International International MonetaryMonetary FundFundJune 9, 2012June 9, 2012

Euro Area Crisis: Still in the Danger ZoneEuro Area Crisis: Still in the Danger Zone*/*/

Emil Stavrev Emil Stavrev Research DepartmentResearch Departmentpp

((*/*/ Views expressed in this presentation are those of the author and do not necessarily represent those of the IMF or IMF Policy)Views expressed in this presentation are those of the author and do not necessarily represent those of the IMF or IMF Policy)

OverviewOverview

Recent Developments: Still in the Danger ZoneRecent Developments: Still in the Danger ZoneRecent Developments: Still in the Danger ZoneRecent Developments: Still in the Danger Zone

Financial Stress, Bank Deleveraging, and SpilloversFinancial Stress, Bank Deleveraging, and SpilloversFinancial Stress, Bank Deleveraging, and SpilloversFinancial Stress, Bank Deleveraging, and Spillovers

IntraIntra--Euro Area ImbalancesEuro Area ImbalancesIntraIntra--Euro Area ImbalancesEuro Area Imbalances

Policies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMUPolicies to Resolve the Crisis and Build a Stronger EMU

1

Financial Stress in the Euro AreaFinancial Stress in the Euro Area

800500

European Financial CDS (LHS) High Yield Euro-Area Sov. Bond Spreads (RHS)

Key European SpreadsKey European Spreads(basis points)(basis points)

Lehman Greeceprogram

IrelandProgram

ECB LTRO

Dec 2011

600

700

400

Dec 2011

300

400

500

200

300

100

200

300

100

0008 09 10 11 12

Source: IMF, Global Financial Stability Report.

6/4

2

Bond Yields in the Periphery Remain ElevatedBond Yields in the Periphery Remain ElevatedSize of Euro Area Government Bond MarketsSize of Euro Area Government Bond Markets

IrelandGreece IrelandGreece IrelandGreeceN th l d

(percent of total euro(percent of total euro--area government debt)area government debt)

Average sovereign CDS spreads: Over 400 basis points 200-400 basis points 150-200 basis points Under 150 basis points

G G

Portugal2%

1%5%Netherlands5%

1%4%Netherlands5% Portugal

2%

1%4%Netherlands5% Portugal

2%Finland

1%Finland

1%Finland

1%

Italy26%

Italy25%

Italy25%

Germany22%

Germany23%

Germany23%

Spain9%

Spain10%

Spain10%

France21% France

21%France

21%

Belgium5%

Belgium5%

Belgium5%

Austria3% Austria

3%Austria

3%

April 2010April 2010 November 2011November 2011 February 2012February 20125%5%5%

Sources: Bank for International Settlements; Bloomberg L.P.; and IMF staff estimates.3

European Bank Deleveraging Has ContinuedEuropean Bank Deleveraging Has Continued

Evolution of Adjusted Foreign Claims Evolution of Adjusted Foreign Claims during 2011Q4 2/during 2011Q4 2/(by borrower region)

40

Euro area U K U S

Bank Leverage 1/Bank Leverage 1/(adjusted tangible assets to Tier 1 common capital)

All Countries EuropeWestern

Hemisphere Asia & Pacific

30

35

Euro area U.K. U.S.

-1

0p p

20

25

-3

-2

Percentage change

As percent of borrowers' GDP

10

15

2011Q4 -5

-4As percent of available credit

Mar 06 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12

4

Sources: SNL Financial; Bank for International Settlements; and IMF staff estimates.1/ Tangible assets are adjusted on best-endeavor basis to adjust for accounting differences.2/ Data adjusted for exchange rate variations and breaks.

-6

Lending Standards Tightening while Credit DeceleratesLending Standards Tightening while Credit Decelerates

70Balance sheet constraints

Contributions to Euro Area Lending Contributions to Euro Area Lending Conditions for Companies 1/Conditions for Companies 1/(net percentage; balance of respondents)(net percentage; balance of respondents)

Credit Growth to the NonCredit Growth to the Non--Financial Financial Private SectorPrivate Sector(percent; year(percent; year--onon--year)year)

30France Germany Italy

40

50

60 Cyclical factors

Competition

Overall15

20

25 Spain Euro-Area

10

20

30

0

5

10

-10

0

07 08 09 10 11 12

12Q1 -10

-5

07 08 09 10 11 12Apr. 12

Sources: European Central Bank; Haver Analytics; and IMF staff calculationsSources: European Central Bank; Haver Analytics; and IMF staff calculations..1/ Chart based on factors cited by lending conditions survey respondents. Balance sheet constraints include capital, access 1/ Chart based on factors cited by lending conditions survey respondents. Balance sheet constraints include capital, access to financing, liquidity position and collateral needs. Cyclical factors include general economic activity and industry outlooto financing, liquidity position and collateral needs. Cyclical factors include general economic activity and industry outlook.k.

