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Sent to print 25 June 2010 July 2010Global Outlook www.GlobalMarkets.bnpparibas.com

INSERT: The Outlook for Markets "The yellow pages represent reports written by our strategy teams as well as market economics. Such reports do not purport to be an exhaustive analysis and may be subject to conflicts of interest resulting from their interaction with sales and trading which could affect the objectivity of this report." Global Bonds Lower Yields Ahead

i

Eurozone Rates Medium-Term Forecasts

vii

US Rates Medium-Term Forecasts

viii

Corporate Bonds Glass Half Full

ix

Foreign Exchange Fiscal Concerns Keep EUR Pressured

xi

Asian Markets Volatile ST, but Steady LT

xiv

CEEMEA Markets Between a Rock and a Hard Place

xv

Latam Markets Keep Them on Your Radar

xvi

Oil Long-Dated Backwardation First

xvii

Metals Gold to the Fore, Base More Cautious

xix

Summary Tables 2

Summary: Gripping Stuff 4

Risk Scenarios 8

US Recovery Turns to Moderate Expansion

10

Eurozone Double Dip?

14

Japan Growth Still Firm, Deflation Easing

18

China Risks of a Sharp Slowdown

22

Eurozone Countries Germany Still Outperforming

26

France Sorting Out Problems One by One

28

Italy Headwinds Still Blowing

30

Spain Trouble Ahead

32

Netherlands Broad Support for Austerity

34

Belgium Decisive Times

35

Austria Modest Growth

36

Portugal Recession Revisited

37

Finland Delayed Recovery

38

Ireland Past the Worst

39

Greece Another Two Years of Recession

40

Slovenia Back into Recession

41

Slovakia How Robust is the Recovery?

42

Other Europe

Denmark Recovery Continues

43

UK As Good as it Gets

44

Sweden Gaining Momentum

46

Norway Growth Disappoints

48

Switzerland Calm in the Storm

50

CEE

Ukraine Steeled for a Slowdown

51

Russia Recovery in Consumption Visible

52

Kazakhstan Oil-Driven Surprise

54

Poland Growth Momentum Slowing

55

Hungary Not Greece

56

Czech Republic Policy Coordination is Key

57

Bulgaria and Romania Vulnerable Again

58

Turkey Robust Recovery

59

Asia Pacific

Australia Taking a Break

60

India Risky Business

62

South Korea Barrelling Along

64

Taiwan Gradual Normalisation

66

Other Asia Contagion but Containable

68

The Americas

Canada One Step at a Time

71

Brazil Better Brake Than Skid

72

Mexico Much Brighter Outlook

74

Other Latam Got Legs?

76

Financial and Monetary Conditions Indices 78

Global Liquidity 80

Long-Term Economic Forecasts 81

Contacts 84

Disclaimer Inside Back Cover

Market Economics July 2010Global Outlook 2 www.GlobalMarkets.bnpparibas.com

Table 1: Economic Forecasts

GDP Year 2009 2010 2011 (% y/y) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

World (2) 3.2 -0.6 4.5 3.8 4.2 -2.1 -1.7 -0.5 1.8 4.7 4.8 4.5 4.2 3.9 3.8 3.8 3.9US 0.4 -2.4 2.9 2.8 3.2 -3.3 -3.8 -2.6 0.1 2.4 3.4 3.4 2.6 2.6 2.7 2.9 3.1Eurozone 0.4 -4.1 1.2 0.6 1.0 -5.2 -4.9 -4.1 -2.1 0.6 1.4 1.3 1.4 1.2 0.6 0.4 0.4Japan -1.2 -5.2 3.6 2.3 1.8 -8.9 -5.7 -5.2 -1.1 4.6 3.0 3.7 3.2 2.4 2.5 2.2 2.1China 9.6 8.7 9.8 8.4 9.0 6.1 7.9 8.9 10.7 11.9 10.8 9.5 8.7 8.0 8.1 8.5 8.8

Industrial Production Year 2009 2010 2011 (% y/y) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

US -2.2 -9.7 5.5 4.6 4.7 -11.6 -12.9 -9.5 -4.7 2.4 7.0 6.6 5.9 5.1 4.5 4.4 4.5Eurozone -1.8 -14.6 8.1 0.8 1.8 -18.1 -18.4 -14.7 -7.5 4.2 10.1 9.9 8.0 3.4 0.4 -0.2 -0.3Japan -3.4 -21.9 18.6 5.3 3.7 -34.6 -27.4 -19.4 -4.3 27.5 21.4 16.5 11.7 5.7 5.2 5.4 4.8China 12.9 11.0 15.4 11.9 12.6 5.1 9.1 12.4 18.0 19.6 16.1 14.8 13.4 10.5 10.8 12.4 12.6

Unemployment Rate Year 2009 2010 2011 (%) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

US 5.8 9.3 9.6 8.5 6.9 7.0 8.2 9.3 10.0 9.7 9.8 9.6 9.5 9.2 8.7 8.2 8.0Eurozone 7.6 9.4 10.0 10.3 10.5 8.8 9.3 9.7 9.8 10.0 10.0 10.0 10.0 10.1 10.2 10.3 10.4Japan 4.0 5.1 4.8 4.2 3.6 4.5 5.1 5.4 5.2 4.9 5.1 4.8 4.6 4.4 4.3 4.1 4.0

CPI Year 2009 2010 2011 (% y/y) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

US 3.8 -0.3 1.7 1.0 1.0 -0.2 -1.0 -1.6 1.5 2.4 1.8 1.4 1.2 0.9 1.3 1.0 0.8Eurozone 3.3 0.3 1.6 1.4 0.7 1.0 0.2 -0.4 0.4 1.1 1.5 1.8 2.1 1.9 1.4 1.2 1.2Japan 1.4 -1.4 -0.6 -0.2 0.5 -0.1 -1.0 -2.2 -2.1 -1.2 -0.9 -0.5 0.2 -0.2 -0.2 -0.2 -0.2China 5.9 -0.7 3.5 3.0 3.6 -0.6 -1.5 -1.3 0.7 2.2 3.0 4.5 4.3 3.9 3.3 2.6 2.2

Year 2009 2010 2011 Interest Rates (3) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

