Download Scenarios on the sovereign debt crisis

Risks to the Global Outlook:
Insights from the Oxford Global
Economic Model
Rain Newton-Smith
[email protected]
October 2010
Corporate recovery
Outlook still highly uncertain
Financial sector recovery
Outlook still highly uncertain
Corporate recovery
Oxford forecast
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
Financial sector recovery
Outlook still highly uncertain
Corporate recovery
Oxford forecast
Renewed global boom
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
■ Strong corporate liquidity feeds into new
investment boom
■ Faster growth boosts business and
consumer confidence, and trade
multiplier magnifies upturn
■ Bank balance sheets improve quickly and
credit growth resumes
■ Strong growth boosts tax revenues/cuts
social security payments, helping fiscal
consolidation
Financial sector recovery
Outlook still highly uncertain
Corporate recovery
Oxford forecast
Renewed global boom
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
■ Strong corporate liquidity feeds into new
investment boom
■ Faster growth boosts business and
consumer confidence, and trade
multiplier magnifies upturn
■ Bank balance sheets improve quickly and
credit growth resumes
■ Strong growth boosts tax revenues/cuts
social security payments, helping fiscal
consolidation
Sub-par recovery
■ Business optimism remains low and
corporates continue to hoard cash
■ Investment and job growth is modest as
capacity is underutilised
■ Monetary policy supports banking sector
but fiscal coffers are empty
■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a
stronger housing and consumer recovery
Financial sector recovery
The Oxford Global Economic Model – Overview
 The Oxford Global Economic Model is the most widely used
commercial International Macro Model, with clients including
international institutions, Ministries of Finance and central banks
around the word, and a large number of blue-chip companies.
 It provides a rigorous and consistent structure for forecasting and
scenario analysis.
 The Model covers 46 economies in detail, including many emerging
markets, and provides headline forecasts for another 30 countries.
 Forecasts 5, 10 and 25 years ahead are updated each month.
 Oxford Economics’ powerful user-friendly software is very easy to use.
 Oxford Economics provides telephone and e-mail support, and runs
regular training workshops for clients.
Linkages between country models
 Trade
 Competitiveness
 Interest rates and exchange rates
 Equity markets
 Oil & commodity prices
 World price of manufactured goods
 Capital flows
Extensions following the global financial crisis
 Despite the good performance of the Oxford Global Economic Model,
the global financial crisis did highlight areas for enhancements:
■ Interest rates – expanded coverage to include key corporate and
consumer lending rates, as well as interbank rates and bond
yields
■ Credit conditions – introducing levers to account for
tightness/looseness of bank lending that are not reflected in
interest rates. This analysis is based on research by Prof. John
Muellbauer of Oxford University
■ Balance sheet coverage – expanded to cover financial and nonfinancial corporates as well as households and governments
■ Credit ratings – Reflecting the impact of sovereign debt ratings
on interest rate spreads for government bonds
■ Feedback effects – from unemployment/insolvencies on credit
conditions
Model extensions
Credit conditions
Official policy rates &
Government bond
yields
Interbank spreads
Lending spreads
Lending rates
Household
Government
finances
Corporate
Household
wealth/
equities
Consumer
spending
Housing
investment/
prices
GDP
Business
investment
Availability of
credit/other lending
criteria
Corporates are key
US: Business investment
$2005 billions
650
600
550
500
Base
Renewed boom
Sub-par recovery
450
400
350
300
250
200
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Scenarios for the global economy
Alternative GDP growth forecasts
2009
2010
2011
2012
Oxford Forecast (45%)
US
Eurozone
China
World
-2.6
-4.0
9.1
-0.7
2.7
1.5
9.7
4.4
2.6
1.4
9.0
4.3
3.5
1.8
9.2
5.0
Renewed boom (20%)
US
Eurozone
China
World
-2.6
-4.0
9.1
-0.7
2.9
1.7
10.4
4.7
3.8
2.5
10.7
5.6
4.2
2.9
10.4
6.0
Sub-par recovery (25%)
US
Eurozone
China
World
-2.6
-4.0
9.1
-0.7
2.5
1.2
8.8
4.0
1.9
0.9
7.2
3.4
2.2
1.0
7.5
3.8
Outlook still highly uncertain
Corporate recovery
Oxford forecast
Renewed global boom
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
■ Strong corporate liquidity feeds into new
investment boom
■ Faster growth boosts business and
consumer confidence, and trade
multiplier magnifies upturn
■ Bank balance sheets improve quickly and
credit growth resumes
■ Strong growth boosts tax revenues/cuts
social security payments, helping fiscal
consolidation
Sub-par recovery
■ Business optimism remains low and
corporates continue to hoard cash
■ Investment and job growth is modest as
capacity is underutilised
■ Monetary policy supports banking sector
but fiscal coffers are empty
■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a
stronger housing and consumer recovery
