Tag Archives: PIGS (economics)

Italy And Spain Damage Investor Sentiment

Appetite for risk dissolved today in the face of yet more sovereign debt concerns and worrying economic signals. It was the two countries regarded as the safest of the “PIIGS” – Italy and Spain – that damaged sentiment, according to Markit Credit Research.

“With a general election in Portugal next month and local elections in Italy, political instability could yet create more spread volatility over the course of the year.”

Gavan Nolan

With Europe in a total financial chaos, without someone to lead the economic rescue operations, it’s no wonder investors are a bit sceptical. Another round of bad news sort of nailed the day in credits, Monday.

Late on Friday S&P placed Italy’s “A+” rating on negative outlook, citing the “heightened downside risks” in the government’s debt reduction programme.

Specifically, the agency highlighted the country’s weak growth prospects and the lack of political commitment to reducing the public debt burden (about 120% of GDP).

S&P did acknowledge that Italy’s budget deficit was smaller than the other peripheral euro zone countries, and that its banks have better quality balance sheets.

“These two factors help explain the relative stability in Italy’s spreads compared to the other peripherals,” credit analyst Gavan Nolan at Markit Credit Research writes in his Intraday Alert.

Adding: “Spain is not fortunate enough to be able to claim the same, and its economic problems are causing problems for the government.”

Over the weekend, the incumbent Socialist Party suffered a major defeat in regional and local elections, including the loss of strongholds such as Barcelona and Castilla La Mancha.

While a resounding defeat was expected, the result showed just how difficult it will be to maintain social unity in a time of austerity, Nolan points out.

There is talk of bringing forward the general election to this year, though this has been dismissed by prime minister Zapatero.

“With a general election in Portugal next month and local elections in Italy, political instability could yet create more spread volatility over the course of the year.”

The events in Italy and Spain temporarily took attention away from Greece.

“But the fate of the Hellenic Republic is central to how the debt crisis will unfold, and the uncertainty surrounding the country is set to shape sentiment until the denouement, whenever that may be,” Gavan Nolan writes.

The government met today to approve a fifth austerity plan, and there are reports that the EU and IMF will require them to quicken the pace of state assets sales in order to receive bailout funds.

“The country’s capacity to withstand yet more austerity is questionable and is only likely to heighten speculation around debt restructuring,” the Markit analyst states.

Away from the travails of the periphery, markets were also troubled by disappointing economic leading indicators.

The preliminary estimate of the Markit/HSBC China Manufacturing PMI showed that the world’s second-biggest economy is continuing to cool.

“The index dropped to 51.1 in May, a 10-month low, and added to fears that monetary tightening could lead to sharp slowdown,” Nolan comments.

Germany, another of the world’s growth engines, also saw its rate of expansion slow.

The Markit Flash Composite PMI came in at 56.4, still indicating growth but the lowest reading since October 2010.

“Signals that China and Germany are running out of steam will put even more emphasis on the US and the ISM number at the beginning of next month,” Gavan Nolan concludes.

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Middle East CDS Spreads Explodes

The spreads on middle east sovereign CDS spreads exploded yesterday, and is assumed to continue to widen today as protesters fueled by Mubarak’s TV appearance are about to make the situation even more unstable. And the contagion is now evident. The costs of insuring debt of several nations in the area is skyrocketing, indirectly affecting the European sovereigns.

“More spreads volatility can be expected as the story unfolds.”

Gavan Nolan

The Egyptian sovereign CDS spread jumped a whopping 30 basis points Thursday, hitting a record wide of 305 bp’s, and is now approaching the Portuguese level. The most critical part, however, is that the rising financial costs is spreading to neighboring countries and even affecting Europe.

The Egyptian CDS spread tightened a bit before Egyptian president Mubarak’s TV speech, on expectations that he would announce his resignation.

Well, he did the exact opposite, sparking a new wave of fury amongst the protesters and providing more uncertainty about the whole mid-east situation.

Egyptian sovereigns closed at 305 bp’s (+20), pumping the spreads on Tunisian CDS’ up to 188 basis points (+17) and the  Moroccan up to 188 basis points ((+21).

