2011 Sovereign Credit Risk Outlook

Dagong Global Credit Rating Co., LTD
(January 27, 2011) Solvency of the central government is the embodiment of a country's overall economic strength; sovereign credit determines the trend of international credit relations1. Whether international credit relations are stable or not has a direct impact on the healthy development of the world economy. Since 2007, the evolution of the global credit crisis proved that the sovereign credit risk is the continuation of debt crisis in the financial and economic fields and that the sovereign debt crisis is the inevitable response of national economic recession and an advanced form of the credit crisis. Scientific forecast of the sovereign credit risk in 2011 is conducive to human society to grasp the law of development of international credit relations, and respond to the challenges of the sovereign debt crisis.

Review of Sovereign Credit Risk in 2010
The sovereign debt crisis of the United States and Europe in 2010 was the world's most significant sovereign credit risk event. To get rid of the sovereign debt crisis, the United States continued to implement quantitative easing monetary policy, which led to the violent shock of the international monetary and credit systems, resulting in the complete out-break of a world credit warfare. The drawing effect of strong economic growth in emerging creditor countries to the global economy and their continued buying of the treasury bonds of big debtor countries has prevented the sovereign debt crisis in developed debtor economies from getting into collapse. Emerging creditor countries were able to effectively stabilize the international credit relations and laid the credit foundation for the recovery growth of the world economy.

International credit relations mean the credit and debt relations between different countries,

with the subject of the relations including not only natural persons, and legal persons, but also government agencies.


Looking back at 2010, the state of credit risk development in the world shows the following five basic characteristics: 1. The basic layout of worldwide system of sovereign credit and debt is mainly comprised of the debt system of the developed countries and the credit system of the emerging countries The debt system of developed countries is made up of developed debtor countries. Developed debtor countries refer to the countries that has a relatively high level of government debt and net debt in both the absolute volume and relative volume (the ratio of total debt volume to gross domestic product), including: the United States, Japan, Germany, France, Britain, Italy, Spain, Austria, Belgium, Portugal, Ireland, Greece, Iceland, Canada and the Netherlands, the total size of all levels of government debt was about 39.5 trillion USD. The credit system of emerging economies is comprised of emerging creditor countries and regions. Emerging creditor countries and regions refer to the emerging countries and regions that have become the official creditors of the government debt of developed debtor countries due to the rapid increase in their foreign exchange reserves since the 1980’s and 1990’s, which are mainly in Asia and Latin America, including: China, Russia, Saudi Arabia, China Taiwan, China Hong Kong, India, South Korea, Brazil, Thailand, Indonesia, Singapore, Malaysia, Argentina and other countries and regions, which constitute the system of emerging economies credit system. These emerging countries and regions are the major big export countries characterized by the export-oriented manufacturing, energy and raw materials sectors. Embodied in the sovereign credit and debt layout is the situation as follows: the decline in the endogenic solvency of the developed debtor economies led to the increased demand for government debt. Whereas the growth of the economic strength of the emerging creditor economies made them the key external provider of government debt revenues for the developed debtor countries. Therefore the debt system of the developed countries is the main source of the global sovereign credit risk. 2. In the developed countries the financial crisis turned into a sovereign debt crisis, as the solvency of key debtor countries declined sharply This year risks in the financial sector still remained in developed debtor countries, but the crisis has become calm; and the governments have experienced 2-3 years of massive financial bailouts and economic stimulus, which caused the sovereign credit risk to significantly increase from before the


