Société Générale - Global Economic Outlook march 2013

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                                                                             March 2013

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 Quarterly                Extract from a report

Global Economic Outlook
Test-driving the recovery


Recovery green light in the US; still red in euro                                European       convergence         returns:      Several     Eastern
periphery: Taking a snapshot across the advanced                                 European members are reviving talk of euro membership
economies, our traffic light system for sustainable recovery                     driven in part by fear of political marginalisation. This will
is flashing green in the US, indicating that conditions for                      be a key driver of currencies medium-term.
sustainable recovery are now present.                                            Asia’s brave new policies: In Japan, we expect the mix of
Life with higher bond yields: We believe that central bank                       monetary and fiscal stimulus to deliver. Cross over to
purchasing flows may have a greater impact than is                               China, however, and structural reform is accelerating. With
suggested by economic theory. The risk is to see US bond                         the right balance of structural reform, we believe China
yields move higher, sooner.                                                      can achieve a relatively seamless deceleration to 4-5%
German Diet still on the menu: A key assumption driving                          growth rates by 2020. We introduce coverage of Taiwan in
our forecast is that additional austerity will be required                       this new GEO.
notably of Spain and France. Gradual repair is nonetheless                       Currency armistice: Fears of currency wars dominated
underway and, although below consensus, our euro area                            the February G20 meeting, but rather than war, we see an
forecast remains one of medium-term recovery.                                    armistice in the making.

Please see important disclaimer and disclosures at the end of the document
       FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                         Test-driving the recovery

              Test driving recoveries .................................................................................................5

              Table: SG Anchor Themes ...........................................................................................8

              Box 1: Where it all began – Housing now in recovery ..............................................14

              Box2: Advantage US on energy.................................................................................15

              Box 3: Upside risks for bond yields ..........................................................................18

              Box 4: French reforms: Maintaining a steady pace in the right direction ...............20

              Box 5: Slow repair of financial fragmentation ...........................................................23

              Box 6: Lessons from the UK’s FLS ............................................................................26

              Box 7: EU exit is a big risk but not the likely outcome .............................................27

              Box 8: Euro convergence is creeping back ..............................................................29

              Box 9: Abenomics will deliver, but for how long ? ...................................................31

              Box 10: Mr. Xi has to, and will, reform China ............................................................33

              Box 11: New investment strategy needed to fight inflation .....................................36

              SG Growth Outlook ....................................................................................................40

              SG Inflation Outlook ...................................................................................................41

              SG Monetary Policy Rate Outlook .............................................................................42

              SG Long Gvt. Bond Yield Outlook .............................................................................43

              SG FX Outlook ............................................................................................................44

              Key Events ..................................................................................................................45

              Election calendar ........................................................................................................46

              Country notes with detailed forecasts for the major Global and European economies are
              available on SG Research website.

              Document completed on 18 March 2013

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                                         Test-driving the recovery

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                                                                                            Test-driving the recovery

                                             Test driving recoveries

                                             With the gradual lifting of policy uncertainty, a roadmap to sustainable recovery is taking
                                             shape. The state of post-crisis repair, however, varies greatly across the advanced
                                             economies. As governments take their economies for a first spring spin, some will discover
                                             gleaming engines while others will lift the hoods to a still decidedly rusty sight. In the US, our
                                             forecast clocks in slightly above consensus and the critical assumption is one of a combined
                                             recovery in housing and jobs. While our euro area forecast for 2014 is notably below
                                             consensus, we emphasise that this is nonetheless a scenario of gradual repair and recovery.
                                             Three factors drive our below consensus view: (1) additional austerity in the pipeline, notably
                                             from Spain and France, (2) a slow pace of repair on credit supply conditions and (3) a
                                             prolonged period of political uncertainty in Italy with a new pro-reform government coming to
                                             office in early 2014. As the UK prepares to hold a referendum on the EU in 2017, euro
                                             convergence discussion is creeping back in Eastern Europe. A common factor for the region
                                             is the headwind from the euro debt crisis, but different states of post-crisis repair and
                                             domestic policy choices explain divergent trends across the region. Having enjoyed a period
                                             of resilient growth, the Russian economy has been slowing and policy accommodation is now
                                             on the cards. Turning to Asia, our policy accommodation forecast is materialising in Japan,
                                             boosting growth near-term. Medium-term, however, the sustainability of this recovery remains
                                             questionable. China has demonstrated a will to steer its economy to a new growth model and
                                             we look for acceleration of reform in 2013. Structurally, we retain our call for a declining trend
                                             in potential output growth. In this first GEO of 2013, we are pleased to introduce coverage of
                                             Taiwan and Brazil; both of which have their own special ties to China.

Chart 1: SG forecasts – Mixed views versus the benchmarks
                                                           SG                          Consensus            EU Commission             IMF
        Growth Forecasts
                                          2013         P        2014        P        2013        2014      2013         2014   2013         2014
     Euro area                             -0.6      -0.3        0.5       0.5       -0.2         1.0       -0.3        1.4    0.2          1.2
       Germany                             0.8        0.8        1.5       1.2       0.7          1.7       0.5         2.0    0.9          1.4
       France                              -0.2       0.0        0.4       0.3       0.1          0.8       0.1         1.2    0.4          1.1
       Italy                               -2.1      -1.3       -0.5       -0.1      -0.9         0.6       -1.0        0.8    -0.7         0.5
       Spain                               -1.4      -1.7       -0.8       -0.8      -1.5         0.3       -1.4        0.8    -1.3         1.0
     United States                         2.1        2.4       3.0        2.8       1.9          2.8       1.9         2.6    2.1          2.9
     China                                 7.8        7.8        7.2       7.2       8.2          8.2       8.0         8.1    8.2          8.5
     Japan                                 1.5        1.5        2.0       1.4       1.2          1.2       1.0         1.6    1.2          1.1
     United Kingdom                        0.6        0.8        1.2       1.4       0.9          1.7       0.9         1.9    1.1          2.2
     Other advanced
     Sweden                                1.4        1.3        2.3       2.4       1.2          2.6       1.3         2.7    2.2          2.5
     Norway (Mainland)                     2.3        2.6        2.7       2.7       2.7          2.8       2.6*        2.5*   2.4          2.0
     Switzerland                           1.3        1.1        1.7       1.8       1.1          1.6       1.4         1.9    1.4          1.8
     Australia                             2.8        2.7        3.1       3.1       2.6          3.1       3.0         2.9    3.0          3.2
     S. Korea                              2.5        3.0        3.3       3.2       3.0          3.7       3.3         3.5    3.6          4.0
     Taiwan                                3.3                   3.3                 3.6          4.1        -           -     3.9          4.5
     Emerging economies
     Brazil                                2.7                   3.5                 3.3          3.9       3.5         4.0    4.0          4.2
     Russia                                2.9        3.3        3.9       3.9       3.3          3.8       3.7         3.9    3.8          3.9
     Poland                                1.5        1.9        3.0       3.0       1.5          2.9       1.2         2.2    2.1          2.7
     Czech Republic                        -0.1       0.3        1.4       1.7       0.3          1.9       0.0         1.9    0.8          2.8
     Slovakia                              1.6        2.0        3.2       3.0       1.5          2.7       1.1         2.9    2.8          3.6
     Romania                               1.3        2.0        2.1       2.6       1.5          2.6       1.6         2.5    2.5          3.0
     Ukraine                               1.5        2.8        3.3       3.3       2.2          3.6        -           -     3.5          3.5
     Kazakhstan                            5.3        5.3        5.8       5.8       5.8          6.3        -           -     5.7          6.0
     *Total economy instead of "Mainland" GDP

Source: IMF, EU Commission, Consensus Economics, SG Cross Asset Research/Economics

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                                                Test-driving the recovery

              Anchor Themes (Summary)
              Progress on post-crisis economic repair sits at the heart of our forecast and each section
              outlines an anchor theme and defines the key assumptions behind our new forecasts.

              1. Recovery green light in the US; still red in euro periphery: We identify five pre-
              requisites for sustainable recovery: (1) well advanced deleveraging, (2) repair of credit
              channels, (3) reduced policy uncertainty, (4) no significant housing overhang and (5) no
              supply-side constraint. Taking a snapshot across the advanced economies, our traffic light
              system for sustainable recovery is flashing green in the US, indicating that conditions for
              sustainable recovery are now present. In the euro area, a mixed picture still prevails with an
              abundance of red still present in the periphery. This underpins our call for still-lacklustre
              growth in the region with only gradual repair paving the way for recovery medium-term. In the
              UK, both recovery fundamentals and policy point to an economy still in the slow lane. But
              while conditions for sustainable recovery are still far from present in Japan, a policy boost will
              deliver a short-term growth boost.

              2. Life with higher bond yields: Signs of US recovery have already ignited a lively debate on
              QE exit. Our central scenario assumes continued QE out to the final months of 2013, albeit at
              a slower pace in the fourth quarter. Academic theory suggests that central bank stock
              holdings as opposed to flows dominate the QE impact on bond yields. In practice, however,
              we believe that flows may have a greater impact than is suggested by economic theory. As
              markets price in QE exit, bond yields will head north; our forecast is 2.75% on the 10-year
              bond by year-end and 5.10% by 2017. The risk is, however, to see US bond yields move
              higher, sooner. The US dollar will also absorb part of the QE adjustment burden.

              3. German Diet still on the menu: As we head to press, Italy remains without a government
              in the wake of the anti-“German Diet” vote at the 24-25 February elections. Germany has
              taken a much more flexible approach than generally recognised outside the country in its
              handling of the euro debt crisis. Inside Germany, the risk is than the election on 22 September
              risks delivering another protest vote; this time against Chancellor Merkel’s cooperative
              approach. A key assumption driving our forecast is that additional austerity will be required
              notably of Spain and France (albeit with further pushing back of budget targets) in 2014. We
              further assume a continued drive for structural reform and, while the EU is set to add further to
              an already long list of growth initiatives, we believe that a lack of sufficient funding will remain
              a common characteristic. The ECB will be keen to explore policy initiatives that can help boost
              lending. The BoE’s FLS offers some valuable lessons, but we see no magic bullet to address
              financial fragmentation near-term. Gradual repair is nonetheless underway and, although
              below consensus, our euro area forecast remains one of medium-term recovery.

              4. European convergence returns: The euro-outs have seen very different growth outcomes
              in the post-crisis world, much of which reflects the state of balance sheets and the degree of
              economic flexibility that prevailed when the crisis first struck. Common to all has been a
              negative headwind from the euro debt crisis. The crisis, however, does not have just
              economic consequences, but at the political level the significant changes in the EU’s
              institutional framework have also catalysed a rethink of national policies towards the EU. As
              the UK prepares to hold a referendum on EU membership in 2017, several Eastern European
              members are reviving talk of euro membership driven in part by fear of political
              marginalisation. This will be a key driver of their currencies medium-term.

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                                                                             Test-driving the recovery

                                            5. Asia’s brave new policies: Abenomics is the new buzzword in Japan and over the coming
                                            years, we expect the mix of monetary and fiscal stimulus to deliver. Longer-term, Japan still
                                            faces the challenge of a shrinking workforce and burgeoning government debt. To address
                                            these issues requires deep-rooted structural reform of the kind not currently visible on the
                                            radar screens. Cross over to China, however, and structural reform is accelerating. With the
                                            right balance of structural reform, we believe China can achieve a relatively seamless
                                            deceleration to 4-5% growth rates by 2020. We introduce coverage of Taiwan in this new
                                            GEO. Short-term, the economy will win from the cyclical recovery in the US and in the region.
                                            Medium-term, China’s shifting growth engines will present important challenges that need to
                                            be prepared for now.

                                            6. Currency armistice: Fears of currency wars dominated the February G20 meeting but,
                                            rather than war, we see an armistice in the making. Brazilian Finance Minister Guido Mantega
                                            first used the term in the context of the current crisis and this has since become synonymous
                                            with QE policies in the advanced economies. We make two points. First, the world has most
                                            likely been better off with the QE policies than it would have been without – currency war
                                            through QE (if this was the intention) is not the same zero-sum game as currency war through
                                            FX. QE in theory also directly creates greater domestic demand, also boosting imports. In
                                            driving financial repression, QE also pushes investors abroad. In many respects, these
                                            potentially disruptive capital inflows were perhaps the greater concern for emerging markets.

                                            On balance, risks to our outlook remain biased to the downside and we maintain a downside
                                            risk probability of 20% with an upside risk probability of 10% relative to our central scenario.

Chart 2: SG Swan Chart: Risks still biased to the downside

Source: SG Cross Asset Research/Economics

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                                  SG Anchor Themes
         Anchor theme                         Growth                     Economic balances         Monetary policy           Market issues

Global              US is finally ready for   Good news for the          US fiscal deal is part    ECB could still find      Firming global
                    recovery and Japan is     global economy, as         of our central            fresh ways of             recovery does not
Recovery green      trying something          US will be back as an      scenario this year.       ensuring funding. Fed     imply one-way trend
lights in the US;   new. Policy               engine of growth.          Still much work to be     will need to clarify      in equities and other
still red in euro   uncertainty still a                                  done on solving euro      communication on          risk assets.
periphery           drag on the euro                                     area debt problems.       exit as recovery
                    area.                                                                          solidifies.

US                  US yields will rise       Higher US yields will      Upward US yields          Rising global yields      A tug of war between
                    long before the           be a consequence of        reflect declining         will make it harder for   better fundamentals
Life with higher    cessation of QE           firming growth             imbalances.               the BoJ to keep its       and still tight
bond yields         occurs. Risk of yields    prospects so should                                  yield curve flat,         Treasury supply.
                    increasing even more      not derail recovery.                                 underlining the need
                    rapidly than in our       Could hurt weaker                                    for more aggressive
                    central scenario.         countries, though.                                   asset purchases.

Euro area           More austerity will be    SG view below              Austerity traps will      ECB will act as           Shift in focus from
                    asked of Spain and        consensus in 2014 in       remain a concern for      lender of last resort     funding to debt
German Diet still   France; we doubt the      the expectation of         the European              via OMTs and              sustainability. Now
on the menu         efficiency of the         more austerity. Italy      periphery. We see         LTROs. Further            comes the hard part;
                    growth policies so far.   and Spain will have at     easing of austerity as    easing targeted to        to agree banking and
                                              least two tough            of 2015.                  address specific          fiscal union.
                                              years.                                               liquidity shortages.

EU                  Eastern Europe still      Divergent growth           Expansion of the euro     East European             The convergence
                    planning euro entry.      trends across the          area should push          central banks to set      process also backs
European            This will be a key        region. SG view in         states to reduce          policie mindful of        our call for currency
convergence         driver of currencies      line with consensus.       imbalances.               future of euro link.      appreciation across
returns             medium term.                                                                                             Eastern Europe.

Asia                New policies should       Japan still faces          China to continue         New 2% BoJ inflation      Yen has weakened
                    revive short term         challenges of              market liberalisation     target to act as the      dramatically without
Asia’s brave new    growth in Japan.          shrinking workforce        aimed at tackling over-   driver of further         any policy action.
policies            China will gradually      and high government        investment and            aggressive easing.        Market too ready to
                    switch to a new           debt. China in             moving towards                                      believe further large
                    medium term growth        transition to slower       higher consumption                                  move is likely. We
                    model.                    growth model.              share of GDP                                        disagree.

FX                  Japan probably            Recent fall in the yen     FX caught between         Currency moves are        Currency volatility
                    comfortable with          is sufficient to provide   fundamentals and          partly a side-effect of   has returned and
Currency            current yen level. US     a growth boost.            inflation expectations.   asset purchases. As       should be a
armistice           will not resist           Rising dollar reflects     Medium-term, dollar       the end of US QE          continuing feature in
                    appreciation of the       improving US growth        set to be strongest       draws near, dollar        the coming year.
                    dollar.                   fundamentals.              G4 currency.              uptrend will be

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                                                                            Recovery green lights in the US; still red in euro periphery
                                                                            Green shoots of recovery have boosted market confidence to new highs. Taking a snapshot of
                                                                            global manufacturing, our PMI heatmap shows a fair amount of green, indicating readings
                                                                            above the 50-line (that defines the line between contraction and expansion). The notable
                                                                            exception is Europe, where red remains the dominant colour. Past green shoots in the post-
                                                                            crisis world, however, have disappointed, failing to grow into sustainable recoveries. New
                                                                            shocks are part of the explanation; we take the view that in many instances the conditions for
                                                                            sustainable recovery were also not yet in place.

