Table of Contents: December 2009

Global Economic Recovery,

but Fiscal Crisis Remains
1. Where Is the Aaa-Aa Demarcation Zone? 4
2. Mapping the Near Future – Our Scenarios6
3. The “Vulnerable”, the “Resilient”
and the “Resistant”: A Reminder
4. Updates on the Four Largest
Aaa Countries
France
Germany
United Kingdom
United States
5. Updates on Selected
Other Aaa Countries
6. Special Focus: How Do We Measure Debt
Financeability?
Appendix: Debt Projections
Moody’s Related Research
2 Now that the worst of the financial and economic crisis appears to be behind us,
there are three major challenges facing the eight Aaa-rated sovereigns – France,
Germany, UK, US, Austria, Luxembourg, New Zealand and Switzerland – that are
discussed in this second issue of Moody’s Aaa Sovereign Monitor.
7
8 1. Some countries will struggle to deal with the very large fiscal imbalances and
8 accumulated debt that have resulted from the global crisis.
10
12
2. The sustainability of the recovery that now seems to have begun is open to
14
question. Economic growth will be an important factor in supporting (or not)
17 fiscal consolidation.
21 3. The currently abnormally low interest rates are unlikely to last, and will be
25 replaced by higher interest rates that will affect the affordability of the much
28
larger debt burdens that some Aaa governments now carry.

Analyst Contacts: In 2010, Aaa governments with stretched government balance sheets will be under
pressure to announce credible fiscal plans and – if financial markets start losing
London 44.20.7772.5454 patience – to start implementing them. This will complicate the recovery and test
Pierre Cailleteau political cohesion.
Arnaud Marès
Frankfurt 49.69.7073.0700 This report analyzes these challenges for the four largest Aaa governments and
Dietmar Hornung selected others with the help of detailed charts for each country. In addition, a
Alexander Kockerbeck special section at the end of this report discusses the concept of debt
“financeability” – a key characteristic that all Aaa governments are endowed with
New York 1.212.553.1653
– and the varying degrees to which Aaa governments are able to issue debt to
Steven Hess
Analytical Coordinator for this issue meet their financing needs.
Quarterly Monitor Moody’s Aaa Sovereign Monitor

Global Economic Recovery, but Fiscal Crisis Remains

The global economy has stabilized and is recovering from the recession. Eastern Asia (including Aaa-rated
Singapore) is recording the most rapid recovery. Three of the four largest Aaa-rated countries that are covered
in this Monitor also recorded positive growth in Q3. Indeed, the US and the Eurozone as a whole reported
increases in real GDP, although the Eurozone’s rate of increase was not impressive. However, the UK
economy continued to decline. Figures are not yet available for all other countries, but it appears very likely
that Australia’s growth was sustained, and Canada eked out a small positive increase during the quarter.

Nevertheless, questions remain about the durability of the recovery. The effects of the financial crisis and
global downturn on the fiscal and debt positions of Aaa governments are still unfolding and likely to be long-
lasting. Moody’s considers government financial strength – i.e. the future trajectory of the government’s debt
and its affordability – to be the primary and currently most crucial rating consideration for Aaa-rated
sovereigns. We believe that the other rating factors – economic and institutional strength as well as
susceptibility to event risk – continue to be supportive of the Aaa ratings of the 17 countries in this category.

Over the next year or two, the extent of the sustainability and strength of the recovery will become apparent.
The questions we will be seeking to address are as follows:

„ How much of the recent return to growth was due to the stimulus spending by governments and their
expansive monetary policies?

„ If the stimulus is removed, will growth be sustainable?

„ Has the crisis lowered the growth trend of some Aaa economies for an extended period?

The answers to these questions, in addition to actual fiscal policies, will be important in determining how and
whether governments can achieve fiscal consolidation or reverse their debt trajectories.

So, while the macroeconomic and financial-system crises may be close to an end, the fiscal crisis in a number
of Aaa-rated countries continues and will last for several years. In 2009, Moody’s has downgraded only one

Debt trajectories 2009-2013 - Baseline scenarios

Countries covered by the Dec. 09 Aaa Sovereign Monitor
0 20 40 60 80 100 120
0
Debt to GDP (%) Aaa Space
Interest payments to GG revenue (%)

Luxembourg
2

4
Switzerland
New Zealand Germany
6
Austria

France
8

UK
USA (GG)
10

Debt Reversibility Band

12

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

Aaa government: Ireland. The lack of rating actions on other Aaa countries indicates that, while most of these
countries have “lost altitude” within the Aaa space, they retain the characteristics necessary for a Aaa rating.

These characteristics include, among others, a high degree of “debt financeability,” “debt affordability,” and
“debt reversibility”. Moody’s approach to measuring debt financeability – i.e. the ability to raise debt without it
substantially affecting the cost of the debt – is the subject of a special section (page 21).

Debt affordability – which is best represented by the ratio of interest payments to government revenue – is one
of the biggest uncertainties going forward. In the graphs on individual Aaa countries shown over the following
pages, we have illustrated a range of possible outcomes for this ratio. Under some scenarios, this ratio could
reach problematic levels in the next few years in some countries. However, under the baseline scenario, we
still believe that the trajectory of the debt metrics, while unfavourable in the near term, does not currently
threaten the ratings.

The countries covered in this issue include the largest four Aaas – France, Germany, the United Kingdom and
the United States – which will feature in every issue of this quarterly publication. In addition, we have shorter
sections on four other Aaa countries: Austria, Luxembourg, Switzerland and New Zealand.

Overall, the European countries are characterized by potential contingent liabilities from their banking systems.
Indeed, Luxembourg and Switzerland have very large banking systems in relation to their economic size.
Moreover, the exposure of Austrian banks to Eastern Europe caused some concern at the height of the crisis
and may not have fully materialized yet. In the southern hemisphere, meanwhile, New Zealand’s banks are
mainly owned by strong foreign banks, but the size of the country’s (and the banks’) external liabilities have
also raised questions, now considerably alleviated, about the government’s contingent liability. It is worth
noting that Moody’s maintains negative outlooks on the banking systems of Austria, Luxembourg, and New
Zealand, reflecting uncertainty over possible losses and, therefore, the size of the contingent liability. This is
also the case with many other countries globally, although Switzerland’s system still has a stable outlook.

What To Find in This Report

This quarterly report sheds light on and puts into practice the conceptual framework Moody’s uses in analyzing
debt metrics in order to identify rating pressures on Aaa-rated governments. The report also contains a
number of updated data and analytical tools to dimension debt trends under different scenarios.

Section 1 presents our analytical framework and identifies the Aaa-Aa demarcation zone.

Section 2 briefly recapitulates our three scenarios, which differ in their assumptions in terms of economic and
financial recovery.

Section 3 recapitulates a way of categorizing Aaa countries as Resistant, Resilient, or Vulnerable

Section 4 focuses on the four largest Aaa countries (Germany, France, the UK and the US)

Section 5 briefly introduces recent and forthcoming developments in four other Aaa-rated sovereigns (Austria,
Luxembourg, New Zealand and Switzerland).

Section 6 (Special Focus) describes how we understand and measure the concept of debt financeability.

Appendix presents our debt projections in greater detail for the countries that are the focus of this second
issue of the Aaa Sovereign Monitor.

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

1. Where Is the Aaa-Aa Demarcation Zone?

This section summarizes our analytical approach to differentiating between Aaa and Aa sovereigns, developed
in the Special Comment Why Aaa Sovereigns Get Downgraded.

Moody’s approach is based on the following elements:

„ Governments are rated on the same scale as corporations or banks. However, governments are “special”
in the sense that they can improve their creditworthiness at the expense of other agents’ creditworthiness
– through taxation – and also because they can, in admittedly rare circumstances, influence the cost at
which they borrow. For instance, in the UK we recently saw the FSA requesting banks to buy more gilts to
manage liquidity risk and the central bank purchasing gilts.

„ The Aaa category does not have an upper boundary. A country can always become more creditworthy.
Therefore, the “altitude” of a government within the Aaa space matters. As a result, negative economic
and financial news does not necessarily have to translate into a rating downgrade – it could simply lead a
country to lose altitude within the Aaa category. For instance, in 2000 the US was clearly flying at a higher
altitude within the Aaa space than it had been in the early 1980s because of the debates about the risk of
the disappearance of federal debt and the rise in the country’s growth potential as a result of a productivity
shock.

„ This begs the question as to how much altitude a Aaa needs to lose for it cross the Aaa-Aa boundary?
Since the risk of an imminent default within the Aa range is no greater than it is in the Aaa range, the
distinction lies in the extent to which debt is an inconvenience rather than whether it would be intolerable.