Financial sector recovery
Outlook still highly uncertain
Corporate recovery
Oxford forecast
Renewed global boom
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
■ Strong corporate liquidity feeds into new
investment boom
■ Faster growth boosts business and
consumer confidence, and trade
multiplier magnifies upturn
■ Bank balance sheets improve quickly and
credit growth resumes
■ Strong growth boosts tax revenues/cuts
social security payments, helping fiscal
consolidation
Sub-par recovery
Renewed crisis
■ Threat of double-dip means renewed
slump in asset prices as Eurozone
sovereign debt crisis re-emerges
■ Pressure to cut budget deficits rapidly
in all major economies
■ Rising unemployment and business
failures feed back into banking
■ Limited scope for monetary policy
offset
■ Business optimism remains low and
corporates continue to hoard cash
■ Investment and job growth is modest as
capacity is underutilised
■ Monetary policy supports banking sector
but fiscal coffers are empty
■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a
stronger housing and consumer recovery
Financial sector recovery
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
Fiscal plans for 2010 and 2011
Greece
Ireland
Spain
Portugal
Belgium
Italy
France
Netherlands
Austria
2010
2011
Finland
Germany
-3
-2
-1
0
1
2
3
4
5
6
7
8
Change in cyclically adjusted budget balance % GDP
Source : IMF/Oxford Economics
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
Eurozone: Credit spreads
% spread of 10-year bonds over German bunds
12.0
10.0
Greece
Spain
Portugal
Ireland
Italy
8.0
6.0
4.0
2.0
0.0
Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010
Source : Oxford Economics/Haver Analytics
Eurozone sovereign debt crisis
Eurozone: ECB lending to 'periphery'
€ billion
400
Ireland
350
Portugal
300
Spain
Greece
250
200
150
100
50
0
2007
2008
2009
Source : Oxford Economics/Haver Analytics
2010
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
‘North’ Eurozone’s trade exposure
Trade spillovers
North*
% total exports, 2007-09
Germany
10%
8%
6%
4%
2%
0%
South*
China
Source : IMF, Oxford Economics
UK
US
* North = Ger, Fra, Neth, Bel
* South= Spa, Gre, Por & Ire
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
 The Eurozone sovereign debt crisis will have a significant impact on
economic growth over several years, with this impact operating through a
number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and
investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone
states have been driven up by higher default risk and in some cases liquidity
squeezes have also taken place in the banking sectors of weaker states as
foreign funds have fled. These developments have driven up borrowing costs
and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling
growth prospects have also created negative wealth effects on business and
consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the
exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
 Set against these negative effects, there are also potential positives such a
lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by
investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
Eurozone: Exchange rates
Eurozone: Interest rates
%
6
Dec 30 2005=100
150
140
£/€
Dollar/€
5
130
4
120
3
110
2
100
Nominal effective
rate
90
Dec- Jul-06 Jan- Jul-07 Jan- Jul-08 Jan- Jul-09 Jan- Jul-10
05
07
08
09
10
1
Bunds
(10-year yields)
Euribor
(3-month rates)
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Scenarios on the sovereign debt crisis
Baseline
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Eurozone muddles through
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Eurozone-Med*: Government bond yields
Germany: Government bond yields
%
7
%
6
6
5
5
4
4
3
3
2
2
1
Base
EZ Peripheral Crisis
*Greece, Portugal, Spain & Italy
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
1
Base
EZ Peripheral Crisis
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Peripheral Eurozone Sovereign Debt Crisis
Eurozone-Med*: GDP
Eurozone: GDP
% year
4
% year
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-4
-5
Base
*Greece, Portugal, Spain
& Italy
Base
-4
EZ Peripheral Crisis
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
-3
-5
EZ Peripheral Crisis
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Growth in peripheral EZ hit hard, limited contagion
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Growth in peripheral EZ hit hard, limited contagion
European Banking Crisis
Banks sell assets
and euro
plummets
European banks
face large losses
Credit conditions
tighten across
Europe
Interbank rates
rise
European Banking Crisis
Eurozone: Government bond yields
%
6
5
4
3
2
Base
1
EZ Peripheral Crisis
EU Banking Crisis
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
European Banking Crisis
Eurozone: Interbank rates
%
6.0
Base
EZ Peripheral Crisis
EU Banking Crisis
5.0
4.0
3.0
2.0
1.0
0.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
European Banking Crisis
Eurozone: GDP
% year
4
3
2
1
0
-1
-2
-3
-4
-5
Base
EZ Peripheral Crisis
EU Banking Crisis
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
European Banking Crisis
US: GDP