Chart 3: PMI hints at cyclical recovery                                                                                                United Kingdom
                           United States

                                                                                                                                                                                                                                                                                                            New Zealand
                                                                                                                                                                                                                                                                      South Korea
                                                                                                                                                                                                                                               South Africa

                                           Euro Area














Feb-13            50.8 54.3 47.9 50.3 43.9 45.8 46.8 49.0 48.3 43.0 51.5 47.9 50.8 60.3 50.9 48.3 48.9 52.0 52.5 53.4 53.5 53.6 48.5 50.9                                                                                                                                           50.2      45.6         56.3           50.4 50.5 54.2 48.3

Source: Datastream, Market, SG Cross Asset Research/Economics

                                                                            We identify five conditions for sustainable recovery, which we score in our traffic light system
                                                                            below (cf. chart 7):

                                                                            1. Advanced deleveraging: Top of the list is progress on deleveraging of household, non-
                                                                            financial corporations and government debt. In the US, we consider this well-advanced for
                                                                            households, but more is needed in the government sector. Turning to Europe, we still see icy
                                                                            headwinds from deleveraging, and notably in Spain and the UK.

                                                                            2. Working credit channels: Properly functioning credit channels describe our second
                                                                            criterion for sustainable recovery. The US again scores a green light, while financial
                                                                            fragmentation remains an issue for the euro area periphery. Although we note some repair,
                                                                            progress is proving painfully slow (cf. Box 5 Slow repair of Europe’s financial fragmentation for
                                                                            more detailed discussion).

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                                                                                                              Test-driving the recovery

                                                             3. Policy uncertainty: Elections, expiring tax codes, uncertainty on public spending and a
                                                             still very sketchy outline on banking and fiscal union in the euro area have kept policy
                                                             uncertainty high. With a first resolution of the US fiscal cliff, uncertainty has begun to lift.

Chart 4: A gradual process of deleveraging

    300                       2007 debt vs. 2012 debt: Non-financial corporates                                                2007 debt vs. 2012 debt: Households


    200                                                                                              100



      0                                                                                                   0

    250                         2007 debt vs. 2012 debt: General Government                          800                   2007 debt vs. 2012 debt: Financial corporates


    150                                                                                              500




      0                                                                                                   0

*: 2007 vs 2011 data; Source: Datastream, Eurostat, Federal Reserve, SG Cross Asset Research/Economics

                                                             This, in turn, should help unleash pent-up investment, hiring and demand. We estimate that
                                                             policy uncertainty in the US may have held back as many as 2.1 million jobs and 2.5% of
                                                             GDP. Again, situations vary across countries. The absence of a government in Italy implies a
                                                             heightened level of policy uncertainty – a factor that we expect to be visible in the economic
                                                             data over the coming months.

                                                             4. Housing market repair: The crisis began in US housing and we are encouraged to see
                                                             advanced repair. Our housing heat-map shows prices turning north in several economies
                                                             although the picture remains weak. Unwinding of past over-build and reduction of foreclosed
                                                             stocks are key criteria for sustainable recovery in this sector. Housing recovery is a key
                                                             component of our US scenario and we offer discussion in Box 1: Where it all began – US
                                                             housing now in recovery.

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Chart 5: Housing heat map paints a still mixed picture (yoy growth of real house prices)

                                                                                                                                                                                United Kingdom

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                                      Euro Area












Q4 2012            1.1      2.4                   1.8                               -12.0     -9.5                                1.4        -13.6      -7.4      -4.0          -0.2             3.7                                                                             -0.3
Q3 2012   0.6      2.8      3.0      -4.6         2.8        -2.8          -6.5     -12.0    -10.2          -0.5        8.3       -1.0       -13.2     -13.1      -4.7          -0.8             4.0             -4.7      -1.8       6.4       0.9      -1.8      0.3           -2.3          3.4
Q2 2012   -0.3     1.8      4.1      -3.5         5.1        -2.1          -6.3     -10.6     -6.9          0.2        11.9       -2.0       -12.3     -16.7      -3.6          -1.0             3.7             -7.6      -4.2       6.8      -0.7      -2.3      1.1           -3.6          2.8
Q1 2012   -0.3     -0.1     4.3      -3.1         4.9        -0.3          -6.1      -9.5     -6.1          0.6         7.4       -1.7       -11.8     -18.8      -4.2          -2.2             5.1             -8.0      -5.2       4.5       0.2      -2.5      2.6           -4.9          2.2
Q4 2011   -1.5     -1.9     4.6      -2.8         4.7        1.4           -5.8      -9.4     -5.7          -1.2        2.0       -2.6        -9.4     -17.5      -4.5          -4.6             4.3             -8.7      -3.4       7.1       2.9      -2.6      3.0           -6.8          1.3
Q3 2011   -2.8     -4.5     3.2      -1.3         3.9        3.9           -4.8      -8.3     -4.6          0.6         2.0       -0.8        -6.6     -14.6      -4.1          -5.7             3.6             -6.3      -1.0       6.8       6.5      -2.7      2.3           -5.7          -0.6
Q2 2011   -3.2     -6.1     1.5      -1.3         2.0        4.9           -4.3      -9.3     -4.3          0.5        -2.2       0.0         -8.5     -13.7      -3.6          -5.8             4.5             -3.7       0.5       4.9       8.7      -2.1      1.0           -4.9          -3.1
Q1 2011   -4.1     -6.6     1.6      -0.6         2.5        5.1           -3.6      -8.2     -3.4          0.2         0.7       0.9         -9.8     -12.0      -3.3          -4.8             3.6             -1.9       2.1       7.6      10.5      -2.1     -0.8           -2.1          -4.6
Q4 2010   -3.4     -4.2     3.2      -0.2         0.6        6.1           -3.4      -6.4     -2.3          2.9         4.3       2.5        -10.6      -9.7      -0.7          -0.1             3.1             0.4        3.6       3.6      11.3      -2.1     -1.5            2.8          -4.5
Q3 2010   -2.3     -4.0     7.9      -0.2         0.1        5.3           -3.3      -5.6     -2.3          3.3         2.9       5.8        -10.0     -10.1      0.7           3.3              4.3             0.5        5.8       4.7      13.6      -1.9     -0.3            7.4          -1.2
Q2 2010   -1.4     -2.8    10.9      -0.3         0.8        4.0           -3.5      -4.4     -3.5          3.9         3.2       8.4         -7.6     -11.1      0.8           6.0              3.4             1.0        6.9       7.8      16.6      -2.2      0.6           12.7          2.4
Q1 2010   -0.7     -3.4     7.5      -1.9         0.5        0.7           -3.9      -5.6     -4.7          3.0         4.1       9.6         -4.2     -13.8      1.3           4.8              4.2             -1.0       8.6       7.7      16.2      -2.1      0.5           15.6          5.0
Q4 2009   -1.5     -3.7     1.5      -2.2         0.9        -3.7          -3.5      -5.8     -5.5          1.8         1.0       7.7         -5.5     -12.9      1.3           -0.9             6.9             -6.4       5.2      10.4      15.3      -1.3     -1.1           11.2          3.6
Q3 2009   -1.8     -2.7    -2.9      -2.9         1.4        -6.8          -3.4      -6.8     -4.2          0.4         3.1       -0.2        -5.2     -14.1      2.5           -6.7             5.7            -13.2      -0.4       2.1      11.1      -0.9     -2.8            4.2          -1.5
Q2 2009   -3.1     -2.9    -6.4      -3.4         0.1        -8.2          -3.6      -6.9     -1.5          -1.0        4.9       -5.6        -4.1     -12.6      3.1          -13.7             5.3            -16.5      -1.6       -4.8      9.8      -1.5     -3.0           -3.1          -6.3
Q1 2009   -5.0     -4.6    -4.7      -2.7         0.1        -7.4          -3.8      -6.8     0.0           0.4         3.9       -7.8        -4.9     -10.3      3.9          -14.3             5.1            -16.5      -5.0       -8.6      7.6      -1.8     -2.2           -8.3         -12.7
Q4 2008   -5.9     -8.4    -0.9      -1.9         -0.1       -5.3          -3.1      -5.9     1.6           1.2         1.1       -7.6        -2.6     -11.6      4.1          -12.0             1.6            -13.3      -5.4      -10.6      5.8      -2.2     -0.8           -7.0         -12.7
Q3 2008   -6.6     -9.9     1.9      -1.6         -1.2       -2.6          -2.5      -4.4     1.2           0.3        -1.6       -3.7        -3.4      -8.0      1.7           -7.8             0.0             -8.0      -1.7       -6.5      2.5      -2.5      0.0           -2.1         -10.8
Q2 2008   -6.3     -9.2     5.9      -0.1         -1.0       -0.7          -1.0      -2.0     1.7           2.2        -2.8       0.0         -2.7      -6.3      0.7           0.0              -0.8            -3.9       1.6       -1.7      0.8      -1.5     -0.3            4.5          -7.6
Q1 2008   -4.4     -7.3     9.0      0.8          -1.7       1.0            1.0      -0.6     2.8           2.5        -0.7       0.5         -1.8      -3.7      -1.0          3.4              -2.7            -2.9       6.7       1.6       0.4      -1.0     -1.0            9.2          0.4
Q4 2007   -2.6     -5.4     8.9      1.0          -1.2       2.6            1.9      -0.1     2.2           4.6         0.7       1.4         -1.1      -0.3      -1.8          7.5              -0.6            -0.2       9.8       6.3      -1.3      -0.4      2.4           10.0          5.5
Q3 2007   -0.8     -3.1     9.6      2.3          -0.3       3.7            2.8      2.2      2.8           7.6         2.4       3.4         3.2        2.5      -1.6          8.9              0.9             2.0       10.6      10.3      -0.1      0.1       7.1            7.8          9.7
Q2 2007   1.2      -0.8    10.5      2.6          0.0        5.0            3.4      2.8      2.1           6.1         2.2       3.6         4.3        7.9      -1.9          8.0              0.0             3.5        8.5      13.6      -2.0      -0.4      8.1            6.3         11.9
Q1 2007   1.8      -0.2    10.4      3.2          -0.1       6.4            3.4      4.1      2.3           6.6         1.2       4.6         6.0       11.8      -1.2          8.1              1.3             8.3        7.0      15.0      -4.8      -0.5     10.5            6.2          9.2

Source: OECD, SG Cross Asset Research/Economics

                                                                       5. No supply-side constraints: While the most academic of our recovery criteria, we also
                                                                       consider the condition of the supply side. Just how much damage the crisis did to this side of
                                                                       the economy is the topic of much debate. One simple metric that can offer a useful guide is
                                                                       non-residential investment in % of GDP (cf. chart 6). While we urge caution on simple
                                                                       comparisons across countries, we note that the euro area periphery is once again where the
                                                                       greatest disparities exist relative to the pre-crisis environment, hinting that this is also where
                                                                       the greatest destruction on the supply side is taking place. Other metrics behind our view
                                                                       include labour market trends, credit supply and structural rigidities. On the supply side of the
                                                                       economy we note an additional advantage for the US economy with the development of shale
                                                                       gas as a new source of energy supply (cf. Box 2: Advantage US on energy).

                                                                       Chart 6: A mixed picture on the investment share of GDP

                                                                                                                                  Non-residential investment as % of GDP
                                                                          20%          1999-2007

                                                                          18%          2008-2012









                                                                                             US                        Japan                           UK                     Germany                                France                    Italy                   Spain

                                                                       Source: OECD, Eurostat, SG Cross Asset Research/Economics

                                                                                                               March 2013                    11

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                                                                                                                                Test-driving the recovery

                                                         We have made little mention of Japan so far in our discussion but, as illustrated in our
                                                         recovery traffic light, the economy faces several constraints. This is one of the main reasons
                                                         why we remain concerned that the lift that policy stimulus will deliver over the coming years
                                                         will fail to translate into sustainable recovery, unless a serious programme of structural reform
                                                         is adopted (cf. Box 9: Abenomics will deliver, but for how long?).

Chart 7: Traffic lights for recovery

                           US     Western Europe                                                                       Eastern Europe                                                                  Asia-Pacific                                 Latin America
                                  Euro area                                       Other

                                                                                                                                 Czech Republic

                                   Euro area











 Credit conditons
       Excess supply
 Policy uncertainty
 Supply side

Source: SG Cross Asset Research/Economics

                                                         Our recovery traffic lights also frame our medium-term forecasts. As seen from the chart
                                                         below, we have considerable confidence in the ability of the US to generate sustainable
                                                         recovery. While our euro area forecasts for 2014 are below consensus, we nonetheless take a
                                                         constructive view of the medium-term, believing that financial fragmentation sees gradual
                                                         repair and austerity over time will present a fading drag. A key assumption is also that
                                                         structural reform both nationally and at the European level will continue to advance. The UK
                                                         referendum remains a point of uncertainty, but a potential exit falls beyond our forecast
                                                         horizon. We assume that the uncertainty up to the UK referendum will only have a moderately
                                                         negative impact.

                                                                                           March 2013                           12

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                                                          Test-driving the recovery

              Chart 8: SG 2017 growth outlook

                                                                                   United States          Euro Area

                8                                                                  United Kingdom         China








                           2012                2013            2014         2015                   2016        2017
              Source: SG Cross Asset Research/Economics

              Turning to the emerging economies, structural reform is a common theme. In Eastern Europe,
              a move to euro entry and convergence is a reform driver. In Russia, the challenge is to
              diversify the economy’s growth engines. This is also the challenge for China, albeit against a
              very different economic backdrop. Brazil, for its part, needs to switch from consumption to
              investment to prevent stagflation setting in. In our medium-term outlook, we assume that
              some progress is achieved over the 2013-2017 horizon, although we see room for upside
              across the emerging economies (and for that matter the advanced economies) on this front.
              For more detailed discussion see Box 8: Euro convergence is creeping back, Box 10: Mr Xi
              has to, and will, reform China and Box 11: New investment strategy needed to fight inflation.

              The outlook for individual economies is detailed in our Country Notes.