„ Our preferred measure is debt affordability (DA) as it synthesizes both the size and the cost of debt. DA is
measured by the share of revenues that must be channelled to repay interest on debt. In extremis,
creditors may compete with the provision of elementary public services. Historically, countries with a DA
ratio in excess of 10% are characterized by a size and a cost of debt that affect policy choices – and they
therefore share the same attributes in terms of economic and institutional strength and susceptibility to
event risk. In other words, at this ratio, there is a debt problem – although within the Aaa range we expect
countries to have plenty of time to deal with it.

„ DA must be looked at in a dynamic way because, ultimately, a sovereign Aaa is not so much characterized
by low debt – although this can be the case of course – as by the ability to raise a lot of debt at a non-
punitive price in order to address a shock, and the subsequent ability to reverse such a debt increase.
These two characteristics are indicative of the level of the government’s balance sheet flexibility: high
financeability and high debt reversibility.

„ In other words, a Aaa government is a government that enjoys a sufficiently high level of balance sheet
flexibility to allow it to keep debt highly affordable through cycles and crises.

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One way of depicting the “distance-to-downgrade” is proposed below:

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

2. Mapping the Near Future – Our Scenarios

Moody’s debt scenarios combine two types of analysis:

„ a macro-economic scenario based on different economic recovery prospects 1 and

„ a financial stability scenario, based on different recovery prospects for the assets of the financial system
that are now held by governments.

We should note from the start that the size of the debt “problem” for the Aaa economies that are affected by
the crisis is still largely unknown. Indeed, while Aaa governments’ public finances are affected in the
“traditional way” (lower revenues, higher spending in a context of GDP contraction), the financial stability
operations in which governments have guaranteed or purchased assets and taken equity stakes in banks are
hard to evaluate. 2

While it would be an exaggeration to rate governments on the assumption that all these operations will result
in a total loss – after all, historical experience is much more nuanced – it would be too optimistic to imagine
that all this will be entirely neutral for public finances. The final cost, which does not have to be acknowledged
immediately as governments are not “marked-to-market,” will depend on the vigour of the economic rebound.

We have developed three scenarios by combining different assumptions about macroeconomic trends and
recovery prospects for financial assets. The precise data for the countries are to be found in the Appendix.

Table 1

Medium-term scenarios
Benign Scenario
(Green line with triangles on
the debt graphs)
Baseline Scenario
(Blue line with dots)
Economic Recovery Prospects
Same as Baseline
Central scenario: “hook-shaped”
economic rebound and moderate fiscal
adjustment
Financial Recovery Prospects
Financial stability operations are in the
end debt-neutral, i.e. the added debt in
gross terms is fully offset by a full
recovery of the assets acquired.
Financial stability operations add to net
debt, with recovery rates close to
historical experience (55% on fiscal
measures). Recovery time of 5 years.

Adverse Scenario Adverse economic scenario: lower More severe recovery assumptions: 30%
(Orange lines) growth (by 0.5% each year), lower fiscal on fiscal measures, recovery time
adjustment (primary balance lower by horizon: 10 years.
1% each year), higher interest rates*

1
See “On the Hook – Update on Moody’s Global Macroeconomic Risk Scenarios 2009-2010”, Moody’s Global Financial Risk Perspectives, May 2009.
2
Moody’s government liability map is explained in Moody’s Special Comment entitled “Not All Public Debt is the Same: Navigating the Public Accounts
Maze”, February 2009.
* In the baseline scenario, we consider the three-month moving average of the country-specific 5 year bond yield for 2009, to which we add 100 basis points
(bps) for 2010, and an additional 100 bps for 2011. In the adverse scenario, we add 100 bps in 2010, and an additional 100 bps in 2011 to the baseline
yield. The assumed increases refer to the market yield, not to the effective interest rate on the country’s debt.

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

3. The “Vulnerable”, the “Resilient” and the “Resistant”:

A Reminder
These three categories reflect Moody’s view that, while all Aaa governments were affected by the synchronized
global crisis, there were differences in the extent of the impact on each Aaa-rated country and its ability to
respond. Below we recap the key features of these three categories. Note that at present there are no
“vulnerable” Aaa governments, although Ireland was classified as vulnerable before being downgraded. There
are two “resilient” governments, the US and the UK. The rest of the countries are considered “resistant.”

RESISTANT
These are Aaa countries that started from a
comparatively robust position and/or are not undergoing
a lasting challenge to their economic model or facing a
massive risk of crystallization of contingent liabilities.
While resistant, they are clearly not immune. Debt may
increase, but not to the extent of stretching
affordability beyond a level consistent with a Aaa status.
The typical “resistant” Aaa is Canada. Germany and
France are also resistant, but clearly more weakened by
the crisis.
In the debt graphs, these are countries that remain
clear of the ”debt reversibility” zone in the
baseline scenario – and well below the top of that
zone in the unlikely adverse case.
RESILIENT
These are the Aaa countries whose public finances are
deteriorating considerably and may therefore test the
Aaa boundaries, but which display, in our opinion, an
adequate reaction capacity to rise to the challenge and
rebound. These countries are rated Aaa more because of
their balance sheet flexibility than because of
their current or projected debt levels over the next few
years.
The typical “resilient” Aaa is the USA.
In the debt graphs, we see a considerable
deterioration of debt metrics, which, in the adverse
scenario, may even exceed the top of the “debt
reversibility” zone. However, the low probability we
assign to the adverse scenario, combined with the
ample adjustment capacity, justifies the
characterization as “resilient”.

VULNERABLE
These are the Aaa countries whose public finances face
even greater challenges and seem to be stretched beyond
the point of ‘no return’ to the Aaa category. Time is
working against such countries and they are less likely to
retain their Aaa rating – however, they can nonetheless do
so if they display a 'back-to-the wall' adjustment capacity
that exceeds expectations. We are therefore monitoring
the near-term prospects in terms of debt reversibility.
The typical “vulnerable” Aaa was Ireland (prior to its
downgrade in July 2009).
In terms of debt graphs, “vulnerable” Aaa countries
have weaker debt metrics than "resistant" Aaas and
weaker debt reversibility capacity than "resilient" Aaas.

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

4. Updates on the Four Largest Aaa Countries

France: A Resistant Aaa

Growth Trend Now Positive, But Still Subdued

The French economy has absorbed the shock of the financial and economic crisis with less damage than
some of its peers, suffering a peak-to-trough contraction in output of “only” 3.5%. France’s growth turned
positive again in Q2 2009, at the same time as that of Germany and ahead of that of other large advanced
economies. It confirmed its timid recovery in Q3 with a further 0.3% increase, and now seems likely to remain
on a moderately positive trend throughout 2010. The resilience of the French economy is explained, on the
one hand, by its lower vulnerability to the features of this particular global crisis (e.g. lower reliance on the
financial sector than the UK, lower household indebtedness than in the US or Spain, lower reliance on exports
than Germany) and, on the other hand, by the measures taken by the government to support domestic
demand.

The large size of the government sector in the French economy has helped to cushion the shock initially, as
government expenditure is, if anything, counter-cyclical in nature. Automatic stabilizers have also played their
role fully. The public deficit has risen to an expected 8.2% of GDP in 2009, and is projected to further increase
marginally to 8½% in 2010, when an improvement in the central government’s position is expected to be offset
by an increase in social security deficits (impacted notably by the rise in unemployment, with a lag).

The very large size of the government sector in France is, however, a double-edged sword. On the one hand,
it benefits debt affordability in the sense that government revenues are large in comparison to those of other
countries with similar levels of public debt. On the other hand, it casts a shadow on the degree of debt
reversibility in France.

Fiscal Flexibility Constrained by Already Large Public Sector and High

Taxation Levels
As the government already levies a substantial share of the country’s resources, the ability to increase taxation
further without depressing economic potential is questionable. Indeed, the government’s 2010 budget does not
include an increase in taxation nor a significant adjustment on the expenditure side. Instead, it envisages rising
expenditure at a rate of 1% per annum in real terms (reducing only very slowly the ratio of expenditure to GDP,
from a very high level of almost 56% in 2009 and 2010).

This strategy implies that a reversal of the current erosion of debt metrics hinges disproportionately on an
acceleration of growth, above and beyond the 2% annual trend that prevailed prior to the crisis. This was
stated explicitly by President Sarkozy in his address to the Parliament in June 2009, when he rejected the
concept of a policy of austerity to reduce France’s public deficit and debt and instead outlined a policy of public
investment, with the aim of generating higher growth and therefore higher revenues over time.

The large size of the government sector in the economy is not supportive of this acceleration, since its
contribution to growth will be constrained by the cap on expenditure for several years to come. President
Sarkozy’s policy of public investments (known as the grand emprunt) may eventually contribute to enhancing
the economy’s potential, but Moody’s considers its size (1¾% of GDP) too limited and its net effect too
uncertain for it to improve the reversibility of France’s debt metrics. 3 Without such an improvement in debt
reversibility, the ongoing deterioration of government debt affordability will slowly erode the country’s (still
significant) “distance-to-downgrade”.

