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CIPFA London Division
Delivering the Spending
Review
7th March 2011
cipfa.org.uk
Welcome & introductions
Peter Gilmour
Chairman
CIPFA London Division
cipfa.org.uk
\Agenda
Now
Chief Executive’s perspective of the spending
review realities – Kevin Crompton
10:30am
CIPFA London Division AGM Business
10:35am
Tax, Inflate, Confiscate - Andrew Cole
11:00am
The finance officer’s role in managing finance and
change - Chris Bilsland
11:30am
Panel Debate
12:00pm
Buffet Lunch
cipfa.org.uk
Chief Executive’s
perspective of the
spending review
realities
Kevin Crompton
Chief Executive
LB of Haringey
cipfa.org.uk
\Agenda
Now
CIPFA London Division AGM Business
10:35am
Tax, Inflate, Confiscate - Andrew Cole
11:00am
The finance officer’s role in managing finance and
change - Chris Bilsland
11:30am
Panel Debate
12:00pm
Buffet Lunch
cipfa.org.uk
CIPFA London
Annual General
Meeting
Peter Gilmour
Chair
CIPFA London division
cipfa.org.uk
\Agenda
Now
Tax, Inflate, Confiscate - Andrew Cole
11:00am
The finance officer’s role in managing finance and
change - Chris Bilsland
11:30am
Panel Debate
12:00pm
Buffet Lunch
cipfa.org.uk
Tax, Inflate,
Confiscate
Andrew Cole
Lead manager of the Barings
Multi Asset Fund
Barings Asset Management
Not just in the UK
A G7 Challenge
Our forecast

Every G7 sovereign will pursue Fiscal Austerity (Tax)

Every G7 sovereign will Print (Inflate)

Every G7 sovereign will Default (Confiscate)
Every G7 Government struggling with the same issues.
Source: Barings, as at 2nd November 2010
9
The issues? Which way out of a debt crisis?
120
Sovereign Debt to GDP for G7 nations
1950 - 2009
Debt/ GDP (%)
100
80
60
40
20
0
1950
1960
1970
1980
1990
2000
2010
Sovereign Debt to GDP in the G7
Source: Fathom and OECD, June 2010
10
What causes these crises?

Excessive debt


Excessive interest payments


Measured by debt to GDP or to revenue or to exports
Measured by debt service to GDP or to tax revenue
Excessive reliance on foreign capital

Measure by debt to exports or net international investment position
11
What causes these crises?


Economic weakness

Low growth

Low returns on private sector investment
Political weakness


Excessive expenditure and insufficient taxation are politically determined
Irrational exuberance

Investors keep forgetting to learn from history
12
In theory, 4 ways out

A higher growth rate of GDP

Fiscal pain, meaning an increase in taxes and/or a cut in public spending

Increased Seigniorage, the increased printing of money by the central bank leading to
inflation.

Default, including every form of non-compliance with the original terms of the debt contract,
including repudiation, standstill, moratorium, restructuring, rescheduling of interest or
principal repayment etc.
Source: Barings 2010
13
Actually, only 3 ways out

