Atradius Economic Research Light in the Tunnel still Faint John Lorié, Chief Economist

1. Atradius Economic Research Light in the Tunnel still Faint John Lorié, Chief Economist The ICTF International Credit Professionals Symposium Amsterdam, April 15, 2013

2. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

3. Global growth weak as Eurozone crisis still dominates Source: IHS Global Insight. Source: IHS Global Insight. • Global growth rates started to slide during the second half of 2011 after the escalation of the Eurozone crisis. The slide has not even completely stopped. Global growth rates were weak during 2012: average quarterly growth rate 2.2% y-o-y, with a weak Q4: 2%. • Global growth was dragged down by the advanced economies: 1.2% on average in 2012 (vs 1.5% in 2011). Q4 was especially weak: 0.6% y-o-y. • Emerging economies were affected as well: average 4.7% growth versus 6% in 2011, whilst Q4 was even somewhat better: 5.2% y-o-y growth. The growth gap between the advance economies and emerging economies has widened again. • The Eurozone crisis dominates growth in the advanced economies, as the Eurozone contracted: 0.2% y-o-y shrinkage (1.5% growth in 2011), with -0.5% in Q4. US growth remains positive, on average 2.2% y-o-y, but in Q4 also lower at 1.6% y-o-y. • Latin America posted a lower growth at 2.3% (Q4 2.4% y-o-y), whilst global growth power house Asia could welcome on average 4.9% y-o-y growth (Q4 5.1% y-o-y).

4. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

5. Fiscal policy provides no relief: austerity is the (global) buzzword • Debt levels in relation to GDP have grown rapidly from below 80% in 2008 to above 100% on average (bank rescue operations and fiscal stimulus). • Advanced economies: very limited, if any, means of further fiscal policy stimulus. Emerging economies: room for fiscal stimulation, with an average level of about 35%. • Fiscal consolidation is the buzzword in the advanced economies: budget deficits (% of GDP) rapidly declining. • Eurozone: average fiscal deficit decreased from slightly above 6.4% in 2009 to 3.3% in 2012 and is to decline to 2.6% in 2013. Huge differences between countries in the Eurozone: Ireland has a deficit of 7.5%, Germany of 0.4% (2012). • US: much budget deficit higher level in 2009, at 13.3%, to be reduced gradually to 8.7% in 2012, with 7.3% projected for 2013. Similar pattern for the UK. • Emerging economies: fiscal consolidation as well with an already low 4.5% deficit 2009 reduced to 1.9% in 2012, 1.8% in 2013. • Large differences: within the BRIC India has a deficit of 10.2%, China 1.6% (2012). China: US$ 158bn investment program to upgrade the infrastructure, pushing the budget deficit to 2% in 2013. Sources: IMF; Atradius Economic Research. Source: IMF; Atradius Economic Research.

6. Monetary policy very loose • Monetary authorities continue to pursue a very loose monetary policy: by low interest rates and ample liquidity. Interest rates: • Low real interest rates hold for the advances economies (where the rate is about - 1%) and, to a lesser extent, emerging economies: the real rate in the emerging markets is considerably higher, but at slightly above 2% still accommodative. • Trend of increasing real interest rates in both advanced as well as emerging economies of early 2012 as a result of lower inflation rates has not continued: deflationary tendencies have somewhat eased, lowering official policy rates. • Lowering official rates in emerging economies In the advanced economies, authorities have hardly any further room: rates at 0.125% (FED Funds Rate) and 1% (ECB Refinancing Rate). Liquidity: • FED and ECB: vigilant as the 2008 crisis exploded, providing ample liquidity to the banking system. • Since then liquidity growth, as indicated by the total central bank balance sheet, relatively moderate. Holds in particular for the FED, although the most recent Q3 move provided a boost: USD 85bln per month pumped into the market. ECB however has further expanded its balance sheet as the Long Term Refinancing Operation (LTRO) of about Euro 1 trillion gathered pace in early 2012. In early 2013 over 60% of the extra liquidity of Euro 500 bln • LTRO critical to counter serious interbank funding problems, in the Eurozone as well as the US. But it had some negative side effects. Source: IHS Global Insight.

7. Monetary transmission hick up: Southern European funding • Firstly, the interbank funding market has thinned as particularly Southern European banks have significantly less access. Their deposit base is also being eroded as depositors increasingly seek refuge in Northern European banks they have to turn to the ECB. This process has stabilised since mid 2012. • Secondly, the LTRO seems to have aggravated an issue that we have already alluded to above: the sovereign debt crisis. Sources: BIS; Atradius Economic Research.