US Fed Funds Rate (%) 0.25 0.25 0.25 0.25 2.00 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.253-Month Rate (%) 1.43 0.25 0.95 0.75 2.50 1.19 0.60 0.29 0.25 0.29 0.54 1.00 0.95 0.90 0.85 0.80 0.7510-Year Rate (%) 2.22 3.84 3.00 3.75 4.50 2.67 3.54 3.31 3.84 3.83 3.12 2.90 3.00 3.10 3.25 3.50 3.75Eurozone Refinancing Rate 2.50 1.00 1.00 1.00 1.50 1.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.003-Month Rate (%) 2.89 0.70 0.70 1.00 2.00 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.0010-Year Rate (%) 2.95 3.40 2.00 3.00 3.75 3.00 3.38 3.23 3.40 3.10 2.65 2.20 2.00 2.10 2.25 2.60 3.00Japan O/N Call Rate 0.10 0.10 0.10 0.10 1.00 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.103-Month Rate (%) 0.74 0.46 0.40 0.40 1.10 0.65 0.56 0.54 0.46 0.43 0.38 0.40 0.40 0.40 0.40 0.40 0.4010-Year Rate (%) 1.18 1.30 1.40 1.80 1.90 1.35 1.36 1.31 1.30 1.40 1.15 1.30 1.40 1.50 1.60 1.70 1.80China Official Interest Rate (%) 5.31 5.31 5.31 5.58 6.12 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.58 5.58

Year 2009 2010 2011 FX Rates (3) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

EUR/USD 1.40 1.43 1.08 1.00 1.15 1.33 1.40 1.46 1.43 1.35 1.22 1.16 1.08 1.00 0.98 0.97 1.00USD/JPY 91 93 94 118 126 99 96 90 93 93 90 92 94 100 105 110 118USD/RMB 6.83 6.83 6.80 6.60 6.41 6.84 6.83 6.83 6.83 6.83 6.75 6.70 6.80 6.75 6.70 6.64 6.60EUR/JPY 127 133 102 118 145 131 135 131 133 126 110 107 102 100 103 107 118EUR/GBP 0.96 0.89 0.80 0.79 0.90 0.92 0.85 0.91 0.89 0.89 0.83 0.81 0.80 0.78 0.78 0.80 0.79GBP/USD 1.46 1.62 1.35 1.27 1.28 1.43 1.65 1.60 1.62 1.52 1.47 1.43 1.35 1.28 1.26 1.21 1.27

Current Account Year General Government Year (% GDP) ’08 ’09 ’10 (1) ’11 (1) ’12 (1) (% GDP) ’08 ’09 ’10 (1) ’11 (1) ’12 (1)

US -4.6 -2.7 -2.7 -2.7 -2.8 US (4) -3.1 -9.9 -10.0 -8.4 -6.8Eurozone -1.7 -0.6 -0.3 -0.1 0.1 Eurozone -2.0 -6.3 -6.6 -5.3 -4.3Japan 3.2 2.8 3.9 3.9 3.7 Japan -4.9 -10.7 -9.4 -6.8 -6.8China 9.3 6.0 3.5 2.9 2.8 China -0.4 -2.8 -1.1 -0.8 -0.6Footnotes: (1) Forecast (2) BNPP estimates based on country weights in the IMF World Economic Outlook Update, April 2010 (3) End Period (4) Fiscal year Figures are y/y percentage change unless otherwise indicated

Source: BNP Paribas

Market Economics July 2010Global Outlook 3 www.GlobalMarkets.bnpparibas.com

Table 2: GDP and CPI Forecasts (% y/y)

Real GDP CPI (1)

2008 2009 2010 (2) 2011 (2) 2012 (2) 2008 2009 2010 (2) 2011 (2) 2012 (2)

World (3) 3.2 -0.6 4.5 3.8 4.2 5.8 1.8 3.5 3.1 3.1 G7 (3) 0.1 -3.4 2.6 2.2 2.4 3.2 -0.1 1.4 1.1 1.0 Asia ex Japan (3) 7.2 5.9 8.9 7.6 8.0 6.6 0.6 4.4 3.5 3.7 CEE (3) 5.1 -5.8 3.4 3.1 3.8 10.4 7.9 4.3 5.3 6.3 Latam (3) 4.0 -1.9 5.4 3.8 3.9 8.5 5.6 8.4 7.7 7.8 US 0.4 -2.4 2.9 2.8 3.2 3.8 -0.3 1.7 1.0 1.0 Eurozone 0.4 -4.1 1.2 0.6 1.0 3.3 0.3 1.6 1.4 0.7 Japan -1.2 -5.2 3.6 2.3 1.8 1.4 -1.4 -0.6 -0.2 0.5 China 9.6 8.7 9.8 8.4 9.0 5.9 -0.7 3.5 3.0 3.6 Eurozone Countries Germany 1.0 -4.9 2.0 1.4 1.6 2.8 0.2 1.3 1.5 0.7 France 0.1 -2.5 1.4 1.0 1.2 3.2 0.1 1.9 1.5 1.1 Italy -1.3 -5.1 0.9 0.2 0.7 3.5 0.8 1.5 1.5 0.9 Spain 0.9 -3.6 -0.4 -0.6 1.2 4.1 -0.2 1.6 1.2 0.2 Netherlands 2.0 -4.0 1.0 0.8 1.2 2.2 1.0 1.3 2.1 1.4 Belgium 0.8 -3.0 1.3 1.2 1.6 4.5 0.0 2.3 1.8 0.5 Austria 1.8 -3.4 1.3 1.2 1.9 3.2 0.4 1.3 1.4 0.9 Portugal 0.0 -2.7 1.4 -0.5 0.8 2.7 -0.9 1.0 1.1 0.5 Finland 1.5 -8.0 1.0 1.8 2.5 3.9 1.6 2.2 2.1 1.8 Ireland -3.0 -7.1 -0.5 1.8 3.7 3.1 -1.7 -1.6 -0.1 -0.3 Greece 2.0 -2.0 -4.0 -3.2 0.7 4.2 1.3 3.0 1.6 1.0 Slovenia 3.5 -7.8 0.8 1.2 1.6 5.2 1.0 1.8 1.5 1.1 Slovakia 6.4 -4.7 3.8 1.4 3.1 3.9 0.9 1.0 2.9 2.6 Other Europe Denmark -0.9 -4.9 1.3 1.0 1.4 3.4 1.3 2.1 1.5 1.7 UK 0.7 -4.9 1.4 1.0 1.5 3.6 2.2 3.1 2.0 1.6 Sweden -0.6 -5.1 3.6 3.0 3.7 3.4 -0.3 1.6 2.4 2.3 Norway 1.6 -1.5 1.0 2.0 2.7 3.8 2.2 2.4 1.8 2.3 Switzerland 1.8 -1.5 2.2 1.9 2.4 2.4 -0.5 1.2 0.9 1.0 Russia 5.6 -7.9 4.7 4.2 4.5 14.1 11.8 6.3 8.1 9.8 Ukraine 2.1 -15.0 4.0 3.5 3.7 22.3 12.3 9.0 11.5 10.5 Kazakhstan 3.3 1.1 4.0 5.0 5.0 9.5 6.2 7.0 7.0 6.5 Poland 5.2 1.7 2.9 2.0 2.8 4.1 3.5 2.3 1.9 1.5 Hungary 0.8 -6.3 1.5 1.2 2.1 5.6 4.3 4.2 2.5 1.4 Czech Republic 2.3 -4.0 1.8 2.7 3.0 6.0 1.1 1.3 2.0 2.0 Bulgaria 6.1 -4.9 -2.5 1.8 4.1 12.0 2.3 -0.3 1.6 1.2 Romania 7.7 -7.1 -0.6 0.8 0.9 7.7 5.6 4.0 2.3 1.0 Turkey 0.7 -4.7 7.0 4.0 4.0 10.4 6.3 9.0 7.5 6.7 Asia Pacific Australia 2.3 1.3 3.4 3.3 3.3 4.4 1.8 3.2 3.3 3.2 India 7.4 6.7 9.0 9.0 9.1 9.1 2.1 8.7 5.1 4.5 South Korea 2.3 0.2 6.3 3.5 3.8 4.7 2.8 2.7 3.2 3.1 Indonesia 6.0 4.5 5.9 5.8 6.0 9.8 4.8 4.4 5.2 5.4 Taiwan 0.7 -1.9 9.1 3.1 4.4 3.5 -0.9 0.9 0.6 1.2 Thailand 2.5 -2.3 7.8 5.0 5.5 5.5 -0.8 3.0 3.7 3.5 Malaysia 4.6 -1.7 8.2 7.0 6.3 5.4 0.6 2.0 2.6 2.5 Hong Kong 2.2 -2.8 6.9 4.8 5.5 4.3 0.5 2.6 1.8 2.9 Singapore 1.8 -1.3 8.6 5.8 6.5 6.5 0.2 2.5 1.9 1.5 Phillipines 3.8 0.9 5.4 5.1 5.0 9.3 3.3 4.0 3.5 3.4 Americas Canada 0.5 -2.5 3.3 2.9 3.0 2.4 0.3 1.8 1.8 1.9 Brazil 5.1 -0.2 7.2 4.6 4.4 5.9 4.3 5.2 4.5 4.5 Mexico 1.5 -6.5 5.0 3.7 3.3 6.5 3.6 4.7 3.7 3.9 Argentina 6.8 0.9 4.9 4.0 3.5 7.2 7.7 19.6 14.4 10.6 Chile 3.7 -1.5 4.7 5.4 5.1 7.1 -2.6 3.4 3.4 3.2 Colombia 2.4 0.4 3.0 3.8 4.4 7.7 2.0 3.7 3.5 4.2 Venezuela 4.8 -3.3 -2.0 -1.0 1.4 30.9 25.1 39.4 34.9 56.2 (1) HICP where available, India WPI (2) Forecast (3) BNPP estimates based on weights calculated using PPP valuation of GDP in IMF WEO April 2010