crisis. The developed debtor countries experienced gradual economic recovery in 2010, but the growth rate was very low, the nominal economic growth rate averaged only 2.7%, while the debt growth rate was high, reaching 10.9%, this is the third consecutive year that economic growth and debt growth are seriously out of line, this has led the governments to rely more heavily on financing income to maintain the financial operation, which will result in a further decline in solvency. In mid-2010 as well as at the end of the year two sovereign debt crises, happened in the eurozone, which resulted in Greece and Ireland being in need of official assistance; besides , they set Portugal and Spain, two other highlyindebted eurozone members exposed to even greater financing risks. The European Union temporary aid mechanism established for the purpose of assisting euro member states, although provided provisional relief from the crisis, yet due to deterioration and no significant improvement in macroeconomic fundamentals, the future sovereign credit risks of the eurozone countries will still be very fragile. 3. The United States, the world's largest debtor country used the US Dollar to distribute the output of debt, and waged a global credit warfare. After the United States indicated in August 2010 that it would launch a new round of quantitative easing monetary policy, capital accelerated the outflow from the United States, and transferred to emerging market countries, causing a new round of depreciation of the US dollar. Trends such as this had a strong impact on emerging market countries, large-scale international capital flows and international commodity prices rise led to currency appreciation, rising inflation pressure and asset prices in emerging market countries. The World Bank estimated that in 2010 the net flows of international capital into the stock market and bond market of developing countries increased by 42% and 30% respectively. The continuous devaluation caused by excess issuance of US dollars eroded the legitimacy of the global monetary system that takes the US dollar as the key reserve currency, bringing the US dollar’s credit-worthiness to a vulnerable position. The excess issuance of the US currency and the emerging market countries’ fighting in an effort to resist massive short-term international capital inflows and imported inflation are the signs of a global credit war. Credit war is the result of development of the debt crisis of an economic subject into the sovereign debt crisis phase; and it is waged by a country that issues international reserve currency; it aims at encroach on other countries’ interests through continuous depreciating the actual value of the currency; and it arouses all the countries in the world to take various credit resources as a financial weapon to


safeguard the national interests. 4. The emerging creditor countries’ powerful capability to create wealth was the catalyst to the stabilization of international credit relations In 2010, emerging creditor countries continued to lead the growth of the global economy, while exports continued to grow, the expansion of domestic demand led imports to rise faster, while the main emerging creditor countries such as China, Brazil and India, were the main source of growth in global trade and foreign direct investment, which contributed to the recovery of the global economy from the crisis as soon as possible, and getting it back to a steady growth path; at the same time that the subject of institutional investors in international sovereign bond markets – emerging creditor countries continued to hold the treasury bonds of developed debtor countries in 2010 prevented the sovereign debt crisis in developed debtor economies from getting into collapse, thus stabilizing the international credit relations and laying the credit foundation for the recovery growth of the world economy. 5. The credit risk of developed debtor countries damaged the healthy development of the world economy. The expansionary fiscal policy generally implemented in developed debtor countries during the financial crisis has played a positive role in stabilizing the financial system and preventing the economy from large-scale recession; however, as the government debt ratio increased significantly, and economic weakness became a normal state in the developed countries, sovereign credit risk become a destructive force to the national and global economy in 2010. First of all, the increasingly rising sovereign credit risk forced some developed countries to shrink the scale of fiscal expenditure in the second half of 2010; when it was difficult to improve the situation of private consumption and there was a decline in public spending for economic recovery, therefore the drawing capability of developed countries to global economic growth seemed less than before the crisis. Secondly, the quantitative easing monetary policy adopted by major developed debtor countries to sustain the economic recovery and ease credit risk gradually resulted in the following adverse trends in 2010: a rise in global inflation, rapid currency appreciation in emerging market countries and some developed countries alike, and appearance of asset price bubbles; and these tendencies were extremely detrimental to the healthy recovery and development of the global economy .


Outlook of Sovereign Credit Risk in 2011
In 2011, there is a large uncertainty in the sovereign credit risk of developed countries, and the overall debt servicing capacity of developed debtor countries is very vulnerable as there lack of fundamental measure for restoring economic growth in the debt system of the developed countries. The United States is the biggest sovereign debt crisis country, the declining trend of the national debt repayment intention triggered by the collapse of the United States actual debt solvency will not change, it will inevitably continue its quantitative easing monetary policy, which would escalate the world credit war, and the consequent global inflation and liquidity risk will exert noticeable impact to countries that depend heavily on external factors and have economic vulnerability. Debt crisis may occur to the developed economies that have the weakest solvency, such as Portugal and Spain. The debt situation of expenditure over income in developed debtor countries can be bound to drag down the world economy’s sustainable development. The strong wealth creation capability of emerging creditor countries and regions make creditor countries the important providers of financing income for developed debtor countries. They are bound to be the mainstay in stabilizing and reforming international credit relations. 1. The financing needs of the developed debtor countries will continue to rise, and debt income will remain the basis for stabilizing the credit relations of these countries In 2011, the financing needs of developed debtor countries will continue an upward trend. Dagong estimates that the total debt financing needs for developed countries will be over 26.5% of GDP, slightly higher than 26.2% in 2010 (see Table 1). Most of the debt financing needs of major debtor countries will exceed 20% of GDP of the year; the highest financing needs in Japan will be 57.8%. In 2011, the rise in the total financing needs of these developed debtor countries has increased their reliance on debt income in order to maintain financial sustainability and stability of the sovereign credit relationship. The key reason for the increased debt financing needs for developed debtor countries in 2011 is the increase in the debt maturity scale. After a peak in bonds for three consecutive years, the size of the debt due for major developed debtor countries will continue a higher trend after 2011. Major financing powers such as Japan, the United States, Germany and Spain have a large size of debt due in 2011 which is greater than 2010. Due to the fact that matured debt accounts for about two-thirds of the total debt financing needs of developed debtor countries,