                                        March 2013        13 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                                         Test-driving the recovery

Box 1                             United States
   Where it all began - Housing now in recovery
The US housing sector has been in recovery mode for                                      level. Our model suggests that it will take three to four
two years now. In the early phase of the recovery,                                       years to close this gap. During this time, the equilibrium
gains were limited to construction activity, which                                       level is projected to rise by a further 7%. Therefore the
contributed modestly to GDP and employment growth.                                       total increase over the next three years is projected to be
However, depressed home prices have continued to be                                      as high as 22%. Extending the projections out to 2017, i.e.
a structural headwind to growth by keeping a lid on                                      our five-year forecast horizon, the model suggests a 35%
confidence and clogging up key transmission channels                                     increase in home prices relative to current levels, or an
of monetary policy. We believe that housing is now                                       average annual gain of 6.2%.
entering a new phase of recovery in which these
                                                                                         The projections described above are notably higher than the
structural headwinds will begin to reverse. Home
                                                                                         current consensus outlook for home prices. Based on a
prices registered a decisive bottom during the course
                                                                                         December survey conducted by Pulsenomics, the mean
of 2012 and we believe there is significant room for
                                                                                         projection of professional forecasters is for a 17% cumulative
further increases.
                                                                                         increase through 2017 or an average annual gain of 3.2%. We
A standard approach to modelling home price trends is to                                 view these projections as quite shy. While they are consistent
define two equations: a structural one which estimates fair                              with the likely gains in per-capita income, they fail to account
value levels for home prices, and an adjustment equation                                 for the current undershoot of home prices relative to fair
which describes how prices ultimately return to their fair                               values. An alternative to our fair value approach is to simply
values. Following this approach, we have estimated an
                                                                                         extend the pre-bubble trend and see where we are relative to
equilibrium equation for the S&P/Case-Shiller National
                                                                                         it. This approach also points to a significant undershoot which
Price index on the level of income per household and on
                                                                                         the consensus forecast fails to account for.
changes in the 30-year mortgage rate. Our short-term
adjustment equation is driven by the lagged variation in                                 Our home price projections vs consensus
home prices, a mean reversion component and a lagged                                          210                  S&P/Case Shiller National Index
change in the mortgage rate.                                                                  190
                                                                                                                   Pre-bubble trend (1987-1999)
                                                                                                                   SG actual projection
How much upside for home prices?                                                              170                  Decem ber 2012 consensus *

  210                  S&P/Case Shiller National Index
                       SG equilibrium value estimate
                       SG equilibrium projection
                       SG actual projection
   90                                                                                               87   89   91    93   95   97   99   01   03   05   07   09   11   13   15   17

                                                                                         Source: SG Cross Asset Research, Economics

                                                                                         The above analysis suggests that home prices have not only
        87   89   91    93   95   97   99   01   03   05   07   09   11   13   15   17   bottomed, but there is also upside risk relative to the current
Source: S&P/Case-Shiller, SG Cross Asset Research/Economics
                                                                                         consensus view which calls for only modest gains. As home
As shown on the chart above, home prices clearly                                         prices rise, they are likely to bring sidelined homebuyers
overshot their equilibrium values during 2001-2009.                                      back into the market which in turn has the potential to ignite
However, this overshoot was followed by a subsequent                                     a positive feedback loop. This represents an upside risk to
undershoot driven by tight mortgage conditions, lack of                                  our forecast which looks for a gradual increase in housing
confidence and by self-fulfilling expectations for further                               demand.
price declines. By our estimates, the equilibrium value is
currently about 15% above the prevailing national price                                                                             

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                                                                                      Test-driving the recovery

Box 2                                                                                           United States
                                                                                      Advantage US on energy
North America is experiencing an energy revolution                                    The combined result is restraining electricity costs in the
thanks to technological advances that are opening up                                  US. This is true for both consumer and commercial use.
vast supplies of shale gas. The abundance of cheap,
                                                                                      US Consumer energy costs
relatively clean energy is a positive supply shock that
can increase production and reduce costs. The payoff                                             Index of price =
                                                                                       400         100 in 2000
for consumers, manufacturers and exporters should
persist for years to come.                                                                                                                          Utility [Piped]
Price differentials between North America and Europe (cf.                              250                                                          Electricity

chart below) demonstrate that the supply shock is                                      200
                                                                                                                                                    Fuel Oil #2
concentrated in North America at present. Local geological                             150
formations and local regulations outside of North America                              100                                                          Gasoline, All
may prevent these regions from taking advantage of new                                                                                              Types
technologies that tap into shale gas. We use the UK price as
a proxy for Europe. With natural gas increasingly a source of                                   00 01 02 03 04 05 06 07 08 09 10 11 12 13
power generation as well as a raw material in production,                             Source: US BLS, SG Cross Asset Research/Economics

the cost advantage is substantial. In time, producers are
                                                                                      Manufacturer demand: Natural gas is both a source of
likely to view the wide price divergence as a norm, and as
                                                                                      heat and a raw material. Heat is used to melt, bake, glaze
they do, they are more likely to invest directly into gas
                                                                                      and dry materials in the production processes particularly
production and shipment. Additionally, manufacturers are
                                                                                      for steel, glass, ceramics, food and paper. As a raw
likely to locate production facilities near the abundant gas
                                                                                      material, natural gas is used for fertilisers, plastics and
                                                                                      chemicals. At one-third the cost of European natural gas,
 Natural Gas prices between US and Europe diverge                                     North American gas provides a distinct cost advantage for
                                                                                      these industries. We can expect import substitution as well
        $/MMBtu                                                                       as export growth in goods using significant amounts of
                                                              Gas N America
  16                                                          Gas UK                  natural gas. Moreover, as employment in these sectors
  14                                                                                  grows, consumers will gain income.
                                                                                      Export demand: Price differentials persist because of the
                                                                                      challenges to an open, free market for natural gas.
                                                                                      Abundant sources of cheap, North American gas are new,
                                                                                      and there is only minimal export infrastructure.
                                                                                      Manufacturers, consumers and environmentalists generally
                                                                                      oppose efforts to bolster exports of US gas. US government
       00   01   02    03    04   05    06    07    08   09    10      11   12   13   policy is leaning towards support for gas producers to
 Source: Bloomberg, SG Cross Asset Research/Economics                                 export. Even so, the build-up of infrastructure requires time.
Consumer demand: Households have gas piped directly to                                Liquefied natural gas (LNG) is still expensive and the cost
their homes for space heating, water heating and for                                  should be part of the differential even if adequate LNG-
cooking. Additionally, electricity used to power their homes                          transport facilities are built. As exports grow, the
is increasingly dependent on cheap sources of gas. Gas-                               advantages highlighted here for consumers and
generated electricity is replacing coal-generation. Coal-                             manufacturers could shrink, but that would be offset by
generated electricity comprised 44.8% of the total electricity                        gains accruing directly to gas producers who would sell
generated in the US in 2010, but that is down from 51.7% in                           their product at considerably higher prices on the global
2000. Meanwhile, gas-generated electricity rose from 17%                              market. Economic theory, with comparative advantage,
of the total generated in 2000, to 23.9% in 2010. Gas is                              suggests the economy as a whole will gain the most, in an
cleaner and additionally, cheaper gas offers stiff competition                        open economy with product specialisation.
to more traditional coal-generated electricity.

                                                                       March 2013     15

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                                                            Test-driving the recovery

              Life with higher bond yields
              Our 2017 forecast for the US 10-year Treasury yield at 5.1% seems extreme from the current
              vantage point of 2.0%; in reality, this just returns Treasury yields to the pre-crisis level and
              with a very gradual pace of normalisation. The risk we see relative to this baseline is that
              markets adjust more rapidly than we expect. Once we remove the QE factor, our economic
              fair value model for the 10-year Treasury yield suggests a figure of 3.50%. Our recent special
              report on The return of yield offered detailed analysis of what a faster return to fair value would
              entail. For the US economy, we conclude that higher bond yields would exert only a limited
              drag on growth, given the assumption that the normalisation process reflects stronger
              economic outcomes.

              The only relevant historical case study on QE exit is that of the Bank of Japan in 2006. Back
              then, the process proved smooth without triggering any market dislocation. Several factors
              explain the BoJ’s success: (1) credible exit strategy communication, (2) flexibility in the exit
              strategy and (3) sufficient exit management tools.

              Chart 9: Japan has the highest real yields... UK the lowest







              -1                    Japan
              -2                    Germany

                   2007               2008                2009          2010            2011   2012        2013
              Source: Datastream, SG Cross Asset Research/Economics

              There are, nonetheless, important differences that entail greater uncertainty surrounding the
              Fed’s exit today. First, the BoJ conducted its exit primarily in short-term instruments with
              banks. Second, inflation remained very low and this despite yen depreciation. Third, the BoJ
              continued to buy JGBs and never completed the exit as the Sub-prime crisis struck. Finally,
              the yen is not the world’s reserve currency. A key assumption in our new Global Economic
              Outlook is that the Fed manages the QE exit out to the 2017 horizon without triggering any
              major dislocations.

              As an anchor in the global monetary system, higher US Treasury yields will spillover globally.
              Moreover, as financial repression eases, the allocation impact could be significant. For the
              rest of the world, the common positive offset to higher US interest rates is greater confidence
              in the US recovery. How individual national central banks respond will determine the relative

                                         March 2013         16 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                                                  Test-driving the recovery

Chart 10: German bund yields below fair value                                                    Chart 11: Peripheral spreads close to fair value

    7                                                                                               8
                                                                                                               Peripheral Spreads
    6                                                                                               7
                                                                                                               Fair Value

    5                                                                                               6          Fair Value adjusted for ECB
                                                                                                               and OMT
    2                10Y Bunds Rate
                     Fair Value 1
                     FV1 adjusted for ECB's balance sheet
                     Fair Value 2
                     FV2 adjusted for ECB's balance sheet
     1999        2001        2003       2005        2007       2009        2011       2013          0
                                                                                                        2008     2009         2010           2011   2012
Both models are grounded in rational expectations hypothesis, where bond yields are a function
of expected real rates, expected inflation and a term premium.
* In FV1, rates are modeled on euro funds minus inflation, a weighted consensus of inflation
expectations on the current and the next year, and term premium modeled on the level of
expected unemployment.
**In FV2, rates are modeled on euro area potential growth, a weighted consensus of inflation
expectations on the current and the next year, and term premium modeled on the level of
expected unemployment.
***The ECB balance sheet is modeled as Eurosystem total assets divided by potential GDP.
Source:Datastream, Consensus Economics, IMF, ECB, SG Cross Asset Research/Economics

                                                  Zooming in on the euro area, our economic fair value model suggests that German bund
                                                  yields are currently 40-80bp below fundamental fair value. A correction in US Treasuries to fair
                                                  value could thus also see the German bund yield correct upwards. The greater concern would
                                                  be to see an increase in peripheral yield levels. Our model suggests that spreads are close to
                                                  equilibrium, offering little room for further compression in the absence of significant
                                                  improvement in the economic fundamentals. In aggregate, an increase in US Treasury yields
                                                  would thus present a modest headwind to the European economy.

                                                  As with any model, caution must be exercised when interpreting results. Our model of euro
                                                  area bond spreads shows then currently close to fundamental fair value, suggesting that
                                                  further spread narrowing now requires improvement in labour markets and/or in terms of
                                                  growth dynamics. Indeed, while the OMT essentially fixed funding, solvency requires growth.

                                                                               March 2013         17

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                                                                                    Test-driving the recovery

Box 3                                                                                  United States
                                                                        Upside risks for bond yields
Our increasingly positive outlook for the US economy                               significantly, putting it at 2.3%-2.6%, or about 70bp below
suggests that bond yields have bottomed. In most                                   the standard fair values. This is broadly consistent with the
economic expansions bond yields tend to rise                                       Fed’s own estimates of the cumulative impact of QE to date.
gradually as above-trend growth chips away at the                                  If our projections of SOMA holdings are correct, the total
output gap and eventually leads to a build-up of                                   impact is likely to peak at around 140bps as additional asset
inflationary pressures. Today, the output gap remains                              purchases continue to depress the term premia. That said,
quite large and inflationary pressures well-capped,                                we acknowledge that our simple linear model does not
arguing against a rapid rise. However, this cycle                                  capture diminishing returns of QE. Additionally, the forward-
stands apart because of a significant dislocation in                               looking nature of the markets means that the impact of future
Treasury yields away from their fundamental fair                                   asset purchases may already be largely discounted in today’s
values. The dislocation – caused by the Fed’s buying                               rate levels (hence the undershoot even relative to our
of various fixed income assets – implies a possibility                             adjusted fair values).
that yields could move up quite rapidly.
                                                                                   If QE has truly dislocated the Treasury market by 70-140bp,
What’s the fair value yield? Our models for the 10-year                            the reversal could be quite dramatic. The Fed’s view, and one
Treasury yield are grounded in the rational expectations                           that probably drives consensus estimates, is that the QE-
hypothesis, where long-term rates are a function of                                related yield compression will only be unwound as assets are
expected real interest rates, inflation expectations and a                         sold, or as they roll off the Fed’s balance sheet via natural
term premium. Since none of these components are                                   runoff. This gradual rise is depicted in our adjusted fair value
directly observable, we follow the standard practice of                            projections which, after falling initially on the back of further
using various proxies. This traditional approach suggests                          QE, do not hit 3% until 2016 (and note that by then the
current fair values in the range of 3.0%-3.4%. Based on                            unadjusted fair value range is 4.20%-4.60%).
our economic forecasts, and assuming that long-term
inflation expectations remain stable, the projected fair                           Treasury fair values and their projections

value range rises to 3.1%-3.8% by the end of 2013, and                                                                 10yr Treasury
to 3.3%-4.0% by the end of 2014.                                                                                       Fair Value 1 *
                                                                                                                       Fair Value 2 **
                                                                                   12                                  FV1 adjusted for impact of QE ***
Treasury fair values and their projections                                                                             FV2 adjusted for impact of QE ***
                       Basic Fair Values       SOMA adjusted ***
                           FV1 *      FV2 **       FV1       FV2
                                                                                                                                                       Dislocation due
 YE 2012                    2.97        3.43       2.53      2.40                   8                                                                  to QE - will it
 YE 2013                    3.16        3.72       2.23      1.96                                                                                      persist until the
                                                                                                                                                       Fed sells all the
 YE 2014                    3.28        3.98       2.29      2.19                   6                                                                  assets?
 YE 2015                    3.38        4.23       2.32      2.41
 YE 2016                    4.35        4.57       3.34      2.88                   4
 YE 2017                    5.10        4.91       4.12      3.31

Both models are grounded in the rational expectations hypothesis, where bond        2
yields are a function of expected real rates, expected inflation and a term
* In FV1, real rates are modelled on fed funds minus inflation, inflation           0
                                                                                        82   85    88     91    94    97     00    03     06     09   12     15     18
expectations on professional forecasts (10yr), and the term premium on the
output gap                                                                         Source: Federal Reserve, SG Cross Asset Research, Economics
**In FV2, real rates are modelled on potential growth, inflation expectations on
professional forecasts (10yr), and the term premium on the output gap
***The Fed's balance sheet is modelled as SOMA holdings divided by potential       Our central scenario, which calls for a 10-year Treasury yield
GDP. Fed's asset purchases assumed to continue through end of 2013, MBS
drawdown to begin in mid-2015 and asset sales to begin in mid-2016.                of 2.75% by year-end 2013, effectively splits the difference
Source: SG Cross Asset Research, Economics
                                                                                   between fundamental fair values and those adjusted by the
                                                                                   impact of QE. In essence, we expect that the market will
The Fed’s asset buying accounts for much of the                                    front-run the Fed and discount asset sales long before they
dislocation. Consequently, including the Fed’s balance                             materialise.
sheet in the various models lowers the fair value range

                                                                    March 2013      18

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                                                Test-driving the recovery

              German Diet still on the menu
              The debate on the “German Diet” of structural reform and austerity is a recurring theme in the
              European debate, and the Italian election has brought it back centre-stage. A key call behind
              our euro area growth forecast is that austerity and structural reform will continue in line with
              the framework set by the Stability and Growth Pact (SGP). A number of points deserve
              mention in this context.

              Less austerity and reform carries both upside and downside risks: Critics of austerity and
              structural reform are all too numerous; few propose any real alternative solution. If member
              states with endangered debt sustainability simply abandon austerity and structural reform, the
              risk is that this in itself could trigger a new crisis of confidence. More so, if this leads to
              reduced acceptance of risk sharing mechanisms in Germany. At the national level, we see little
              alternative to the austerity and structural reform as set out in the SGP. Where we do see room
              for upside surprise is some form of “fiscal capacity” at the European level (i.e. fiscal transfers).
              There has been no lack of initiatives, but common to all is a lack of sufficient funding.
              Moreover, the recent cut to the EU budget for 2014-2020 does not bode well on this front. We
              thus see a low probability for upside risks.

              Germany has limited room to do more: The suggestion that Germany do more, either in
              terms of fiscal stimulus or accepting higher wages is frequently heard. On the fiscal side,
              German general government debt is already at 80% of GDP, the robustness of public finances
              in the euro area’s largest economy is weaker than generally assumed and more so given the
              demographic time bomb. On 13 March, the German government presented the parameters for
              the 2014 budget and the medium-term plan to 2017. There was little hint of any appetite for
              fiscal expansion, targeting a further improvement in the structural balance from the official
              forecast of -0.3% in 2013 to +0.3% in 2017.

