Market Economics | Interest Rate Strategy - BNP PARIBAS ...

• Credibility. Spain’s record in terms of public
finances is one of the strongest within the
eurozone while Portugal has achieved significant
adjustments in the past. Greece, with a record of
having published incorrect figures on more than
one occasion, has much less credibility; and
• Last but not least, social tolerance. Portugal’s
past adjustment has shown a high degree of
social tolerance. The ability of Greek society to
withstand the needed fiscal adjustment is one of
the market’s primary reasons for concern.
Yesterday’s tragic events were a harsh reminder
of the difficulties lying ahead for the Greek
government.
That said, peripheral economies share a number of
weaknesses that, in the absence of a quick and
credible adjustment, make them vulnerable to further
market tensions.
More specifically, Portugal and Greece share a key
feature: a lack of competitiveness associated with a
low rate of national savings. This implies they rely on
inflows of capital to finance consumption.
Conversely, in Spain and Ireland, private debt and
the state of the financial system are the core of the
problem. Both economies are undergoing a
significant adjustment in the housing sector which is
heavily weighing on growth, with negative
implications for the banking sector. Italy is in a group
of its own. Both internal and external imbalances are
less of an issue than for other peripheral economies
but the high level of public debt is a persistent risk
factor.
Portugal
As for Greece, a distinguishing feature of the
Portuguese economy is the extremely low level of the
national saving ratio; this has its roots in the
structural lack of competitiveness of the economy. In
2009, Portugal’s gross national saving amounted to a
modest 8.6% of GDP, versus an average of 18.5%
for the eurozone as a whole. Once adjusted for
capital consumption, Portugal’s national saving rate
was negative at -8.5% of GDP (Chart 3).
Low levels of savings imply that the economy has to
continuously rely on large inflows of capital to finance
consumption, as shown by Portugal’s high current
account deficit (-10.2% of GDP in 2009). Over time,
these imbalances have led to the accumulation of a
sizeable external debt. As of 2008, Portugal’s net
external financial asset position was in deficit to the
extent of 95% of GDP (Chart 4).
Under these circumstances, when the government
tries to achieve a deficit reduction by cutting transfer
spending or increasing taxes, the private sector will
find it difficult to borrow more and will be forced to cut
Chart 3: Net National Savings (% of GDP)
Source: Reuters EcoWin Pro
Chart 4: Total Economy Net Financial Assets
(% of GDP)
Source: Reuters EcoWin Pro
back investment and consumption. This is different
from the ‘standard’ fiscal adjustment, in which the
private sector dis-saves in reaction to fiscal
tightening, thus partially compensating for the
negative impact on growth of the fiscal retrenchment.
In sum, more than a fiscal problem, Portugal has got
a chronic problem of low growth. But persistently low
growth is likely to frustrate any attempt to correct
fiscal imbalances. In the absence of a combination of
fiscal adjustment and supply-side reforms, fiscal
trends could therefore become unsustainable.
Spain
Spain’s problem is an excess of private debt, which
can be traced back to the interest rate shock due to
the EMU accession. Historically loose credit
conditions led to a massive credit expansion and
debt accumulation by both households and
corporations, which was associated with a boom in
the housing market and growing external deficits.
The financial crisis has triggered a sharp adjustment
in most of these imbalances (Chart 5) which has
already taken a significant toll on domestic demand
(-6.5% y/y in 2009), employment (unemployment just
Luigi Speranza / Eoin O’Callaghan 7 May 2010
Market Mover
8
www.GlobalMarkets.bnpparibas.com