% year
5
4
3
2
1
0
-1
-2
Base
-3
EZ Peripheral Crisis
-4
EU Banking Crisis
-5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
European Banking Crisis
World: GDP
% year
6
5
4
3
2
1
Base
EZ Peripheral Crisis
EU Banking Crisis
0
-1
-2
-3
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Growth in peripheral EZ hit hard, limited contagion
European Banking Crisis
Banks sell assets
and euro
plummets
European banks
face large losses
Credit conditions
tighten across
Europe
Interbank rates
rise
Europe falls into recession and global growth slows
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Growth in peripheral EZ hit hard, limited contagion
Global Financial Crisis
European Banking Crisis
Global credit
conditions
tighten
Dramatic rise in
financial market
stress
Banks sell assets
and euro
plummets
European banks
face large losses
Asset prices fall
further
Households and
businesses
retrench sharply
Credit conditions
tighten across
Europe
Interbank rates
rise
Europe falls into recession and global growth slows
Global Financial Crisis
Eurozone: Government bond yields
US: Government bond yields
%
6
%
6
5
5
4
4
3
3
2
1
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
2
1
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Global Financial Crisis
Eurozone: GDP
% year
4
3
2
1
0
-1
-2
-3
-4
-5
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Global Financial Crisis
US: GDP
% year
6
4
2
0
-2
-4
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
-6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Global Financial Crisis
World: GDP
% year
6
5
4
3
2
1
0
-1
-2
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
-3
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Scenarios on the sovereign debt crisis
Baseline
Peripheral Eurozone Sovereign Debt Crisis
Rise in investor
concerns about
medium- term
creditworthiness
Government debt
& deficits surge
in peripheral
Eurozone
Local banks cut
lending
Bank funding
costs and lending
rates rise
Rise in sovereign
spreads
Fiscal
consolidation &
IMF/EU support
Markets continue
to fear default
and sovereign
spreads surge
Other banks lose
confidence in
peripheral EZ
banks
Eurozone muddles through
Growth in peripheral EZ hit hard, limited contagion
Global Financial Crisis
European Banking Crisis
Global credit
conditions
tighten
Dramatic rise in
financial market
stress
Banks sell assets
and euro
plummets
European banks
face large losses
Asset prices fall
further
Households and
businesses
retrench sharply
Credit conditions
tighten across
Europe
Interbank rates
rise
All major economies slide into a deep recession
Europe falls into recession and global growth slows
Eurozone debt crisis scenarios
Alternative GDP growth forecasts
2009
2010
2011
2012
2013
-2.6
-4.0
9.1
-0.7
2.7
1.5
9.7
4.4
2.6
1.4
9.0
4.3
3.5
1.8
9.2
5.0
3.8
2.0
8.8
5.0
Peripheral Eurozone Sovereign Debt Crisis
US
-2.6
Eurozone
-4.0
China
9.1
World
-0.7
2.7
1.5
9.7
4.4
2.5
1.0
8.9
4.2
3.6
1.7
9.2
5.0
3.9
2.1
9.0
5.0
European Banking Crisis
US
Eurozone
China
World
-2.6
-4.0
9.1
-0.7
2.6
1.4
9.7
4.4
1.7
0.0
7.9
3.4
2.9
1.2
8.6
4.4
3.9
1.6
9.4
5.0
Global Financial Crisis
US
Eurozone
China
World
-2.6
-4.0
9.1
-0.7
2.5
1.3
9.6
4.2
-0.9
-1.2
5.4
1.8
0.0
-0.4
5.8
2.4
3.4
0.9
9.5
4.4
Oxford Forecast
US
Eurozone
China
World
Policy response to Eurozone debt crisis
Eurozone: Refi rate
%
4.5
4.0
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
US rates in Eurozone debt crisis scenarios
US: Fed Funds rate
%
6
Base
EZ Peripheral Crisis
EU Banking Crisis
Global financial crisis
5
4
3
2
1
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Oxford Economics
Outlook still highly uncertain
Corporate recovery
Oxford forecast (45%)
■ Gradual rise in business confidence
encourages corporates to invest
■ But weak banks combined with excess
capacity limit scale of investment
recovery
■ Consumer spending recovery limited
by pace of job growth and fiscal
retrenchment
■ But recovery strong enough that fiscal
crisis remains contained
Renewed crisis (10%)
■ Threat of double-dip means renewed
slump in asset prices as Eurozone
sovereign debt crisis re-emerges
■ Pressure to cut budget deficits rapidly
in all major economies
■ Rising unemployment and business
failures feed back into banking
■ Limited scope for monetary policy
offset
Renewed global boom (20%)
■ Strong corporate liquidity feeds into new
investment boom
■ Faster growth boosts business and
consumer confidence, and trade
multiplier magnifies upturn
■ Bank balance sheets improve quickly and
credit growth resumes
■ Strong growth boosts tax revenues/cuts
social security payments, helping fiscal
consolidation
Sub-par recovery (25%)
■ Business optimism remains low and
corporates continue to hoard cash
■ Investment and job growth is modest as
capacity is underutilised
■ Monetary policy supports banking sector
but fiscal coffers are empty
■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a
stronger housing and consumer recovery
Financial sector recovery
New Basel III rules
 The new Basel III rules provide for tighter definitions of tier one
capital, increased liquidity requirements for banks and ceilings on
bank leverage.