which is the main factor in the increase of debt financing needs. The second reason for the increased debt financing needs for developed debtor countries in 2011 is that they generally proceed with fiscal policy adjustment in 2011, but different fiscal adjustment has resulted in the overall decline to be small. For developed countries, the average size of the deficit in 2011 is expected to fall from 8.0% (ratio of deficit to GDP of the year) in 2010 to 6.9% (see Table 2). The degree of deficit reduction in developed countries reflect the difference among different countries in the rate of increase in debt, financing conditions, the macroeconomic outlook and the difficulty of the deficit compression. After the outbreak of the financial crisis, the large-scale rescue of the banking sector leads to the significant deterioration in the economic situation, big and extended economic contraction for countries with fast increase in government debt such as Ireland, Spain, Britain, Iceland and other countries, and there will be more substantial fiscal adjustment in 2011. In addition, countries like Greece, Portugal, France and other countries have long been in a situation with high debt and weak economic growth, facing the pressure of deteriorating market financing conditions; they will also make significant fiscal adjustment. Except Greece that focused its adjustment in 2010, adjustments in other countries in 2011 will be 2% and above. For big debtor countries whose financing conditions are still fairly relaxed, the government is insufficiently motivated to cut deficit sharply,and the adjustment will be small, taking into account the importance of maintaining economic growth momentum and confidence in the ability of national financing, as in the United States; or takes uniform minor adjustments to practices, such as Japan and Germany. Meanwhile there are many countries that due to their structural deficit throughout the years, resulted in a higher scale of national government debt, although there was little increase in the temporary deficit after the erupt of the financial crisis, yet it is very difficult to decrease the structural deficit, so there is a slight decline in the deficit, such as in Italy, Belgium and Austria. In contrast, the debt requirement of developing countries is steadily declining. Except Central and Eastern Europe and CIS countries, developing countries gradually got rid of the negative impact of the financial crisis in 2010, economic growth contributed to improved financial situations. Most developing countries have made it clear that in 2011 there will be withdrawal of stimulatory fiscal policy, only to different degrees. Especially in emerging market countries, rapid capital inflows and inflation pressure will cause the expansionary fiscal policy to be withdrawn in great extent in 2011. In developing countries the average deficit is expected to decrease from 3.1% (ratio of deficit to GDP) in

2010 to 2.4% (see Table 2). According to the forecast of International Monetary Fund on 52 emerging economies, the needs of their government financing will drop from 9.75% of GDP in 2010 to 9% in 2011.

Table 1

2010-2011 Debt Financing Needs of Governments in Developed Debtor Countries 2010e Debt Maturity Fiscal Balance -4.6 -3.2 -2.5 -8.0 -4.5 -9.6 -10.9 -30.7 -5.1 -9.6 -6.0 -7.3 -9.3 -10.1 -10.6 Financing Needs 9.6 24.1 18.8 23.5 13.9 23.8 22.1 37.2 25.4 53.0 19.8 22.7 21.0 15.4 25.8 2011p Debt Maturity 2.6 18.5 13.2 16.0 9.3 18.8 21.2 6.2 18.2 48.9 13 16.2 14.0 7.5 18.3 Fiscal Balance -4.0 -2.4 -2.1 -6.0 -3.7 -7.4 -6.8 -14.7 -4.3 -9.2 -5.3 -4.6 -7.0 -7.5 -9.3


Financing Needs 6.6 20.9 15.3 22.0 13.0 25.5 28.0 20.9 22.5 57.8 18.3 20.8 21 15.0 27.6

Austria Belgium Canada France Germany Greece Iceland Ireland Italy Japan Holland Portugal Spain Britain USA Total Financing Needs

5.2 21.9 16.3 14.7 9.4 12.9 11.2 6.5 20.3 43.4 14.1 15.4 11.7 5.3 15.2







Source: IMF, Countries Ministry of Finance, Dagong Note 1: all the data are the percentage of absolute value to GDP, the total financing needs are the weighted average of the percentage value of all countries.. 2, e means the estimated value, p the predicted value.

