September 2012 Fall 2012 Eurozone crisis continues to

September 2012 Fall 2012: Eurozone crisis continues to dominate Presented by Simon Derrick Information Security Identification: Confidential

Key events through until the November elections • October 3 rd • Televised debate between President Barack Obama and Mitt Romney on domestic policy October 4 th • ECB Governing Council meeting in Ljubljana concludes • BOE MPC meeting concludes October 8 th • Troika review regarding bailout disbursement to Greece to be presented at the Eurogroup meeting in Luxembourg October 9 th/14 th • Annual meeting of IMF in Tokyo October 11 th • Televised debate between Vice President Joe Biden and Congressman Paul Ryan on domestic & domestic policy October 16 th • Televised debate between President Barack Obama and Mitt Romney on foreign & domestic policy October 18 th/19 th • EU Summit in Brussels October 24 th • FOMC meeting concludes November 6 th • US Presidential and Congressional elections Information Security Identification: Confidential

Greece: make or break (again…) • The Finance Ministry’s latest projection are that State cash reserves will last until the middle of October. (Kathimerini August 24 th) • Greece therefore needs to get the EUR 31. 5 Bn due in the next tranche of aid within the next eight weeks or so. • However, Greek government officials say that the IMF now expects that Greece won't meet the 2020 targeted debt to GDP ratio of 120%. (WSJ August 23 rd) • The Troika’s preliminary reportedly says the additional shortfalls are the result of lower than expected tax revenues due to the country's ongoing recession as well as a privatization program which has not lived up to expectations. (Der Spiegel August 20 th) • The WSJ quotes senior euro-zone officials as saying that the funding shortfall is so big that Greece can't close it on its own. • Europe is left with a stark choice: “Lend Greece extra money, or let it go bust. ” Information Security Identification: Confidential

Greece: the view from Berlin • Unnamed German government source says it is “inconceivable that Chancellor Angela Merkel will again ask German parliament for approval for a third Greece bailout package. ” (Süddeutsche Zeitung July 23 rd) • Chancellor Merkel is waiting for the ruling from the constitutional court on the ESM and the Troika report before making a decision. Chancellery officials also believe a Greek bankruptcy and exit would be messier, costlier and more contagious for other euro members than many lawmakers think. (WSJ August 22 nd) • Decision needs to be made by the EU summit on October 18 th. Information Security Identification: Confidential

Greece: the view for elsewhere in the Euro-area • Eurogroup President Jean-Claude Juncker : “As far as the immediate future is concerned, the ball is in the Greek court. In fact this is the last chance and Greek citizens have to know this. ” He also stated: “I am totally opposed to the exit of Greece from the euro area. ” (August 22 nd) • The WSJ reports that much of the political class in the Netherlands, Finland, Estonia, Slovakia and Austria are against even-higher aid for Greece. The paper also reports that although France is eager to keep the euro zone intact, advisers to Mr. Hollande say that Greece's fate is increasingly tied to German domestic politics. (August 22 nd) • Welt am Sonntag reports that France and other southern European countries are pressing to give Greece further aid if necessary to avoid a "Grexit. " (August 19 th) Information Security Identification: Confidential

Information Security Identification: Confidential

Grexit • The Financial Times Deutschland (August 24 th) Cited finance ministry sources, as saying that a 10 -person working group led by Deputy Finance Minister Thomas Steffen is studying the possible economic impact of a Greek exit from the euro zone. “Colleagues are making calculations about the financial consequences (of a Greek exit) and are considering how a domino effect on other euro member states might be prevented. ” • MNI (August 24 th) Quoted senior Eurozone officials as saying the German Finance Ministry is seriously considering a plan in which Greece would be obliged to ask for a temporary exit from the Eurozone until it sorts out its public finances. One official says: “Germany is backed by Finland, the Netherlands, Slovakia and Estonia as the voluntary exit scenario gains support. But there are moderates in the picture, such as France and Eurogroup president Jean. Claude Juncker, who believe that even a temporary exit will send the Eurozone into a spiral of destruction. ” A second official notes: “It all comes down to the fact that Greece will need a third loan. Even if everyone denies it, we all know it's unavoidable” He adds: “The hawkish team of the German finance ministry believes that since Greece will need more money, it would be better given as a bridge loan to facilitate a temporary exit. ” In the German finance ministry's scenario, Greece's temporary exit would be initiated by the Greek government, at least publicly, so that Berlin could avoid being seen as the "villain, " the officials say. Information Security Identification: Confidential

The cost to Germany of Grexit • Bild (citing work by IFO institute) stated that a Greek insolvency and EUR exit would cost Germany as much as EUR 82 Bn. However, the paper also noted that Greece remaining in the EUR after insolvency would cost German taxpayers as much as EUR 89 Bn. (July 25 th) • The Economist estimated that the one-off cost for Germany of a Euro-area exit by Greece would amount to around EUR 118 Bn, or 4. 5% of GDP. (August 11 th) Information Security Identification: Confidential