In addition the Bahrain spreads widened 13 bp’s to 245.

Lebanese CDS spreads closed at 348 bp’s, Saudia Arabia 120 bp’s and the Israeli at 139.

These nations are closing in on the Spanish and Portuguese levels – next stop is the Irish level, while it’s still some way to go before they reach the Greek level around 1.000 basis points above the German benchmark.

It is obvious the there’s a group of “PIIGS” forming in the Middle East, consisting of Egypt, Bahrain, Lebanon, Morocco and Tunisia.

I’ve been trying to find a suitable acronym, but I’m still working on it. Any suggestions?




One might also include Israel and Saudi Arabia who also are infected with a CDS level of 139 and 120, respectively.

Then we have:





Okay, I’ll stop now…..

Here’s some quote from Markit’s credit analyst Gavan Nolan commentary, Thursday:

“This morning Twitter was alive with rumors that Saudi Arabia’s King Abdullah was dead. This was swiftly denied by the Saudi foreign minister, who said that the King was alive and well in Morocco. Nonetheless, the idle speculation caused the oil price to spike upwards before it recovered on the denials. Saudi’s sovereign spreads also widened sharply and didn’t really recover, though it should be noted that it is quite an illiquid credit (Markit Liquidity Score of 3).”

“Trading was light in other MENA names (Middle East NAtion) but Israel also saw some modest tightening. But it is still unclear how the transition from the current form of government will develop, though we can be fairly sure that the army will play a major role; as it was always likely to. More spreads volatility can be expected as the story unfolds.”

“Did markets in Europe and North America finally sit up and take notice of the Egypt revolution? There was some improvement in risky assets late afternoon, though how much of this was due to Middle Eastern developments is debatable. The Markit iTraxx Europe opened wider and stayed there until the close. It broke out of the 95bp-97bp range, where it has been trading for most of February, before recovering towards the close.”

“Aside from Saudi Arabia and Egypt, European sovereigns were not without incident. This morning Portugal’s CDS spreads widened sharply after bond yields reached unprecedented levels. This in turn prompted the ECB to enter the market and buy Portuguese government debt, the first time it has intervened for a few weeks. The intervention was effective, at least partially, and caused peripheral spreads to come back in from their earlier wides.”

  • Markit iTraxx Europe 97bp (+0.75), Markit iTraxx Crossover 397.25bp (+2.25)
  • Markit iTraxx SovX Western Europe 170bp (+2)
  • Markit iTraxx Senior Financials 162.5bp (+4), Markit iTraxx Subordinated Financials 272.5bp (+2.5)
  • Sovereigns – Greece 829bp (+15), Spain 238bp (+3), Portugal 440bp (+11), Italy 173bp (0), Ireland 565bp (+5), Belgium 168bp (+3), France 90bp (+1)
  • UK 60bp (+1)
  • Egypt 335bp (-20), Tunisia 188bp (+17), Morocco 188bp (+21), Saudi Arabia 120bp (+12), Bahrain 245bp (+13), Qatar 98bp (+2), Lebanon 348bp (-7), Israel 139bp (+4)

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Europe In Debt (Part 2): Poisonous PIIGS With Toxic Lipstick

This is the second article in the in-depth analysis of the European economy by Satyajit Das at EVRO Intelligence. In this post Mr. Das takes  a closer look at the so-called PIIGS – a useful geographical clarification provided by European politicians and central bankers. However, besides Greece, no other nation accept this rather condescending classification. I suppose most of you is familiar with the term “putting lipstick on a pig”. Using this metaphor we can conclude that EU’s efforts to prevent these countries from financial default is like putting toxic lipstick on poisonous and contagious pigs – It just makes things worse.

“While Germany currently has opposed any expansion, it remains an option. Perversely, increasing the funding available to support troubled countries may signal that problems were imminent, with a resulting loss of confidence necessitating a bailout.”