3
See Moody’s Special Comment “France’s Grand Emprunt: A Short-Term Cost for an Uncertain Long-Term Gain”, November 2009.

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

France: Moderate erosion in “distance to downgrade”

Distance to Downgrade - Main Scenarios Interest Rate Sensitivity

60 70 80 90 100 110 60 70 80 90 100
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

5 2008
5
2009 2010
6 2007 6 2007
2008 F
2011 2009
2010
7 2012 7
2011 2013 2011 B
8 8

9 9
2012
10 10
2012
S
11 Reversibility band 11 Reversibility band
2013
12 12
2013 VS
13 13
Aa Space Adverse scenario Benign scenario Baseline scenario Aa Space
14 14

Fiscal Adjustment Sensitivity Nominal Growth Sensitivity

60 70 80 90 100 60 70 80 90 100
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

5 5 2008
2008 2009 2010 2009 2010
6 2007 6 2007
2011 2011
7 7
2012 2012
VF 2013 VF
F F 2013
8 B 8 B
S S
VS VS
9 9

10 10

11 Reversibility band 11 Reversibility band

12 12

13 13
Aa Space Aa Space
14 14

Nominal Growth Fiscal Adjustment Interest Rate

Sensitivity Sensitivity Sensitivity
Uplift/Discount applied 2011 2011 2011
2010 onwards 2010 onwards 2010 onwards
VF Very Favorable +1%p +2%p -1%p -2%p - -
F Favorable +0.5%p +1%p -0.5%p -1%p -50bps -100bps
S Severe -0.5%p -1%p +0.5%p +1%p +100bps +200bps
VS Very Severe -1%p -2%p +1%p +2%p +150bps +300bps

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Quarterly Monitor Moody’s Aaa Sovereign Monitor

Germany: A Resistant Aaa

Relatively well placed to absorb the fiscal and economic shock, but
unemployment and banks may weigh on the recovery
Germany has been particularly hard-hit by the effects of the global recession because the shock has come
from exports, the main driver of its economic growth. At the same time, Germany seems better placed to
recover momentum than a number of other European countries whose economies are seriously impaired by
high private indebtedness and the collapse of over-inflated financial and construction sectors.

Germany’s real GDP is projected to grow by around 1.2% in 2010 and 1.8% in 2011. A rebound in exports
helped the German economy to bounce back in Q2 2009. Since this export recovery was boosted mainly by
global stimulus measures, its sustainability will be tested. The ongoing deleveraging of the private sector in
many countries will continue to constrain export growth potential. However, in light of Germany’s high cost
competitiveness – mainly based on former adjustment efforts in the aftermath of German unification – and its
expertise in supplying investment goods, the country should be well placed to benefit from a global recovery.

There are further factors that challenge Germany’s growth outlook. Private consumption and German banks’
financial strength remain potential constraints for a stronger economic recovery. The expected rise in
unemployment will weigh on private consumption in 2010 when companies will in turn be forced to align their
workforce with smaller order books. Government labour market support measures have so far delayed this
process. Moreover, the capital base of German banks has been substantially weakened by the financial crisis.
In addition, bank balance sheets face the risk of increasing losses in their loan books as a result of a potential
surge in insolvencies. Therefore, a further stabilization of the banking sector will be important to secure access
to finance for the corporate sector.

Germany’s debt affordability and reversibility expected to remain very

high, but further fiscal adjustment capacity will be tested
Germany entered the global recession in a relatively solid fiscal position, with a balanced general government
budget in 2008. However, as in many other countries around the world, the cost of adjusting to the crisis will
be high and a large portion of the burden will be absorbed by the public sector. Germany's government debt is
projected to rise significantly, approaching 80% of GDP by 2011 on the back of new borrowing, only moderate
economic growth and costly financial and economic stabilization measures. The coalition programme of the
new Christian-Liberal government seems to continue to prioritize economic support measures over fiscal
consolidation - at least temporarily. The programme contains further stimulus measures to provide (tax) relief
to households and enterprises and to increase public infrastructure investment. At the same time, automatic
stabilizers are allowed to fully operate. As a consequence, the general government balance will turn into a
deficit of close to 3% of nominal GDP in 2009. The deficit ratio is expected to increase to around 5% of GDP in
2010 and 2011, thereby further adding to a rising public debt ratio.

Germany and other highly rated sovereigns will not be able to rely on robust growth to help them reverse their
debt trajectories. Fiscal adjustment capacity, especially through expenditure control, will be of increasing
importance. In that respect, the recent decision to introduce a public "debt brake" to limit the structural deficit at
all levels of government is a supportive factor in terms of debt reversibility, provided the rules are observed.
The new fiscal rule is anchored in the German constitution and stipulates a ceiling of 0.35% of GDP for the
structural deficit of the Federal government as of 2016. The German Länder will be forced to present balanced
structural budgets as of 2020. These rules require fiscal consolidation from 2011 onwards. The government’s
ability to adhere to the rules will be tested, especially if tax and other support measures do not bring about the
targeted economic recovery. This also means that the government’s capacity and willingness to better control
expenditure will be further tested.

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Germany: Still well within Aaa space in all but severe scenarios

Distance to Downgrade - Main Scenarios Interest Rate Sensitivity

60 65 70 75 80 85 90 95 60 65 70 75 80 85 90 95
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

5 5
2009
2008 2009 2008 2009
6 2010 6 F
2010
2008 2010 2011 2011 2007
7 2007 7 2010
2012 2012
2013 B
2011 2011
8 2013 8

9 9
2012 2012 S
10 10
2013 VS
11 11
2013
Reversibility band Reversibility band
12 12

13 13
Aa Space Adverse scenario Benign scenario Baseline scenario Aa Space
14 14

Fiscal Adjustment Sensitivity Nominal Growth Sensitivity

60 65 70 75 80 85 90 95 60 65 70 75 80 85 90 95
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

5 5
2008 2009 2008 2009
6 2010 6 2010
2007 2011 2007 2011
7 VF 2012 7 2012
F VF
2013 F 2013
B B
8 S 8 S
VS VS
9 9

10 10

11 11
Reversibility band Reversibility band
12 12

13 13
Aa Space Aa Space
14 14

Nominal Growth Fiscal Adjustment Interest Rate

Sensitivity Sensitivity Sensitivity
Uplift/Discount applied 2011 2011 2011
2010 onwards 2010 onwards 2010 onwards
VF Very Favorable +1%p +2%p -1%p -2%p - -
F Favorable +0.5%p +1%p -0.5%p -1%p -50bps -100bps
S Severe -0.5%p -1%p +0.5%p +1%p +100bps +200bps
VS Very Severe -1%p -2%p +1%p +2%p +150bps +300bps

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United Kingdom: A Resilient Aaa

Inexorable deterioration of debt affordability as a long recession takes

its toll
The UK economy entered the crisis in a vulnerable position, owing to the (overly) large size of its banking
sector and the high level of household indebtedness. Both continue to weigh on economic performance. Net
bank lending to the UK business sector has continued to contract through Q3 2009, and repairs to household
balance sheets (i.e. the rising savings ratio) may weigh on demand for some time to come. Based on
preliminary data, the UK’s GDP has fallen for the sixth consecutive quarter, resulting in a cumulative
contraction of output by 5.9% so far from its peak. Other indicators, however, suggest that the UK economy
has already started to expand again, and will continue to recover throughout 2010.

The depth of the crisis has been mirrored by the ongoing deterioration of public finances (with gross debt/GDP
having risen from 44% at the end of 2007 to an estimated 69% at the end of 2009). It also raises considerable
challenges going forward, as the downward adjustment of potential output during the crisis will result in a
recurrent shortfall in tax revenues, which, if not compensated by a parallel adjustment in expenditure, would
leave the government with a permanent deficit. The structural public deficit, which was already in excess of 3%
prior to the crisis, now stands above 10% of GDP, according to the European Commission. The result, as
illustrated by the debt trajectory charts on page 13, is an inexorable deterioration of debt affordability in the
short term under almost all foreseeable scenarios.

Considerable debt financeability offers the government time to react

Against this background, the characterization of the UK Government as a “resilient” Aaa issuer is supported by
a very high degree of debt financeability and an equally high assessment of debt reversibility.

Over recent months, the UK Debt Management Office has issued inflation-linked gilts across the maturity
spectrum at real yields close to or even below 0.5%. As this is a very low yield in comparison to the medium-
to long-term growth potential of the economy (hence trend growth in revenues), very favourable funding costs
will (all other variables remaining equal) contribute to an improvement in debt affordability over time.