              German demand would benefit primarily Northern and Eastern Europe: On the wage
              front, the EU Commission forecast German employee compensation per head to expand
              2.4%, well above the 1.6% forecast for the rest of the euro area. Even assuming that Germany
              were to deliver a further boost (or opt for lower savings), the impact on the periphery
              according to the Commission’s paper Current Account Surpluses in the EU (December 2012)
              would still be weak. The Commission estimates that a 1% boost to German domestic demand
              would lower the trade balance by a modest 0.2% of GDP. Within the EU, the main
              beneficiaries would be the Czech Republic, Slovakia, Hungary, Austria and the Netherlands,
              each winning close to 0.1% of GDP on net trade. Spain, Italy and Portugal would win just
              0.02% of GDP. Even if we assume that the Commission is underestimating the impact by a
              factor of 5 (i.e. a 1% boost to German domestic demand lowers the trade balance by 1% of
              GDP), that would still imply a modest impact on the periphery. Ideally, companies in Northern
              Europe would take this opportunity to invest aggressively in the periphery, buying up assets at
              discounted values. This would yield a potentially much greater boost to the periphery. There is
              however little evidence hereof to date, and in the financial sector, we observe the reverse.

                                 March 2013     19 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                     Test-driving the recovery

Box 4                                                                                                  French reforms
               Maintaining a steady pace in the right direction
The 2013 budget, the Fiscal Pact, the 6 November                    growth model is sometimes known as a fiscal devaluation. Our
competitiveness pact and the 11 January labour                      model suggests that the long term impact on competiveness of
market reforms reassured markets that France is                     this set of measures is modest: the GDP level is improved by
moving in the right direction on reform. Even if the                1.1pp, the trade balance is improved by 0.4% of GDP.
economic impact of these reforms is modest,
                                                                    However, the political changes are significant. Just after the
political changes are significant. All main political
parties now recognize that France needs a new                       CICE announcement, a Le Monde editorial wrote that with this
growth model, that corporate profitability is one of                new competitiveness pact, President Hollande breaks three
the main weaknesses of the economy, which                           taboos for the Socialists: 1) the acceptance that labour costs
requires shifting resources to the export sector.                   are one cause of the industrial decline in France; 2) the cut in
                                                             public expenditure to finance half of the cost reduction for
Looking ahead, the reform timetable is not set in stone. The
                                                             businesses, earlier considered impossible; and 3) the rise in VAT
next key event will be the Stability and Growth Program of
                                                             (after having unwind during the summer the rise in the main VAT
2013-2017, to be sent to the EU Commission in early April.
                                                             rate that was proposed by the former conservative government).
The agenda over the coming quarters will include cuts to
                                                             This illustrates that deciding on this fiscal devaluation has
public spending, amounting to €60bn from 2014 to 2017
                                                             probably been not so easy for the ruling party.
and reforms to unemployment insurance and pensions.
These issues are likely to prove more politically challenging France: nominal and structural public deficits (% of GDP)
than recently presented initiatives. Against a backdrop of            09       10       11        12e         13f     14f
weak economic growth, bold reforms would probably have a
negative impact on activity in the short run (J curve effect),       -1

which in turn would affect market sentiment. Therefore, we           -2

do not forecast a glut of reforms. In our opinion, it is key that    -3
the French public gets used to the idea of reform and that           -4
the government keeps heading in the right direction, even if
individual steps on reform are modest.
                                                                     -6                                             nominal public deficit
1. France needs a new growth model: In our European                  -7                                             structural public deficit
Theme, France needs a new growth model, we discuss the
framework for reform on France. We argue that the French            Source: European Commission, SG Cross Asset Research/Economics

growth model has reached its limits. Over the decade 3. Austerity in action: Austerity has been tough in France since
leading up to the crisis, consumption, the housing market 2009 and in particular in 2013. The public deficit is expected to
and government expenditures were the main engines of reach 3.7% of GDP in 2013. This is well above the official target
growth in France. But this probably led to a loss of of 3.0% but down from 7.5% in 2009. The French government
competitiveness and to the weakening of corporate sector has emphasised its adherence to the structural deficit target:
profitability. Medium term, a new growth model needs to be 1.9% of GDP in 2013, implicitly arguing that any slippage in the
developed. France needs to shift resources from the nominal deficit target is poor due to weaker cyclical outturns
domestic public sector to the export-producing sector.     and should not require additional austerity. Anyway, the extent
2. Fiscal devaluation: The Pact for Competiveness signals of the fiscal tightening has been unprecedented, with a
the new direction: Among decisions taken by the new reduction of the structural deficit by 4.2pp of GDP between
government, the “Pact for Competitiveness” and the CICE 2009 and 2013 and by 2.3pp of GDP over the last two years. In
are doubtless a major move. See French Compass. The all likelihood, this trend will carry on in 2014 as suggested by
CICE is a meaningful corporate tax cut (that represents 8pp government announcements. Given the new euro area
of profits after tax) which is financed by cuts in public governance procedures, the public deficit will have to fall well
spending, VAT hikes and green taxes. This shift in the tax below the 3.0% threshold in 2014. This probably implies a
burden which is consistent with the idea of building a new strong fiscal tightening in 2014, worth 1.1% of GDP.

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4. Cutting public spending by €24bn in 2014 and €60bn for the government. First, spending on pensions would only be
over three years: The government has committed to reduced over the long term. Furthermore, the government will
maintaining the share of tax receipts unchanged from 2014 have to tread carefully having in 2012 cut the retirement age for
and to reduce the public deficit mainly through public those that began work at an early age to 60 years from 62 years.
spending cuts, representing €60bn over three years. The Another option would be to reduce the amount paid in pensions.
main areas will be announced in the new Stability and One way of rapidly reducing the size of the pension inventory
Growth Pact 2013-2017, to be released in early April. We would be to discontinue its indexation. This avenue has just
assume that the government will cut public spending by been favoured by the social partners for complementary
€24bn (1.2% of GDP) in 2014, which would bring the public pension systems AGIRC-ARCCO (the part of the pay as you go
deficit to 2.8% of GDP in 2014. Leaks will occur during the system that is directly managed by the private sector).
summer but details won’t be available before the 2014
                                                            Doubtless, this will be a key test for the government this year.
budget bill in September. In a country where social
                                                            Indeed each reform since the early 1990s has been met with
protection and health spending represents 33% of GDP, it is
                                                            strike action (mostly in the public sector and in the utilities).
hard to consider a sharp reduction in public spending
                                                            Furthermore, all pension reform in France so far has been
without a considerable overhaul of the French welfare
                                                            implemented by conservative governments.
system. This will prove politically challenging.
                                                            6. Huge potential gains from structural reforms: If the French
France: Social protection and health spending represent
33% of GDP (2010)                                                                  government manages to safely pass the pitfalls of the cuts to
                                                                                   public spending and the pension reform that would be a great
                                2.5                    Sickness and disability     achievement this year. Indeed, those reforms will help the
                                                       Old age                     French public to get used to the idea of reform in order to build
               8.3                                     Survivors                   the new growth model which is required. Against a backdrop of
                                                       Family and children         weak economic growth, bolder reforms would probably have a
  0.1                                                  Unemployment                negative impact on activity in the short run, which in turn would
                                                       Housing                     affect market sentiment. Therefore, we do not forecast a glut of
        1.1   1.9                           13.5
                                                       Social exclusion n.e.c.
                    2.5                                                            reforms. Longer term, a well-designed package of reform has
                          1.5                          Social protection n.e.c.
                                                                                   the potential to deliver 15% extra GDP over a decade according
                                                                                   to OECD studies.
                                                                                     Impact on GDP per capita of a broad set of reforms in
Source: Eurostat, INSEE, SG Cross Asset Research/Economics
                                                                                     selected countries after 10 years
5. Saving 1pp of GDP on pensions: The French
                                                                                                     PM    EPL reform          Unemp     ALMP        Labour      Pension
government has not yet set the next key dates relative to the
pension reform. But President Hollande said it will be done                                Spain

in 2013. Some sense of timing suggests that it will be in Q4
13, just after the budget law. The government will have to                                   Italy

find 1.0% of GDP per year until the end of its term (2017) to
cover the financing gap. Basically, there are three ways in                              France

which the financing gap could be closed: 1) increase
contributions (+1.1% up to 2020 and +5.0% up to 2040                                   Germany
according to the COR), 2) reduce the replacement rate, ie,
                                                                                                     0                     5                       10                      15
the ratio of pensions to average wage (by -5% up to 2020
                                                                                     Source : OECD (2011), SG Cross Asset Research/Economics.
and -20% up to 2040), 3) extend the retirement age (9
                                                                                     Note for the reader: PM means Product market reforms, EPL means Employment Protection
months up to 2020, +4 years up to 2040).                                             Legislation, Unemp: Unemployment benefits reform. ALMP: Active Labour Market Policy
                                                                                     include individualised support for the unemployed as well as strong controls, Labour means
None of these measures will be popular and the debate                                policies that reduce the tax wedge on labour

promises to be costly politically. Relying essentially on the                                                                
first solution would seem at odds with the aim of improving
corporate competiveness and reducing labour costs. The
third solution would undoubtedly be the most effective over
the long term. However, it would represent two difficulties

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              Germany has already been flexible … with conditionality: Germany (and other Northern
              Europeans) has already been far more flexible than generally credited in numerous ways: (1)
              new programs to Greece despite repeatedly missing numerical targets, (2) lower interest rates
              and maturity extensions on official sector loans (most recently for Ireland and Portugal), (3) a
              shift to evaluate budget targets taking account of economic growth (i.e. a focus on structural
              deficits, (4) little appetite to fine any member states for missing budget targets and (5) a
              combined EFSF/ESM at now €700bn. Acceptance of the ECB’s OMT and Ireland’s promissory
              note deal can also be added to this list. The price for this flexibility, however, has been greater
              control at the EU level over national budgets with the Two-Pact as the latest addition.

              The SPD is pro-conditionality: The SPD party in Germany is traditionally considered pro-
              European and the hope is that, should they win a hand in government in the 22 September
              general election, Germany would adopt a “softer” approach to euro debt crisis resolution. The
              SPD champions a European Redemption Fund (ERF) and would prefer to see OMT scrapped.
              A proposal was drafted for an ERP back in November 2011 with the idea that member states
              would pool debt above 60% of GDP into the fund which, in turn, would issue bonds with joint
              and several liability. The ERF would be open to all member states and paid back over a 20-25
              year period. For the hard-hit periphery, ERP could offer relief on debt servicing costs and
              confidence in the commitment to Europe. On the flipside, the ERF would come with a long list
              of conditions ranging from collateral, fiscal consolidation, structural reform and implicit
              seniority over national debt. Conditionality is here to stay!

              Chart 12: France amongst top austerity performers – structural budget balance (% of GDP)

                 2                                         2010      2011     2012     2013   2014






                      Portugal         Greece           UK           France          Italy    Euro area   Germany   Spain
              Source: EU Commission, SG Cross Asset Research/Economics

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Box 5                                                                     Euro area
                                            Slow repair of financial fragmentation
Slow repair on financial fragmentation                                                The ECB’s OMT delivered significant improvement of
                                                                                      funding conditions for banks and sovereigns in the
                            YoY grow th of total bank credit
 30%                                                                                  hard-hit periphery. Lending conditions to the segments
 25%                                                                                  of the economy without access to international bond
 20%                                                                                  markets have seen only modest improvement, however.
 15%                                                                                  Looking ahead, we assume repair will continue to
 10%                                                                                  progress, but in the absence of any significant ECB
  5%                                                                                  action the repair process is set to remain slow.

                                                                                      A picture tells a thousand words … we have selected a few
                                                                                      that highlight the issue of financial fragmentation. Credit
-15%                                                                                  surveys also tell a similar story. The fragmentation has
        2007        2008           2009     2010      2011        2012       2013
                                                                                      several causes: (1) continuing repair of bank balance sheets
               Lending rate on loans to NFCs up to 1 m illion euro,
                                    1Y rate                                           in the periphery, (2) concerns on renewed sovereign stress
                                                                                      in the broader European banking sector and (3) tighter
                                                                                      regulatory demands. Looking ahead, slow feed-through of
5%                                                                                    lower funding costs to bank lending rates and continued
4%                                                                                    progress on resolution of the euro crisis, including banking
                                                                                      union, should ease fragmentation. This raises the question
                  ECB Repo
                  Germany                                                             of what the ECB could do to alleviate this problem.
1%                Spain                                                               As a first step, the ECB could ease collateral rules (both
                                                                                      what is accepted and haircuts) on instruments that fund
     2007          2008            2009     2010       2011        2012               new lending to SMEs. The ECB could also replicate the
                            YoY grow th of total bank credit                          UK’s Funding for Lending scheme offering LTRO’s on
 30%                                                                                  condition that these are then used to fund lending to SMEs
                                                                                      (cf. Box 6 for more on FLS). These measures would
                                                                                      address funding (access and cost). Our concern, however,
                                                                                      is that funding is the lesser issue at present and the
                                                                                      problem rather is capital. Regulators could ease capital
                                                                                      rules, but this seems unlikely at present. This means that

                                                                                      banks have to find investors or vehicules prepared to take
                                                                                      some of the loans off banks’ balance sheets.
        2007        2008           2009     2010      2011        2012       2013
                                                                                      The ECB could make asset purchases of securitised loans
                                                                                      (i.e. a form of quantitative easing). This option would
                Total foreign claim s on Italy and Spain, USDbn
                                                                                      certainly have more teeth. Unless the economic situation
 1300                                                                                 deteriorates significantly, we find it unlikely that the ECB
 1200                                                                                 would put its balance sheet at risk a significant way.
 1000                                                                                 This brings us to the European Investment Bank (EIB) as
                                                                                      an alternative balance sheet to place the risk on. The EIB is
                                                                                      already a key element of the “Growth Pact” and the more
   600                                                                                capital euro area governments are willing to inject, the
   500                                                                                more this institution could lend. Structural and Cohesion
                                                                                      funds could also be targeted at initiatives to help SMEs.
         2007                        2009                 2011
Source: ECB, BiS, Datastream, SG Cross Asset Research/Economics                       Again, it all boils down to finding the funds.


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                                              France is committed to austerity: In line with expectations, the French government now
                                              projects the budget deficit to clock in at 3.7% in 2013, thus exceeding the official 3% target
                                              by quite a margin. A lack of growth – and not a lack of austerity – is to blame. Indeed, the EU
                                              Commission estimates show a marked improvement in the structural budget balance, from -
                                              4.5% in 2011 to -3.3% in 2012. Looking ahead, we expect President Hollande to remain
                                              committed to balancing the budget. The next round of austerity will be more challenging,
                                              however. Taxes have already been raised and now politically sensitive spending cuts are on
                                              the agenda. Pension reform will be one area where the administration will hope to improve the
                                              path of public finances medium-term without too much of a short-term drag on the economy.

                                              Italy is on austerity auto-pilot: For Italy, the EU Commission forecast a general government
                                              deficit of 2.1% of GDP in both 2013 and 2014. Moreover, the structural budget deficit forecast
                                              falls within the medium-term limit of-0.5% set out in the Treaty on Stability, Coordination and
                                              Government. Given the Commission forecasts are built on a current policy assumption, this
                                              indicates that Italy a priori does not need to take on additional fiscal austerity in 2014. This is
                                              what ECB President Draghi referred to when he indicated that Italian fiscal policy is on “auto-
                                              pilot”. Nonetheless, the current political situation in Italy raises considerable uncertainty. We
                                              make the key assumption that by early 2014, a reform willing government will be in place in
                                              Italy and that in the interim there will be no significant scaling back of the austerity measures
                                              already in place.

                                              Spain needs to do more: Turning finally to Spain, we believe additional austerity is on the
                                              cards. The EU Commission forecast a decline in the structural balance by around 1.5pp and,
                                              given that Spain is forecast to post a structural deficit of 4.6% of GDP (i.e. well above the
                                              0.5% medium-term target), we forecast a fiscal tightening of just over 1% of GDP in 2014.

Chart 13: Growth advantage US...                                                Chart 14: ... catching up on profits
                EU Real GDP yoy (%)
                US Real GDP yoy (%)
        3                                                                            5

                                                                                       EU gross operating
        2                                                                            4 income growth yoy (%)

                                                                                       US gross operating
        1                                                                            3 income growth yoy (%)


                2013           2014         2015        2016      2017
                                                                                             2013          2014   2015   2016       2017

Source: Datastream, SG Cross Asset Research/Economics

                                              It is no wonder against this backdrop that attention has once again turned to the ECB’s
                                              toolbox. The main issue is the still very tight credit conditions for households and SMEs in the
                                              periphery caused by financial fragmentation (cf. Box 5: Slow repair of financial fragmentation)
                                              and a rate cut would offer little relief. The ECB’s toolbox already contains LTRO, CBPP and
                                              OMT as part of its crisis-fighting arsenal. None of these facilities, however, directly targets
                                              lending conditions to SMEs. As we discuss in Box 5, the ECB still has options but those with
                                              potential teeth would mean putting part of the ECB’s own balance sheet at risk. A quick

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                                                          glance across the Channel, however, shows that tackling weak lending in the UK has been no
                                                          easy task (Box 6: Lessons from the UK’s FLS).