Source: BNP Paribas

Paul Mortimer-Lee July 2010Global Outlook 4 www.GlobalMarkets.bnpparibas.com

Global Outlook: Gripping Stuff Worries about global growth intensify

Since our last Global Outlook, published data showed a stronger Q1 in several countries (including China, Turkey, Brazil and Japan) than we had expected, but worries about future growth have increased. Most of this relates to the eurozone crisis, but purchasing managers’ indices in several countries (including, crucially, China) have softened, as have some of the US regional PMIs.

Manufacturing has done very well over the past year. Previously disrupted trade flows have normalised, as a reflection of the inventory cycle and because capital expenditure that had been mothballed or delayed has come back on stream. However, a more modest pace of growth was always likely at some stage and now appears to be materialising.

As the PMIs globally continue to soften in H2 2010, worries about growth may mount, with some likely to talk of a double dip. In the US and Japan, the recovery, which had initially been centred on manufacturing, seems to be building and broadening beyond the sector so that a double dip looks unlikely. Europe is more concerning given the fiscal tightening next year, the likely restrictive attitude towards lending by banks and their adverse effects on confidence. If there is going to be a double dip, it will probably be in Europe.

In terms of global growth for 2010, we have nudged up our forecast from 4.3% in the last Global Outlook to 4.5%, leaving our projection for 2011 growth at 3.8%. The biggest change has been an upward revision to Japan’s 2010 growth from 2.2% to 3.6%, largely reflecting the strength of GDP in Q1. In addition, our forecast for US growth in 2010 has been edged up from 2.8% to 2.9%, with a similar revision in 2011. Were it not for the eurozone, 2011 US growth would have been revised up by more.

The eurozone growth forecast for 2010 is a bit better than before (1.2% versus 1.0%) because the economy’s momentum in the first half of the year was stronger than expected (especially in German manufacturing) and this may continue for a while. However, the confidence-sapping effects of the financial crisis and accelerated fiscal tightening will soon start to bite. Thus we have halved our estimate of eurozone growth to a mere 0.6% next year, with risks of a lower out-turn even if the financial crisis abates sooner than we expect.

Chinese tightening and exporters’ worries about the prospects in their biggest market – the EU – seem to be biting harder than expected and we have revised our 2010 growth forecast for China down to 9.8% from

2008 2009 2010 (1) 2011 (1) 2012 (1)

World (2) 3.2 -0.6 4.5 3.8 4.2

G7 0.1 -3.4 2.6 2.2 2.4

US 0.4 -2.4 2.9 2.8 3.2

Japan -1.2 -5.2 3.6 2.3 1.8

Eurozone 0.4 -4.1 1.2 0.6 1.0

China 9.6 8.7 9.8 8.4 9.0

UK 0.7 -4.9 1.4 1.0 1.5

Canada 0.5 -2.5 3.3 2.9 3.0Other Advanced (2) 1.3 -1.4 2.8 2.7 3.0Asia Ex-Japan (2) 7.2 5.9 8.9 7.6 8.0CEE & Russia (2) 5.1 -5.8 3.4 3.1 3.8Latin America (2) 4.0 -1.9 5.4 3.8 3.9

Source: BNP Paribas

Table 1: GDP (% y/y)

(1) Forecasts (2) BNP Paribas estimates based on weights calculated using the PPP valuation of country GDP in IMF WEO April 2010

2008 2009 2010 (1) 2011 (1) 2012 (1)

World GDP (% y/y) 100.0 3.2 -0.6 4.5 3.8 4.2G7 40.9 0.1 -1.4 1.1 0.9 1.0US 20.5 0.1 -0.5 0.6 0.6 0.7Japan 6.0 -0.1 -0.3 0.2 0.1 0.1Eurozone 15.2 0.1 -0.6 0.2 0.1 0.2China 12.5 1.2 1.1 1.2 1.1 1.1UK 3.1 0.0 -0.2 0.0 0.0 0.0Canada 1.8 0.0 0.0 0.1 0.1 0.1Other Advanced (2) 3.6 0.0 0.0 0.1 0.1 0.1Asia Ex-Japan (2) 26.2 1.9 1.5 2.3 2.0 2.1CEE & Russia (2) 7.8 0.4 -0.5 0.3 0.2 0.3Latin America (2) 8.5 0.3 -0.2 0.5 0.3 0.3