8. Monetary transmission hick up: sovereign holding woes Sources: BIS; Atradius Economic Research. • Banks were, and still are, holding large portfolios of intra Eurozone sovereign bonds. Large portfolios of Southern European sovereign bonds are held by German and French banks. Following the escalation of the sovereign debt crisis these portfolios were reduced, but not spectacularly. • The risk related to sovereign debt is therefore still weighing on Northern European banks. The LTRO has had limited impact on that. • More important was the purchase of sovereign debt by local banks. In the first two months of the LTRO Spanish banks bought Euro 47bn Spanish government bonds to bring the portfolio to Euro 220bn, for Italian banks these figures are Euro 315bln and Euro 112bn. • These purchases of relatively high risk sovereign bonds have clearly raised the risk profile of the banks. And, in turn, of the governments that will ultimately have to stand behind these banks. The by product of the LTRO is that the sovereign debt crisis now weighs even more heavily on the banking system. • Only recently Italian and Spanish banks have started to off load sovereign bonds, but at a very limited scale.

9. Monetary transmission fails in the Eurozone Sources: IHS Global Insight; ECB; Federal Reserve; Atradius Economic Research. • The implications of a banking system that is in ill health for growth are severe. It causes a dysfunctional credit channel: banks are simply very reluctant to lend. • That is expressed by the ever tightening of the conditions for loan supply since the 2008 crisis in the Eurozone, whereas in the US conditions have been relaxed starting early 2010. • Direct evidence of dysfunctionality can be obtained from the development of credit growth. This is hovering around zero in the Eurozone (now even negative for non financial companies), but has clearly gathered pace in the US since mid 2011. • The picture that imposes itself for the Eurozone is an expansionary monetary policy that is impotent to help push growth due to banking sector health issues. • Some alleviation may be expected from the most recent decision to postpone increasing liquidity requirements for banks.

10. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

11. Policy steps since June Summit to solve crisis encouraging… 1. Fiscal compact: - enshrine budgetary discipline in national law, self correcting mechanism. -European Commission: policing role -compliance: European Court of Justice. In force since January 1, 2013 17 members ratified (15 EMU members) Aims at: budgettary discipline Member States 2. ESM: -lend to countries in trouble as the ECB does to banks. -17 EZ countries provide Euro 80bn paid capital, Euro 500bn drawn from the capital market. -Euro 355bn is available for new loans; EFSF/EFSM loans to Greece, Spain and Italy will be taken over. -new ESM loans will not be senior relative to other debt issued. -lending or capital to banks, European Banking supervision mechanism in place. • EC proposal supervisory mechanism during first half of 2013 Aims at: breaking banking sovereign feedback loop Sources: IHS Global Insight; OECD; Atradius Economic Research.

12. Policy steps since June Summit to solve crisis encouraging (2)… 3. European Banking Union: -European Banking supervision to be created, a responsibility to be taken on by the ECB. -European Commission proposal (September 2013): (i) introduction of a Single Supervision Mechanism per January 1, 2012, with all banks to be included one year later at the latest. (ii) the Commission envisages a supervisory role for the ECB, actual work largely national supervisors. Proposal for bank resolution in first half 2013. Details to be approved by all participating EU member states. Not in yet: European Depository Guarantee System Aims at: reinforcing European banking system 4. ECB action: ‘Whatever it takes‘ • -purchase an unlimited amount of short term (max 3 • year) government bonds in the secondary market. • -tied to conditions (IMF, European Commission). • - the ECB will not consider itself senior debt holder for • bonds being purchased under the program. • -inflation neutral by sterilisation. • Aims at: fears of Eurozone break up. Sources: IHS Global Insight; OECD; Atradius Economic Research.

13. …and havecalmed down financial markets Sources: IHS Global Insight; CBOE; Atradius Economic Research. • Following Mid July 2011 stress has hurted the financial markets, with high levels of volatility in the equity markets. Since late 2011 pressure has eased considerably, now for the Eurozone as well (LH graph). • Volatility is currently no longer markedly lower for the US. • Corporate credit spreads in the US and Eurozone widened considerably since Mid July 2011 as the financial turmoil intensified. The CDS premium for European investment grade has increased from 100 basis points in May to 190 basis points in September. Since late 2011 the tension has eased, with an interruption in early Spring of 2012 - even for the Eurozone as well (RH graph). • CDS spreads are currently still lower for the US, but the gap is decreasing.

14. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

15. Global growth expectations for 2013 are flat Source: Consensus Forecast (survey date March 2013). • Despite the negative impact of the Eurozone debt crisis, the overall expectation for real economic conditions is, globally, positive. As growth landed at 2.5% for 2012, it will marginally improve (2.6%) for 2013 and leap up again in 2014 - towards 3.2%. • But we do see overall divergence push on in 2013. Firstly, within the advanced economies, where the Eurozone growth is expected to remain marginally negative at -0.3%, and the US with a projected growth of 1.8%. Secondly, between the advanced economies and emerging economies, with the latter growing at a pace of around 4%, led by Asia Pacific.

16. In major markets they show a divergent picture… Source: Consensus Forecast (survey date March 2013). • In 2012 the Eurozone economies showed a mild contraction at -0.5%. Spain and Italy more pronounced at a higher contraction at -1.6% and -1.2% respectively; US growth is expected to continue, just as Japan’s, although for the latter at a much lower pace. • The projection of economic growth in the US, Japan and Western European countries, if any is well below potential. In 2013 Eurozone countries (as a whole) are expected to show a marginal contraction of -0.3%. • Month-on-month revisions broadly point at slowdown of the negative momentum of growth, whilst the trend (2013 vs 2012) for the Eurozone countries is unambiguously negative (with the exception of Germany and France), just as the one for the US.

17. …whilst the forecast slide for 2013 weakly slows Source: Consensus Forecast. Note: Evolution in Consensus GDP growth forecasts for 2012 across 20 consecutive surveys (January - November 2012). • For 2013 the slide of the momentum seems to slow, even for the Eurozone as a whole. Exceptions are Germany and The Netherlands.

18. Emerging markets will pick up and drive growth Source: Consensus Forecasts (regional surveys, March 2013). • After a shallow recession in 2009 caused by the collapse of global trade and subsequently a drop in commodity prices, the Emerging Regions resumed their strong positive growth trend of the years before: 2010 and 2011 turned out to be excellent years. Growth in 2012 was impacted by the Eurozone crisis, particularly in Asia. In 2013 as the Eurozone crisis has calmed down growth will pick up again. • Growth rates vary significantly between the Emerging Regions and between the BRIC countries, with China and India growing much faster than Brazil and Russia. Brazil suffered from restrictive monetary policy and erosion of competitiveness in 2012 but those factors are expected to fade in 2013. • Trend arrows revisions provide a mixed signal as to the trend, which also holds for m-o-m forecast revisions: a mixed signal as to momentum. But, the growth remains at a high level anyway.

19. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

20. The outlook implies stabilising insolvency rates, at a high level… Source: Atradius Economic Research. Note: TPE-weighted regional averages. • The outlook of depressed demand and lending restrictions implies stabilising insolvency conditions across the board, at a rather high level (compared to pre Lehmann). • The default outlook for the Eurozone is still mixed, which aligns with the large differences in economic performance across the north and the south. • But importantly, the Southern European countries are expected to show stabilisation as well. • We can only expect an improvement in the insolvency environment not earlier than in late or after 2013, with a gradual adjustment back toward long-run average default levels.

21. …with divergence between major markets Insolvency growth per annum in % Note: Forecasts are based on the outcome of statistical models and expert opinion. Values for 2011 represent actual data. All views expressed here are those of Atradius Economic Research (final forecast: April 2013). • The picture for 2012 is mixed, with a number of countries indeed improving, such Canada, Norway and the US. A number of Eurozone countries, Northern (Netherlands, Luxembourg) as well as Southern countries (Greece, Italy, Portugal, Spain) see a worsening of the insolvency rates. • For 2013 we expect stabilisation at a rather high level, with a number of countries improving (the US, the UK and Ireland for example) but also quite a few worsening: Italy, Greece, Belgium, Portugal and Spain.