                                                          Medium-term, our euro area scenario remains one of recovery, based on the assumption of
                                                          continued gradual repair of finical fragmentation, continued structural reform and a slowdown
                                                          of new austerity measures. For 2013, we continued to predict negative growth and remain
                                                          below consensus in 2014. Contrasting our medium-term forecasts of the euro area with those
                                                          of the US, one surprising feature is the medium-term catching up of the euro area when it
                                                          comes to corporate profit.

Chart 15: Europe’s new house is still under construction but continues to expand

                                                                                                 Europe's New House
                                                                        Fiscal union and E-bonds ?

                                                                                                                                                                                      Full banking union ?
    Treaty on Stability, Coordination and Governance                         ESM direct bank                                 ESM
                          (TSCG)                                                 recap                              (effective Oct. 2012)
Enters into f orce once 12 euro area member states have ratif ied.                                      Ef f ective lending capacity of €500bn. €80bn of
Fiscal com pact: Structural def icit of 0.5% of GDP. Target general         Ef f ective once banking    paid-in capital and €620bn in callable shares.
                                                                                                                                                                                               Single euro bank supervisor
government debt of 60% of GDP. Budget rules in national law .               union is in place.
Coordination of econom ic policies: Fostering competitiveness and
promoting employment.                                                                         EFSF                                                                                                       Details to f ollow !
                                                                                       PRP & CIF (Oct. 2011)                               OMT
                                                                            Partial Risk Protection (PRP): Fixed credit
                                                        Two-pack            protection of 20-30% of principal amount of                    CACs
                                                        (Jan.2013)                                                                                                              CT1 of 9%
                                                                            bond.                                                           2013
                                                                            Co-Investm ent Funds: Combination of public
                "Six Pack"                         Enhanced surveillance    and private f unding.
         (Effective Dec-13, 2011)                                                                                                        3Y LTRO              Exceptional and temporary capital buf f er against
                                                                                                                                                              sovereign debt exposure. CT1 at 9% by Jun.'12.
Fiscal: strengthens Stability and Grow th Pact
                                                          Europe                                                                           ECB
Macroeconom ic: Excessive Imbalances
                                                           2020                                                                            SMP
Procedure (EIP).
                                                   Strategy f or grow th.
Reversed qualif ied majority.                                                                                                                                                                  ESFS
                                                                                                  EFSF (May 2010) & EFSM
                                                                                                                                                                                        (started Jan. 2011)

                                                                            EFSM: Guarantees f rom community. Loan capacity of €60bn.                         Includes a European Systemic Risk Board (ESRB), European Banking
            European Semester (Started Jan. 2011)
                                                                            EFSF: Euro area member state guarantees. Loan capacity of €440bn. Strict          Authority (EBA), European Securities and Market Authority (ESMA),
                   Euro+ Pact (Mar. 2011)                                   conditionality on programmes. Assistance can be given to recapitalise             European Insurance and Occupational Pensions Authority (EIOPA).
"Upstream" coordination of economic and f iscal policy. Member states       banks f or member states not in a programme.
submit Stability or Convergence Programmes and National Ref orm
Programmes. Euro+ Pact commits 23 signatories to even stronger

                                                                                           Bilateral loans                                 ECB
                                                                                                                                                                                National financial supervisors
                                                                                      (1st Greek programme)                              1Y LTRO

                       Economic governance
                                                                                                       Stability mechanisms                                                             Financial stability
                      and policy coordination

Europe is building a new framework based on three pillars; (1) economic governance and policy co-ordination, (2) crisis management and (3) financial stability. Dark blue indicates the facility is
operational, light blue soon to be finalised, white elements in very early stages but we expect will come (ultimately). Measures indicated black relate to ECB action.

                                                                                                                                                           Source: EU Commission, EFSF, EBA, SG Cross Asset Research / Economics

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Box 6                                                                                     Tackling weak lending
                                                                                   Lessons from the UK’s FLS
QE has delivered growth in money but not in loans. The                              The Bank of England’s Q3 2012 Credit Conditions survey
thrust of UK monetary policy during the Great                                       showed that banks expected to ease conditions for
Recession was to boost nominal demand through asset                                 mortgages in Q4 but not for business loans but then the
purchases. That has pushed up money supply growth,                                  Q4 survey delivered the unexpected news that, as well as
to an acceptable rate. Unfortunately, the same cannot                               the confirmation that mortgage conditions did ease in Q3,
be said of lending growth.                                                          conditions for business loans were eased even more.
                                                                                    However, demand from small businesses for loans
Money growth responds to QE but lending does not
                                                                                    declined substantially. This raises serious questions about
   6                                                                                the eventual impact of the scheme on lending, and by
               M4 ex IOFCs yoy                 M4 ex IOFCs Lending yoy
   5                                                                                extension, real economic activity, the ultimate goal of
                                                                                    monetary stimulus.

   3                                                                                The constraints on lending

   2                                                                                The regulatory environment provides a significant deterrent
   1                                                                                to lending. Internationally, the Basel III requirements are
                                                                                    discouraging banks from expanding their balance sheets,
                                                                                    and in the UK, the requirements are even more onerous. To
  -1                                                                                ease those constraints the BoE announced in June that
  -2                                                                                banks could release their regulatory liquidity buffers but the
    Jun-10        Dec-10         Jun-11        Dec-11        Jun-12      Dec-12     FSA did not announce that no additional capital would be
Source: Bank of England, SG Cross Asset Research/Economics
                                                                                    required to back FLS loans until late September.
From the very beginning of the QE programme at the start
of 2009, it was hoped and expected that the programme                               We are sceptical that the relaxation of these domestic
would boost lending as well as money growth. The lack of                            constraints will generate much lending. Given that the
lending response became increasingly contentious                                    reduction in funding costs is between 100bp and 200bp,
politically; for example, the Treasury Select Committee on                          the size of the cuts in lending interest rates has been very
several occasions aggressively questioned the Governor of                           disappointing, especially for business loans where in many
the Bank of England about the reasons for loan weakness.                            cases, rates have risen not fallen. The news is better for
Eventually, the government appeared to have lost patience                           mortgages, though. The bulk of new mortgages has been
with the explanations of Sir Mervyn as to why the BoE could                         in fixed rate loans where rates have fallen by about 80bp.
not deliver loan growth and so in June 2012 the Funding for                         Do not expect the FLS to suddenly boost growth
Lending Scheme was launched jointly by the government
and the BoE.                                                                        In February, King and Fisher joined Miles in voting for an
                                                                                    additional £25bn QE. With regard to the FLS, the striking
The scheme provides a massive funding subsidy to the UK
                                                                                    feature of the February vote is that Fisher is the BoE
banking sector. Over the 18 months to January 2014, the
                                                                                    director in charge of the FLS, yet he voted for more QE.
banks can present bundles of eligible loans to the BoE
which then swaps them for Treasury bills for up to four                             The message is clear. Even though the committee believes
years. Those bills can then be repoed at close to Bank Rate                         that the FLS will eventually deliver some boost to lending, it
which the BoE calculates will represent a subsidy of                                believes that there is still no substitute for QE when a rapid
between 100bp and 200bp.                                                            boost to activity is desired. Sir Mervyn has recently said
                                                                                    that the full impact of the lending scheme will not be
The hope and expectation of the BoE is that this will trigger
                                                                                    known until at least the full 2013 lending data are known.
competition to lend out these much cheaper funds. How
                                                                                    With Mr Carney arriving in July and the GDP outlook still
can the BoE monitor the success of the scheme? The first
                                                                                    weak, we should therefore expect more QE. Moreover, the
effect should be that banks plan to increase the availability
                                                                                    next dose may well be delivered before he arrives.
of loans and then they reduce their loan interest rates.

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Box 7                                                               The UK EU referendum
                   EU exit is a big risk but not the likely outcome
On 23 January, the UK prime minister, David Cameron,           The key principle is the return of powers from the centre to
announced his plans for a referendum on whether the            the UK. Mr Cameron’s success on this issue will be the
UK should stay in the European Union. Why has he               main test of his campaign. If he is deemed to have failed,
done this and what is the outcome likely to be?                then he will almost certainly lose the referendum.

Cameron is a victim of two related factors. First, the         The timetable
Conservative MPs who entered Parliament in May 2010 are
highly antagonistic towards anything to do with the                Before 2015    –   draft   legislation   to   prepare   for
European Union and, second, the hitherto fringe party, the          referendum
UK Independence party, is enjoying an enormous surge in
                                                                   May 2015 – general election to obtain mandate “to
its popularity on a platform whose centrepiece is
                                                                    negotiate a new settlement with our European partners”
withdrawal from the EU.
                                                                   Before the end of 2015 – introduce enabling legislation
Party discipline has crumbled
                                                                    and pass it by the end of that year
The recent travails of the euro area have emboldened the
                                                                   Within the first half of the next parliament – complete
eurosceptics and critics of the EU within Cameron’s party.
                                                                    the negotiation of the new settlement and hold the
He badly mishandled the EU issue by making various
                                                                    referendum with the question “in or out?”
parliamentary votes on the EU a vote on confidence in his
leadership. He failed to impose party discipline in these      The stumbling blocks
votes and ever since has looked badly weakened on this
topic, especially after his tragically inept casting of a      Mr Cameron can probably draft the legislation without
supposed veto of EU plans for financial regulation.            much difficulty, but will he win the next election? At
                                                               present, the odds are heavily against him, in which case,
UKIP is eating away at Conservative support                    there would be no need to hold a referendum. At present,
                                                               the Labour party (most likely to win the election outright)
Conservative party support has steadily declined since the
                                                               has only undertaken to hold a referendum if the EU seeks
election. One cause is the usual “mid-term blues,”
                                                               fresh powers. Moreover, the Liberal Democrats are also
especially given the austerity cuts but, most recently, UKIP
                                                               opposed to a referendum.
has stolen support from the Conservative right wing.
Cameron’s response has been to move the party to the           Even if Cameron wins the election, we see little chance of
right to recapture those votes. The launching of the           him being able to extract any meaningful concessions from
referendum is one element of that strategy.                    his EU peers. However, there are many countries in the EU
                                                               who are keen for the UK to remain a member, despite the
Cameron’s speech
                                                               difficult nature of the relationship. One would therefore
He laid out five principles:                                   expect some crumbs to be offered to the British prime
                                                               minister which he could then present as major successes.
        Competitiveness
        Flexibility
                                                                    1)   If Cameron manages to form the next government,
        Power must flow back to Member States                           so manages to hold the referendum, we think the
                                                                         vote will be to stay in.
        Democratic accountability – “democratic consent
         for the EU in Britain is now wafer thin”                   2)   The Conservatives will have to work hard to turn
                                                                         around their poor position in the opinion polls so
        Fairness – whatever new arrangements are                        there is a major possibility that the referendum
         enacted for the euro area, they must work fairly                does not take place.
         for those both within and without.                                               

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              Euro convergence returns
              European institutions are undergoing significant change and, while the process at times is
              painful in terms of both complexity and speed, our chart on the European House continues to
              expand. The changes driven from the euro area are also triggering new debates in the other
              European Union members. In the UK, PM Cameron has promised a referendum if he is re-
              elected to a second term. Should a referendum take place, there is a very real possibility of a
              No vote. For the UK economy, there would be a high price to pay for such an outcome (cf.
              Box 7: EU exit is a big risk but not the likely outcome). Moreover, we consider that the
              uncertainty generated by the prospect of a referendum will exert a moderate drag on the UK

              In Eastern Europe, on the other hand, fear of political marginalisation has created fresh
              appetite for euro convergence. Poland, Czech Republic, Romania, Lithuania and Latvia are
              discussing this possibility and, by the end of this decade, all of these countries could have
              joined the euro. Keeping the option open is becoming a policy priority, and that requires
              economic reform.

              As seen from the chart below, differences in GDP per capita remain significant and no doubt
              the hope is that the convergence policies will be helpful in offering a boost from both the
              domestic side and in generating new FDI inflows. One area that will be under close watch,
              however, is the credit side. This dark side of credit and housing booms to boost growth has
              been made abundantly clear by the current crisis. Medium-term, the convergence process
              also backs our call for currency appreciation for the bulk of the region.

              Chart 16: Ample room to catch up, but no credit boom please!

                                                                      GDP per capita in 2012 (euro area = 100)









              Source: IMF, SG Cross Asset Research/Economics

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Box 8                                                                                                                                       EU
                                                       Euro convergence is creeping back
For many countries, the issue of euro adoption continues to                            A long road ahead for most countries
be an attractive prospect, especially as it concerns the
institutional changes taking place in the euro area. Once                              The Romanian government, the National Bank of
the necessary reforms are introduced there, its new                                    Romania (NBR) and the EC are currently resetting the
members may strengthen the common currency area. As                                    target for euro adoption, which will probably be
for the coming years, the near-term adoption of the euro                               postponed to a more realistic deadline than the
has been discussed in Poland, the Czech Republic,                                      previous 2015 date. Due to the limited progress made
Romania, Lithuania and Latvia.                                                         on structural reform and competitiveness, the NBR still
                                                                                       needs to retain control over the exchange rate as a
Poland has not set a specific date for euro adoption. However,                         supplementary adjustment channel. Romania is the
that country’s ability to meet the fiscal criteria this year and                       only non-euro area EU member for which the majority
removal of the excessive deficit procedure make the issue of                           of those surveyed believes that introducing the euro
euro adoption more relevant than ever. After negotiations on                           would have positive consequences for their country.
the multi-annual financial outlook were concluded and as a                             The Czech Republic has not raised the issue of euro
result of the successful fiscal consolidation, politicians began to                    adoption at all, as it is one of the most euro-sceptic
realise that Poland would benefit from adopting the euro before                        nations in Europe. According to opinion polls, Czech
the end of the 2014-2020 budget perspective. And the Polish                            households and entrepreneurs (even exporters) are
government is well aware that remaining outside the euro area                          also against euro entry. The central bank and the
puts Poland at risk of political marginalisation. However, few                         government do not support early adoption of the
Polish citizens (about 20%) support euro entry, so convincing                          common currency either. The first theoretically
Poles about the benefits of the euro should prove time-                                possible (although very unlikely in reality) date for euro
consuming. In theory, Poland could apply for accession to ERM                          adoption is 2017. Another potential date would be
II in 2014, but an essential element preventing this from                              2019, when the Czechs will be celebrating the 100th
happening is the lack of a majority in Parliament to change the                        anniversary of the koruna. Against this backdrop, the
Constitution. The National Bank of Poland is examining the                             Baltic countries seem to be the most advanced in
consequences of remaining outside the euro area¹. It is hard at                        terms of the euro preparation process. Estonia already
this stage to determine in what year Poland could adopt the                            entered the euro area in 2011. Lithuania and Latvia
euro. We believe it could do so sometime between 2018 and                              have had their currencies pegged to the euro since
2020.                                                                                  2002 and 2005, respectively. The Latvian authorities
                                                                                       have officially applied for euro adoption, with a 2014
    SG forecasts of eastern European currencies against euro
    (base 100 in 2013)

     115                                                                               Latvia to adopt the euro, Lithuania to follow

     110                                                                               The European Commission and ECB are set to
                                                                                       prepare a convergence report, while the finance
     105                                                                               ministers of euro area countries are expected to
                                                                                       formally accept Latvia’s entry in July. Meanwhile, the
     100                                                 Polish zloty                  Lithuanian government recently approved in principle
                                                                                       a euro introduction plan that calls for setting up
                                                         Czech koruna
      95                                                                               strategic/coordination commissions and working
                                                         Romanian Leu
                                                                                       groups aimed at determining how to fulfil the
      90                                                                               Maastricht criteria. Lithuania aims to join the euro area
                2013            2014            2015     2016           2017
    Source: SG Cross Asset Research/Economics
                                                                                       in 2015.