Demand for gilts has also been supported by the Bank of England’s quantitative easing operations (with £181
billion of gilts purchased since March – about the same as total government issuance over the same period).
This has been supplemented by regulatory pressure by the Financial Services Authority on banks to purchase
government bonds to build up liquidity buffers. While both measures only generate demand temporarily, they
contribute significantly to the ability of the government to borrow very large amounts on favourable terms. A
high degree of financeability does not substitute for fiscal adjustment, but offers the government time to
prepare and implement this adjustment.

Public consensus on the desirability of fiscal retrenchment suggests

genuine capacity to repair the damage
Moody’s assessment that the UK government exhibits a high degree of debt reversibility is supported by the
trend over recent months towards an apparent consensus among the public that fiscal retrenchment (including
cuts in expenditure) is both inevitable and desirable. This broad-based consensus is reflected in the stances of
the UK’s three main political parties towards fiscal policy going forward. It effectively increases the room for
fiscal manoeuvre of the government that will emerge after the general elections due to take place by June
2010, by which time economic recovery is likely to be more solidly anchored. While assumed capacity for
fiscal adjustment currently supports the maintenance of the Aaa rating of the UK government, this assumption
will have to be validated by actions in the not-too-distant future to continue to provide support for the rating.

12 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

The UK: Fiscal adjustment effort to test resiliency

Distance to Downgrade - Main Scenarios Interest Rate Sensitivity

40 50 60 70 80 90 100 110 40 50 60 70 80 90 100 110

2 2
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

4 4
2007 2008 2007 2008
2010
6 6
2010 2009 2010
2010
2009 2009 2011 2011 F
8 2012 2012 8
2013 2013 B
2011 2011
10 10
2012
Reversibility band Reversibility band 2012
12 12
S
2013
14 14
2013 VS
Aa Space Aa Space
Adverse scenario Benign scenario Baseline scenario
16 16
Fiscal Adjustment Sensitivity Nominal Growth Sensitivity
40 50 60 70 80 90 100 110 40 50 60 70 80 90 100 110
2 2
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

4 4
2007 2008 2007 2008

6 2010 6 2009 2010

2009
2011 2011
8 8
2012 2012
VF 2013
F 2013 VF F
B B
10 S 10 S
VS VS

Reversibility band Reversibility band

12 12

14 14
Aa Space Aa Space
16 16

Nominal Growth Fiscal Adjustment Interest Rate

Sensitivity Sensitivity Sensitivity
Uplift/Discount applied 2011 2011 2011
2010 onwards 2010 onwards 2010 onwards
VF Very Favorable +1%p +2%p -1%p -2%p - -
F Favorable +0.5%p +1%p -0.5%p -1%p -50bps -100bps
S Severe -0.5%p -1%p +0.5%p +1%p +100bps +200bps
VS Very Severe -1%p -2%p +1%p +2%p +150bps +300bps

13 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

United States: A Resilient Aaa

GDP growth is back, but how strong is it?

The US economy returned to positive real GDP growth in Q3 2009, following negative growth in five of the
previous six quarters. The annualized growth rate of 2.8% during Q3 was led by personal consumption, and
there is a question about the sustainability of this trend given the situation of household balance sheets.
Residential construction was also quite strong, and the large inventory of unsold homes indicates that this
factor is likely to fade in coming quarters.

The government’s stimulus plan appears to have been an important factor in the resumption of growth, and the
initial impact was primarily through tax measures. However, infrastructure spending will continue into 2010.
Nonetheless, it is uncertain whether the initial impact of the stimulus will wane. Overall, Moody’s expects the
rebound from the recession to be relatively modest compared to the patterns observed following previous
recessions. Real GDP growth of 2.0-2.5% in 2010 will undoubtedly help government revenues, but will not yet
be high enough to make major progress in reducing the budget deficit.

Debt rising to new highs

US federal government debt is rising rapidly. At the end of the last fiscal year (September 30), the ratio of debt
to GDP had risen to 53.5% from 40.2% one year earlier. However, it is notable that the ratio of interest
payments to government revenue declined from 10.0 % to 8.4%, despite the sharp rise in the debt
outstanding, a clear indication that US debt financeability is strong. By our measure, discussed in the special
focus article in this publication, it is the strongest of any country.

However, under our baseline case, which relies on figures in the government budget, federal government debt
and interest costs will rise considerably between now and 2012, with debt to GDP reaching 70% and interest
to revenue (affordability) climbing to 13%. Under an adverse scenario, which Moody’s does not consider likely,
debt affordability could become a problem as interest payments would exceed 18% of revenue - the historic
high for this indicator that was reached during the 1980s. As the graphs on the following page indicate, such a
scenario would also lead to a ratio of federal debt to GDP of around 80%, which would be by far the highest
level since the Second World War.

Recently, the announcement that Bank of America will redeem the $45 billion in government-owned preferred
shares means that recoveries under the Treasury’s Capital Purchase Program (part of the Troubled Asset
Relief Program), at about $115 billion, are now more than 50% of the amount initially purchased. Recoveries,
of course, mean that debt issuance to finance the budget deficit is less than it otherwise would be.

The forecast for general government debt (including state and local governments and certain pension
liabilities), which we use for international comparison purposes, is somewhat better on the affordability front,
with the ratio of interest payments to GDP remaining below 10% throughout 2010. This is comparable to the
ratios for large European Aaa-rated governments.

Next Year: A Fiscal Consolidation Strategy?

With the federal budget deficit at 10% of GDP in the previous fiscal year and a projected negative balance of
9.1% during the current fiscal year, it is clearly necessary to bring the deficit down to a sustainable level to
avoid an unsustainable upward trajectory in debt ratios in the future. The latest budget documents show the
deficit going down gradually to around 4% of GDP by 2015 and stabilizing at that level. Administration officials
have said that the next budget, which will be presented in February 2010, will include measures to reduce the
deficit to a lower level in order to prevent debt from reaching the levels implied by the current projections. A
credible fiscal consolidation strategy would reduce the risk of higher interest rates and therefore a major
deterioration in debt affordability that could come from a decline in confidence in financial markets. Without
such a strategy, the federal government’s interest payments could come closer to those in the adverse
scenario.

14 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

USA – General Government

Assessing debt reversibility will become important in coming years

Distance to Downgrade – Main Scenarios Interest Rate Sensitivity

60 70 80 90 100 110 120 60 70 80 90 100 110 120
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

6 6
2007 2010 2007 2010
2008 2008
2009 2010 2009
8 2011
8
F
2012 2011 2011
10 10
2013 B
2012
12 Reversibility band 12 Reversibility band
2012

14 14
2013 S
2013
16 16 VS
Aa Space Adverse scenario Benign scenario Baseline scenario Aa Space
18 18
Fiscal Adjustment Sensitivity Nominal Growth Sensitivity
60 70 80 90 100 110 120 60 70 80 90 100 110 120
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

6 2010 6
2007 2007 2010
2008 2008
2009 2009
8 2011 8 2011
2012 2012
10 VF 10
F 2013 VF 2013
B F B
S S
VS VS
12 Reversibility band 12 Reversibility band

14 14

16 16

Aa Space Aa Space
18 18

Nominal Growth Fiscal Adjustment Interest Rate

Sensitivity Sensitivity Sensitivity
Uplift/Discount applied 2011 2011 2011
2010 onwards 2010 onwards 2010 onwards
VF Very Favorable +1%p +2%p -1%p -2%p - -
F Favorable +0.5%p +1%p -0.5%p -1%p -50bps -100bps
S Severe -0.5%p -1%p +0.5%p +1%p +100bps +200bps
VS Very Severe -1%p -2%p +1%p +2%p +150bps +300bps

15 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

USA – Federal Government

Interest costs and interest-rate sensitivity are rising

Distance to Downgrade – Main Scenarios Interest Rate Sensitivity

35 45 55 65 75 85 35 45 55 65 75 85
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
6 6
In te re s t P a y m e n t / R e v e n u e (% )

2009 2010 2009

8 8 2010
2007 2010 2007
2009 2010
10 10
2008 2011 2008
12 12 F
2012 2011
14 14
2013 2011 B
16 16
2012
18 18
Historical High - Early 1990's Historical High - Early 1990's 2012
20 20 S
2013
22 22
2013 VS
24 24
Aa Space Adverse scenario Benign scenario Baseline scenario Aa Space
26 26

Fiscal Adjustment Sensitivity Nominal Growth Sensitivity

35 45 55 65 75 85 35 45 55 65 75 85
4 4
Aaa Space Debt/GDP (%) Aaa Space Debt/GDP (%)
In te re s t P a y m e n t / R e v e n u e (% )