Table 2

The World’s Major Financial Data 2011p 2010e 20.2 24.1 2009 19.5 23.4

Unit:Trillion USD % 2008 20.6 21.9 2007 19.3 19.5

Global Financial Revenue Global Financial Expenditure

21.5 25.1


Global Average Fiscal Deficit/GDP Developed Countries Average Deficit/GDP Developing Countries Average Deficit/GDP

-5.7 -6.9 -2.4

-6.3 -8.0 -3.1

-6.6 -8.1 -3.2

-2.2 -3.6 0.8

-4.2 -1.4 2.0

Sources:IMF、OECD、African Union、Countries Ministry of Finance、Dagong Notes:1, Estimated according to data from 150 countries. Includes: 30 countries in the Middle East, 44 countries in Africa, 32 countries in Latin America, 28 OECD countries, 6 countries in East and South Asia, 4 countries in Central and Eastern Europe. 2, e means the estimated value, p the predicted value. 3, the deficit rate is weighted average. 4, Developed and developing countries are defined by the same method adopted by the International Monetary Fund.

2. In 2011 the developed debtor countries, constrained by the macroeconomic environment of the debt system, lack of the basic conditions to improve their solvency, their actual solvency will be in an unstable state In 2011 global government debt levels will continue the trend of significant increase, but the growth rate will slow down compared with 2008-09. Dagong expects the global total size of government debt to GDP ratio to increase from 76.3% in 2010 to 79.6% in 2011, and debt growth rate to slow from 10.9% to 8.5% (see Table 3). The developed debtor countries that account for more than 90% of the global government debt are the driving force for debt increase. Government debt in develop countries is expected to increase from 94.9% of GDP in 2010 to 100.5% in 2011 while the level of government debt in developing countries begins to decline or remains relatively stable. It is difficult for developed debtor countries to reduce the deficit level, meanwhile, with the weak economic recovery the debt ratio will not be stable in the near future. The debt rolling pressure inflicted by high debt erodes a country's debt-enduring space, the actual solvency of the developed debtor countries will be in an unstable state. The main factors influencing its deficit and debt reduction process are: First, weak economic growth. In developed countries ever since the 1980s, financial liberalization policies have given rise to the continuous expansion of the scale of borrowing; the ever-increasing debt scale in government, financial institutions and the general public resulted in the over-expansion of the virtual economy. The outbreak of the financial crisis indicates that economic laws are playing their role in forcing developed countries to adjust the ratio between the real economy the virtual economy, so that a concordance can be regained


between the two; the whole process of deleveraging the economy is bound to reduce the domestic demand in the private sector, resulting in the correction of the abnormal economic expansion in the past. In this process, sluggish consumption and investment will become the norm, while the economy will experience a long period of low growth. In 2011, developed countries government expenditures will show an overall declining trend, the increase in the scale of investment by corporations is not sufficient to absorb the large number of the unemployed, private consumption is difficult to significantly rebound and the level of economic growth will be slightly lower than in 2010 at an expected rate of 2.2%. Sluggish economy will lead to decreased fiscal revenues, while high unemployment rate will result in increased social security spending, therefore, the deficit size will be increased even if no additional expansionary fiscal policy is adopted by the government. Second, financial aid is still needed. After 2010 there were less cases of direct capital injection into the financial sector by governments of developed countries . However, financial institutions still face the serious challenge of two types of risks. One is that the increased bad debts caused by the weak economic recovery challenges the bank's balance sheet; although the banking industry has been generally strengthened, the capital adequacy ratio is still insufficient. The US banking industry experienced a high rate of bankruptcy in 2010, while the possibility of a double-dip recession in the US real estate industry cannot be ruled out in 2011, and continued high unemployment makes it difficult for the bank failure to effectively decrease in the future. In the United States Freddie Mac, Fannie Mae and the Federal Deposit Insurance Corporation and other government-sponsored enterprises (GSEs) also need the support of the government's strong capital injection to survive. Another risk is that banks are facing impending financing pressures. The International Monetary Fund forecasts in the "Global Financial Stability Report" in October 2010 that in the next 24 months, the banking industry in developed countries needs to finance for 4 trillion USD worth of matured debts. The banking sector in developed countries rely on wholesale funding, especially European banks, wholesale financing (including loans from the European Central Bank) account for more than 40% of the total debt in the eurozone banking system; the structural weakness creates a greater liquidity risk for banks in the eurozone than those in the U.S., Japan and the United Kingdom. Ireland, Spain, Greece and other countries rely more instead of less on the liquidity support measures of European Central Bank. The prominent liquidity risk of the banking sector makes the government need to provide