Source: BNP Paribas


Weight Contributions to Global Growth (pp)

Table 2: Contributions to Global Growth

2008 2009 2010 (1) 2011 (1) 2012 (1)

World (2) 5.8 1.8 3.5 3.1 3.1

G7 3.2 -0.1 1.4 1.1 1.0US 3.8 -0.3 1.7 1.0 1.0

Japan 1.4 -1.4 -0.6 -0.2 0.5

Eurozone 3.3 0.3 1.6 1.4 0.7

China 5.9 -0.7 3.5 3.0 3.6

UK 3.6 2.2 3.1 2.0 1.6

Canada 2.4 0.3 1.8 1.8 1.9Other Advanced (2) 3.8 1.1 2.4 2.4 2.4Asia Ex-Japan (2) 6.6 0.6 4.4 3.5 3.7CEE & Russia (2) 10.4 7.9 4.3 5.3 6.3Latin America (2) 8.5 5.6 8.4 7.7 7.8

Source: BNP Paribas

Table 3: CPI (% y/y)



10.5%, but with our projection for 2011 unchanged at 8.4%. The markets may become worried about a sharper slowdown in China, but if this were to start to materialise, our view is that the authorities would act to bolster growth. We continue to see robust growth in the rest of Asia. In many countries, the output gap seems to have closed, with monetary policy still firmly in accommodative mode.

Policy is tightening in several countries but, on the whole, we expect tightening to be modest – witness Taiwan’s 0.125% hike in late June – because of worries about export markets in the West and a reluctance to raise rates rapidly, for FX reasons, when the US seems to be firmly on hold. This is a recipe for continued robust domestic demand in many countries in the emerging markets. Thus the slowdown we see in global growth in 2011 should be more or less reversed in 2012.

Financial crisis in Europe the main focus Uncertainty about the eurozone sovereign debt crisis and possible spillover into the banking system is high. Despite several policy initiatives, many investors remain reluctant to buy peripheral debt, and liquidity in the markets has decreased. One factor behind the markets’ lack of a favourable reaction is that moves have generally been too slow and were, at an early stage, not large enough to cause “shock and awe”.

The eurozone has never fully given the impression that it will do whatever it takes to stabilise the situation, though ultimately that is exactly what we think will happen. In many episodes, details about the support mechanisms/schemes have emerged too late to calm fast-moving markets.

However, official support for markets is now substantial. The European Financial Stability Facility (EFSF) has, when combined with IMF and EU contributions, some EUR 750bn at its disposal, and the ECB’s purchasing of sovereign bonds to support markets was a significant step that seemed a long way away not so long ago. So there has been substantial action and we believe that – if needed – there will be more.

The other factor that continues to overshadow the markets is the widespread belief that a Greek default – or a restructuring of debt with haircuts and a sizeable write-down in the NPV of Greek government debt – is inevitable. With big uncertainties about fiscal and banking systems elsewhere still unresolved (e.g. in Portugal and Spain), the risks are that a Greek restructuring would have substantial spillover effects in other countries. This threat of systemic consequences is what spurred the Greek IMF programme and the EFSF. However, we believe that the programmes are too short to give Greece and others enough time to build credibility through fiscal performance – they

should have been five-year, not three-year, programmes.

In terms of how the crisis develops from here, we reject the notion that it will go away quickly – the problems in fiscal accounts and banking are chronic, with acute symptoms from time to time. The markets’ perception that a Greek restructuring is only a matter of time is a constant rubbing sore.

Despite the considerable steps that have been taken, the markets are not convinced that eurozone sovereign debt markets are stable. Further steps are needed in our view (e.g. a clearer commitment that no country will be left without support, more commitment from the ECB to debt purchases, and an extension of the EFSF and the Greek programme from three to five years). However, we are doubtful that these steps will be taken without further market pressure. The upcoming stress tests may give more comfort about the state of the Continent’s biggest banks, but doubts about regionals in Spain and Germany will continue to concern markets. Pre-emptive official action (which we urge on the authorities but are doubtful about seeing) and thin summer markets could be testing. Given the reactive nature of policy in the eurozone, things may need to get worse before they get better.

That is our central scenario. We see the use of the IMF/eurozone fund as very likely and expect the ECB to have to broaden and deepen its purchases of government debt.

Since our central scenario is not for an EMU meltdown, the knock-on effects on other regions – which will mainly come from confidence and financial market transmission channels – should be relatively limited, with perhaps only about 0.25pp being trimmed from US growth relative to what would otherwise have been the case. However, were we to see a more substantial feedback loop develop between the real, banking and government sectors in the eurozone, the impact elsewhere could be noticeably bigger.

Disinflation in developed countries On inflation, we continue to see downward pressure persisting at the core level in the US and Europe next year, taking us close to zero core inflation (headline should be about 1% due to higher oil prices). The factors contributing to this include relatively wide output gaps, muted pay increases and the effects of recent very low rates of money supply growth.

Will the US or Europe become Japan? We see this as being primarily a question of how inflation expectations evolve, which will, in turn, depend on what people experience, what central banks say and what central banks do. There is a risk that inflation expectations respond to declining core inflation by more than we have factored in, which would take us


towards a more long-lasting disinflationary environment.

However, the lesson from Japan would appear to be that, as long as the economic expansion persists, deflation expectations are unlikely to become the norm. If we were to see another sharp downturn or recession without core inflation having come off the lows we predict, then the onset of true and lasting deflation would be much more likely.

Within the eurozone, we expect inflation to be very subdued in the peripherals. Spanish core inflation in Q1 last year was 1.6% y/y. By Q1 2010 it was only 0.2%. The VAT hike from July will temporarily boost core prices, but we expect core inflation to end 2011 at -1.3%. In Portugal and Greece, we expect core prices to fall by 0.4% and 0.2%, respectively, in 2011 as a whole. Clearly, falling prices will affect fiscal performances by subduing tax receipts. Debt-to-GDP ratios will also be higher than they would be otherwise.

As we have written before, we are now living in a two-speed world, where the economies of the advanced countries are generally growing at a much slower pace than those in emerging markets. Many emerging markets have closed or nearly closed their output gaps while monetary policy remains accommodative. There is an understandable reluctance to raise rates in emerging markets until the situation regarding growth and financial markets becomes clearer in the West. Thus, in many countries, the level of rates remains too accommodative, with consequent risks to inflation. Inflation risks are mainly in emerging markets (though we have taken the top off our Chinese inflation forecasts).