6 6
2009 2009
8 2010 8 2010
2007 2007
10 10
2008 2008 2011
2011
12 12
2012 2012
14 VF 14
F VF F
B 2013 B 2013
16 S 16 S VS
VS
18 18
Historical High - Early 1990's Historical High - Early 1990's
20 20
22 22
24 24
Aa Space Aa Space
26 26

Nominal Growth Fiscal Adjustment Interest Rate

Sensitivity Sensitivity Sensitivity
Uplift/Discount applied 2011 2011 2011
2010 onwards 2010 onwards 2010 onwards
VF Very Favorable +1%p +2%p -1%p -2%p - -
F Favorable +0.5%p +1%p -0.5%p -1%p -50bps -100bps
S Severe -0.5%p -1%p +0.5%p +1%p +100bps +200bps
VS Very Severe -1%p -2%p +1%p +2%p +150bps +300bps

16 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor
5. Updates on Selected Other Aaa Countries
Austria and Luxembourg: Resistant Aaas
Recent and Forthcoming Developments
Debt
Austria The measures taken in 2008 to support
economic and financial markets
generated increases in gross general
government debt in relation to
nominal GDP. The general government
debt ratio is expected to rise to
around 77% of GDP in 2011 from a
level slightly below 60% in 2007. As in
the case of Germany, Austria’s
relatively solid public finances at the
beginning of the crisis offer
substantial room for manoeuvre and
shock absorption without
compromising the country’s very high
debt affordability. However, Austrian
banks’ substantial exposure to Central
and Eastern Europe caused market
concerns in early 2009. We have
emphasized that almost 75% of such
exposure resulted from business in
more advanced and integrated EU
countries. Furthermore, recent stress
tests run by the OENB seem to confirm
that increased provisioning and higher
capitalization mean increased loss
absorption capacity at the bank level.
Luxembourg Luxembourg’s debt was negligible at
the start of the crisis. Although the
rescue and recovery packages
implemented by the authorities are
likely to nearly triple the debt
affordability ratios (i.e. interest
payments/revenues of 1.5%), public
debt will obviously remain very
manageable at these levels. On the
other hand, an effective exit strategy
from recent stimulus measures – once
macroeconomic conditions improve –
would be needed to avoid entering a
vicious circle of high fiscal deficits
and fast-growing debt, especially in
view of the long-term spending
pressures stemming from an ageing
population.
17 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor
Growth
There are no important structural
imbalances in the real economy or in
government finances. Private
households are not particularly highly
indebted. The savings rate is high.
This means that the Austrian economy
does not face brutal adjustment needs
during the crisis. This is comparable
with the situation in Germany.
However, fiscal support measures will
gradually be phased out. The
production impulse from inventory
liquidation will also fade soon. As a
result, we only expect an anaemic
economic recovery for Austria’s small
and open economy, although this will
also depend on the German economic
cycle and world trade. There will
probably be no endogenous economic
growth in Austria before the end of
2010. Austrian real GDP is expected to
shrink by around 3.5 % in 2009 and to
grow at around 1% in 2010, mainly as
a consequence of substantial fiscal
action in Austria and abroad.
With a location in the centre of
Europe and the availability of a highly
educated, multilingual (including
cross-border) workforce,
Luxembourg’s economy has grown
more rapidly than the European
average, generating the highest per
capita incomes in the EU. However,
growth is likely to be constrained in
the future. The financial sector is
unlikely to reach its pre-crisis growth
levels for several years at least.
Moreover, cost competitiveness has
diminished, which is expected to
reduce the attractiveness of the
country as a business location.
Together, these are expected to lead
to a reduction in potential growth and
a further deterioration in employment
prospects.
Moody’s Aaa Sovereign Monitor
Fiscal Consolidation
Fiscal consolidation will probably not
happen before 2011/12 due to the
expected fragile economic recovery,
the extra spending to support the
economy and the substantial weakness
on the government revenue side. As a
consequence, the general government
deficit may head towards 4% in 2009
and reach around 5% in 2010 - a
substantial deterioration from a
nearly balanced position in 2008. As in
other Eurozone countries, the plan is
to let automatic stabilizers fully play
their role in 2009 and 2010, refraining
from substantial fiscal consolidation
to prevent pro-cyclicality during this
year and next. The government sees
no room for further tax cuts further to
the recent lowering of income taxes.
Instead, a broadening of the tax base
is targeted to secure government
revenues in the coming years. As in
previous years, fiscal consolidation
will have to focus on healthcare
spending and savings through reforms
in public administration.
Public revenues are highly sensitive to
the financial sector’s performance, so
a slow recovery of the sector would
likely keep the fiscal position in
deficit. Luxembourg’s old-age pension
obligations are particularly onerous
because of the high salary base and
the fact that cross-border workers are
also qualified to receive benefits. The
country’s small size and wealth may
help the authorities achieve a quick
and early exit from the stimulus
package, but some popular resistance
is expected when so many other
European countries are likely to
contravene the Growth and Stability
Pact for several more years.
Quarterly Monitor Moody’s Aaa Sovereign Monitor

Debt trajectories 2007-2013 - Austria

55 60 65 70 75 80 85 90
4
Debt to GDP (%)
5
2008
Interest payments to GG revenue (%)

2007
2009
6 2010
2009 2011
2010 2011 2012
2012 2013
7
2013
2011
8

2012
9

10
2013
11 Reversibility band
Adverse scenario Benign scenario Baseline scenario
12

Debt Trajectories 2007-2013 - Luxembourg

5 10 15 20 25 30
0
2008 Debt/GDP (%)
2007 2011 2010
2008 2011
2009 2010 2011
2 2009
2013 2013 2012 2012
Interest Payment / Revenue (%)

2013
4

10

Reversibility band
Adverse Scenario Benign Scenario Baseline Scenario
12

18 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor
New Zealand and Switzerland: Resistant Aaas
Recent and Forthcoming Developments
Debt
New Zealand Starting from a low level of debt, New
Zealand has experienced a major
change in its outlook for government
debt. The government has already
announced measures to deal with the
deterioration, but debt ratios are still
set to rise through 2013 under the
scenario laid out in the budget. From
17.5% in 2008, the ratio of debt to
GDP is forecast to more than double,
but there is a risk it could go even
higher. Nonetheless, these ratios are
still much lower than they are for a
number of other Aaa countries.
Switzerland Switzerland entered the economic
crisis with favourable debt metrics,
with general government debt at
40.9% of GDP in 2008. The
government’s support for the financial
system and three economic stimulus
packages has caused these metrics to
deteriorate, with interest payments to
general government revenue expected
to peak in 2010. Because the
government was able to sell its stake
in UBS profitably, the government was
able to blunt the impact of its bank
rescue on its finances, making their
deterioration relatively small as
compared to many other Aaa-rated
countries.
19 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor
Growth
The economy recorded positive
growth in Q2 2009 after five
consecutive negative quarters.
However, the growth rate, at just
0,1%, was not enough for the economy
to be out of the woods yet. A number
of important sectors in the economy
continued to contract. For Q3,
indicators including housing, retail
sales and net migration indicate that
momentum probably picked up a bit.
The growth outlook has improved for
2010, with expected positive growth
of around 3%.
Although the contraction in Swiss
growth is milder than that seen among
many of its Aaa peers, the country’s
economic recovery is expected to be
quite gradual in spite of the fiscal
stimulus and the central bank’s
quantitative easing programme.
However, business surveys and new
orders data indicate that the economy
may be turning a corner, although the
recovery is expected to be slow and
shallow and real GDP growth is
expected to remain largely flat in
2010.
Moody’s Aaa Sovereign Monitor
Fiscal Consolidation
Large operating deficits averaging
close to 5% of GDP are forecast to
characterize the 2010-2012 period,
before beginning a gradual decline.
Thus, fiscal consolidation will occur
only in the middle of the next decade.
This will depend on a pick-up in
economic growth as well as the
government’s ability to control
expenditure. Measures to increase
revenues may be necessary at some
point, particularly if economic growth
does not resume at a higher level.
The introduction of the debt brake
rule in the early years of this decade
meant that Switzerland entered the
crisis with a fiscal surplus. The deficit
will continue to rise in 2010 as further
stimulus measures are introduced;
these have required that an escape
clause in the debt brake rule be
invoked. In early November, the
Federal Council announced a
preliminary fiscal consolidation
programme for 2011-2013 that will
achieve around SFr1.5bn in annual
savings in order to unwind the impact
of stimulus measures on key fiscal
metrics.
Quarterly Monitor Moody’s Aaa Sovereign Monitor

Debt Trajectories 2007-2013 - New Zealand

20 25 30 35 40 45 50 55
2
2007 Debt/GDP (%)
2010
3
2008
2009 2010
4
Interest Payment / Revenue (%)

2011 2011
5
2012
6
2013
2012
7

9
2013
10

11 Reversibility band
Adverse Scenario Benign Scenario Baseline Scenario
12

Debt trajectories 2007-2013 - Switzerland

39 41 43 45 47 49 51 53 55
2
Debt to GDP (%)
3
Interest payments to GG revenue (%)

2007
4
2013
5 2008
2012
6
2011
2009
2010 2010 2011
7
2012 2013
8

10

11 Reversibility band
Adverse scenario Benign Scenario Baseline scenario
12

20 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

6. Special Focus: How Do We Measure Debt

Financeability?
In a previous Special Comment, we introduced our “Aaa debt triangle”, which reflects the interplay between its
three components: debt affordability, debt reversibility and debt financeability.