22. Contents • Global economy weak as Eurozone crisis still dominates • Fiscal contraction and monetary loosening • Encouraging policy steps • Forecast and sentiment slide weakly slows • Default outlook: stabilisation at high level • Appendices with additional slides

23. Global trade growth and financial flows still under pressure Global trade • Global trade aguably follows Eurozone crisis. Since early 2011 it has weakly picked up and is expected to reach a 3% level for 2012 (5.4% 20 year average). • Background: (i) muted GDP growth, (ii) trade finance constraints as Eurozone banks withdraw from that business due to dollar liquidity and balance sheet issues and (iii) increase in protectionism. Financial flows to the emerging economies • Declined in 2011 by 10.7% on a GDP indexed basis and are expected to further shrink in 2012 by another 12.3%. • The pattern is most noticeable in Asia and Emerging Europe, showing declines of 21% and 29.6% in 2012 respectively. • Background general: (i) Eurozone crisis, Eurozone banks lowering flows (deleveraging) (ii) shift to safe havens, such as the United Stated and Switzerland. • Emerging Europe: predominantly bank deleveraging, Asia: financial flows towards China hampered by an appreciated currency. Rest of world: also reflecting local issues, such as the Arab Spring (Egypt) and restrictions to dampen carry trade flows (Brazil). Sources: IHS Global Insight; Netherlands Bureau for Economic Policy Analysis (CPB). Sources: Atradius Economic Research, IIF.

24. Commodity prices still volatile but less of an issue Commodity prices (excluding oil): • Prices have risen since 2009 and peaked in early 2011. Structural factor: growth in emerging economies. Since then prices have declined with the weakening global economy, except for food prices (32% up versus June, US drought). • In 2011 food prices peaked because of adverse weather conditions leading to harvest short falls in wheat, rice, rubber, cotton, corn and sugar. The (bad) policy reaction was stock accumulation and trade restrictions such as in Russia and Ukraine. • This time is different. Since the second half of 2011 the acreage increased. Demand is more subdued. Policy to be coordinated: ‘Rapid Response Forum’ of G-20. Oil: • In oil market similar demand forces. Unrest in the Middle East pushed the price further up to levels close to US $ 120 a barrel in January 2011. • During 2011 the oil price slipped a bit towards US$ 110 per barrel. Following low stock levels and geopolitical tensions (Iran nuclear program) prices peaked at US$ 128 in March 2012, then raced down and came back to around US$ 120. • Given the underlying uncertainties, especially political, and low stock levels the oil price is bound to remain volatile. • Brent premium vs WTI US$ 20 per barrel: supply surplus for WTI can not be arbitraged away (transport cost). Source: IHS Global Insight.

25. Dysfunctional monetary transmission: Eurozone banking woes • US supervisory authorities managed to act relatively quickly to restore confidence following the 2008 crisis, the Eurozone, with its fragmented supervisory system, failed to do so. Eurozone banking system more vulnerable to shocks. • These indeed occurred, as the sovereign debt crisis escalated. US banks are not very much impacted by the crisis, which is another reason why they are in better shapeespecially in the Eurozone since the ECB intervention. • European bank share prices performed poorly, initially in line with banks in the rest of the world, and since mid 2011 even worse. Current improvement only in line with the world; no gain versus US banks. • Underlying this ill Eurozone banking health are at least two major issues: (i) interbank funding for Southern European countries and (ii) feedback loop sovereign and banking crisis. Sources: IHS Global Insight; CBOE; Atradius Economic Research.

26. Policy steps have lifted the Euro (somewhat) Source: IHS Global Insight • The impact of the escalating sovereign debt crisis is evident from July 2011 in the Euro dollar rate, just like the dollar benefits from increasing risk aversion as well (US is seen as a safe haven). • The pressure, however, has waned since the ECB intervention in 2012. Pressure briefly returned in before June 2012 (the Greek election drama) but was countered by Eurozone policy measures. Also US Q3 provided a non negligible role. • A lower Euro provides an impetus to exports, mitigating the real effects of the crisis.

27. The momentum for 2012 fared badly… Source: Consensus Forecast. Note: Evolution in Consensus GDP growth forecasts for 2013 across 20 consecutive surveys (January - November 2012). • This is a detailed picture of what was shown for the advanced markets: growth forecasts have aggressively been revised downward since the Eurozone tensions escalated Mid July 2011 and financial markets went into turmoil. • For 2012 this process seems to have slowed for the Eurozone as a whole, whereas for a number of countries it has even bottomed out, even for The Netherlands. For the UK the notable worsening has not stopped yet.

28. …but for 2013 stabilisationfor some Southern European countries Source: Consensus Forecast. Note: Evolution in Consensus GDP growth forecasts for 2013 across 20 consecutive surveys (January - November 2012). • The LHS graph was already discussed: some momentum for slowdown in the slide of expectations for 2013. • The RHS graph indicates that this also holds for the Southern European countries process, even for Greece.