guarantees on bank debts. For the foresaid reasons, the government can not withdraw from the financial relief measures; and the financial aid will still affect the size of government deficits and debts. Third, it is difficult to cut the structural deficits. During the process of implementing neo-liberalistic reform in the developed countries, tax revenue reduced significantly, but it is hard to effectively cut the expenditures on social welfare due to the pressures from various interest groups, resulting in longstanding structural deficits that became even worse and intractable after the drop of economic growth. In view of the existing high rate of tax burden, different countries currently tend to take one-off measures—cutting salaries of the public sectors and expenditures on social services instead of public investment and social security - to solve the issues regarding structural deficits, in an effort to reduce the adverse impact of fiscal adjustment on the economy to the minimum and reduce the resistance to the decision. Although many countries have initiated reform on pension fund system, there is still a long way to go to implement the overall reform of the social security system. According to IMF, it is estimated that the pension fund system reform already performed in the developed countries will make the predicted average expenditures on pension funds in those countries increase 1% of GDP in the coming 2 decades, rather than 3% before the reform. Nevertheless, the predicted growth in expenditures is still considerable, which requires further reform. Almost no country has made progress in medical system reform because it involves a wider range of interest groups and more difficulties exist during the reform process. In 2010, pension fund system reform was conducted in three countries, Greece, France and Spain where massive protests broke out from the public, giving a sign of difficulties in the reform. Given the foregoing reasons, the total liabilities of the developed countries will continue to rise in the coming 5 years, and consequently the solvency of those developed debtor countries will not be stabilized. The vulnerability of credit risks in the developed countries lies in the interest rate rise risk and financing risk, wherein the former comes before rupture of financing. The pressure on rising of interest rate in the major developed debtor countries is accumulating. An obvious sign for this is since December 2010, the yield of treasury bonds in major debtor countries such as the United States, Japan and Germany has shown an upward trend, reflecting an increasing concern of the market on the solvency of central government of those countries though the figure is still low, and the governments’


pressure on debt repayment will increase rapidly in case of inflation, reverse economic recovery or dumping of bonds.
Table 3 Global Governments’ Debt Data 2011p Global Governments’ Total Debt Global Government’s Total Debt /GDP Global Governments’ Debt Growth Rate Developed Countries’ Governments’ Debt /GDP Developed Countries’ Governments’ Debt Growth Rate Developing Countries’ Governments’ Debt /GDP Developing Countries’ Governments’ Debt Growth Rate Sources: IMF, OECD, African Union, Ministry of Finance of All Related Countries, Dagong Note: i) the figures in table 3 are calculated according to data of 125 countries, including 30 countries in the Middle East, 28 countries in the OECD, 20 countries in Africa, 32 countries in Latin America, 8 countries in East Asia and South Asia and 7 countries in Central and Eastern Europe and Commonwealth of Independent States; ii) ‘e’ means estimated number and ‘p’ means predicated number; and iii) debt burden rate is the weighted average value. 6.1 9.9 10.9 7.0 6.4 33.4 33.6 32.0 28.4 25.8 8.8 10.9 13.8 7.0 7.2 50.3 79.6 8.5 100.5 2010e 46.4 76.3 10.9 94.9 2009 41.8 71.9 12.9 89.0 Unit: trillion US Dollar % 2008 38.6 63.9 7.7 81.2 2007 34.1 62.4 6.9 75.7

Table 4

2010-11 Economic Growth and Debt Data in Developed Debtor Countries 2010e Economic Growth Rate Debt/GDP Net Debt/GDP 74.9 102.5 84.4 92.4 78.9 129.6 124.9 41.7 82.4 31.4 57.1 50.5 97.8 45.2 2011p Economic Growth Rate 1.4 1.4 2.6 1.6 2.6 -2.8 2.5 78.4 104.3 85.5 97.1 80.7 -138.1 116.9 Debt/GDP Net

Unit: %

Debt/GDP 43.2 84.2 33.7 61.8 50.3 106.5 45.7

Austria Belgium Canada France Germany Greece Iceland

1.5 1.6 3.1 1.7 3.4 -4.0 -3.1


Ireland Italy Japan Netherlands Portugal Spain England America

-0.2 1.0 2.8 1.8 1.8 -0.3 1.7 2.6

96.9 131.3 198.4 74.6 83.3 72.2 81.3 94.3

70.9 103.3 114.0 34.7 59.0 43.4 51.3 68.8

1.5 1.0 1.5 1.7 -1.5 0.7 2.0 2.3

105.7 132.7 204.2 77.6 89.6 78.2 88.6 99.0

75.3 104.7 120.4 37.7 63.8 49.3 57.6 70.9

Sources: OECD, Dagong Note: i) the economic growth rate refers to the actual number, and the debt data refers to t he debt of governments in different levels; and ii) ‘e’ means estimated number and ‘p’ means predicated number.