While we have concerns about EM inflation and see upside risks, a number of economies will experience a flattening off of inflation or even a peak this year. Inflation in China this year is forecast to average 3.5%, easing to 3.0% next year. Similarly, we see lower inflation in Brazil and Mexico next year than in 2010. Russia is an exception, with a further rise in inflation in our forecasts.

The inflation forecast overall, together with growth close to potential in the global economy as a whole, is a recipe for only modest tightening in global monetary conditions. Hence monetary conditions should, overall, remain supportive of asset prices and of longer-term growth.

Accommodative central bank policy in the advanced economies With tighter fiscal policy in the eurozone and more financial risks globally, monetary policy will be easier than we previously expected. In addition to more asset purchases by the ECB, we now do not expect any interest rate hikes from the Fed, ECB or BoJ until

2012. As we saw in the recent Fed meeting, worries about financial developments in Europe are a reason to soft-pedal on interest rate policy globally. The core inflation environment in Europe and the US next year is decisively not a reason to raise rates.

Until financial markets calm down, an exit from unconventional policies is off the agenda. The lessons from the eurozone are that, under the surface, conditions remain quite fragile and that exits from supportive policies (which in the US and UK would imply selling securities) need to be delayed.

The ECB has denied that its Securities Markets Programme represents monetary easing and has said it will sterilise the effect on base money of the programme. We have two criticisms of this stance. First, the concept of sterilisation of a central bank’s action in the context of repo activity where the central bank supplies unlimited liquidity to the banks is, to say the least, questionable. Second, while the ECB’s actions may limit the effect on narrow money, M3 will still be boosted by the SMP. With SMP purchases only amounting to some EUR 51bn at the time of writing, compared with eurozone GDP and M3 of around EUR 9trn each, the degree of monetary easing so far

Chart 1: US Inflation Measures

Source: Reuters EcoWin Pro

Chart 2: Eurozone HICP Core



has been minimal. With M3 having declined over the last year, much more substantial purchases are justified on monetary as well as financial-stabilisation grounds. Since we fear that periods of market tension are not over, it is likely that the ECB will have to buy more bonds for a longer period than it would like to. It may have to broaden its purchases at some stage to include Spanish bonds. We suspect that the end-2010 total for ECB purchases could be in the EUR 200bn to EUR 300bn range.

The UK budget recently saw a tightening that will shave more off GDP than the independent Office for Budget Responsibility (OBR) has forecast. We expect the Bank of England to revise down its GDP forecast in its upcoming Inflation Report, as well as its longer-term assessment for inflation and inflation risks. More monetary easing – in the form of further Gilt purchases, looks likely in this context.

What about the US? Will there be further unconventional policy moves? In terms of our base macroeconomic forecast, there are competing influences. On the one hand, we expect growth to proceed at a pretty steady 3% per annum, narrowing the output gap. On the other hand, the trend in core inflation is decisively downward and we expect the core CPI to be flat in 2011. Our assessment is that the decisive factor behind policy moves will be inflation expectations. Michigan five-year forward inflation expectations are currently at the bottom of their range of recent years. As long as they remain there, the Fed will probably resist further unconventional policy. Should inflation expectations break decisively to the downside, with support from breakeven inflation rates in the bond market, then the Fed would find it tough to avoid further action, though that is not in our central forecast. We also expect the Bank of Japan to remain on hold in terms of rates until 2012.

In emerging markets, policy tightening is under way in Asia and Latin America and, by and large, we expect this to continue, albeit slowly. For example, we expect rates in Indonesia to rise from 7% at the end of this year to 7.5% at the end of 2011 and 8.5% at the end of 2012, with slow tightening also in India, the Philippines, Malaysia and other countries. The key for the markets will, of course, be China. Tightening is proceeding but, with the economy slowing, the exchange rate having been de-pegged, and with controls on credit biting, we expect a more balanced

approach in the future. Brazil is tightening more rapidly than Asia is (compare its most recent 75bp hike with the 0.125% move in Taiwan) and we expect the SELIC rate to reach 12.25%.

The overall stance of global monetary policy is thus becoming less accommodative, but the degree and speed of tightening varies globally. Monetary policy in the advanced economies, which face the most pressing challenges in terms of modest growth, low inflation and the need to offset fiscal tightening, will remain softer for longer.

Prospects for bonds and currencies What do our forecasts mean for bond markets? At the moment, both Bunds and Treasuries look expensive. However we are still buyers because we feel they will become more expensive, with our target for 10-year Bunds at the end of Q3 being 2.20% and our target for 10-year Treasuries being 2.9% (though we may go below this level in the interim). Among the bond-supportive factors we expect to see are the slowing in the manufacturing sector (which is already evident in the PMIs and will become more so by the end of the year), a likely continuation of disinflation and easy monetary policy, and risks skewed towards further tensions in sovereign debt markets in the eurozone. Those tensions are likely to lead to a continuation of widening pressures on spreads in the eurozone, with a pick-up in purchases by the ECB in response, limiting the widening. Since our scenario for the eurozone is essentially “muddling through”, the longer-term prospect into next year will be for a gentle drift up in bond yields, muted by subdued inflation.

On the currency front, as we have said above, the US recovery looks more self-sustaining than the recovery in the eurozone, where domestic demand is much less solid, and where confidence has, understandably, been dented more by the sovereign debt crisis. Uncertainty about financial developments also seems higher in the eurozone. Each of these factors individually would argue for a weaker euro and collectively they add up to what we see as being a pretty decisive case. Take into account a widening bond spread between the US and Europe, and the recipe is complete for stronger inflows into the greenback than into the euro. Thus we target EUR/USD sinking to parity and maybe a tad below that in the middle of next year.

Alan Clarke July 2010Global Outlook 8 www.GlobalMarkets.bnpparibas.com

Risk Scenarios Tables 1-6 show our forecasts for the G3 economies under two variations to our base case. We have outlined an upside risk relative to the base case (i.e. the recovery is more vigorous than we have assumed) and a more pessimistic, double-dip scenario. We have apportioned probabilities to each of these alternatives to the base case. Under our base case, to which we apportion a 65% probability, we assume that the recent renewed financial market tensions in continental Europe intensify over the coming quarter or so. We believe that, ultimately, this worsening will provoke a policy response that is aggressive enough to alleviate the situation.