    M.Brzoza-Brzezina, K.Makarski, G.Wesołowski (2012), Would it have paid to be in the eurozone?, NBP Working Paper No. 128.

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              Asia’s brave new policies
              The traditional economic argument on the dangers of deflation runs that when prices are
              falling consumers hold back on spending decisions; raising inflation should thus boost
              consumer spending. We do not believe that anyone would delay the purchase of a washing
              machine for over a decade and thus believe that deflation in Japan is per se not a detriment to
              spending. Rather, we believe that it boosts consumer purchasing power and one key to the
              success of Abeconomics as we have argued on previous occasion is wage growth. Already
              there are some positive signs, but more is needed.

              Medium-term, however, the success of Abeconomics relies of structural reform to tackle a
              burgeoning public debt and shrinking labour force. Here we see no encouraging signs and as
              we detail in Box 9, Abenomics will deliver, but for how long? .

              Korea will be keeping a close eye on Abenomics and notably the impact thereof on exchange
              rate. For now, however, the won remains cheap against the yen. Exports make up half of the
              economy’s GDP and confidence in the export sector is needed to give a much-needed boost
              to investment spending.

              Our call for a structural slowdown of China has been the topic of much of our research on the
              region. Once again, our lead China Economist Wei Yao is ahead of the pack, predicting a
              slowdown in trend potential growth to 4-5% by the end of this decade. Consensus is still that
              growth rates of 6% in China are consistent with hard landing – our own view is today closer to
              4%. As the potential growth rate continues to decline, so too will the level consistent with hard
              landing. Much as we take a more conservative view of China’s long-term growth potential, we
              are also greatly encouraged by the recent policy signals out of Beijing. The commitment to
              structural reform is clearly present and this in itself should significantly reduce risks of hard

              Chart 17: Contributions to global growth







                                    China                             Japan

               -2%                  India                             Korea

                                    Australia                         Hong-Kong
                                    Others                            World growth

                        2001       2002         2003      2004        2005    2006   2007   2008   2009   2010   2011
              Source: World Bank, SG Cross Asset Research/Economics

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Box 9                                                                                          Asia’s Brave New
                                        Abenomics will deliver, but for how long?
The change in government in December, or more                                simulations on the OECD’s model suggest that in year
precisely the radical change of tack in economic                             two, after an exchange rate shock of this magnitude
policy, has transformed the economic outlook for                             (which would correspond to 2014), the level of GDP would
Japan, certainly for the next three to four years.                           be around 1.5-2% higher than base, and the level of
Abenomics have indeed paved the way for Japan to                             consumer prices some 1.5% higher. And in some
escape deflation, stagnation and the strong yen. But                         simulations the effects continue to grow beyond that. We
beyond the three- to four-year horizon, Japan will still                     have not raised our growth and inflation forecasts by that
be faced with the challenges posed by a shrinking                            much, but we now predict real GDP growth to average
labour force, huge public sector debts and an old                            around 2% this year and next, and then fluctuate around
population. These challenges can only be addressed                           1¼% in the subsequent three years. But we see the risks
by root and branch reforms addressing labour and                             to our forecasts biased to the upside.
product market rigidities as well as the tax system and
public administration. And that list is not exhaustive.                      A new improved BoJ

For the next few years, however, economic prospects look                     An important element of Abenomics has been the drastic
brighter than they have in a long time. Already a revision to                increase in pressure on the Bank of Japan to ease policy
the Q4 national accounts has delivered Japan from                            far more aggressively. The proposed candidates for
recession earlier than previously thought, and in the next                   governor and the two deputy governor posts certainly
three to four quarters Mr Abe’s old-fashioned fiscal                         support a shift to a much more radical easing in policy.
stimulus plan is bound to deliver growth as public-sector                    This will almost certainly mean stepping up the pace of
infrastructure is upgraded, schools, hospitals and other                     JGB purchases, possibly combined with an immediate
buildings are made more earthquake-safe and tsunami                          move toward open-ended asset purchases – rather than
defences are strengthened.                                                   waiting until 2014 – as well as some purchases of risk
                                                                             assets such as ETFs and J-REITS. On the latter we are
All hail a weak yen                                                          agnostic, not least given that the main Japan stock indices
                                                                             have gained over 18% just this year, on top of strong
Yen to US dollar, SG forecast after March 2013
                                                                             gains in the last six weeks of 2012. Moreover, the
 130                                                                         resistance of the BoJ bureaucrats to what they see as an
                                                                             inefficient use of the BoJ’s balance sheet is unlikely to
                                                                             have been weakened. In addition to the anticipated
                                                                             expansion in the volume of asset purchases, it is also
                                                                             highly likely that the maturity of JGBs the BoJ buys will be
 100                                                                         extended from the current maximum of 3 years to at least
                                                                             5 years, and more likely 10.
                                                                             The monetary side of Abenomics: consequences
                                                                             All this clearly amounts to a radical shift in monetary policy
  70                                                                         in Japan. But will it make a difference? We think yes and
    2007          2009          2011          2013      2015     2017
Source: WM/Reuters, SG Cross Asset Research/Economics

By the time the stimulus programme winds down, the                           Yes in the sense that one consequence of the policy shift
effects of the approximately 15% depreciation of the yen                     appears to have been the major and abrupt depreciation
will have been unfolding and should by then have reached                     of the yen, which, as described above, we believe will
a notable level. While models, of course, differ in their                    have a strong impact on growth and inflation.
predictions of how large these effects are, different

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There were other reasons to sell the yen as well, such as         The return of inflation would undoubtedly be helpful for
the fall-back into recession and into trade deficit, but there    public sector finances. In the absence of indexation, fiscal
are good reasons to believe that the exchange rate was            drag would increase income tax revenue, and rising prices
impacted by politics. The remarkable thing was that the           would boost consumption tax revenue as well. Lastly,
government did not in fact do anything concrete to                rising asset prices would also help.
influence the exchange rate directly.
                                                                  No-one knows if Abenomics will work, but the mere fact
But we are doubtful that a more rapid expansion of the            that policy paralysis has been broken is positive, and
BoJ’s balance sheet will have much impact on the                  economic growth and inflation will surely come. But to
economy – it is unlikely to suddenly trigger a rush of            make growth sustainable, deep structural reforms are
borrowing by households or corporates, the latter being as        indispensable.
cash-rich as they are. Perhaps the best way to look at the
issue is that aggressive JGB buying will cap the upside for
bond yields, which would otherwise be likely to react to
the higher growth and inflation outlook as well as the
accelerated build-up of public debt.

Nevertheless, public sector deficits in excess of 10% of
GDP as they are being run currently are clearly
unsustainable. Hence, once the economy has returned to
growth, it is imperative that the government implements
fiscal consolidation, in particular the planned hikes in
consumption taxes in 2014 and 2015. Given current
conditions and demographic developments, a structural
move towards greater reliance on indirect taxes is

For better or for worse, Japan wants inflation back

Numerous questions remain: will bond yields remain at
current low levels, regardless of rising indebtedness and
inflation? With the help of BoJ we are inclined to assume
so, at least for the time being. That would mean that real
rates will at long last turn negative, which will be helpful.

How will the consumer react to inflation? There are
arguments for both stronger and weaker expenditure
trends. Some will argue that overcoming deflation will
encourage more spending as consumers expect prices to
be higher in future, rather than lower as is the case now.
Also, the return of consumer price inflation is likely to be
accompanied by rising asset prices, which will trigger
positive wealth effects and more spending – judging by
the Japanese stock market this process has already
begun. But there are also arguments that point in the
opposite direction: inflation will erode the real value of
nominal savings, which could lead to a desire to save
more rather than less.

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Box 10                                                                            Asia’s Brave New Policies
                                                           Mr. Xi has to, and will, reform China
Throughout 2012, Chinese policymakers kept resisting                               This trend cuts into the already precious time left for
the pressure of a sharper-than-expected economic                                   policymakers to develop a new growth model.
slowdown and stayed on the path of cautious easing. In
our view, that was a big achievement and a first                                   However, there is also good news: there is still plenty of
indication of stronger willingness of Beijing to steer the                         unlocked potential. On the supply side, in order to extract
economy towards a different growth model, but still far                            additional productivity and efficiency gains, the new leaders
from enough to prevent a hard landing. In the next few                             need to let go their tight control over the economy, i.e.
years, the new leaders, who got the top job in                                     through further liberalisation and privatisation. Allowing the
November 2012, will need to start taking on the ever                               private sector to play a dominant role in setting factor
more challenging task of reforming the growth model                                prices can correct most of the existing inefficiency in capital
altogether. Understandably, there is still plenty of                               allocation in China. On the demand side, refocusing fiscal
scepticism over their willingness and/or capability to                             spending on the people – in areas of education, healthcare
change. In our view, their willingness is unquestionable                           and social security – can go a long way to encourage
and the chances of an acceleration of reforms starting                             private consumption (cf. “Asian Themes: China’s leadership
in 2013 look very promising.                                                       transition – handing over challenges,” October 2012). The
                                                                                   key is to act fast and decisively.
The absolute necessity of reforms
                                                                                   China still has more miles to go in urbanisation
China’s strong demographic headwinds                                                   100
                                                                                             Urbanization rate, %
   4 Annual working population growth,


   2                                                                                    60


                                                                                                    China:0=2010               Korea:0=2000           Japan:0=1980
                China:0=2010              Korea:0=2000          Japan:0=1980             0
  -2                                                                                          -30 -25 -20 -15 -10         -5    T=0     5   10   15   20   25   30
       -30 -25 -20 -15 -10           -5   T=0     5   10   15   20    25   30
                                                                                   Source: ADB, UN, SG Cross Asset Research/Economics
Source: UNPD, SG Cross Asset Research/Economics

                                                                                   Mr. Xi really has little time to hesitate. Encouragingly, we
China has overstretched its potential under the current
                                                                                   have seen numerous indications that suggest his leadership
economic framework in recent years. The outsized push for
                                                                                   team truly understands this.
public investment in 2009-10 has led the economy as well
as society to a dangerous place. Questionable investment                           What can we expect in the near term?
efficiency and the fast-rising leverage of the economy in the
past four years will be the major sources of downside risks                        In a nutshell, what China needs is a fairer and freer market
in the near term. Economic history has taught us over and                          plus a good safety net, but each of the two aspects
again that correction of excess is always inevitable.                              involves a daunting number of complicated reforms. Given
However, if well managed, the pain can be mitigated and                            the hints and signs so far, here are our calls for economic
the suffering can be shortened. In China’s case, the bad                           reform in 2013-14. Some may look bold, but we still think
news is that the unusually fast ageing demographics                                they are highly possible.
complicate things further. This used to be a remote
                                                                                        Resource price liberalisation: retail prices of gasoline
problem, but no more. China’s working-age population
                                                                                         will be allowed to fluctuate more closely in line with
growth is going to turn negative within the 10-year term
                                                                                         global crude oil prices; the current dual-track coal
under the new Communist Party Chief Xi Jinping’s watch.
                                                                                         prices will be abolished, and at the same time,

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    electricity tariff setting will become more market-        Short-term pain, long-term gain
                                                               Although these would all be positive for China’s long-term
   Capital account openness: the channels for portfolio       prospects, the short-term impact would probably be either
    flows will be expanded under the existing QFII, RQFII,     limited or even negative. For instance, factor price
    QDII and RQDII programmes; credit flows will be first      liberalisation may result in higher production costs, further
    tested in the Qianhai special zone then permitted in       squeezing inefficient companies. Vested interests and
    more places.                                               cronyism are likely to be the biggest obstacles to reform.
                                                               The new leaders have begun to tackle these issues with a
   Currency liberalisation: the daily trading band of the     war on corruption and downsizing of ministries. The path is
    yuan will be widened further or may even be changed        unlikely to be smooth. Although we are certain that things
    into a weekly/monthly band.                                will start to change, we still have doubts as to whether
                                                               changes can happen quickly enough.
   Interest rate liberalisation: the floor on bank lending
    rates will be abolished and the ceiling on deposits will    One hard landing scenario: GDP -3%, no massive stimulus
    be lifted; the central bank will adopt a new policy rate    from the government
    similar to those used in the developed economies and            9
                                                                         Real GDP grow th, %yoy
    guide market rates with active two-way liquidity                8

   De-monopolisation: sectors, such as infrastructure              6

    telecommunications, energy, utilities, healthcare,                                                            at the height of
    education and financial services, will open to private          4                                                the crisis
                                                                                                                 four quarter avg.
    investors, to a significantly greater extent.                   3                                                   3%
                                                                                  SG central scenario
   Relaxation of the household registration system                 1
                                                                                  one case of a hard landing
    (Hukou): Hukou control in medium-and-small sized                0
    cities will be relaxed considerably; farmers will get a             3/2012 6/2012 9/2012 12/2012 3/2013 6/2013 9/2013 12/2013 3/2014 6/2014 9/2014 12/2014

    bigger share of land sales revenues, as an incentive to     Source: NBS, SG Cross Asset Research/Economics

    encourage further urbanisation.                            With timely and decisive reform, we think China can
                                                               achieve a relatively harmless deceleration towards 4-5%
   Fiscal system reform: local governments will gain more
                                                               growth by 2020. If not, the end game for China is probably
    taxing power and rights to raise debt directly, but at
                                                               either a very hard landing or, worse still, devastating social
    the same time will be subject to closer scrutiny by the
                                                               instability (cf. “Cross Asset Strategy: What if China lands
    public; the government balance sheet will be
                                                               hard?” January 2013).
    consolidated to reflect currently off-budget spending
    and borrowing.                                                                                                     

   Relaxation of the one-child policy: all families where
    just one of the parents is an only child him/herself can
    have two children.

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              For Taiwan, China’s shifting growth engines will present a major challenge. Today, exports of
              investment goods to China account for 14.2% of Taiwanese GDP, while exports of
              consumption goods only account for 4.7% of GDP (2011 data).

              Currency armistice
              The term “currency war” was first used by Brazilian Finance Minister Guido Mantega in 2010
              and has since been used in the context of both direct FX intervention and QE. But rather than
              war, we see an armistice in the making. Japan ranks top of the list when it comes to further
              central bank balance sheet expansion, but while we have little doubt that Japan wants a
              weaker yen, we are also quite confident that it does not want too weak a yen either. In our
              view, the yen depreciation of the past six months has broadly met the government’s goal to
              escape from strong yen environment. At Y95 to the dollar, Japanese industry is in a relatively
              comfortable competitive position – as underlined by the series of profit upgrades in recent
              weeks and months.

              At the other end of the QE spectrum, the Federal Reserve is slowly contemplating an exit. A
              stronger US dollar could be very helpful in that context, dampening any imported inflation
              risks at a critical time for bond markets. In the UK, a weak pound has done little to lift exports,
              but has eroded household purchasing power through higher inflation. While additional QE to
              boost the economy may be desirable, further sterling weakness would, in our opinion, not be
              welcome. In the euro area, euro depreciation is considered by some observers to offer a
              potential boost to growth. In our opinion, the traditional multipliers from currency depreciation
              to growth are lower in the post crisis environment. While the ECB does not want to see an
              excessively strong euro, nor does it want to see weakness. Finally, China continues to target a
              gradual regime change in FX policy. While China has warned against currency wars, we see
              little appetite from China to launch one either.