3. As the inherent factors affecting the sovereign debt crisis in the eurozone countries have not been fundamentally changed, sovereign debt crisis in the eurozone countries will be further intensified in 2011, with possible downgrade of sovereign credit ratings on Portugal and Spain Some debt-ridden countries in the eurozone still have fragile credit risks in 2011, including Spain, Portugal, Italy and Belgium. The debt crisis in the eurozone arisen from the crisis in Ireland might exacerbate again in 2011, although it was temporarily pacified after November,2010; because first of all, those countries’ macro economic situation has not significantly improved, and the economy may still be in recession or just realize slight growth in 2011, leading to slow fiscal revenue growth and difficulty in cutting deficits. Second, the financing requirements of the government in Greece, Portugal, Spain, Italy and Belgium will exceed 20% of GDP in the respective country, and their banking industries, at the same time, have considerable financing requirements. Because the banks hold a large amount of government debts, a negative feedback loop is formed between banks and government. Third, the excessively large size of external debts of those countries will increase the possibility of speculative dumping. Fourth, the dispute concerning the long-term solution to risks in treasury bonds in the eurozone countries makes investors worry about highly risky countries losing their credit guarantee. In case of bad macro economic performance in those countries, investors continue to buy the treasury bonds of countries such as Portugal based on their trust in Germany and France, two powerful countries in the eurozone. However, these two countries recently proposed to implement European Stability Mechanism (ESM), indicating that creditors might bear part of

the losses after 2013. This reflects the dilemma for the powerful countries in the eurozone while facing the conflict of domestic interest and interest in the eurozone in response to the debt crisis, which will not allow them to help the countries under crisis with their best efforts. In addition, the European Central Bank is prudential to conduct Southeast European Project (SEP), showing that the European Central Bank is not willing to purchase a large number of the treasury bonds of the brink counties in the eurozone as the Fed did. Dagong believes the key risk of the debt-ridden eurozone countries is rising of interest rate for financing in 2011, but there is still no default risk. The marginal rate of interest for financing in those countries may rise substantially in 2011, but given the historical low interest rate, the average interest rate for the government to repay the debt is still low, reflecting relatively small proportion of interest expenditure of the fiscal expenditure. In addition, with average long maturity of the government debt, those governments don’t have to repay the due debt in a concentrated period of time. As for those European countries with large debt, the international capital market only requires interest rate to be commensurate with its risk level, and they can still receive some financing support. However, this doesn’t mean those countries do not need the bailout provided by EU and IMF. On the contrary, more countries, such as Portugal and Spain, will have to ask for bailout in 2011 for the reasons of preventing debt crisis from spreading and endangering more countries. Accordingly, Dagong is considering the necessity of adjusting sovereign credit rating of both local and foreign currency on the foregoing countries. According to the current financial bailout package set by EU, the temporary bailout mechanism, totaling 750 billion euro including EFSF, could help some small countries under deepened crisis by meeting their financing requirements, such as Portugal, but can not withstand the potential risk events of countries systemically influential in the eurozone, for example, exacerbated fiscal status in Spain. The leading forces, including EU, European Central Bank and core member countries, need to make even greater effort in collaboration of series of intervention policies in 2011, to guarantee the fiscal sustainability in the eurozone countries, avoid spread of debt crisis and seek for effective solution under a more constructive policy framework, and consequently to maintain the healthy economic development in the eurozone and the vitality of euro. 4. The United States, as the biggest country involved in sovereign debt crisis around the world, will continue its quantitative easing policy when