Debt financeability measures the ability of a government to raise a significant amount of debt in its own
currency in order to face a temporary shock, without paying punishing or even elevated interest rates. This
concept can be boiled down to the question of whether there is a likely demand for a sudden significant
increase in the supply of government debt.

This is therefore a forward-looking “measure” of financial flexibility – but one that does not lend itself to a
simple determination. The paragraphs below illustrate one way to approach the question.

By a “significant amount of debt”, we mean a level in the region of 10%-20% of GDP, which is consistent with
government borrowing requirements in periods of major financial crises, as we saw recently. When we refer to
“not elevated prices”, we mean raising debt at spreads close to long-term averages.

There are two key questions to in the assessment of financeability:

„ How large is the ability of the government to mobilize domestic financial savings?

On the domestic front, the questions are: (1) Is there a pool of savings that can be tapped? and (2) Can the
government effectively mobilize it?

One way to approximate the domestic demand 4 for government securities is simply to consider the stock of
the country’s financial assets. There are many indicators of financial depth; but here we choose to look at bank
deposits and bond market capitalisation. 5 An alternative is to deduct sovereign debt from the financial stock to
better capture the financial savings that are still untapped – we do this as an alternative in Chart 3 below.

As for the question of the capacity to mobilize resources, it is clear that this differs among Aaa countries: the
ability of governments to capture domestic savings to meet their debt issuance needs depends on the attitude
of local investors towards their government.

In some cases, trust is low so that the government cannot raise finance in its own currency. This is the so-
called ‘original sin’ that has plagued emerging market governments for a long time. To take this situation into
account, we marginally adjust a country’s financial stock by an indicator of “original sin” (foreign currency
denominated debt/total government debt) when the government borrows more than 30% of its debt in another
country’s currency.

At the other extreme, there are governments that find it easy to divert domestic savings toward their own
bonds (thereby possibly crowding out private sector debt issuance in the process) because of a significant
‘home bias’ among investors and a form of loyalty towards the sovereign. This is the case for Japan. This
home bias reflects societal characteristics that have not always been well identified and understood. Hence,
we adjust positively the country’s financial stock by an indicator of portfolio capital outflow variability; the idea
being that the home bias, or the inclination to buy government debt, can be approximated by a high level of
stickiness of capital (i.e. a low volatility of portfolio capital outflows).

In sum, and as reflected in the charts below, we adjust the country’s financial stock in two ways: negatively, by
an “original sin” factor when the government borrows in a foreign currency for more than 30% of its needs;
positively, by a “home bias” factor, as indicated by a low variability of portfolio capital outflows.

4
Note that, by focusing purely on savings or financial stock, we leave aside the important question of the ability of governments to create an “artificial”
demand for their debt - for instance, by getting the central bank to purchase debt or by altering financial regulation and requiring banks to hold more
government debt. This is undoubtedly an element of financeability: some countries can do it; others cannot do so without triggering a run on the currency…
However, much depends on the elusive concept of trust and credibility, so we do not attempt to measure it here.
5
We do not take equities into account because this skews the outcome in favour of large international stock markets, as it is unclear whether the funds they
attract could easily be redirected to government securities.

21 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

„ How large is the ability of the government to mobilize international savings in its own currency?

We address this question by trying to measure the extent to which an increase in debt can also be absorbed
by foreign investors - because the domestic funding currency could be an international currency or, better still,
an international reserve currency.

This concept in turn requires two levels of analysis: (i) whether international investors are naturally willing to
hold the currency of the government (we use the share of a country’s domestic currency in global foreign
exchange turnover as a proxy); and (ii) whether the bonds issued by the government are a natural investment
vehicle for their holdings of the currency,

For example, the dominant role (by far) of the US dollar as an international currency means that there is a
large structural demand for USD-denominated assets. The depth of the US Treasury market and the fact that
Treasuries are seen as the undisputed benchmark and safe-haven in the dollar market means that the US
government potentially has access to this larger pool of global savings. This magnifies the level of
financeability of the US government, as explained in the main body of this report.

German and French government bonds also hold the status of benchmarks in the euro market. Hence, these
governments benefit fully or largely from potential international demand for the euro and accordingly have high
levels of financeability – although less so than the US government, reflecting the relative international roles of
the dollar and the euro. The UK or Japanese governments, in turn, have a lower albeit still very high
financeability. Smaller countries with their own currencies generally have somewhat lower financeability.

There are also governments whose bonds are not undisputed benchmarks in their respective currency market.
This is particularly the case of euro area governments other than Germany or France. However, such
governments benefit from issuing their debt in a domestic currency that happens to be a large international
currency. Nonetheless, it would be illusory to conclude that this affords all EMU countries the same degree of
financeability as Germany, as was acutely illustrated by the recent experience of Ireland. In the chart below,
we have accordingly scaled down the scores of euro area governments commensurate with their status in the
euro capital market.

„ Illustration

The three charts below show how countries fare in the two dimensions explained above: the ability to mobilize
domestic savings on the vertical axis; and the ability to mobilize international savings in their own currencies
on the horizontal axis.

Chart 1 uses a linear scale for the two axes. This shows the significant degree of debt financeability of the US
compared with any other country because of the role of the dollar. The other countries are grouped at the
other side of the graph.

Chart 2 uses a semi-logarithmic scale to provide more granularity – but understates the superior financeability
of the US in terms of its ability to tap international savings. This graphs shows that, after the US, very high
levels of financeability are also enjoyed by Germany, Japan (Aa2), the UK, France, as well as by the
Netherlands and Italy (Aa2). Note that Japan’s very high degree of financeability allows it to keep debt
affordable despite the debt’s enormous size.

Chart 3 uses another way to calculate the financial stock: it deducts the public debt from the stock of financial
assets. In other words, it measures the stock of savings not already captured by the government and therefore
arguably better reflects the potential that governments have for raising further public debt. One striking
difference is Japan, which has already used much of its initial financeability, with the result that its residual
financeability - while still considerable - has declined.

22 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Chart 1 – The US and the others…

100
High ability to attract
D om estic R esource M ob ilisation C apacity 90 international savings

80

70

60
High ability to capture
domestic savings
50

40

30 United States

20

10

-
0 5 10 15 20 25 30 35 40 45 50
Ability To Tap International Savings

Chart 2 – Debt financeability (on a semi-logarithmic scale)

100
Russia
90
D o m estic R eso u rce M o b ilisatio n C ap acity

Slovakia

80

Brazil Mexico
70
Poland
60 India
South Africa
Singapore Hong Kong
50 China Finland
Greece
New Zealand Australia
40 Sweden Belgium
Korea Germany
Canada Austria
France
30 UK
Ireland CH Italy US
Portugal Spain
20
Netherlands
10 Japan
Denmark
-
0.1 1 10 100
Ability To Tap International Savings

23 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Chart 3 – Debt financeability from a more forward-looking perspective

100

Russia
D o m estic R eso u rce M o b ilisatio n C ap acity 90 Slovakia

80 Brazil
India
Mexico
70
Poland

60 South Africa Greece

Singapore Belgium
China Finland
50 New Zealand
Italy
Hong Kong Japan Germany
Korea Canada Austria France
40 Australia
Sweden UK US
CH Portugal
30
Ireland Spain
20 Netherlands

10

Denmark
-
0.1 1 10 100
Ability To Tap International Savings

Description of the Axis

X-Axis: Ability to Tap International Savings: Score from 1- 50 according to the country’s share of global foreign
exchange turnover. For the Euro countries, we weighted the Euro turnover according to the size of the
economy.

Y-Axis: Domestic Resource Mobilization Capacity: Score from 1-100 as a measure of financial depth (defined
as Private Sector Credit + Bond Market Capitalization + General Government Debt as % of GDP). We adjust
the score negatively if the ratio of foreign currency denominated debt to total government debt is above 30%
(indicator of “original sin”). We adjust positively the scores for countries whose ratio of FC denominated debt to
total government debt is below 30%, by the portfolio capital outflow variability (measured as the standard
deviation-to-average of the portfolio capital outflow over the period 1999-2009) as an indication of “home bias”.

