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In the absence of a political and fiscal union Europe’s sovereign debt crisis continues to be a huge issue for financial markets, even as policymakers head to the European Council meeting later this week.In a new note, UBS analyst Thomas Wacker and his team give us their update view of the European debt crisis focusing on Greece, Italy, Ireland, Portugal and Spain.
We drew on UBS’ report to highlight key issues on debt sustainability, economic outlook, and the next steps for the PIIGS economies.
Debt sustainability: Greek debt is beyond sustainable levels and the country needs more haircuts on its debt. For debt sustainability the country needs a 70 per cent haircut on its current debt. 'We expect another event of default later in 2012 or early in 2013 as part of a series of restructuring events.'
Economic outlook: UBS analysts expect a recession for a fifth straight year in 2012 and the outlook is hugely dependent on policy and therefore uncertain. 'The delay in the implementation of the conditions of the second bailout plan will likely lead to a back loaded austerity profile, and poses considerable downside risk to the 2013 UBS real GDP forecast of 0.7%.'
Next steps: The New Democracy-PASOK coalition should agree on a modified plan with the Troika to open up the second bailout plan. Exit risk is likely to return later this year, or in early 2013 since the Troika will want more reform measures.
Debt sustainability: There are signs of stabilisation and only a moderate probability of default. The debt to GDP ratio could stabilise at 115% by 2013. A key test will be the nations return to the bond market with bills this year, and bonds in 2013.
Economic outlook: Since Ireland's economy is heavily dependent on exports, its direction will depend on the changes in the Eurozone economy. UBS analysts project 2 per cent growth in 2013 but warn that lack of macro stability in Europe is a major risk to this forecast.
Next steps: Ireland should resume issuing bills in the fall and for the most part meet its consolidation (reducing fiscal debt) targets. Contagion risk from Greece is less pronounced for Ireland than for Spain, Portugal, and Italy.
Debt sustainability: Italy is not expected to default on its debt in the next five years. Its debt ratio should stabilise to 120 per cent of GDP. But debt could balloon if austerity measures enacted by Monti's government are abandoned.
Economic outlook: The economy is expected to contract 1.8 per cent this year. This will be a transition year with 2013 only likely to see 0.2 per cent growth given the austerity and weak external demand. But UBS analysts are more optimistic on Italy that Spain because of its strong private-sector balance sheet and low bank loan-to-deposit ratio.
Next steps: Italy isn't expected to ask for a bailout. 'Trigger points for renewed pressure on Italy include a move away from its consolidation program, perhaps triggered by the Monti government losing power, and a possible Greek exit from the euro, which may lead to a deposit flight also in Italy.'
Debt sustainability: Without continued financial support from the EU/IMF there is a high probability that Portugal will default on its debt. 'The debt ratio is currently on an explosive path and expected to grow towards 120% of GDP by 2013.
Economic outlook: Portugal's real GDP could be cut by 3.2 per cent this year. Next year's fiscal tightening is expected to be smaller but uncertainty about the expiring EU/IMF program in 2014 could impact confidence early. Moreover weakening demand from Spain could weigh on exports in 2013, so GDP is expected to contract 1.5 per cent next year.
Next steps: Portugal will require an amended second bailout to cover deficits and lack of access to funding through the bond market. The country would will still need a debt haircut for its debt to return to sustainable levels.
Debt sustainability: Spain isn't expected to default in the next five years but structural deficits need to be cut to stabilise the debt-to-GDP ratio to 90% in the longer term.
Economic outlook: 'The economy is being squeezed by the deflating housing bubble, credit crunch, government bond market stress and simultaneous fiscal austerity.' Current negative economic momentum is still strong and levels of non-performing loans are high. More austerity is likely next year and this caused UBS analysts to forecast a 1.3 per cent GDP contraction next year (subject to bank bailout conditions).
Next steps: The government is likely to continue to fund itself in the bond market despite high borrowing costs. Spanish credit rating is close to junk levels because of its debt to GDP ratio. And more negative headlines are likely given the execution risk of the fiscal adjustment program.