Double dip (25% probability) Under this scenario, the sovereign debt crisis in peripheral Europe spreads to the banking and financial sector. Funding problems between financial institutions are made worse by domestic savers withdrawing savings from local banks on a large scale and depositing them in core European banks. The effects would be akin to a rerun of the financial market seizure that was experienced in the aftermath

of the collapse of Lehman Brothers. Lending to households and businesses is curtailed and measures of confidence that have enjoyed a robust recovery suffer a renewed slump. These effects would stifle the recovery just when the short-term boost to growth from the reversal of destocking is disappearing. Although the epicentre of this latest phase of the financial crisis is in peripheral Europe, linkages in the financial system, such as the ownership of peripheral European sovereign debt, will mean that shockwaves are felt much further afield. The effects are likely to be strongest in Europe, with a significant echo in the US. With a lack of conventional monetary policy ammunition at their disposal, central banks will be less able to mitigate the effects of this wave of the financial crisis than they were the effects of the previous wave. Even assuming that most economies have seen their potential growth rates shrink, another phase of contracting output would mean that output gaps widen sharply again toward double-digit territory. Similarly, renewed increases in unemployment would widen the overshoot relative to the NAIRU. Both intensify the

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q ann) 0.4 -2.4 2.9 -0.2 1.7 -3.3 -3.8 -2.6 0.1 2.4 3.4 2.5 -0.5 -1.5 -1.5 0.0 1.0

CPI (% y/y) 3.8 -0.3 1.4 -0.3 1.0 -0.2 -1.0 -1.6 1.5 2.4 1.8 1.0 0.5 0.0 -0.5 -0.5 0.0

CPI (Ex F&E) 2.3 1.7 0.7 -1.1 -0.5 1.7 1.8 1.5 1.7 1.3 0.9 0.5 0.0 -0.5 -1.0 -1.5 -1.5Fed Funds Rate (%)(2) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.252-Year Rate (%)(2) 0.77 1.14 0.60 0.75 2.50 0.80 1.12 0.95 1.14 1.02 0.68 0.60 0.60 0.60 0.60 0.60 0.7510-Year Rate (%)(2) 2.22 3.84 2.40 2.80 5.25 2.67 3.54 3.31 3.84 3.83 3.12 2.60 2.40 2.30 2.30 2.50 2.80EUR/USD(2) 1.40 1.43 1.05 0.94 1.35 1.33 1.40 1.46 1.43 1.35 1.22 1.16 1.05 0.95 0.90 0.90 0.94USD/JPY(2) 91 93 96 130 126 99 96 90 93 93 90 92 96 105 115 125 130

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q) - - - - - -2.5 -0.1 0.4 0.1 0.2 0.6 0.0 -0.4 -1.0 -1.5 -0.8 -0.3

GDP (% y/y) 0.4 -4.1 0.8 -2.7 -0.3 -5.2 -4.9 -4.1 -2.1 0.6 1.3 0.9 0.4 -0.8 -2.9 -3.6 -3.5

HICP (% y/y) 3.3 0.3 1.6 0.7 -1.0 1.0 0.2 -0.4 0.4 1.1 1.5 1.7 1.9 1.4 0.9 0.3 0.3

CPI (Ex F&E) 1.8 1.4 0.7 -0.6 -1.2 1.6 1.6 1.3 1.1 0.9 0.8 0.7 0.4 -0.1 -0.5 -0.9 -0.8Refinancing Rate (%)(2) 2.50 1.00 0.50 0.50 0.50 1.50 1.00 1.00 1.00 1.00 1.00 0.50 0.50 0.50 0.50 0.50 0.502-Year Rate (%)(2) 1.74 1.37 0.50 1.50 2.40 1.23 1.38 1.28 1.37 0.97 0.58 0.45 0.50 0.50 0.50 0.60 1.5010-Year Rate (%)(2) 2.95 3.40 1.80 2.00 5.00 3.00 3.38 3.23 3.40 3.10 2.65 2.00 1.80 1.80 1.80 1.80 2.00EUR/JPY(2) 127 133 101 122 170 131 135 131 133 126 110 107 101 100 104 113 122

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q) - - - - - -4.2 1.7 0.1 1.1 1.2 0.5 0.6 0.3 -0.2 0.0 0.1 0.2GDP (% y/y) -1.2 -5.2 3.4 0.6 1.1 -8.9 -5.7 -5.2 -1.1 4.6 3.0 3.5 2.6 1.2 0.7 0.2 0.1CPI (% y/y) 1.4 -1.3 -0.5 -0.6 -1.5 -0.1 -1.0 -2.2 -2.1 -1.2 -0.9 -0.3 0.3 -0.1 -0.7 -0.9 -0.9CPI (Ex F&E) 0.0 -0.7 -1.3 -1.0 -1.8 -0.2 -0.6 -0.9 -1.1 -1.2 -1.6 -1.3 -1.2 -1.1 -1.0 -1.0 -1.0O/N Call Rate (%)(2) 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.102-Year Rate (%)(2) 0.40 0.15 0.15 0.30 1.00 0.41 0.32 0.25 0.15 0.18 0.16 0.18 0.15 0.15 0.20 0.25 0.3010-Year Rate (%)(2) 1.18 1.30 0.90 1.40 1.20 1.35 1.36 1.31 1.30 1.40 1.15 1.00 0.90 0.85 0.90 1.00 1.40

Source: BNP Paribas

2009

Table 2: Eurozone Economic & Financial Data － Double-Dip Scenario2011

2009 2010

2010

2011

Year

Year

Table 1: US Economic & Financial Data － Double-Dip Scenario2009 2010Year 2011

Footnotes: (1) Forecast (2) End period

Table 3: Japanese Economic & Financial Data － Double-Dip Scenario


downward pressure on underlying inflation, making a spell of persistently negative inflation all the more likely. The spell of core deflation would be deeper and more prolonged than our base-case assumption. Under this scenario, we would expect oil prices to be around USD 20/bbl below our base case, reinforcing a lower path for headline inflation. Under this scenario, the Fed would probably leave the funds rate at 0.25% indefinitely, and the ECB would lower the refi rate to 0.5%. These moves would be accompanied by renewed unconventional monetary policy action by the Fed and a stepping up of asset purchases by the ECB. With central banks committing to keep policy rates this low for a long period, short-term bond yields would stay below 1% and 10-year yields in the core of the eurozone would fall to below 2% initially, before rising on the back of surging issuance.

More robust recovery (10% probability) Under this scenario, the effects of banks stress tests, the SPV and ECB asset purchases are more effective than we and the market currently assume.

Sovereign debt jitters fade to a large extent and peripheral European bond spreads to core paper narrow sharply. This, along with the associated bounce in sentiment in equity markets, loosens financial and monetary conditions. In turn, early signs of a topping out in the upstream leading indicators of economic activity prove to be temporary. Surveys such as the PMIs rise again, limited only by the proximity to past cyclical highs. An easing in credit conditions, and greater confidence among firms about hiring and investing, and among consumers about purchasing, facilitate a more robust recovery in GDP growth. The likely narrowing in output gaps and lower unemployment rates would help to moderate the near-term slowdown in underlying inflation. Furthermore, a USD 5-10/bbl increase in oil prices relative to our base case would reinforce a higher path for headline inflation. A fading of deflation fears, combined with above-trend GDP growth rates, would probably provoke an earlier normalisation in policy rates, albeit at a moderate pace.