24 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Appendix: Debt Projections

Debt Projections: Benign Scenario
Average
2004 to 2007 2008 2009 2010 2011 2012 2013
France Nominal GDP Growth 4.4 2.9 -0.3 2.4 3.1 3.8 4.1
Aaa/STA Budget Balance -2.9 -3.4 -8.2 -8.3 -7.8 -7.2 -6.7
Interest Rate 4.3 4.5 4.1 3.9 3.9 4.1 4.3
Debt/GDP 64.7 67.8 75.7 82.1 87.5 91.5 94.6
Intpaym/Revenue 5.4 5.7 5.9 6.2 6.5 7.1 7.7
Germany Nominal GDP Growth 2.9 2.8 -4.2 1.8 2.4 2.1 2.3
Aaa/STA Budget Balance -2.2 0.0 -3.0 -4.8 -4.4 -3.1 -2.2
Interest Rate 4.4 4.3 3.9 3.9 3.9 4.0 4.1
Debt/GDP 66.5 62.5 68.7 72.4 75.0 76.6 77.0
Intpaym/Revenue 6.4 6.2 5.7 6.1 6.4 6.9 7.1
UK Nominal GDP Growth 5.3 3.5 -3.5 2.6 5.9 5.4 5.5
Aaa/STA Budget Balance -3.0 -5.1 -12.1 -12.6 -11.0 -10.2 -9.0
Interest Rate 5.3 5.4 5.1 4.2 4.2 4.3 4.5
Debt/GDP 42.6 50.9 61.7 73.5 80.2 86.3 90.8
Intpaym/Revenue 5.1 5.4 6.9 6.5 7.1 8.0 8.7
US FG Nominal GDP Growth 6.0 2.6 -2.2 3.3 5.1 6.0 5.3
Aaa/STA Budget Balance -2.3 -3.2 -10.0 -9.0 -7.2 -4.7 -4.7
Interest Rate 4.6 4.9 3.0 2.7 3.0 3.5 3.8
Debt/GDP 37.2 38.9 50.8 63.0 67.1 68.0 69.3
Intpaym/Revenue 8.9 10.0 8.1 8.3 11.0 12.7 14.2
US GG Nominal GDP Growth 6.0 2.6 -2.2 3.3 5.1 6.0 5.3
Aaa/STA Budget Balance -3.2 -5.9 -12.0 -10.2 -8.2 -5.0 -5.4
Interest Rate 3.3 3.4 2.9 2.6 2.9 3.3 3.6
Debt/GDP 62.2 69.8 84.4 96.7 100.1 99.5 99.9
Intpaym/Revenue 5.8 6.3 6.6 6.8 8.2 9.2 10.2
Austria Nominal GDP Growth 4.9 4.1 -2.3 2.0 3.1 3.6 3.8
Aaa/STA Budget Balance -2.2 -0.5 -4.4 -5.4 -5.1 -5.0 -4.8
Interest Rate 4.7 4.4 4.5 4.4 4.3 4.4 4.4
Debt/GDP 62.6 61.8 67.4 72.2 75.1 77.5 79.5
Intpaym/Revenue 5.9 5.2 6.0 6.2 6.4 6.7 6.9
Luxembourg Nominal GDP Growth 9.8 5.0 -4.6 4.3 3.5 4.2 4.4
Aaa/STA Budget Balance 1.0 2.5 -2.2 -4.0 -4.1 -1.8 -0.7
Interest Rate 3.5 4.8 4.2 4.2 4.1 4.3 4.3
Debt/GDP 6.4 9.0 10.3 11.9 15.4 16.6 16.6
Intpaym/Revenue 0.5 0.8 1.0 1.0 1.2 1.6 1.7
New Zealand Nominal GDP Growth 6.2 0.9 2.1 4.8 4.5 5.7 5.5
Aaa/STA Budget Balance 5.0 2.9 -2.8 -5.0 -5.7 -6.4 -7.1
Interest Rate 5.3 5.3 5.5 4.9 5.6 6.2 6.8
Debt/GDP 27.3 25.5 27.3 33.4 37.7 42.0 46.9
Intpaym/Revenue 3.2 3.1 3.2 3.1 4.3 5.3 6.5
Switzerland Nominal GDP Growth 4.5 4.0 -0.9 1.1 2.1 2.3 2.5
Aaa/STA Budget Balance 0.0 -0.4 -2.9 -3.7 -2.7 -1.8 -0.9
Interest Rate 2.8 4.0 4.3 4.3 3.9 3.7 3.5
Debt/GDP 49.5 40.9 43.9 44.3 46.1 46.9 46.6
Intpaym/Revenue 4.1 5.3 5.9 6.1 5.5 5.3 5.1
Note: Interest rate refers to the effective interest rate on the country’s debt, not to the market yield. The cells shaded in
light green reflect a positive revision of Moody’s estimate compared to the forecast published in the September Aaa
Sovereign Monitor, the ones shaded in light red a negative revision.

25 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Debt Projections: Baseline Scenario

Average
2004 to 2007 2008 2009 2010 2011 2012 2013
France Nominal GDP Growth 4.4 2.9 -0.3 2.4 3.1 3.8 4.1
Aaa/STA Budget Balance -2.9 -3.4 -8.2 -8.3 -7.8 -7.2 -6.7
Interest Rate 4.3 4.5 4.1 3.9 3.9 4.1 4.3
Debt/GDP 64.7 68.1 76.1 82.5 87.8 91.8 94.9
Intpaym/Revenue 5.4 5.7 6.0 6.2 6.5 7.2 7.7
Germany Nominal GDP Growth 2.9 2.8 -4.2 1.8 2.4 2.1 2.3
Aaa/STA Budget Balance -2.2 0.0 -3.0 -5.0 -4.6 -3.3 -2.3
Interest Rate 4.4 4.3 3.9 3.9 3.9 4.0 4.1
Debt/GDP 66.5 65.9 73.1 76.7 79.1 80.3 80.3
Intpaym/Revenue 6.4 6.2 6.1 6.5 6.8 7.2 7.5
UK Nominal GDP Growth 5.3 3.5 -3.5 2.6 5.9 5.4 5.5
Aaa/STA Budget Balance -3.0 -5.1 -12.1 -12.9 -11.3 -10.5 -9.2
Interest Rate 5.3 5.4 5.1 4.2 4.2 4.3 4.4
Debt/GDP 42.6 51.8 68.6 80.3 86.4 91.8 95.5
Intpaym/Revenue 5.1 5.4 7.0 7.2 7.8 8.5 9.1
US FG Nominal GDP Growth 6.0 2.6 -2.2 3.3 5.1 6.0 5.3
Aaa/STA Budget Balance -2.3 -3.2 -10.0 -9.1 -7.3 -4.7 -4.7
Interest Rate 4.6 4.9 3.0 2.7 3.0 3.4 3.8
Debt/GDP 37.2 40.2 53.2 65.3 69.2 69.8 70.8
Intpaym/Revenue 8.9 10.0 8.4 8.7 11.3 13.0 14.5
US GG Nominal GDP Growth 6.0 2.6 -2.2 3.3 5.1 6.0 5.3
Aaa/STA Budget Balance -3.2 -5.9 -12.0 -10.3 -8.2 -5.0 -5.5
Interest Rate 3.3 3.4 2.9 2.6 2.9 3.3 3.6
Debt/GDP 62.2 71.1 86.7 99.0 102.2 101.2 101.4
Intpaym/Revenue 5.8 6.3 6.7 7.0 8.4 9.4 10.4
Austria Nominal GDP Growth 4.9 4.1 -2.3 2.0 3.1 3.6 3.8
Aaa/STA Budget Balance -2.2 -0.5 -4.4 -5.5 -5.2 -5.1 -4.9
Interest Rate 4.7 4.4 4.5 4.4 4.3 4.4 4.4
Debt/GDP 62.6 62.6 69.1 73.9 76.7 78.9 80.8
Intpaym/Revenue 5.9 5.2 6.1 6.4 6.6 6.8 7.1
Luxembourg Nominal GDP Growth 9.8 5.0 -4.6 4.3 3.5 4.2 4.4
Aaa/STA Budget Balance 1.0 2.5 -2.2 -4.2 -4.3 -2.0 -0.8
Interest Rate 3.5 4.8 4.2 4.2 4.1 4.2 4.3
Debt/GDP 6.4 13.5 15.0 16.4 19.6 20.4 19.9
Intpaym/Revenue 0.5 0.8 1.5 1.5 1.7 2.0 2.1
New Zealand Nominal GDP Growth 6.2 0.9 2.1 4.8 4.5 5.7 5.5
Aaa/STA Budget Balance 5.0 2.9 -2.8 -5.0 -5.7 -6.4 -7.1
Interest Rate 5.3 5.3 5.5 4.9 5.6 6.2 6.8
Debt/GDP 27.3 25.5 27.3 33.4 37.7 42.0 46.9
Intpaym/Revenue 3.2 3.1 3.2 3.1 4.3 5.3 6.5
Switzerland Nominal GDP Growth 4.5 4.0 -0.9 1.1 2.1 2.3 2.5
Aaa/STA Budget Balance 0.0 -0.4 -2.9 -3.7 -2.7 -1.8 -0.9
Interest Rate 2.8 4.0 4.3 4.3 3.9 3.7 3.5
Debt/GDP 49.5 40.9 43.9 44.3 46.1 46.9 46.6
Intpaym/Revenue 4.1 5.3 5.9 6.1 5.5 5.3 5.1
Note: Interest rate refers to the effective interest rate on the country’s debt, not to the market yield. The cells shaded in
light green reflect a positive revision of Moody’s estimate compared to the forecast published in the September Aaa
Sovereign Monitor, the ones shaded in light red a negative revision.