the country is in danger, and the world credit war will be escalated due to the overflow of US dollars The second round quantitative easing policy ongoing in the United States can not change its weak domestic demand in the short term. In fact, it can only lower the interest rate of US Treasuries so as to maintain stable interest rate in the capital market in the long term, playing the indirect role of clearing some obstacles for a stable recovery. However, the plan of purchasing 600 billion US dollar Treasury bonds can not realize its predicted goal; and therefore, the United States will hardly change its predetermined monetary policy in 2011. The continuous implementation of such unconventional monetary policy in the United States will lead to the escalation of world credit war and inflict greater losses for related parties in the world credit system. First, the trend of long-term depreciation of US dollar will result in haircut of international creditors’ debts dominated in US dollar. As the interest rate of US government debt is lowered due to the quantitative easing policy adopted by the United States, creditors can not obtain the investment return commensurate with the risk status of US Treasuries. At the same time, the depreciation will also cause continuous exchange losses for the international creditors. Since June 2010, the US dollar has significantly depreciated compared with the currencies in emerging market countries and some developed countries, and the depreciation is 3.0% against RMB, 12% against Brazilian Real, 14% against South African Rand, 19.5% against Australian dollar and 11.4% against Korean won. The trend will continue in 2011, and international creditors will lose all their profits of the US dollars in exchange for the export income under the gradual depreciation of the currency. The behavior that the United States ignores international creditors’ legitimate interests indicates a dramatic decline of the country’s willingness to repay the debt. Second, rapid inflow of capital will cause risks regarding inflation and asset bubbles in the emerging market countries, which is unfavorable for those countries to maintain their debt repayment credit. As a result, emerging market countries, including some developed countries and regions with good economic recovery, will have to withstand the economic and financial impact arisen from the inflow of capital in 2011. If the capital inflow exceeded the capacity that the domestic economic and financial development can absorb, some of the capital will flow over in the real estate market, capital market such as stocks and bonds and some commodity market to raise the asset price in the domestic market and eventually accelerate the inflation. Most of the countries have transferred to

neutral monetary policies and will speed up the contraction of their monetary policies; however, due to the viscosity of the currency and imbalance of capital inflow in different industry, and yet the policies and measures will exert general restrictive effect on capital in the overall domestic market, the healthy development of the domestic economy will inevitably be damaged. Some Asian countries, for the purpose of eliminating the damage to the export in case of rapid currency appreciation, take some intervention measures, which bring increase of foreign reserves at a faster speed, and the consequent hedge cost is not favorable for the inflation control. While the capital retrieves quickly, the fall of asset prices will impose adverse impact on the robustness of the banks, domestic consumption and stability of the exchange rate. Third, the issuance of US dollar encourages numerous speculative capitals into the global commodity market, leading to an increasing pressure on global inflation. The quantitative easing policy conducted by the Fed in a continuous way failed to promote the expansion of domestic credit scale; rather, the liquidity accumulated inside the financial system, in addition to flowing to foreign markets, has been used for financial speculative investment, causing surge of prices of global commodities including energy, raw materials, and foods; and almost all countries, as a result, have suffered losses arisen from the imported inflation to different extent. In EU and the eurozone countries where see the slowest recovery, the annual inflation rate has increased to 2.6% and 2.2% respectively by December 2010, the figure for countries with serious inflation, such as Romania, Greece and Hungary, has reached 7.9%, 5.2% and 4.6% respectively. The anti-inflation measures make the weak economic recovery even worse. In general, the capital inflow and inflation pressure that emerging market countries are experiencing will, on one side, directly affect the governments’ capacity for repaying local currency debt from the perspective of its influence on the value of local currency, and on the other side, indirectly and more seriously threaten the governments’ credit based on its adverse influence on healthy development of macro economy and financial security. Currency system is the carrier of credit system, and therefore, the value of the currency determines the quality of credit system. International currency is the carrier of international credit system, and the instability of the currency value and the depreciation trend arisen from the over issuance make the function of the US dollar as the value scale distorted, which make other countries in the world pay an undeserved cost for their subsistence and development. The strike of shortterm capital dominated in US dollar to the emerging economics has made the