29. Meanwhile labour markets continue to perform poorly… Sources: HIS Global Insight; OECD. • Unemployment rates are still creeping up towards 12% in the Eurozone. Unemployment in the United States has decreased since the beginning of the year, but it remains at unprecedented (and unacceptable) high levels above 7.5%. • Background: firms remain hesitant to create employment amidst uncertainties about the strength of the recovery and on average rates of investment growth are too low for the time being. • Eurozone difference in labour market performance across countries is large and growing. Germany for example, with high export-driven growth and more fiscal headroom to subsidise short-time working and job creation, has outperformed its peers. • At the same time, Eurozone member countries in the South have continued to deteriorate from already high levels. In Spain (like in Greece), unemployment has increased to levels well above 25%.

30. …and confidence indicators down and divergent…of consumers… • Persistent labour market overhangs, together with a weak wage growth and the upcoming declines in public spending to be discussed below, help to explain the halt of growing consumer confidence in the first part of 2011. • Nevertheless, overall consumer confidence in the robustness of the recovery appears to be reasonably stable in the Eurozone – until July 2011. • Following that month, confidence nosedived, including the one of Germany. The latter remains at a relatively high level, indicating growth (>100). EZ confidence decline seems to have bottomed out. • UK and US confidence had already declined much earlier to levels where Eurozone is now at and seem to be heading up again, but still indicate negative growth. • Confidence indicators in Italy and Spain have further declined during 2012, and now seem to have bottomed out just like the EZ . France’s has trailed, but is now in negative territory. All indicate contraction now. Sources: Global Insight; OECD.

31. …and for producers, still • Global industrial confidence has fallen since March 2011. Eurozone events since Mid 2011 have not helped either, pushing it into negative territory in early 2012. Some recovery is now visible. • The level for the US wobbled around an almost neutral stance in 2012 and has now slipped into negative territory. • The UK indicator is somewhat volatile and indicates weak growth at this stage. • Confidence levels in Italy, Spain and France have been trailing the Eurozone average and are all in negative territory, just like the Eurozone’s. • Confidence levels are improving since Mid 2012, however. Sources: Global Insight; OECD.

32. Expected default levels show finally some stabilisation • Expected Default Frequencies (EDFs) have moderated until mid 2011 and then started to climb again, both in North America and across major European countries. In particular Italy saw a fairly steep increase. • Measures still reflect a rather high level as well, but have declined considerably since Mid 2013. The EDF of the pool of large firms in the listed corporate universe are indeed moving towards default risk levels 5 years ago. France and Italy however still have markedly higher levels. • This trend across Eurozone markets is directly affected by the call in the financial markets following the ECB Mid August statement, which has give a boost sto stock markets. Still, EDFs for Greece and Portugal displaying high, but declining, default levels. Companies in Greece still run a default risk higher than 8% over the next 12 months. • Default probabilites of this magnitude, although improved, have a severe impact on the financial health of firms and consumers. Sources: Moody’s KMV Credit Monitor; Atradius Economic Research. Note: The EDF represents a measure for tracking default risk among stock listed companies. Combining balance sheet and stock market information for a particular firm yields a 1-year ahead default forecast. The median EDF represents the 50th percentile in the firm aggregate of interest.

33. Summary of insolvency environment: levels and dynamics • Anticipated stabilisation in the insolvency environment is fully consistent in general with GDP growth in 2013 (flat versus 2012). • Table shows the advanced economies classified in terms of the level of commercial risk together with their forecasted performance this year. • Quite a few countries are expected to see an or improving insolvency rate this year, the majority of countries’ rate will be stable. Only the ones for Greece and Italy worsen. The high insolvency remains dominant. • Heterogeneity across European countries markets is evident. Greece and Italy are expected to experience an insolvency increase whilst already on very high levels. But Portugal and Spain will be stable, and Ireland even improves. All, however, remain at high levels. Source: Atradius Economic Research. Note: This assessment is based on the outcome of statistical models and expert opinion. The categories ‘Low’, ‘Average’ and ‘High’ describe our perception of absolute default risk across different countries. For example, any country classified as belonging to the ‘Low’ category in the table was associated with a perceived low default rate in 2010. The default rate is here defined as the fraction of business failures in the entire pool of firms in a country measured within a calendar year. The buckets ‘Improving’, ‘Stable’ and ‘Deteriorating’ further describe how we project insolvencies to develop in 2011, as illustrated in the previous forecast tables. All views expressed here are those of Atradius Economic Research.

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