              Chart 18: Winners and losers (REERs)

                 140                          US               Japan       China       UK          Euro area







                       2007              2008                   2009        2010            2011          2012

              Source: IMF, SG Cross Asset Research/Economics

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Box 11                                                                                         The challenge for Brazil
             New investment strategy needed to fight inflation
The Brazilian economy faces two critical challenges: to                                        The household consumption to GDP ratio has risen to
increase the investment/GDP ratio and productivity                                             its highest level in a decade and is threatening to
growth. The low levels of these variables are the cause of                                     touch the levels seen in the 1990s and early 2000s
the low actual growth and falling potential growth and                                         when hyperinflation kept households from saving and
stagflation in the economy.                                                                    high interest rates made investment unattractive.
                                                                                               Furthermore, high credit growth for consumption
Investment cycle: Low investment is clearly linked to the                                      purposes (a lot of these loans are subsidised by the
sharp reduction in household savings and corporate earnings.                                   Brazilian Development Bank), has robbed the economy
The gross savings/GDP ratio fell to 11.2% in Q4 12 compared                                    of funds for investment. Household leverage has
to the cyclical high of 19.6% in Q3 10. That is a substantial                                  reached new high unsustainable levels, sparking fears
reduction, even after accounting for the growth reversal since                                 that a bubble may develop.
then. The annual savings/GDP ratio fell to 14.8% in 2012 from
the high of 18.8% in 2008. The decline in the investment ratio                                 Consumption/GDP ratio is at highest levels in a decade
was not as dramatic (from 20.7% in 2008 to 17.6% in 2012),                                           %                Household consumption as share of GDP
but nevertheless fairly substantial.                                                            65

Savings touched a multi-year low in Q4 12, dragging investment in
its wake                                                                                        63

       % of GDP                Gross Sav ings                  Gross capital f ormation
                                                                                                     2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
 16                                                                                            Source: Datastream, SG Cross Asset Research/Economics

                                                                                               Household credit is now over 16% of GDP and
 12                                                                                            household debt over 43% of disposable income; both
 10                                                                                            ratios are modest from a cross-country standpoint, but
      2003           2005            2007               2009            2011
                                                                                               significant given the fact that they have almost
Source: Datastream, SG Cross Asset Research/Economics                                          doubled in just seven years. More critically, the high
                                                                                               interest rates charged on consumer borrowing are
The current quarterly investment ratio of 15.2% is well short of
                                                                                               leading to a fast rising debt service ratio that could
the level required to generate respectable economic growth.
                                                                                               lead to a marked slowdown in consumption growth. It
The low and falling investment ratio has serious implications
                                                                                               is difficult to see these ratios rising for much longer,
for Brazil’s potential growth rate that will adversely affect
                                                                                               particularly the debt service ratio.
consumption (private and public) in the short/medium term,
further eroding growth and generating a vicious circle of
continued slowdown. The counterpart of the decline in savings
responsible for the decline in the investment ratio is overly-
strong consumption. The policy-fuelled consumption boom
has harmed the economy instead of maintaining stable
growth, and this has been going on for a few years now.

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     Leveraged consumption raising debt servicing burden                                The strong currency over a number of years has hurt
                    Household credit as % of GDP                                        competitiveness      vis-à-vis   rival    countries     in
        %                                                                %
                    Household debt as % of disposable income
                                                                                        manufacturing exports. As a result, manufacturing
                    Household debt serv ice as % of disposable income (RHS)
      45                                                                      23
                                                                                        exports have suffered significantly, sparking a
                                                                              22        reduction in traditionally healthy trade balances
                                                                              21        (thanks mainly to the commodities boom over the last

      25                                                                      20
                                                                                        decade). The fact that most developed markets are in
                                                                                        easing mode has not helped either. Brazil therefore felt
      15                                                                                forced to respond to what it saw as a “currency war”
      10                                                                                by imposing restrictions on inflows, thereby further
       5                                                                      17        eroding investment possibilities. However, the
            2005    2006    2007     2008    2009    2010      2011   2012
                                                                                        resulting currency depreciation also affected inflation –
     Source: Datastream, SG Cross Asset Research/Economics
                                                                                        already hovering above 5% – in the last six months or
Productivity        growth      and       competitiveness:      The                     so, pushing it above acceptable levels. The central
overregulated labour market prohibits prospective investment                            bank’s recent moves to remove capital controls
in Brazil. It is responsible for raising the cost of doing business                     officially ended the currency war for 2013 and should
on the one hand and the worsening of productivity growth on                             help fight inflation. Further measures such as rate
the other. Unit labour costs (ULC) increased by an average 12-                          hikes are likely to have only marginal effects on both
13% (including the collapse in 2009) over the last five years.                          the currency (although the removal of capital controls
Labour hoarding is leading to declines in productivity growth,                          might continue to support it) and on competitiveness.
boosting ULC growth and eroding competitiveness,                                        Brazil must fight its war on structural fronts – tackling
particularly in manufacturing industries. Moreover, high ULC                            the labour market and tax reforms. That is what will
growth has aggravated the persistent inflation problem,                                 matter more than its approach on currency in the long
creating a scenario close to stagflation.                                               run. Time will tell.


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                                            This picture hints at a configuration that feels more like a currency armistice that any renewed
                                            currency war. A point worth making here is that competitiveness boils down to much more
                                            than currencies and wages. Our focus is on productivity, flexibility of product and service
                                            markets, entrepreneurship, quality of institutions (for example speed of reform of the legal
                                            system), education levels, infrastructure, flexibility of labour markets, etc. Improvements in
                                            these areas yield sustainable competitiveness gains. Indeed, one concern we have in the euro
                                            area is that the improvement in unit labour costs in the periphery has to date been driven by
                                            job cuts and wage restraint; medium-term, these are not sustainable means of enhancing
                                            competitiveness and we are concerned that progress in terms of the structural reforms
                                            needed to boost long-term trend potential remains slow.

                                            Structural reform is not just a topic for the euro area as we have highlighted in this new GEO.
                                            Our final box fittingly introduces our new coverage on Brazil, looking at some of the structural
                                            challenges that the economy now faces. Finance Minister Mantega recently noted that the
                                            currency war as far as Brazil is concerned has ceased. In our opinion, however, the need for
                                            structural reform has not.

                                            Risks – Swans are still slow moving

Chart 19: SG Swan Chart: Risks still biased to the downside

Source: SG Cross Asset Research/Economics

                                                               March 2013    38

          FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                Test-driving the recovery

              A theme already introduced in previous GEOs is how central bank action has slowed down the
              “speed” of many black swans. Stronger fundamentals, however, ultimately hold the key to
              lowering risks.

              More balanced risks in the US: Starting on the positive, we have taken the fiscal cliff swan
              off our chart, and now see more evenly balanced risks. As a result, we have lowered our
              downside risk probability to 15% and increased the weight on our central scenario to 75%.
              On the downside, a QE-exit triggered market dislocation is the main source of concern. On the
              upside, a stronger-than-expected housing recovery could drive upside surprise to our growth

              Downside risks still dominate in Europe: Euro area economic outcomes have been
              consistently weaker-than-forecast due to (1) uncertainty shocks from the crisis, (2) financial
              fragmentation and (3) higher-than-expected fiscal contraction multipliers. Our central scenario
              relies on all three factors improving over the forecast horizon and while it can be argued that
              there are both upside and downside risks to this configuration, we take the view that the bias
              of risks is still to the downside. Political risks bring an additional source of uncertainty and, as
              we head to press, Italy is still without a government. Turning to the German election, there is
              little evidence to suggest that a change in government would bring about a sharp shift away
              from the conditionality that has been the backbone of the German policy response to date.

              China hard landing risks have eased: Still a risk we include on our chart, but with the recent
              announcements around the structural reform agenda we believe that the probability of a hard
              landing has declined.


                                 March 2013     39 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                       Test-driving the recovery

SG Growth Outlook
Real GDP

P*= previous forecast     2011 2012     P*     2013f        P*     2014f   P*     2015f   P*    2016f   P*    2017f   P*

World (Mkt FX weights)    3.0    2.6    2.6     2.7         2.9     3.3    3.3     3.5    3.5    3.8    3.7    3.8    3.8
World (PPP FX weights)    3.8    3.2    3.2     3.3         3.5     3.8    3.7     4.0    3.9    4.2    4.2    4.2    4.1
Developed countries (PPP) 1.6    1.3    1.3     1.3         1.5     2.1    2.0     2.4    2.3    2.7    2.6    2.9    2.8
Emerging countries (PPP)  6.1    5.1    5.2     5.3         5.4     5.4    5.5     5.5    5.5    5.5    5.6    5.3    5.3
Euro area                 1.5    -0.5   -0.4    -0.6        -0.3    0.5    0.5     1.2    1.1    1.6    1.4    1.7    1.5
  Germany                 3.1    0.9    0.9     0.8         0.8     1.5    1.2     1.5    1.4    1.5    1.4    1.4    1.4
  France                  1.7    0.0    0.1     -0.2        0.0     0.4    0.3     1.1    1.1    1.7    1.7    1.9    1.9
  Italy                   0.5    -2.4   -2.1    -2.1        -1.3    -0.5   -0.1    0.9    0.8    1.5    1.2    1.7    1.2
  Spain                   0.4    -1.5   -1.3    -1.4        -1.7    -0.8   -0.8    0.3    0.1    1.4    0.8    1.7    1.1
United States             1.8    2.2    2.2     2.1         2.4     3.0    2.8     3.3    3.1    3.7    3.6    4.1    3.9
China                     9.3    7.8    7.8     7.8         7.8     7.2    7.2     6.9    6.9    6.9    6.9    6.0    6.0
Japan                     -0.8   2.0    2.0     1.5         1.5     2.0    1.4     1.2    0.7    1.3    0.9    1.2    1.3
United Kingdom            0.9    0.2    0.1     0.6         0.8     1.2    1.4     1.6    1.7    2.1    2.1    2.5    2.5
Other advanced
Sweden                    3.8    1.8    1.8     1.4         1.3     2.3    2.4     2.6    2.6    2.6    2.6    2.6    2.6
Norway                    2.6    3.3    3.8     2.3         2.6     2.7    2.7     2.6    2.6    2.6    2.6    2.6    2.6
Switzerland               1.9    1.0    1.0     1.3         1.1     1.7    1.8     1.8    1.8    1.8    1.8    1.8    1.9
Australia                 2.4    3.6    3.6     2.8         2.7     3.1    3.1     2.9    3.1    3.0    3.0    3.1    2.9
S. Korea                  3.6    2.1    2.1     2.5         3.0     3.3    3.2     3.6    3.7    3.5    3.4    3.4    3.4
Taiwan                    4.1    1.3            3.3                 3.3            4.6           4.2           4.0
Emerging economies
Brazil                    2.7    0.9            2.9                 3.4            3.6           3.6           3.7
Russia                    4.3    3.4    3.6     2.9         3.3     3.9    3.9     4.0    4.0    3.7    3.7    3.7    3.7
Poland                    4.3    2.0    2.4     1.5         1.9     3.0    3.0     3.5    3.5    4.0    4.0    3.5    4.5
Czech Republic            1.9    -1.0   -0.8    -0.1        0.3     1.4    1.7     2.0    2.3    2.3    2.5    2.3    2.1
Slovakia                  3.2    2.0    2.5     1.6         2.0     3.2    3.0     3.7    3.3    3.5    3.5    3.2    3.3
Romania                   2.2    0.3    1.1     1.3         2.0     2.1    2.6     2.6    4.0    2.8    4.4    3.0    3.5
Ukraine                   5.2    0.2    0.8     1.5         2.8     3.3    3.3     3.4    3.4    3.2    3.2    3.2    3.2
Kazakhstan                7.4    5.0    5.1     5.3         5.5     5.8    5.8     5.9    5.9    6.0    6.0    5.8    5.8

                                    March 2013         40 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                      Test-driving the recovery

SG Inflation Outlook

P*= previous forecast     2011 2012     P*     2013f       P*    2014f   P*     2015f   P*     2016f   P*     2017f   P*

World (Mkt FX weights)    4.1    3.3    3.3     3.2        3.1    3.1    3.1     3.4    3.0     3.8    3.1     3.8    2.9
World (PPP FX weights)    4.9    4.0    4.0     3.8        3.8    3.6    3.6     3.8    3.4     4.0    3.4     4.0    3.3
Developed countries (PPP) 2.7    2.0    2.0     1.7        1.6    1.9    1.9     2.5    1.8     3.1    1.9     3.3    1.9
Emerging countries (PPP)  7.3    6.2    6.1     5.9        5.9    5.2    5.2     5.0    4.9     4.9    4.8     4.6    4.6
Euro area                 2.7    2.5    2.5     1.8        2.0    1.6    1.5     3.7    1.3     5.5    1.4     6.3    1.6
  Germany                 2.5    2.1    2.1     2.0        2.2    2.5    2.2     2.4    2.4     2.4    2.4     2.4    2.4
  France                  2.3    2.2    2.3     1.5        2.1    2.6    2.4     1.8    1.8     1.7    1.7     1.9    1.9
  Italy                   2.9    3.3    3.3     1.7        1.9    1.4    1.1     2.2    0.7     3.1    0.8     1.5    1.2
  Spain                   3.1    2.4    2.5     1.8        2.8    -0.6   -0.5    -1.2   -0.5    -1.0   -0.1    0.6    0.3
United States             3.1    2.1    2.1     1.8        1.4    1.7    2.0     2.0    1.9     2.1    1.9     2.3    2.0
China                     5.4    2.7    2.7     3.1        3.1    2.5    2.5     3.0    3.0     3.5    3.5     3.0    3.0
Japan                     -0.3   0.0    0.0     0.2        0.1    2.2    2.0     1.8    1.5     2.0    1.8     1.6    0.8
United Kingdom            4.5    2.8    2.8     2.8        2.2    2.7    2.0     2.4    2.3     2.4    2.4     2.5    2.5
Other advanced
Sweden                    3.0    0.9    0.9     0.3        0.9    1.9    2.4     2.3    2.6     2.1    2.2     2.1    2.0
Norway                    1.3    0.7    0.7     1.5        1.5    2.2    2.2     2.5    2.5     2.5    2.5     2.5    2.5
Switzerland               0.2    -0.7   -0.6    0.1        0.3    0.8    0.8     1.3    1.3     1.5    1.5     1.7    1.7
Australia                 3.3    1.8    1.9     2.7        3.0    2.6    2.7     3.0    2.9     2.8    2.6     2.8    2.7
S. Korea                  4.0    2.2    2.2     1.9        2.3    2.2    2.5     2.5    2.8     2.8    3.0     3.0    3.0
Taiwan                    1.4    1.9            1.9               1.4            3.4            2.2            1.8
Emerging economies
Brazil                    6.6    5.4            5.8               5.1            5.3            5.1            5.1
Russia                    8.4    5.1    5.1     6.4        6.6    5.4    5.7     5.1    5.2     4.7    4.8     4.4    4.5
Poland                    4.3    3.7    3.8     1.7        2.6    2.7    2.5     3.0    3.0     2.5    2.5     2.5    3.5
Czech Republic            1.9    3.3    3.3     2.3        2.5    1.5    0.9     1.2    1.4     1.5    2.1     1.8    2.4
Slovakia                  4.1    3.7    3.7     2.8        2.9    2.3    2.4     1.9    2.0     2.0    2.3     2.3    2.4
Romania                   5.6    3.4    3.5     5.4        4.9    2.8    3.1     2.9    2.9     3.0    3.0     3.8    3.8
Ukraine                   7.5    0.1    0.5     3.4        7.2    6.9    6.9     6.5    6.5     6.3    6.3     6.0    6.0
Kazakhstan                8.4    5.2    5.3     6.8        6.4    5.2    5.2     4.9    4.9     4.7    4.7     4.4    4.4

                                    March 2013        41 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                                                           Test-driving the recovery

 SG Monetary Policy Rate Outlook
                               Monetary Policy - Key Rates
                                    Mar             Jun             Sep             Dec             Mar                                                                             Neutral
                                                                                                                       2013            2014            2015          2016    2017
                                     15             2013            2013            2013            2014                                                                             rate


Euro area                         0.75             0.75            0.75            0.75            0.75               0.75            0.75             1.00          1.96    2.96   3.75

US                                0.25             0.25            0.25            0.25            0.25               0.25            0.25             0.25          1.42    3.90   4.00

China                             3.00             3.00            3.00            3.00            3.00               3.00              na                 na         na     na     4.00

Japan                             0.10             0.10            0.10            0.10            0.10               0.10            0.10             0.10          0.10    0.10   1.75

UK                                0.50             0.50            0.50            0.50            0.50               0.50            0.50             0.63          2.06    3.56   4.50

Other advanced

Sweden                            1.00             1.00            1.00            1.50            1.50               1.13            1.88             2.69          3.63    4.00   4.25