Satyajit Das

European politicians and central bankers have provided useful geographical clarifications. Prior to succumbing to the inevitable, the Ireland told everyone that they were not Greece. Portugal is now telling everyone that it is not Greece or Ireland. Spain insists that it is not Greece, Ireland or Portugal. Italy says it is not in the “PIGS”. Belgium insists it was no “B” in “PIGS” or “PIIGS”.

EU pressure on Ireland to accept external “help” was to safeguard financial stability in the Euro area, as much as rescue Ireland. However, contagion is proving difficult to prevent.

Russian writer Leo Tolstoy wrote that: “All happy families resemble one another, every unhappy family is unhappy in its own way.”

The same applies to beleaguered European countries.

Communicable Diseases

Greece had a bloated public sector and an uncompetitive economy sustained by low Euro interest rates. Ireland suffered from excessive dependence on the financial sector, poor lending, a property bubble and an increasingly generous welfare state. Portugal has slow growth, anemic productivity, large budget deficits and poor domestic savings. Spain has low productivity, high unemployment, an inflexible labor market and a banking system with large exposures to property and European sovereigns. Italy has low growth, poor productivity and a close association with the other peripheral European economies.

Italy has recently started to rein in its budget deficit. The Italian banking system is relatively healthy but exposed to European sovereign debt. Belgium is really two ethnic groups that share a king and high levels of debt (about Euro 470 billion, 100% of GDP).

“Portugal, Ireland, Greece and Belgium are also small, narrowly based economies which increases investor’s risks. The countries have in common, very high and potentially unsustainable debt levels. They also have in common a reliance on foreign investors to purchase their debt.”

Contagion is transmitted through different channels.

The rising cost of borrowing increasingly makes high levels of debt unsustainable because of the cost of meeting interest payments. Eventually, countries lose access to commercial funding sources, which is what happened to Greece and Ireland. By the end of 2010, the cost of funds for the relevant countries had risen, in some cases to punitive levels. Greek debt is trading around 12%. Ireland trades at around 9.50%. Portugal trades around 6.60%. Spanish debt now trades at 5.50-6.00%, while Italy is trading close to 5.00%.

Rising rates result in unrealized losses on investor holdings of the debt. If EU/ IMF support is not available and the debt is restructured or defaults when it falls due, then this loss is realized.

This affects the profitability and potentially the solvency of investors or banks depending on the quantum of exposure or size of the losses.

“In total, banks have lent over $2.2 trillion to the PIGS. French and German banks have lent around $510 billion and $410 billion respectively. British banks have lent $324 billion to Ireland and Spain.”

The problem is compounded by complex cross funding arrangements. Spain, which may need financial support, has $98.3 billion exposure to Portugal as well as a $17.7 billion exposure to Ireland.

The risk of losses is not only on sovereign debt, but also increasingly on normal mortgages and loans affected by the deep recessions in these economies.

In December 2010, British bank Lloyds increased debt impairment charges to £4.3 billion for the year, almost 30% higher than expected, warning of a sharp rise in charges relating to its Irish loan portfolio.

Lloyds took a write down of £1.5 billion on Irish loans in the first half of the year and signaled similar losses in the second half. The announcement fomented concerns about RBS, which has the highest exposure to Ireland among British banks.

The final channel of transmission is less obvious.

Where stronger countries move to support the weaker countries, financing the bailouts affects their own credit quality and ability to raise funds. As concerns about the peripheral countries increased, interest rates for Germany and France, which would have to bear the burden of supporting others, rose.

“Europe increasingly resembles a group of mountaineers roped together. As the members fall one by one, the survival of the stronger ones is increasingly threatened.”

European leaders see markets as the cause of the problems. George Papandreou, Greece’s Prime Minister, spoke of “psychological terror” that traders were inflicting.

EU Commissioner Michel Barnier complained that traders were “making money on the back of the unhappiness of the people”.

Others variously blamed “wolf-pack markets”, hedge funds and credit ratings agencies.

But unsustainable levels of debt remain the heart of the problem.

Unpalatable Dishes

The EU and IMF are hoping that the bailouts of Greece and Ireland will restore market confidence.

