IMF’s report warns of massive deleveraging by European banks

Italy has revised its numbers. GDP this year has been reduced to -1.2% (+0.5%, from +0.3% previously in 2013), from -0.5% previously, the budget deficit raised to +1.7% (-0.5%, from -0.1% previously in 2013), from +1.6%. The IMF suggests that the budget deficit will be -2.4% this year, and that GDP will decline by -1.9% for comparison purposes.
Mr Monti essentially is having a tougher time and over optimistic views as to his achievements will have to be tempered. Italy looks as if it is followed Spain in ignoring the German inspired “fiscal compact”. Well what a surprise – I think not. In coming months, the German prescription is going to be ignored – once again no surprise, it was lunacy in the 1st place and totally unachievable anyway;

The only EZ country that has met its targets is Ireland. The Irish finance minister reported that the country would meet it’s budget deficit target this year. He admitted that growth was “a little disappointing” YTD, though expects a pick up in the 2nd half of the year. Apparently, the authorities are E400mn ahead in terms of revenue collection;

The IMF suggests that 58 European banks will have to sell some US$3.8tr of assets in the worse case scenario. The baseline forecast suggests asset sales of US$2.6tr over the next 18 months. The relevant banks disposed of US$580bn of assets in the 4th Q 2011 and the IMF warned that European banks may dump 7.0% of their assets by the end of next year. Hmmm. The fund believes that credit supply will decline by -1.7% as banks reduce lending. They added that better policies would result in a smaller -6.0% reduction in bank balance sheets, with a positive +0.6% increase in growth as a result. If EZ officials failed to act, bank balance sheets would shrink by 10%, resulting in a -1.4% fall in EZ output and a global retrenchment in credit, as stress was transmitted to the US financial system through the derivative markets and the fire sale of assets. The IMF’s chief economist calls for a state funded bank recap scheme.

In addition, the IMF’s Global Financial Stability Report states that their assessment of the potential European bank deleveraging is much larger than suggested by the European Banking Authority (the “EBA”).
The EBA reported that European banks needed to raise just E115bn to ensure that capital ratios met their 9.0% threshold. Amusingly, the IMF reported that they had assessed a larger number of banks than the EBA had (the EBA reviewed just 28 banks) over a longer period and, in addition, examined the impact of market forces and funding stresses and not just the EBA’s focus on the need for additional capital. They summarise by reporting that their report is “driven by a range of structural and cyclical factors”, whilst the EBA’s exercise was merely to increase banks capital positions. Basically, the IMF is suggesting (in semi diplomatic terminology) that the EBA’s report is a load of …..No surprise there, the EBA’s report was a load of …..Whilst the IMF report was being circulated today, the head of the Bundesbank, Mr “Weirdmann” stated that the EFSF/ESM funds should not be used to recap European banks. Yes, he is the head of the Bundesbank, though I understand that a number of you believe he should seek another position. Forget Mr “Weirdmann”, the only question I have is how long, I wonder, will it be before the EFSF/ESM and/or the IMF resources are used for bank recaps – very likely sometime this year in my humble view.

Importantly, the continued relative strength of the Euro could well reflect European banks repatriating funds back home, following sales of assets, particularly in Asia. With Asia’s huge requirement for capital, this is undoubtedly going to affect economies in the region;

Deutsche Bank reports that the worst of the crisis is yet to come. The state that CDS’s imply that 4 or more European countries may suffer credit events. Perhaps Deutsche Bank should send the report to the Bundesbank and to Berlin;

Persistently higher inflation calls into question whether the BoE will undertake more QE. At present unlikely, but if the economy faces a set back, I have no doubt that they will, irrespective of the prevailing inflation rate;

Canadian central bank governor reported that inflation would remain near 2.0% through 2014. GDP growth was about +0.5% in the 1st Q and will be roughly the same through the year. Global uncertainties have less of an impact on Canada. Finally, he hinted that rates may well rise gradually through 2014. The FT reported today that he was approached to take over as governor of the BoE, following Mervyn Kings retirement – though the story was denied. Mr Carney stated that he was completely focused on his role – until…..?;

The US Environmental Protection Agency eased rules on pollution matters in respect of fracking till 2015;

Argentina’s nationalisation of Repsol’s YPF unit is causing a real push back from Europe. Spain has warned of a trade war and even the EU has expressed concern – EU foreign minister’s meet next Monday to discuss a response. I expect the nationalisation was mainly due to domestic politics, but this stupid ploy will backfire as investors equate Argentina to Venezuela. Mexico’s President has criticised Argentina. Repsol was in the process of selling its shareholding to China’s Sinopec;


European markets closed over -1.0% weaker today (ex the UK – just -0.4% lower), though Spain closed -4.0% lower, with Italy down -2.4%.
The Spanish 10 year bond auction will be watched tomorrow. US markets are just between -0.3% to -0.4% weaker.

The Euro has rebounded to US$1.3118, though Sterling is much stronger (US$1.6024), given the details contained in the BoE minutes.

Spot Brent continues to decline – currently just above US$117, with the spread to WTI declining to approximately US$15, from near US$25 recently.

Increasingly, I believe that EZ countries will back off the German inspired “fiscal compact” (“fiscal compost” some have suggested), either because they cant make it and/or because they they realise its a lunatic solution, especially if civil disorder rises. Its highly important to have fiscal constraint and reduced Government spending, but austerity without growth does not work – plain and simple. That will put Germany in an unenviable position, as she is consistently outvoted on the ECB etc, etc. With a lefter leaning France possible in coming weeks (though even a returning Sarkozy is unlikely to play ball
– will not be able to use “Merkozy” any more), the current German prescription is untenable. It will be fascinating to see what Germany does thereafter. If they leave the Euro (highly unlikely), the DM will become a supercharged Swissy, making German exports uncompetitive.
Jobs will be exported out of Germany to adjust for the stronger currency. Interest rates will decline even further though, and they will have to worry about deflation, rather than inflation. If Germany stays in, it will have to accept higher inflation and a lower current account surplus. That’s going to be difficult to sell to their voters.
Not easy for them, I must admit.

Interesting times.

Kiron Sarkar

18th April 2012

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