment banking services in the next three months from or inrelation to any person mentioned in this report. Any person mentioned in this report may have been provided with sections ofthis report prior to its publication in order to verify its factual accuracy.

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