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q ann) 0.4 -2.4 3.5 4.5 3.4 -3.3 -3.8 -2.6 0.1 2.4 3.4 4.0 5.0 5.0 4.5 4.0 4.0

CPI (% y/y) 3.8 -0.3 1.8 2.0 2.0 -0.2 -1.0 -1.6 1.5 2.4 1.8 1.6 1.6 1.5 2.2 2.1 2.0

CPI (Ex F&E) 2.3 1.7 0.9 0.9 1.3 1.7 1.8 1.5 1.7 1.3 0.9 0.8 0.6 0.6 0.8 1.0 1.2Fed Funds Rate (%)(2) 0.25 0.25 0.75 3.00 5.50 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.75 1.25 1.75 2.25 3.002-Year Rate (%)(2) 0.77 1.14 2.25 3.50 5.75 0.80 1.12 0.95 1.14 1.02 0.68 1.25 2.25 2.50 2.75 3.00 3.5010-Year Rate (%)(2) 2.22 3.84 3.75 5.00 6.50 2.67 3.54 3.31 3.84 3.83 3.12 3.25 3.75 4.00 4.35 4.70 5.00EUR/USD(2) 1.40 1.43 1.17 1.35 1.40 1.33 1.40 1.46 1.43 1.35 1.22 1.17 1.17 1.20 1.25 1.30 1.35USD/JPY(2) 91 93 94 118 126 99 96 90 93 93 90 92 94 100 105 110 118

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q) - - - - - -2.5 -0.1 0.4 0.1 0.2 0.6 0.6 0.7 0.6 0.5 0.5 0.5

GDP (% y/y) 0.4 -4.1 1.4 2.3 1.9 -5.2 -4.9 -4.1 -2.1 0.6 1.3 1.5 2.1 2.5 2.4 2.3 2.1

HICP (% y/y) -4.1 0.3 1.7 2.3 2.0 1.0 0.2 -0.4 0.4 1.1 1.5 1.9 2.2 2.3 2.1 2.2 2.5

CPI (Ex F&E) 0.3 1.4 0.8 0.8 1.8 1.6 1.6 1.3 1.1 0.9 0.8 0.7 0.7 0.6 0.5 0.8 1.2Refinancing Rate (%)(2) 1.4 1.00 1.00 2.25 5.00 1.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.75 2.252-Year Rate (%)(2) 1.0 1.37 0.90 2.75 5.25 1.23 1.38 1.28 1.37 0.97 0.58 0.60 0.90 1.75 2.00 2.25 2.7510-Year Rate (%)(2) 1.4 3.40 2.90 4.20 6.25 3.00 3.38 3.23 3.40 3.10 2.65 2.50 2.90 3.40 3.60 3.80 4.20EUR/JPY(2) 127 133 96 150 164 131 135 131 133 126 110 101 96 115 121 138 150

’08 ’09 ’10(1) ’11(1) ’12(1) Q1 Q2 Q3 Q4 Q1 Q2(1) Q3(1) Q4(1) Q1(1) Q2(1) Q3(1) Q4(1)

GDP (% q/q) - - - - - -4.2 1.7 0.1 1.1 1.2 0.5 0.9 1.0 0.8 0.7 0.6 0.5GDP (% y/y) -1.2 -5.2 3.8 3.1 2.1 -8.9 -5.7 -5.2 -1.1 4.6 3.0 3.8 3.7 3.2 3.4 3.1 2.6CPI (% y/y) 1.4 -1.3 -0.4 0.2 -0.1 -0.1 -1.0 -2.2 -2.1 -1.2 -0.9 -0.1 0.6 0.3 0.1 0.1 0.3CPI (Ex F&E) 0.0 -0.7 -1.2 -0.2 -0.2 -0.2 -0.6 -0.9 -1.1 -1.2 -1.6 -1.1 -0.9 -0.7 -0.2 0.0 0.2O/N Call Rate (%)(2) 0.10 0.10 0.10 0.75 2.00 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.25 0.50 0.752-Year Rate (%)(2) 0.40 0.15 0.30 1.00 2.50 0.41 0.32 0.25 0.15 0.18 0.16 0.20 0.30 0.35 0.55 0.75 1.0010-Year Rate (%)(2) 1.18 1.30 1.75 2.50 3.00 1.35 1.36 1.31 1.30 1.40 1.15 1.50 1.75 2.00 2.20 2.40 2.50

Source: BNP Paribas

Year

Footnotes: (1) Forecast (2) End period

Year 2009 2010

2009 2010

Table 4: US Economic & Financial Data － More Robust Recovery Scenario

Year 2011

Table 5: Eurozone Economic & Financial Data － More Robust Recovery Scenario20102009

2011

Table 6: Japanese Economic & Financial Data － More A227Robust Recovery Scenario2011

Brian Fabbri July 2010Global Outlook 10 www.GlobalMarkets.bnpparibas.com

US: Recovery Turns to Moderate Expansion Activity: after three solid quarters of growth,

the recovery is turning into a sustainable expansion led by business investment GDP is forecast to rise by around 3% this year

and over the next two years. Growth in business investment in IT and employment should support personal consumption. In addition, robust international growth will stimulate manufacturing output for export, businesses will rebuild depressed inventory levels, and extremely low interest rates should boost housing affordability and support the rebound in housing construction.

In the past year consumption has improved, largely due to tax cuts. Consumers have now spent that extra money.

While consumer confidence is much higher than its recession low, it has stalled in recent months, restrained by the decline in stock prices, the Gulf of Mexico oil spill, the European debt crisis and the slow recovery in permanent jobs.

Employment is the most important factor in consumers’ confidence and in their ability to keep spending. Since big business in the US is booming with profits up 30% y/y for two successive quarters on the back of surging productivity growth, employment should expand in future months. Given the very sharp decline in employment during the recession, we forecast payrolls will rise by 1.2% in the year to Q4 2010 and a robust 2.3% in the year to Q4 2011.

As demand for homes increased in the lead-up to the expiry of the government’s homebuyers’ credit scheme, residential investment is forecast to have surged by 17% annualised in Q2 and then to decelerate in Q3. Thereafter, residential investment is forecast to continue supporting growth for the next year or two as house building returns to normal demographic demands.

The reduction in fiscal stimulus will be one of the main drags on growth, primarily as higher taxes in the next twelve months lower disposable income after the federal stimulus raised it in the year ended in May 2010.

Meanwhile, most local governments remain deep in fiscal deficit and should remain a drag on growth for at least the next four quarters.