■ Banks may only make up 15% of their tier one capital from ‘lower
quality’ items such as deferred tax assets, stakes in related institutions
and mortgage servicing rights
■ Liquidity – the rules propose the introduction of a ‘net stable funding
ratio’ to reduce banks’ reliance on short-term funding and minimum
liquidity levels specified based on a stress test involving a freezing of
financial markets for a given period
■ Leverage – the minimum tier one capital/total assets ratio set at 3%
(e.g. maximum leverage 33 times). Off balance sheet items and
securitisations must also be included but banks can net out derivative
positions
New Basel III rules
 The Basel Committee also proposes to increase bank minimum
capital requirements
■ Capital requirements for trading assets will roughly double by alteration
of risk weightings.
■ Minimum requirement for common equity will rise from 2% of riskweighted assets (RWA) to 4.5% by 2015. Minimum Tier 1 capital
(which includes other qualifying instruments) to rise from 4% to 6%.
■ On top of this a ‘capital conservation buffer’ of a further 2.5% of RWA
to be implemented by 2019 taking total common equity minimum to 7%
and Tier 1 minimum to 8.5%
■ A countercyclical capital buffer of 0-2.5% made up of common equity
also to be implemented for use as a macroprudential tool – this buffer
to come into effect in periods of excess credit growth.
Modelling the impact of bank regulation
Credit conditions
Official policy rates &
Government bond
yields
Interbank spreads
Lending spreads
Bank regulation
Lending rates
Household
Government
finances
Corporate
Liquidity
Capital
requirements requirements
Household
wealth/
equities
Consumer
spending
Housing
investment/
prices
GDP
Availability of
credit/other lending
criteria
Business
investment
Bank
levies
The costs of tighter bank regulation
 The potential costs and benefits of new regulations for the global
banking sector have been explored in a number of studies. Of critical
importance is the impact of bank regulation on lending rates and
estimate vary:
■ BIS: 1% rise in capital ratio raises loan spreads 13bp, new liquidity standards by
25bps.
■ The IIF claimed the Basel III rules outlined last December increase bank loan
costs by 130 bp in the US.
■ University of Harvard & Chicago studies – even a 10% rise in capital ratios
would only raise weighted cost of capital for banks by 25-35 basis points.
■ McKinsey estimates quite small rise in loan costs to the economy from the
Basel III changes - mostly around10-20 basis points, up to 50-60 for short-term
loans, covered bonds, illiquid securities.
 There are also benefits from reducing the risk of banking crises
Interest rate impact
Impact on interest rates of tighter regulation
%
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
Lending spreads
Policy rates
-0.8
US
Source : Oxford Economics
EZ
UK
GDP impact
World: Effect of bank regulations
% difference in GDP from base
US
With monetary policy
response
Without monetary policy
response
EZ
UK
-1.4
-1.2
-1
Source : Oxford Economics
-0.8
-0.6
-0.4
-0.2
0
Concluding remarks on bank regulation
 There is a wide variation in costs of regulation found by different studies reflecting
significant differences in underlying assumptions and model design.
 Some studies may over-estimate the impact. It is more expensive to fund assets with
equity than debt or deposits, so initially this implies higher bank funding costs and
loan rates. But –
■ Equity only accounts for around a fifth of the cost of a loan.