A higher growth rate of GDP

Fiscal pain, meaning an increase in taxes and/or a cut in public spending

Increased recourse to seigniorage (printing money) by the central bank

Default, including every form of non-compliance with the original terms of the debt contract,
including repudiation, standstill, moratorium, restructuring, rescheduling of interest or
principal repayment etc.
Tax, Inflate, Confiscate
Source: Buiter (2010)
14
Debt Crisis, ways out. Option #1:
Fiscal Pain
Government Primary Balances
1970 – 2009 (%GDP)
Govt Primary Balances to Stabilise
Debt/GDP by 2020
15
15
10
10
5
5
0
0
-5
-5
-10
-10
-15
1970
1980
UK
1990
Japan
2000
US
2010
2020
Germany
-15
15yr Av
to ‘07
UK
2010
US
60%
Target
Japan
Source: OECD and Barings, June 2010. Primary surplus targets to stabilize government debt/ GDP ratios assume Barings trend real growth rates of
1% in Japan, 2.3% in US, 2.2% in UK, and 1.5% in Germany. It is assumed that real interest rates are 1%. The projections take IMF assessments of
current government debt. Net debt has been used for Japan, gross debt for others.
80%
Target
Germany
15
Debt Crisis, ways out. Option #1:
Fiscal Pain
GDP Growth vs Previous Trend
Real Growth by Deleveraging Strategy
7
6
105
5
GDP Growth (%)
100
95
90
85
4
3
2
1
-
-1
80
-2
75
-3
-4
70
t=0
t+2
t+4
t+6
t+8
t+10
t+12
t+14
Belt tightening
10yr pre 1-2 yrs 2-3 yrs 4-5 yrs
Trend
+10yr
Belt tightening
Source: McKinsey & Matt King - Citigroup, Arresting the Sovereign Avalanche?, June 2010.
16
Debt Crisis, ways out. Option #1:
Fiscal Pain
6
2.1
5.5
1.9
5
1.7
4.5
1.5
4
1.3
3.5
1.1
3
0.9
2.5
0.7
2
Jun 07
Japan YTM (%)
Yield to Maturity (YTM) (%)
Ten Year Government Bond Yields June
2007 – December 2010
0.5
Dec 07
Jun 08
10yr Treasury
Dec 08
10yr Germany
Jun 09
Dec 09
10yr UK Gilt
Jun 10
Dec 10
10yr Japan (RHS)
Source: Bloomberg, as at 31st December 2010
17
Debt Crisis, ways out. Option #2:
Print
Central Bank Total Balance Sheet as % of Annual Nominal GDP
APF
Federal Reserve
25
Phase II
Lehman
Euro System
20
Bank of England (a)
15
10
5
0
Jun
2006
Oct Feb Jun Oct
2007
Feb Jun Oct Feb Jun
2008
Oct
2009
Source: Bank of England, http://www.bankofengland.co.uk/publications/speeches/2009/speech413.pdf , 2nd December 2009. (a) Excludes loans
and associated deposits in course of settlement.
18
Debt Crisis, ways out. Option #2:
Print
China Real M1 Growth (yoy) & Chinese Producer Price Inflation (yoy)
lagged by 9 mths
40
45
35
30
20
25
10
20
15
0
10
5
-10
0
-20
-5
Sep
98
Sep
99
Sep
00
Sep
01
Sep
02
Sep
03
PPI (9 month lag)
Sep
04
Sep
05
Sep
06
Sep
07
Sep
08
Sep
09
Sep
10
China Real M1
Source: Barings as at 31st December 2010
19
Real M1 YoY
Producer Price Inflation (%)
40
30
Debt Crisis, ways out. Option #2:
Print
15
15
10
10
5
5
0
0
-5
-5
-10
-10
Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb Feb
99 00 01 02 03 04 05 06 07 08 09 10 11
US PPI
UK PPI
Correlation of PPI annual changes
2000 – 2010
China PPI yoy % chg
YoY % Change
YoY Change in PPIs for China, US, EU & UK
1999 – 2010
CH
US
EU
UK
CH
US
0.82
EU
0.82 0.81
UK
0.57 0.67 0.53
China PPI (RHS)
Eurostat PPI Eurozone
China inflates the World
Source: Bloomberg and Barings, 31st December 2010
20
Debt Crisis, ways out. Option #2:
Print
4.5
1
Breakeven Inflation Rate (%)
4
0
3.5
3
-1
2.5
2
-2
1.5
-3
1
0.5
-4
0
-0.5
Jun 07
Japanese Breakeven Inflation Rate (%)
Breakeven Inflation Rates
30th June 2007 – 31st December 2010
-5
Dec 07
Jun 08
Dec 08
Jun 09
Dec 09
Jun 10
Dec 10
US 10yr Breakeven Inflation
UK 10yr Breakeven Inflation
Italy 10yr Breakeven Inflation
Japan 8yr Breakeven Inflation (RHS)
Source: Bloomberg and Barings, as at 31st December 2010
21
Debt Crisis, ways out. Option #2:
Fiscal Pain
GDP Growth vs Previous Trend
Real Growth by Deleveraging Strategy
7
6
105
5
GDP Growth (%)
100
95
90
85
4
3
2
1
-
-1
80
-2
75
-3
-4
70
t=0
t+2
t+4
t+6
Belt tightening
t+8
t+10
t+12
t+14
Inflation
10yr pre
1-2 yrs
2-3 yrs
Belt tightening
4-5 yrs
Inflation
Source: McKinsey & Matt King - Citigroup, Arresting the Sovereign Avalanche?, June 2010.
22
Trend
+10yr
Debt Crisis, ways out. Option #3:
Default
5yr Credit Default Swap Spreads – Eurozone Periphery
5 year CDS Spread (bps)
1200
1000
800
600
400
200
0
Jun 07
Dec 07
Jun 08
Greece
Dec 08
Portugal
Jun 09
Ireland
Dec 09
Spain
Jun 10
Dec 10
Italy
Source: Bloomberg, as at 31st December 2010
23
Debt Crisis, ways out. Option #3:
Default
5yr Credit Default Swap Spreads – G5
5 year CDS Spread (bps)
180
160
140
120
100
80
60
40
20
0
Jun 07
Dec 07
Jun 08
France
Dec 08
Germany
Jun 09
UK
Dec 09
US
Jun 10
Dec 10
Japan
Source: Bloomberg, as at 31st December 2010
24
Debt Crisis, ways out. Option #3:
Default
Market Value of Over The Counter Derivatives Outstanding
1999 – 2009
35,000
US$ Billion
30,000
25,000
20,000
15,000
10,000
5,000
0
Jun 98
Jun 00
Jun 02
Credit Default Swaps
Jun 04
Commodity Contracts
Foreign Exchange Contracts
Jun 06
Jun 08
Equity-Linked Contracts
Interest Rate Contracts
Source: Bank of International Settlements & Barings, as at 30th June 2010
25
Debt Crisis, ways out. Option #3:
Fiscal Pain
GDP Growth vs Previous Trend
Real Growth by Deleveraging Strategy
7
6
105
5
GDP Growth (%)
100
95
90
85
4
3
2
1
-
-1
80
-2
75
-3
-4
70
t=0
t+2
t+4
Belt tightening
t+6
t+8
t+10
Inflation
t+12
t+14
Default
10yr pre
1-2 yrs
Belt tightening
2-3 yrs
4-5 yrs
Inflation
Trend
+10yr
Default
Source: McKinsey & Matt King - Citigroup, Arresting the Sovereign Avalanche?, June 2010.
26
Which way?
Example: UK