In combination with stronger growth, greater fiscal discipline and domestic structural reforms, they hope that the fear of default or restructuring will recede. Eventually, the troubled countries will regain access to markets. The emergency facilities and support mechanisms will be gradually unwound.

While not impossible, the chances of this script playing out are minimal.

“A more likely scenario is that the support measures do not work and increasingly Portugal and Spain, initially, find themselves under siege.”

As market access closes, they too will need bailouts straining existing arrangements, necessitating new measures.

If Portugal (debt around Euro 180 billion) was to require assistance, then it will reduce the available funds in the existing EU’s bail-out mechanism. Spain (with debt of over Euro 950 billion) is simply too big to bail out using the present facilities.

Under such a scenario, available options include greater economic integration of the EU, expansion of existing arrangements or a decision to allow indebted countries to fail.

Greater economic integration would entail adoption of a common fiscal policy, encompassing strict controls on fiscal policy including tax and spending.

It could also include the issue of Euro zone bonds (“E-Bonds“) to finance member countries. Championed by Jean-Claude Juncker, Luxembourg’s Prime Minister and chairman of the Euro Zone finance ministers’ meetings, the E-Bond would lower borrowing costs for peripheral economies and facilitate access to markets.

Fiscal union would prevent default of over-indebted borrowers without necessarily addressing the fundamental problems of individual economies. The likelihood of greater fiscal union in the near term is limited, as it is unlikely that nations will surrender the required economic powers and autonomy.

The E-Bond proposal, for up to 50% of a State’s funding requirement, is unworkable given large differences in credit quality and interest rates between Euro Zone members of around 10%.

The E-Bond credit support structure would resurrect the ill-fated EFSF on a larger scale.

In any case, Germany takes the view that national governments should bear responsibility for their own decisions. Germany also opposes E-Bonds, as they would increase its borrowing costs. France’s early enthusiasm for E-Bonds seems to have diminished.

“The cost of full fiscal union is prohibitive, entailing between Euro 340 billion and Euro 800 billion, depending on the degree of fiscal imbalances.”

Much of this cost would have to be borne by Germany and other richer economies.

If Portugal and Spain experience problems, then in absence of a full fiscal union, the only available actions are further EU support or default.

There have been proposals to expand the EFSF/ ESM as needed.

While Germany currently has opposed any expansion, it remains an option. Perversely, increasing the funding available to support troubled countries may signal that problems were imminent, with a resulting loss of confidence necessitating a bailout.

The ECB can increase support for the relevant countries, in the form of purchases of bonds or financing Euro Zone banks to purchase them.

Interestingly, the ECB will increase its capital base, from Euro 5.76 billion to Euro 10.76 billion by end 2012, the first such increase in its 12-year history. The increase in capital allows greater support from the ECB, whilst providing reserves against potential losses.

In an extreme scenario, the ECB could simply print money, following the US Fed’s lead, to support its members, known technically as “unsterilized purchases”.

Such action may not be permissible under its existing rules, requiring amendments to EU treaties. It would severely damage the ECB’s already tenuous credibility and be resisted by Germany and other conservative EU countries.

“Extend and pretend” measures would allow orderly default or debt restructuring by some countries over time. It minimizes losses, controlling the timing and form of restructuring.

It would also minimize disruption to financial markets and solvency issues for investors and banks with large exposures.

“If the EU does not agree to fiscal union or continuing support, then pressure on Portugal, Spain, Italy and Belgium may reach a tipping point, making default or restructuring the likely end game.”

Satyajit Das

Presumably, existing programs, such as those for Greece and Ireland, would be suspended. Governments would announce debt moratoriums, defaulting on at least some debts and forcing write downs. This would be followed by a domino effect of defaulting countries within Europe.

The richer nations would still have to pay, but for the recapitalization of their banks rather than foreign countries.

By Satyajit Das

(Satyajit Das is a former derivative trader, and the author of the book; “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.”)


Read also: Europe In Debt (Part 1): Creating a Monster

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