The view from the US • The Independent (August 24 th) Reported that British Government sources have suggested the Obama administration will pressure European governments not to let Greece fall out of the eurozone before November's Presidential elections. The paper said that American officials are understood to be worried that if they decide Greece has not done enough to meet its deficit targets and withhold the money, it would automatically trigger Greece's exit from the eurozone weeks before the Presidential election on 6 November. They are urging eurozone Governments to hold off from taking any drastic action before then – fearing that the resulting market destabilisation could damage President Obama's re-election prospects. Information Security Identification: Confidential

What would Grexit entail? • The announcement would have to come as a “surprise. ” • Markets would remain closed for a number of days in order that the bare minimum of financial plumbing could be carried out. • A number of other announcements would have to take place at the same time. Withdrawals from banks would have to be significantly limited to prevent a run. Concurrently with this capital controls would be introduced (along with travel curbs). Wages would have to be redenominated Domestic debt contracts would have to be redenominated rapidly to prevent the bankruptcy of most households. Temporary banknotes would need to be provided until permanent new notes could be introduced. A number of suggestions have been made including the “overstamping” of existing banknotes. Price controls could be reintroduced on a temporary basis. • Problems Private borrowers with debts outside Greece would not be able to re-denominate them in the new national currency. What would the monetary status of the debts of the national central bank be towards other national banks in the Euro System? • Is the rest of Europe prepared? Information Security Identification: Confidential

Spain (and the ECB) • • How difficult a position is Spain in? The FT’s Lex column notes that the Spanish government still has to deal with EUR 27 Bn of maturities in October. El Confidencial confirms (quoting sources “close to the Ministry of Economy”) that the Treasury still has liquid assets of about EUR 25 Bn. The paper says that this is enough to cover costs related to debt maturity in August and September, but not in October when EUR 9. 2 Bn of notes and EUR 20 Bn of bonds become due. (August 17 th). What is the ECB proposing? • Will Spain ask for support? • Mario Draghi said in August that the ECB “may consider” again buying short-term government debt, but would expect “strict and effective conditionality” to be imposed by the EFSF (i. e. any nation looking for support must approach the rescue funds first and must agree to conditions being imposed). AFP cited an anonymous EU source as saying that Spain would not request EFSF funding if there were more fiscal strings attached to the deal. (August 8 th) German opposition? Finance ministry spokesman Martin Kotthaus told a news conference: “In purely theoretical, abstract terms, such an instrument would certainly be very problematic. ” “The Bundesbank remains critical of the purchase of euro system sovereign bonds, which comes with considerable risks for stability” Information Security Identification: Confidential

Euro-area bond markets over the past 12 months Information Security Identification: Confidential

Information Security Identification: Confidential

Information Security Identification: Confidential

Information Security Identification: Confidential

Emerging currencies over past month Information Security Identification: Confidential

The BIG, big picture: Chinese policy • Sheng Songcheng (head of the PBOC’s statistics department) authors a three-step plan for loosening capital and FX controls over the next five to ten years. Free convertibility of the CNY would be “the last step” to be taken at some unspecified time with restrictions on “speculative” capital flows and short-term foreign borrowing. (Late Jan) • Chairman of CIC’s board of supervisors, Jin Liqun: “It's probably time for China to consider relaxing capital account controls because we enjoy a very safe macro situation, without the problems that affected some Asian countries in 1997 and 1998. ” (April 3 rd) • The PBOC widens the daily trading band for the CNY against the USD to 1% up or down from the mid-point setting, up from the previous 0. 5%. (April 16 th) • Ba Shusong, deputy director-general at the Financial Research Institute under the State Council's Development Research Centre: “Under the current market situation, with major global currencies fluctuating but China's economy stable, the CNY is gaining acceptance in more and more major markets. This presents a rare window of opportunity to move toward capital-account convertibility. ” (May 22 nd) • Financial News (a newspaper backed by the PBOC) says that the main debate now is not whether to open up the capital account, but rather how to sequence such a move with other long-anticipated reforms, including interest-rate liberalization and a free-floating exchange rate. One school of thought believes that interest-rate liberalization and further exchange-rate reform must come before capital-account opening, while another believes the three reforms can be pursued simultaneously in a coordinated manner. (May 22 nd) Information Security Identification: Confidential

Information Security Identification: Confidential

A conclusion? • The risk of a Greek exit remains real. • Spain may be on verge of bailout. • Investors are keen to find alternative homes for their money • Reserve diversification a muted force at present • The big story remains Chinese policy. Information Security Identification: Confidential

Information Security Identification: Confidential