Taxation:


Inflation:


Emergency Budget of June 2010 sees government departments cutting spending by 25%,
and personal taxes have risen.
Bank of England & HM Treasury have swapped traditional roles, with BoE underpinning
nominal GDP growth
Confiscation:

Default on non-tradable contractual obligations: public sector pension defaults; public
sector contract ‘renegotiations’ to come.
It’s here and now
Source: Barings, as at 2nd November 2010
27
Summary and Conclusion

There is no easy way to deleverage

Although markets are busy deciding which will be the route of choice, governments will
commit the all three sovereign sins:

Taxation

Inflation

Confiscation

For Investors and Savers, the outcomes have quite different portfolio implications (often
represented by the inflation/deflation debate)

Markets will likely swing from one extreme to the other as evidence emerges supporting
each route

Understanding the risk premium on different assets will be an increasingly important
discipline.
Source: Barings, as at 2nd November 2010
28
Biography
Andrew Cole
Member of the Multi-Asset Team
Location: London
Investment Experience: 32 Years
Andrew is a member of the Multi Asset Team responsible for the management of multi asset portfolios. He is lead manager
on a number of segregated portfolios. Andrew was appointed to the Strategic Policy Group (SPG), the company’s global
macro research and asset allocation team in 2005. He is chair of the SPG Risk Sub Group and is a member of the Economic
Group. Both groups provide key inputs to the debate of the monthly SPG meetings. Andrew joined the Fixed Income
department at Baring Asset Management in 1986. He was appointed a Director in 1994 and joined the Multi Asset portfolio
team in 1995.
29
Important Information
For Professional Investors/Advisers only. This document is approved and issued by Baring Asset Management Limited and in jurisdictions other than
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information only.
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performance. Quoted yields are not guaranteed. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.
There are additional risks associated with investments (made directly or through investment vehicles which invest) in emerging or developing markets.
Investments in higher yielding bonds issued by borrowers with lower credit ratings may result in a greater risk of default and have a negative impact on
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30
cipfa.org.uk
\Agenda
Now
The finance officer’s role in managing finance and
change - Chris Bilsland
11:30am
Panel Debate
12:00pm
Buffet Lunch
cipfa.org.uk
The finance officers
role in managing
Finance and
Change
Chris Bilsland
Chamberlain
City of London Corporation
The 3 Key Tasks
Balance the Budget
Manage the Budget
Deliver the Change Agenda
Balancing the Budget
Its not just the numbers……
….But the forecast risks and assumptions
• Credibility of savings proposals
• Adequacy of reserves and balances
• Interest rates, pay awards, price inflation
• Resource Review (LAs)
• Council Tax Yield (LAs)
Managing the Budget
Savings Come First
Active Management – savings plan
Intervention not monitoring
Dynamic reporting on risk areas
Delivering the Change Agenda
Shared services plan
Investment in new technology
Ways of working, productivity and buildings
Dynamic reporting on risk areas
Procurement
Income management
Communication
Concluding Thought

Scenario Planning

Lets start at 2015 and work backwards

This is not the time to think we can simply roll
today’s plans forward 4 years
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\Agenda
Now
Panel Debate
12:00pm
Buffet Lunch
cipfa.org.uk
Panel Debate
cipfa.org.uk
CIPFA London Division
www.CIPFALondonDivision.org.uk
Thank you for attending