Norway                            1.50             1.50            1.50            1.75            2.00               1.56            2.44             3.50          3.94    4.00   4.50

Switzerland                       0.00             0.00            0.00            0.25            0.25               0.06            0.63             1.25          1.75    2.00   2.50

Australia                         3.00             3.00            3.00            3.00            3.25               3.00            3.46             4.00          4.50    5.00   5.00

Korea                             2.75             2.50            2.50            2.50            2.75               2.50            3.00             3.80          4.50    4.50   4.50

Taiwan                            1.88             1.88            1.88            1.88            1.88               1.88            2.03             2.15          2.25    2.13   2.50

Emerging economies

Brazil                            7.25             7.75            7.75            7.75            7.75               7.63            7.75             8.63          9.00    9.00   8.50

Russia                            5.50             5.50            5.00            5.00            5.00               5.25            5.00             4.75          4.50    4.25   5.00

Poland                            3.25             3.25            3.25            3.25            3.75               4.75            4.25             4.50          4.50    4.50   4.50

Czech Rep.                        0.05             0.05            0.05            0.05            0.05               0.05            0.05             0.21          1.00    1.78   3.50

Romania                           5.25             5.25            5.25            5.00            4.75               5.19            4.63             4.50          4.50    4.50   5.50

Ukraine                           7.50             7.50            7.50            7.50            7.50               7.50            7.19             6.50          6.00    6.00   6.00

Kazakhstan                        5.50             5.50            5.25            5.25            5.00               5.38            5.00             4.81          4.63    4.50   5.00
The "neutral rate" fo r key rates give o ur estimate o f "fair value" assuming an o utput gap o f zero and inflatio n at trend.
* We expect China t o accelerat e t he liberalisat ion of bank deposit and lending int erest rat es and t o migrat e t o a new policy rat e in 2013/ 14.
* We expect China t o adopt PBoC int erbank repo rat e as it s policy rat e st art ing 2014.
The average rat e of 3%f or 2014 will imply no hike or cut f rom t he previous benchmark of 1-yr deposit rat e at 2.75%.
      Short-Term SG view                                                                                    400     Long-Term SG view

40                                                                                                          300

20                                                                                                          200

 0                                                                                                          100

-20                                                                                                            0

-40                                       Forecast rate change by March 2014 (in bp)                       -100

                                                                                                                               Forecast rate change until end 2017 (in bp)
-60                                                                                                        -200

                                                                                   March 2013              42

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                                                                                                             Test-driving the recovery

SG Long Gvt. Bond Yield Outlook
                                Long Gvt. Bond Yield (10Y)
                                     Mar             Jun             Sep             Dec              Mar                                                                             Trend
                                                                                                                         2013             2014       2015         2016      2017
                                      12             2013            2013            2013            2014                                                                           Fair Value


Euro area                          1.45             1.35            1.70            1.85            2.10                1.59             2.10       2.40         3.00       4.10      4.50

US                                 1.99             2.00            2.50            2.75            3.10                2.31             3.10       3.50         4.00       5.00      4.75

China                              3.39             3.60            3.80            3.80            4.00                3.65             3.50       3.75         4.00       4.00      4.00

Japan                              0.62             0.70            0.80            0.85            0.90                0.74             1.50       1.80         2.25       2.50      2.50

UK                                 1.94             1.65            1.80            2.10            2.40                1.87             2.60       2.90         3.60       4.80      5.00

Other advanced

Sweden                             1.95             1.70            2.00            2.10            2.30                1.94             2.30       2.50         3.00       4.10      4.50

Norway                             2.23             2.05            2.30            2.35            2.60                2.23             3.10       3.40         3.80       3.95      4.80

Switzerland                        0.79             0.55            0.80            0.85            1.10                0.75             1.10       1.40         1.90       3.00      2.75

Australia                          3.64             3.50            4.00            4.10            4.20                3.81             4.30       4.40         4.80       5.20      5.00

Korea                              2.93             2.85            3.00            3.25            3.50                3.01             3.50       3.75         4.40       5.50      5.00

Taiwan                             1.32             1.35            1.40            1.45            1.40                1.38             1.50       2.00         2.50       2.80      2.50

Emerging economies

Brazil                             9.48             9.80           10.30           10.30           10.40                9.97            10.50      11.00         11.00      11.00    11.00

Russia                             6.83             6.50            6.30            6.40            6.40                6.51             6.40       6.35         6.30       6.05      6.50

Poland                             3.86             4.20            4.30            4.40            4.50                4.19             5.00       5.50         5.80       5.80      5.10

Czech Rep.                         1.91             2.30            2.45            2.60            2.80                2.31             2.90       3.20         3.60       3.85      5.00

Romania                            5.72             5.50            5.60            5.60            5.50                5.61             5.20       5.40         5.80       5.80      5.50

Ukraine                              na              na               na              na              na                  na              na         na            na        na        na

Kazakhstan                           na              na               na              na              na                  na              na         na            na        na        na
The " t rend f air value" f or bond yields give our est imat e of " f air value" assuming an out put gap of zero and inf lat ion at t rend.

The t rend f air value f or currencies ref lect s a PPP based valuat ion.

For 2013 t o 1017, dat a are average over t he year f igure

       Short-Term SG view                                                                                             Long-Term SG view
100                                                                                                                          Forecast yield change until end 2017 (in bp)
  40                                                                                                        150

  20                                                                                                        100
   0                                                                                                          50
 -20                                                                                                           0
                   Forecast yield changes by March 2014 (in bp)
 -40                                                                                                         -50

                                                                                    March 2013               43

         FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                                                                        Test-driving the recovery

  SG FX Outlook
                              Foreign Exchange
                                   Mar                Jun                Sep             Dec               Mar                                                                                                Trend
                                                                                                                               2013             2014               2015       2016             2017
                                    12                2013               2013            2013              2014                                                                                             Fair Value

 EURGBP                           0.86               0.86               0.88            0.86              0.84                 0.87            0.85            0.84          0.82               0.8           0.75

 EURUSD                           1.31               1.27               1.25            1.20              1.22                 1.26            1.25            1.20          1.15             1.10            1.20

 USDCNY                           6.21               6.18               6.21            6.19              6.17                 6.20            6.20            6.20          6.20             6.00            5.75

 USDJPY                            95                 95                 98             100           103.00                    97              100                102       100               100            100

 GBPUSD                           1.51               1.48               1.42            1.40              1.45                 1.45            1.45            1.43          1.40             1.38            1.60

 EURSEK                           8.36               8.50               8.30            8.20              8.15                 8.34            8.20            8.28          8.34             8.40            8.50

 EURNOK                           7.55               7.50               7.40            7.30              7.30                 7.44            7.26            7.16          7.23             7.33            7.65

 EURCHF                           1.23               1.22               1.24            1.27              1.30                 1.24            1.32            1.35          1.38               1.4           1.40

 AUDUSD                           1.04               1.01               1.03            1.06              1.02                 1.04            0.95            0.95          0.90             0.90            0.90

 USDKRW                           1110               1070               1060            1050              1040               1073              1020                980       950               950            950

 USDTWD                            30                29.00              28.70           28.80             28.50                 29               29                29          28               29           28.00

 USDBRL                           1.96               1.93               1.90            1.87              1.85                 1.92            1.82            1.75          1.69             1.66            1.80

 USDRUB                           30.63              30.76              31.46           32.57             32.30              31.35            32.98           32.79         33.01            33.49           33.00

 EURPLN                           4.14               4.10               4.05            4.05              4.00                 4.09            3.90            3.80          3.70             3.60            3.85

 EURCZK                           25.60              25.80              26.00           26.10             26.00              25.88            25.74           25.17        24.73             24.24           25.00

 EURRON                           4.39               4.40               4.37            4.35              4.30                 4.38            4.30            4.20          4.10             4.10            4.30

 USDUAH                           8.13               8.20               8.90            8.90              8.90                 8.53            9.00            9.00          9.00             9.00            9.00

 USDKZT                           151                151                150             150           149.00                   150              149                149       149               149            149
 The trend fair value fo r currencies reflects a P P P based valuatio n.
        (%)         Short-Term SG view, vs. Euro                                                                                     Long-Term SG view, vs. euro

 6                                                                                                                15



 -2                                                                                                                0

                             %change forecast by March 2014
-10                                                                                                               -15
                                                                                                                                                                           %change forecast until end2017

      DUAH    JPY     CHF   RUB    CZK   AUD   CNY    KZT   NOK   SEK   RON KRW   GBP   PLN   TWD   BRL   USD
                                                                                                                         AUD    CHF DUAH RUB      JPY   SEK   KZT   NOK CNY TWD CZK      RON GBP     PLN KRW USD    BRL

                                                                                              March 2013                44

                 FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                    Test-driving the recovery

Key Events                                                           July
                                                                     1        EU presidency: Lithuania
                                                                     3-4      BoE meeting
 March                                                               4        ECB meeting
 19-20   FOMC meeting                                                10-11    BoJ meeting
 27      US – Current continuing resolution expires                           G20 Finance Ministers and Central Bank Governors’
 30      The 5th BRICS summit
                                                                     24       Euro Bank Lending Survey
 April                                                               30-31    FOMC meeting
 3-4     BoE meeting                                                          Eurogroup / ECOFIN meetings
 3-4     BoJ meeting
 4       ECB meeting
                                                                     1        ECB meeting
 11      Eurogroup meeting
                                                                     7        BoE Inflation Report
 12      ECOFIN meeting
                                                                     7-8      BoJ meeting
         US – “No budget, no pay” close to go into effect (still
 15                                                                  31-1     BoE meeting
         subject to Senate vote)
         G20 Finance Ministers & Central Bank Governors’
         meetings                                                    September
 19-21   World Bank spring meeting                                   4-5      BoE meeting
 24      Euro Bank Lending Survey                                    4-5      BoJ meeting
 26      BoJ meeting                                                 5        ECB meeting
 30-1    FOMC meeting                                                5-6      G20 Leaders’ Summit (Russia)
                                                                     18       FOMC meeting
 May                                                                 22       German – Parliamentary election
 2       ECB meeting
                                                                              Austria - Parliamentary elections
 8-9     BoE meeting
                                                                              Eurogroup / ECOFIN meetings
 13      Eurogroup meeting
 14      ECOFIN meeting                                              October
 15      BoE Inflation Report                                        2        ECB meeting
 16      ECB meeting                                                 3-4      BoJ meeting
 18      US - Suspension of the debt ceiling to be lifted            9-10     BoE meeting
 21-22   BoJ meeting                                                          G20 Finance Ministers & Central Bank Governors’
 22      European Council                                                     meetings
                                                                     11-13    2013 Annual meetings of World Bank group & IMF
 30      EU Summit
                                                                     17-18    FOMC meeting
 31      OPEC meeting
                                                                     24       European Council
         Italy – Presidential election
                                                                              Latest date for German Parliamentary election if held as
 June                                                                         a regular election (due between 1/9 and 27/10)
                                                                     29-30    FOMC meeting
 5-6     BoE meeting
                                                                     30       Euro Bank Lending Survey
 6       ECB meeting
                                                                     31       BoJ meeting
 10-11   BoJ meeting
                                                                              Eurogroup / ECOFIN meetings
 13-14   Civil 20 Summit (Russia)
 17-18   G8 Summit (UK)                                              November
 18-19   FOMC meeting                                                6-7      BoE meeting
 19-21   International Economic Forum (Russia)                       7        ECB meeting
 20      Eurogroup meeting                                           13       BoE Inflation Report
 21      ECOFIN meeting                                              20-21    BoJ meeting
 21-22   BoJ meeting                                                          Eurogroup / ECOFIN meetings
 27      European Council
                                                                     4-5      BoE meeting
                                                                     5        ECB meeting
                                                                     17-18    FOMC meeting
                                                                     19-20    European Council
                                                                     19-20    BoJ meeting
                                                                              Eurogroup / ECOFIN meetings

                                                       March 2013   45

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                                                     Test-driving the recovery

Election calendar
 EMEA                                                Other EMEA Countries
                                                                 Czech Rep.      Parliamentary   2014
 Euro area
        Austria       Parliamentary   Sep-13
                                                                 Denmark         Parliamentary   Sep-15
                      Presidential    Apr-16

        Belgium       Parliamentary   2014                       Norway          Parliamentary   9-Sep-13

        Cyprus        Parliamentary   2016                       Romania         Presidential    2014

        Estonia       Parliamentary   Mar-15                     Hungary         Parliamentary   April 2014

                      Presidential    Aug-2016

        Finland       Parliamentary   Apr - 15                   South Africa    Parliamentary   Apr-14

                      Presidential    2018                                       Presidential    2014

        France        Presidential    2017                       Sweden          Parliamentary   Sep-14

                      Parliamentary   2017
                                                                 Turkey          Presidential    2014
        Germany       Parliamentary   22-Sep-13
                                                                                 Parliamentary   2015
                      Presidential    2017
        Greece        Presidential    Feb-15                     UK              independence    June-14
                      Parliamentary   2016

        Ireland       Parliamentary   2016                                       Parliamentary   07-May-15

                      Presidential    2018                       Poland          Presidential    2015
        Italy         Presidential    May-13
                                                                 Argentina       Parliamentary   Oct-13
        Luxembourg    Parliamentary   2014
                                                                                 Presidential    Oct-15

                                                                 Brazil          Presidential    Oct-14
        Malta         Presidential    Apr-14
                                                                                 Parliamentary   Oct-14

                                                                 Canada          Parliamentary   2016
        Netherlands   Parliamentary   May-15

                                                                 Mexico          Presidential    2018
        Portugal      Parliamentary   2015
                                                                                 Parliamentary   Jul-15
                      Presidential    Jan-16
                                                                 United States   Presidential    Nov-16
        Slovakia      Presidential    2014
                                                                                 Congressional   4-Nov-14
                      Parliamentary   2016

        Slovenia      Parliamentary   2015
                                                                 Australia       Parliamentary   14-Sep-13

        Spain         Parliamentary   2015
                                                                 India           Presidential    2017
                                                                                 Parliamentary   May-14
                                                                 Indonesia       Presidential    Jul-14
                                                                                 Parliamentary   2014
                                                                 Japan           Parliamentary   30-Aug-13

                                                                 South Korea     Parliamentary   2016

                                                                 Thailand        Parliamentary   Mar-14

                                        March 2013   46
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                                                                                           Test-driving the recovery

       Global Head of Research
       Patrick Legland
       (33) 1 42 13 97 79

                                                  CROSS ASSET RESEARCH – ECONOMICS
       Global Head of Economics
       Michala Marcussen
       (44) 20 7676 7813
       SGCIB, London

       Euro area
       Anatoli Annenkov                               Michel Martinez
       (44) 20 7762 4676                              (33) 1 42 13 34 21           

       United Kingdom
       Brian Hilliard
       (44) 20 7676 7165

       North America
       Aneta Markowska                                Brian Jones
       (1) 212 278 66 53                              (1) 212 278 69 55            

       Asia Pacific                                   China                                     Japan
       Klaus Baader                                   Wei Yao                                   Kiyoko Katahira
       (852) 2166 4095                                (852) 2166 5437                           (81) 355 49 5190                              

       Themes                                         Inflation
       Dev Ashish                                     Hervé Amourda
       (91) 0 80 2802 4381                            (91) 80 2808 6779                

       Central Europe                                 Czech Republic                            Poland                       Romania
       Anne-Françoise Blüher *                        Jiri Skop *                               Jaroslaw Janecki             Roxana Huela *
       (420) 222 008 524                              (420) 222 008 569                         (48) 22 528 41 62            (40) 21 301 44 72                                     

       Miroslav Frayer *
       (420) 222 008 567

       Vladimir Kolychev *                            Vladimir Tsibanov *
       (74) 957 255 637                               (74) 957 255 637              

       Research Associates
       Harriett Beattie                               Fabien Bossy                              Sabine Chaubet               Claire Huang
       Ludovic Martin                                 Yacine Rouimi                             Sami Sørensen

* Contributions from other SG Group entities: Komercni Banka, Rosbank, BRD.

                                                                              March 2013   47

            FIRST LAST 03/23/13 02:08:18 PM Hong Kong Highpower
                                                                                       Test-driving the recovery

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