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12 January, 2009

How much can small sovereigns borrow?
January 2009

Ciaran O’Hagan,
g @ g
+33 1 42 13 58 60
Head Paris Fixed Income Research


12 January.Slovenia €1bn (half the population) 1 2 . 2009 How much can small sovereigns borrow? The simplest answer: there is no real constraint As of Dec 2008 ÎIreland’s borrowing will always be small on a European or global scale Borrowing will always look small. €18bn. to . th Compare Ireland.Greece €35bn (four times the population) . even if on an unsustainable t i bl path.

We emphasise the simplicity of such a table on its own. 12 January. 2 4000 maybe 3 years 3500 But not indefinitely 3000 Are there any signs 2500 of Ricardian 2000 equivalence yet? 1500 1000 500 0 US GB AT B FI F D GR IR I NL PO SL SP Net instead of gross would disfavour Ireland on a relative basis. 2009 Unprecedented borrowing per capita Gross debt issued per capita . Excludes variable rate bonds and bills. Based on forecasts in SG Outlook 2009.Ireland now in the lead 5000 € } 4500 Can lead 1. Conversion of USD and GBP figures to EUR at rates 7-Jan-2009. although lower the pc estimate to under €3500. 2 3 . and bonds sold/bought by central banks. and the uncertainty around the outcomes in 2009-10.

Lehman € guarantees Greece 180 Ireland G Greece 160 Italy 140 Sweden Ireland Spain 120 UK Italy 100 Belgium France 80 German 60 Belgium 40 France Germany 20 0 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Source: SG 3 4 . 12 January. 2009 5-year Credit Default Swaps AIG €.

2009 Irish bonds remain correlated to global risk measures ? Irish Bund asset swap (ASW) spread correlated to corporate CDS M h riskier Much i ki 1150 iT iTraxx €X X-over 140 Irish – Bund iTraxx. such as ASWs. even EM) Î Specific risk on Ireland still has not yet made that much an impression 4 5 . bp 2018. equities. (other risk aversion indicators work too. bp IRL Bund 10y 120 950 100 750 80 60 550 40 350 20 150 0 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Source: SG Î Global risk aversion can explain much spread widening. 12 January.

basis points Corps appetite Corporates GGBs European sovereigns caught in the middle Bunds of the fan Sovereigns Source: SG. 2009 Think of spreads as a part of a fan. As of September 2008 Risk aversion 5 6 . 12 January. or hierarchy Credit Curves Risk asset swaps.

2009 Irish bonds correlated to global risk measures ? Î Irish Bund asset swap spread (2018) is even a little correlated to emerging equities. EM equity EM Equity (MXEF) Irish 2018 Irish ASW -60 1250 inverted. 12 January. Irish less swap) spread vs. Irish asset swap (i. bp -40 1150 -20 1050 950 0 850 20 750 40 650 Equity 60 550 80 450 100 Nov Feb Jun Sep Dec Source: SG 6 7 . I would have expected a better relationship.e.

we saw another C factor became paramount Î Cashflow.g. LB LB. 12 January. … a ffunction ti off confidence fid 7 8 . cashflow hfl off BS BS. unbearable consequences .Binary … Confidence is there or not there. Cash difficulties were paramount in the financial failures of 2008 That lead to a dearth of Credulity Such factors pose large problems for economists. investors Î Trust Credibility Credence … Confidence of investors.Hard H d to t measure … e. … can evaporate quickly . investors … .Small probabilities. In 2008. AIG AIG. Credit Credibility. 2009 So how much can small sovereigns really borrow? There is no mystery… what counts are the big Cs Î Credit.

agency and corporate markets over 2008 was some €250bn. Î Throughout 2008 2008. Î It was as if all this “spare” cash fell into a black hole. Sad fact: Global DCM volume was $4. 2009 Market conditions determine importance of cashflow Sales of debt need buyers of debt If debt sales are to recover in 2009. for now 8 9 .to the eurozone government. eurozone redemptions ran well ahead of issuance Î The cumulative net cash available – but unused . with funds needing either to build up precautionary reserves or else to plug losses on their balance sheets (banks are large holders of bonds in Europe) Europe). investors will have to be present to buy the debt. down some 30% from ’07 (Dealogic) Great news: sales of debt is off to a better start in 2009.300bn in 2008. 12 January. Yet the past 18 months have seen 1) Precautionary savings rise sharply 2) A sharp increase in demand for cash to plug balance sheet losses. 3) Larger governments crowding out the smaller ones & private sector.