26 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Debt Projections: Adverse Scenario

Average
2004 to 2007 2008 2009 2010 2011 2012 2013
France Nominal GDP Growth 4.4 2.9 -0.3 1.9 2.6 3.3 3.6
Aaa/STA Budget Balance -2.9 -3.4 -8.2 -9.3 -9.3 -9.3 -9.5
Interest Rate 4.3 4.5 4.1 3.9 4.4 5.2 5.9
Debt/GDP 64.7 68.1 76.1 83.9 91.1 97.5 103.6
Intpaym/Revenue 5.4 5.7 6.0 6.2 7.5 9.5 11.5
Germany Nominal GDP Growth 2.9 2.8 -4.2 1.3 1.9 1.6 1.8
Aaa/STA Budget Balance -2.2 0.0 -3.0 -6.0 -6.0 -5.1 -4.7
Interest Rate 4.4 4.3 3.9 3.9 4.3 4.9 5.5
Debt/GDP 66.5 65.9 73.1 78.1 82.5 86.2 89.3
Intpaym/Revenue 6.4 6.2 6.3 6.7 7.8 9.3 10.7
UK Nominal GDP Growth 5.3 3.5 -3.5 2.1 5.4 4.9 5.0
Aaa/STA Budget Balance -3.0 -5.1 -12.1 -13.9 -12.7 -12.6 -12.0
Interest Rate 5.3 5.4 5.1 4.2 4.7 5.4 6.0
Debt/GDP 42.6 51.8 68.6 81.6 90.0 98.2 105.3
Intpaym/Revenue 5.1 5.4 7.0 7.2 9.0 11.3 13.5
US FG Nominal GDP Growth 6.0 2.6 -2.2 2.8 4.6 5.5 4.8
Aaa/STA Budget Balance -2.3 -3.2 -10.0 -10.1 -8.6 -6.5 -7.0
Interest Rate 4.6 4.9 3.0 2.7 3.5 4.4 5.2
Debt/GDP 37.2 40.2 53.2 66.5 72.2 74.9 78.3
Intpaym/Revenue 8.9 10.0 8.4 8.8 13.6 17.7 21.8
US GG Nominal GDP Growth 6.0 2.6 -2.2 2.8 4.6 5.5 4.8
Aaa/STA Budget Balance -3.2 -5.9 -12.0 -11.3 -9.6 -6.9 -8.0
Interest Rate 3.3 3.4 2.9 2.6 3.3 4.0 4.8
Debt/GDP 62.2 71.1 86.7 100.4 105.6 106.9 109.9
Intpaym/Revenue 5.8 6.3 6.7 7.0 9.7 12.1 14.8
Austria Nominal GDP Growth 4.9 4.1 -2.3 1.5 2.6 3.1 3.3
Aaa/STA Budget Balance -2.2 -0.5 -4.4 -6.5 -6.6 -7.0 -7.3
Interest Rate 4.7 4.4 4.5 4.4 4.8 5.3 5.8
Debt/GDP 62.6 62.6 69.1 75.2 79.9 84.4 88.9
Intpaym/Revenue 5.9 5.2 6.1 6.4 7.4 8.7 10.0
Luxembourg Nominal GDP Growth 9.8 5.0 -4.6 3.8 3.0 3.7 3.9
Aaa/STA Budget Balance 1.0 2.5 -2.2 -5.2 -5.4 -3.4 -2.4
Interest Rate 3.5 4.8 4.2 4.2 4.6 5.4 6.0
Debt/GDP 6.4 13.5 15.0 17.5 22.2 24.7 26.0
Intpaym/Revenue 0.5 0.8 1.5 1.6 2.0 3.0 3.6
New Zealand Nominal GDP Growth 6.2 0.9 2.1 4.3 4.0 5.2 5.0
Aaa/STA Budget Balance 5.0 2.9 -2.8 -6.0 -7.0 -7.9 -9.0
Interest Rate 5.3 5.3 5.5 4.9 6.2 7.1 8.2
Debt/GDP 27.3 25.5 27.3 34.5 40.1 46.1 52.8
Intpaym/Revenue 3.2 3.1 3.2 3.1 4.9 6.6 8.7
Switzerland Nominal GDP Growth 4.5 4.0 -0.9 0.6 1.6 1.8 2.0
Aaa/STA Budget Balance 0.0 -0.4 -2.9 -4.7 -3.9 -3.3 -2.7
Interest Rate 2.8 4.0 4.3 4.3 4.2 4.5 4.7
Debt/GDP 49.5 40.9 43.9 45.5 48.7 51.1 52.8
Intpaym/Revenue 4.1 5.3 5.9 6.1 6.2 7.0 7.6
Note: Interest rate refers to the effective interest rate on the country’s debt, not to the market yield. The cells shaded in light
green reflect a positive revision of Moody’s estimate compared to the forecast published in the September Aaa Sovereign
Monitor, the ones shaded in light red a negative revision.

27 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Quarterly Monitor Moody’s Aaa Sovereign Monitor

Moody’s Related Research

Special Comments
„ France's Grand Emprunt: A Short-Term Cost for an Uncertain Long-Term Gain, November 2009 (121223)

„ Why Aaa Sovereigns Get Downgraded, September 2009 (119194)

„ Central Bank Exit Strategies May Gradually Exert Pressure on European Government Finance-ability,
November 2009 (121480)

„ Anchors in the Storm: Aaa Governments and Bank Bail-Outs, March 2008 (108164)

„ What Does It Mean To Be A Triple-A Sovereign?, May 2008 (109129)

„ When macroeconomic tensions result in rating changes: how vulnerable are EMEA Sovereigns?, May
2008 (109182)

„ Sovereign Defaults and Interference: Perspectives on Government Risks, July 2008 (110114)

„ The Unshaken Foundations of the U.S. Government's Aaa Rating, September 2008 (111526)

„ Banking Crisis: European Governments Take Calculated Risks With Public Finances - But No Rating
Impact Except for Iceland, October 2008 (111874)

„ Rating Sovereigns During a Global "Sudden Stop" in International Funding, November 2008 (112231)

„ Moody's Interprets Uncovered Aaa Government Bond Auctions, January 2009 (114012)

„ Dimensioning US Government Debt, February 2009 (114559)

„ How Far Can Aaa Governments Stretch Their Balance Sheets?, February 2009 (114682)

„ Not All Public Debt is the Same: Navigating the Public Accounts Maze, February 2009 (114612)

„ Rating Sovereign Risk Through a Once-a-Century Crisis, June 2009 (117727)

„ Are Sovereigns on the Road to Recovery?, July 2009 (119222)

Issuer Comments
„ Moody's: Germany Well Placed to Adjust to Challenges Posed by the Global Crisis, 10 September 2009

„ New Zealand Budget Raises Debt, But Aaa Rating Outlook Remains Stable, June 2009 (117684)

„ U.S. Treasury's Intention to Lengthen Debt Maturity Reduces Vulnerability to Interest Rate Shocks,
November 2009 (120978)

„ U.S. Statutory Debt Limit to be Raised; Longer-Term Fiscal Strategy the Real Question, September 2009
(120298)

„ Germany Faces Delicate Economic Rebalancing Act, May 2009 (117381)

Rating Methodology
„ Sovereign Bond Ratings, September 2008 (109490)

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication
of this report and that more recent reports may be available. All research may not be available to all clients.

28 December 2009 „ Quarterly Monitor „ Aaa-Sovereign Monitor

Report Number: 121362

Senior Associates Editor Production Associate

Annette Fratantaro Maya Penrose David Ainsworth
Cyril Audrin
Jose Abad

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