■ Lower bank riskiness from higher equity levels ought to reduce the cost of both
debt and equity
■ Competitive pressures from the non-bank sector might limit the pass-through
from bank funding costs to loan rates
■ The length of the transition matters – a rapid phase-in of new standards could
see balance sheet shrinkage by banks, longer one allows banks to accumulate
earnings and issue equity. Brookings Institute estimates US banks could raise
most of the extra capital needed by retaining two years’ earnings
■ Banks might settle for a lower ROE than previously, reducing the need to pass
on higher funding costs
■ Banks could cut administrative and other costs to increase profits
China: Growth slows but risks of a bust after the boom?
 We expect China to grow strongly as consumption picks up the
slack from weaker investment and the impact yuan appreciation,
while authorities successfully manage price pressures
 However, significant risks remain that could lead to a sharp
downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government
investment vehicles
China: Growth slows but risks of a bust after the boom?
 We expect China to grow strongly as consumption picks up the
slack from weaker investment and the impact yuan appreciation,
while authorities successfully manage price pressures
 However, significant risks remain that could lead to a sharp
downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government
investment vehicles
Government is reining in credit…
China: Inflation and money supply
% year
10
8
% year
M2: +6 months 45
Inflation
(LHS)
(RHS)
40
35
6
30
4
25
2
20
15
0
-2
M1: +6 months
(RHS)
10
5
-4
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source : CEIC
…leading to slowing investment growth
China: Total RMB loans and investment
% year
60
Investment in
fixed assets
50
40
30
20
10
RMB loans
0
1998
2000
2002
Source: Oxford Economics
2004
2006
2008
2010
China: Growth slows but risks of a bust after the boom?
 We expect China to grow strongly as consumption picks up the
slack from weaker investment and the impact yuan appreciation,
while authorities successfully manage price pressures
 However, significant risks remain that could lead to a sharp
downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government
investment vehicles
And slowing price inflation but is it heating up again?
China: House price inflation
%
25
20
Monthly rate
(annualised)
15
10
5
Annual rate
0
-5
-10
Jul-05
Source : CEIC
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
China: Growth slows but risks of a bust after the boom?
 We expect China to grow strongly as consumption picks up the
slack from weaker investment and the impact yuan appreciation,
while authorities successfully manage price pressures
 However, significant risks remain that could lead to a sharp
downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ Accumulation of non-performing loans following the credit boom
■ Contingent liabilities from lending to local government
investment vehicles
Official NPLs are low but vulnerabilities may lurk beneath
China: Non performing loans
%
RMB bn
2000
14
% of loans
(LHS )
12
1600
Value
(RHS )
10
1200
8
6
800
4
400
2
0
0
2005
2006
Source: CEIC
2007
2008
2009
2010
China: Growth slows but risks of a bust after the boom?
 We expect China to grow strongly as consumption picks up the
slack from weaker investment and the impact yuan appreciation,
while authorities successfully manage price pressures
 However, significant risks remain that could lead to a sharp
downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government
investment vehicles
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
Sharp fall in house prices in 2010 Q4 and 2011 Q1
China: House prices
% year
15
10
Base
5
0
-5
China loan crisis
-10
-15
-20
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
Contributes to credit crunch & weaker investment
China: Investment growth
% year
25
20
China loan crisis
15
10
Base
5
0
-5
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014
And subdued consumption growth
China: Consumption growth
% year
16
14
12
Base
10
8
China loan
crisis
6
4
2
0
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
Weaker domestic demand lowers import growth
China: Import Volumes
% difference from base
1
0
-1
-2
-3
-4
China loan crisis
-5
-6
-7
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014
China: A loan crisis triggered by housing collapse
 Authorities bring forward monetary tightening and introduce
further measures to slow over-heating in the housing market
 This bursts the bubble in the property market which leads to a
rise in non-performing loans in the banking sector
 Central government lowers current spending on health and
education and scales back investment
 Investment and consumption growth is weaker
 Imports decline sharply
 Emerging market premia rise and stockmarkets in Asia are
particularly affected, and global growth hit
…pulling down growth in Asia…
Asia: GDP growth
% oya
12
10
Base
8
6
China Loan
crisis
4
2
0
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014
…and in the US
US: GDP growth
% oya
5
Base
4
3
2
China Loan
Crisis
1
0
-1
-2
-3
-4
-5
2007
2008
2009
2010
Source : Oxford Economics
2011
2012
2013
2014