excess US dollar capital become the destructive factor to the healthy economic development in different countries. The international credit system established on the basis of US dollar as the intermediary has been twisted in a way that the impartiality and reasonable aspect of the current international credit relations gradually vanish. Different countries, in order to avoid unpredictable losses on their own interests, will have to seek for adjustment of international credit relations, and the global credit war, no doubt, will become the turning point of reforming international credit relations in 2011. 5. The credit risks of the developed debtor countries become the major destructive force for the world economic development The value production in the countries in the global debt system cannot catch up with the speed of debt growth, not only lacking of the material basis to reduce the debt, but also consuming the surplus of the creditor countries. Therefore, it is difficult for the world economy to recover from the crisis as soon as possible. In a long period after 2011, the credit risks of the developed debtor countries will constitute the major obstacle to the healthy development of world economy. From the perspective of the domestic economy in the developed debtor countries, they will have to adopt fiscal austerity policy under the circumstance of poor fiscal sustainability since 2011, but the negative growth of public expenditure thereof will slow down the economic recovery of the developed countries. Moreover, the indebtedness of the developed debtor countries will constitute the major obstacle to the development of their domestic economy in a relatively long period in the future. The debt remaining high for a long time will exacerbate the imbalance of the income allocation that capital owners will earn more interest income, the part of national income obligated to be allocated to ordinary citizens further reduces, and consequently weakening the consumption ability of the public. In order to maintain the sustainability of debt and promote economic growth, some super low interest rate policy is taken, which accelerate the outflow of capital and is unable to effectively increase the investment. Longstanding low interest rate and over issuance of currency will lead to the undesirable consequence that serious inflation may come before the full economic recovery. The GDP of the developed debtor countries accounts for 59% of global GDP, and the economic downturn in those countries ruins the ability of developing countries to gain national income from export. The extremely loose monetary policy taken in the major developed debtor countries, such as the United States, the eurozone, Japan and Britain, can not be


substantially changed in 2011, and the global excess liquidity caused thereof is a potential disaster for the developing countries with weak strength and economic vulnerability. The financial crisis occurred in Latin America and Southeast Asia in 1990s is tightly connected to the rapid inflow and outflow of short-term capital from the developed countries, the great damage suffered by countries in Central and Eastern Europe amid this financial crisis is also attributable to the same reason. One can reasonably judge that the new round of strike from hot money and global inflation will, as the less serious consequence, lead to stock turmoil, fall of housing price and economic slowdown in the emerging market countries and some developed countries, or as the more serious consequence, cause sharp depreciation of exchange rate, economic recession or even political crisis, especially in some countries in Latin America Central and Eastern Europe and Africa under fragile political and economic status. In addition, although inflation is not a problem for those developed countries who perform loose monetary policy, the global inflation risk is clear as driven by their monetary policies, and economic performance of most of the countries will be eroded by inflation in different degree in 2011. 6. The emerging creditor nations will maintain high economic growth, they are the backbone to promote the healthy development of international credit relations amid the unstable global credit system Emerging creditor countries resumed high economic growth after the financial crisis, playing an important role in driving the world economy. The emerging creditor countries are less seriously impacted by the global financial crisis on the ground that the governments can easily take measures to boost domestic demands due to relatively high saving rate so as to maintain high economic growth, which also make them the destination counties of the developed countries with fastest export growth. Those emerging creditor counties, though, face pressures on controlling inflation and rising of asset prices in 2011 and are predicted to realize a slower economic growth than that in 2010; they are still the countries with the fastest economic growth around the world. In order to stabilize the international credit relations, it is crucial for the emerging creditor countries to keep or even increase holding the treasury bonds of the developed debtor countries. The scale of the official foreign exchange reserves of emerging creditor countries still increased rapidly in 2010. It is predicted that in 2011, though the surplus of current account will continue to decrease, the scale of foreign exchange reserves will be enlarged at a relatively rapid speed because of the large-scale inflow of the capital. The emerging

creditor countries become the major buyers of the treasury bonds and government debts of the developed debtor countries by spending most of foreign exchange reserves on those bonds, which is of great significance to maintaining the developed debtor countries’ financing capability and helping them stabilize their domestic finance and stimulate their economic recovery. The emerging creditor countries will become the key to facilitate the healthy development of international credit relations. The situation that developed debtor countries rely on debt financing income for the operation of the countries will remain unchanged for a long time in the future; and they, who have vested interest in the current international credit relations, will not be motivated to promote its healthy development. However, the emerging creditor countries who are challenged by three negative factors, including low investment return, gradual depreciation of US dollar and rapid appreciation of their local currencies, will be motivated to drive the international credit relations to develop toward a fairer and more reasonable direction. The emerging creditor countries will make a clearer and more active effort in pursuing steady reform on international credit system in 2011. First, the continuous expansion of local currency capital markets in the emerging countries, especially the acceleration of globalization of RMB capital market, has shown that the emerging market countries are trying to get rid of the position of immature creditors and transfer to mature ones for bonds denominated in the local currency. Second, the emerging market countries will increase their foreign direct investment (FDI). According to the United Nations Conference on Trade and Development, it is estimated that the global FDI flows will recover with double-digit growth in 2011-12, among which the emerging market countries will become the engine for the growth of FDI, especially those in Asia.