5

Adverse Feedback Loops in EuropeAdverse Feedback Loops in Europe

Lower growthLower growthMore More ConsolidationConsolidation

Deleveraging Deleveraging &&Consolidation Consolidation

or stabilizers or stabilizers held backheld back

Less bank Less bank lendinglending

Worsen fiscal Worsen fiscal balancebalance

Lower bank Lower bank asset qualityasset quality

PublicPublicSupport NeedsSupport Needs

FiscalFiscal FinancialFinancial

Sovereign risks Sovereign risks increaseincrease

6

Potential Global Potential Global Spillovers from Euro Crisis ScenarioSpillovers from Euro Crisis Scenario

7

G t B d S dG t B d S d

IntraIntra--Euro Area Imbalances: Euro Area Imbalances: Sovereign Risk Spreads Compressed Sharply after EMU InceptionSovereign Risk Spreads Compressed Sharply after EMU Inception

Government Bond SpreadsGovernment Bond Spreads(10-year yield spreads over German bunds; basis points)

3500

4000

1750

2000France

Italy

2500

3000

3500

1250

1500

1750 Italy

Ireland

Portugal

Spain

1000

1500

2000

500

750

1000 Greece (RHS)

0

500

0

250

6/4-500-250

94 96 98 00 02 04 06 08 10 12

Source: Bloomberg L.P.

6/4

8

Imbalances Have Compressed SomewhatImbalances Have Compressed SomewhatBut FBut Further Rebalancing is Still Neededurther Rebalancing is Still Needed

4.0EA surplus excl. Ger GermanyGIIPS EA deficit excl. GIIPSEuro area

Current Account Balances 1/Current Account Balances 1/(percent of world GDP)(percent of world GDP)

115

Euro area: Growth and Recovery Euro area: Growth and Recovery from the Crisis 1/from the Crisis 1/((2007=100; real GDP index)

2.0

3.0

Euro area

105

110 EA Surplus

EA Deficit

0.0

1.0

95

100

-3.0

-2.0

-1.0

80

85

90

3.099 01 03 05 07 09 11

Source: IMF, World Economic Outlook.

9

8099 01 03 05 07 09 11 13 15 17Source: IMF staff estimates.1/ Euro area external surplus countries: Austria, Belgium, Finland, Germany, Luxembourg, Netherlands. Euro area external deficit countries: Greece, Ireland, Italy, Portugal, Spain.

Target 2 Imbalances Widened Following the CrisisTarget 2 Imbalances Widened Following the Crisis

Claims of euro area NCBs against the ECBClaims of euro area NCBs against the ECB(billions of euros)

600Germany Greece

Claims of euro area NCBs against the ECBClaims of euro area NCBs against the ECB(percent of GDP)

20

30Germany Greece

300

400

500 Italy Portugal

Spain

0

10

20Italy Portugal

Spain

100

200

-30

-20

-10

-200

-100

0

Dec. 11 -60

-50

-40

Dec. 11

10

Source: National central banks.

99 00 01 02 03 04 05 06 07 08 09 10 11 99 00 01 02 03 04 05 06 07 08 09 10 11

Efforts on Several Fronts are Needed to Build Efforts on Several Fronts are Needed to Build a Stronger a Stronger EMUEMU

Resolute crisis management and containmentResolute crisis management and containment

Moving toward a common financial stability frameworkMoving toward a common financial stability framework

Stronger fiscal integration, complemented with exStronger fiscal integration, complemented with ex--ante risk sharingante risk sharing

Institutional monitoring and constraints on excessive imbalancesInstitutional monitoring and constraints on excessive imbalances

Growth and EmploymentGrowth and Employment

11