Restructure debt 9 10 . 2009 A few ways of avoiding cashflow problems Increase competitivity. 12 January. surrogate issuance Very very hard to see states in Borrow from non-market sources Creative accounting with ESA 95 Raise rates on domestic savings schemes } trouble. create wealth Spend less. tax more Privatise Diversify financing. raise productivity. Years likely before the worst arrives Raid domestic sources of cash Î Postpone payments: pay later Sovereign power far reaching Issue IOUs to suppliers Î Restructure debt = pay less up front A sovereign “A” appears far Transformation of credit risk: give guarantees stronger than a corporate “A” Use banks to source liquidity at the ECB Look for a bail-out or a bail-in Currency depreciation.

bonds.3. shall be given the same treatment by national central banks and the ECB as private credit institutions. regional. as shall the purchase directly from them by the ECB or national central banks of debt instruments. central governments. local or other public authorities. overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Community institutions or bodies. 2009 Can the ECB help out a sovereign in trouble ? The simplest answer: no TREATY ON EUROPEAN UNION: PROTOCOL on the Statute of the ECB Article 21 Operations with public entities 21. 12 January.1. The provisions of this Article shall not apply to publicly-owned credit institutions which. In accordance with Article 104 of this Treaty. and place them as collateral in Frankfurt? Would the ECB mind? Would others know or care? Is there a risk of a “bail-in”? How big might the bill become. other bodies governed by public law. in the context of the supply of reserves by central banks. or public undertakings of Member States shall be prohibited. But could banks buy state bills. 21. and who pays it? 10 11 .

Financial Stability Report 2007. page 41 11 12 . 12 January. the UK and Denmark score far less well. 2009 Europe sovereign risk measures – what is key ? Reinhart & Rogoff variables for other types of crises Use now … variables pertaining to household savings & indebtedness … mobilisation of domestic cash savings France. “Personal Savings Rates” Liquid personal savings hard to measure. Italy and Greece score well Ireland. ablility to mobilise is key anyway % 12 10 8 6 4 2 0 -2 FI DK UK IE NL SE PT ES DE BE IT FR Source: Central Bank of Ireland.

bad guarantees and unclear guarantees. Look deep at guarantees.Is timely payment likely or allowed for? .Is there a law or a regulation? How detailed is it? .Is the guarantee subordinate to government debt? . 2009 Are guarantees worth much ? There are good guarantees.Is any of the above written out? Can it be written out? etc.How easily can the guarantee be suspended? . Source: SG 12 13 .Can the guarantee be removed at a later stage? . Get your lawyers working .How is the guarantee Cooked or risk-weighted? . 12 January.Are the logistics in place to provision for same day? .

12 January. 2009 Attractive structuring of guarantees: France’s SFEF • Banks incentivised to loan to French economy State • Attractive funding. even for owns Explicit 34% guarantee small borrowers proceeds bond • Pooling creates liquid bonds SFEF bonds investors for investors • Master trust can live beyond guarantees SFEF • Attractive sovereign accounting Collateral Loans Firms & Banks Loans Households Source: SG 13 14 .

unforeseen . 2009 Weaker finances: more exposure to the unforeseen „ “Lower-rated entities are more exposed to external shocks”. 12 January. Moody Moody’s s „ The low probability of one very painful event can be discounted … harder to do for several low probabilities of very painful events 14 15 . S&P “AAAs AAAs are better able to withstand the unforeseen”.