Another restraint on growth will come from an expected slight widening of the trade deficit. Export growth is projected to slow as growth in other advanced economies decelerates and given the expected appreciation of the trade-weighted dollar, while rising domestic demand will be reflected in an increase in imports.

Banks continue to be stingy with credit. While most are no longer tightening credit conditions, they have not extended credit either.

However, the biggest risk to the forecast is if business confidence fails and firms postpone hiring. Businesses are worried about their European operations, with the threat to EU growth from the sovereign debt crisis. Moreover, banks and businesses share uncertainty about the forthcoming reform of financial legislation in all advanced countries, which is causing delays in some funding and planning decisions.

A significant slowdown in private-sector hiring would increase pressure on the federal government to initiate a new stimulus plan.

Inflation: all price indicators continue to point lower. The economy may flirt with deflation in 2011 Excess supply continues to dominate growing

demand, creating downward pressure on wages and prices in many areas of the economy. In particular, rent, the biggest component of the core CPI, is forecast to continue declining as house prices fall for at least another year due to the large inventory of unsold homes and new home foreclosures.

Meanwhile, high unemployment will exert downward pressure on wages, businesses’ main cost, and an appreciating trade-weighted dollar will contribute to slower rises in import prices.

The huge amount of potential liquidity that the Fed has placed in banks’ hands is not expected to translate into final price inflation until banks use it aggressively to make loans and accelerate domestic demand. By then, the Fed will have taken action to remove the liquidity.

Policy: the Federal Reserve is expected to continue its policy of watchful waiting and is not expected to raise rates until early 2012 The FOMC recently revised down its inflation

outlook to rates well below its assumed goal. The long downward slide in inflation will give the FOMC plenty of time to observe how the European sovereign risk crisis affects domestic banks and businesses, and to patiently wait for business to engage in full-scale hiring.

The FOMC will also have to gauge the economic repercussions from the large reduction of the federal budget deficit.

We do not expect the Fed to raise the Fed funds rate until early 2012.


US: Economic & Financial Forecasts

Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Components of Growth % Q/Q SAAR GDP - - - - - -6.4 -0.7 2.2 5.6 2.7 2.9 2.3 2.6 2.7 3.0 3.2 3.5Dom. Demand ex Stocks -0.4 -2.7 1.8 2.8 3.4 -6.4 -0.9 2.3 1.4 1.6 2.8 1.8 2.5 2.7 3.2 3.3 3.8Private Consumption -0.2 -0.6 2.4 2.9 3.2 0.6 -0.9 2.8 1.6 3.0 2.8 2.6 2.9 2.9 3.0 3.1 3.5Public Consumption 3.1 1.8 0.1 0.3 1.2 -2.6 6.7 2.6 -1.3 -1.9 0.5 0.0 -0.1 -0.2 0.5 1.2 1.5Residential Investment -22.9 -20.5 3.0 15.5 15.8 -38.2 -23.3 18.9 3.8 -10.3 17.0 5.0 15.0 16.0 20.0 18.0 16.0Non-Residential Investment 1.6 -17.8 1.0 3.9 6.4 -39.2 -9.6 -5.9 5.3 2.2 4.5 -0.6 2.2 4.2 5.7 5.7 7.4Stocks (Cont. to Growth) -0.4 -0.7 0.6 0.0 0.1 -2.4 -1.4 0.7 3.8 1.6 0.6 0.2 0.1 0.0 0.1 0.1 0.0Exports 5.4 -9.6 11.7 7.0 6.0 -29.9 -4.1 17.8 22.8 11.3 6.0 11.2 6.9 7.6 4.9 6.3 5.6Imports -3.2 -13.9 10.5 6.3 6.5 -36.4 -14.7 21.3 15.8 14.8 6.3 7.1 6.2 6.3 5.7 6.5 6.4GDP (% y/y) 0.4 -2.4 2.9 2.8 3.2 -3.3 -3.8 -2.6 0.1 2.4 3.4 3.4 2.6 2.6 2.7 2.9 3.1Industrial Production (% y/y) -2.2 -9.7 5.5 4.6 4.7 -11.6 -12.9 -9.5 -4.7 2.4 7.0 6.6 5.9 5.1 4.5 4.4 4.5Savings Ratio (%) 2.7 4.2 3.8 4.1 3.8 3.7 5.4 3.9 3.7 3.4 3.9 4.0 4.0 4.1 4.1 4.1 4.0 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 3.8 -0.3 1.7 1.0 1.0 -0.2 -1.0 -1.6 1.5 2.4 1.8 1.4 1.2 0.9 1.3 1.0 0.8CPI (Ex F&E) 2.3 1.7 0.8 0.0 0.5 1.7 1.8 1.5 1.7 1.3 0.9 0.7 0.2 0.2 0.0 -0.1 0.1Core PCE Deflator 2.4 1.5 1.2 0.4 0.6 1.7 1.6 1.3 1.5 1.4 1.2 1.2 0.8 0.7 0.4 0.3 0.3Producer Prices 6.4 -2.5 4.5 2.6 1.5 -2.2 -4.1 -5.2 1.5 5.2 4.6 4.4 3.7 2.4 3.0 2.8 2.1Monthly Wages 3.0 1.7 1.7 1.3 1.2 2.1 1.8 1.5 1.5 1.7 1.7 1.7 1.6 1.3 1.3 1.3 1.2Employment -0.6 -4.3 -0.3 1.9 2.1 -3.7 -4.6 -4.8 -4.0 -2.3 -0.5 0.4 1.2 1.7 1.7 2.1 2.3Unemployment Rate (%) 5.8 9.3 9.6 8.5 6.9 7.0 8.2 9.3 10.0 9.7 9.8 9.6 9.5 9.2 8.7 8.2 8.0 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (USD bn, sa) -699 -375 -427 -429 -452 -362 -322 -397 -419 -461 -414 -412 -420 -420 -427 -431 -437Current Account (USD bn, sa) -669 -378 -400 -413 -444 -382 -338 -390 -404 -436 -382 -385 -399 -400 -410 -417 -425Current Account (% GDP) -4.6 -2.7 -2.7 -2.7 -2.8 -2.7 -2.4 -2.7 -2.8 -3.0 -2.6 -2.6 -2.7 -2.6 -2.7 -2.7 -2.7 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Financial Variables Money Supply 7.1 7.8 2.6 5.7 6.3 9.6 8.7 7.8 5.1 -1.5 3.0 5.0 6.0 6.0 6.0 5.0 6.0Gen. Gov. Budget (USD bn) (2) -455 -1416 -1482 -1300 -1100 -449 -305 -329 -388 -329 -365 -400 -400 -375 -250 -275 -350Gen. Gov. Budget (% GDP) (2) -3.1 -9.9 -10.0 -8.4 -6.8 -6.5 -8.9 -9.9 -10.2 -9.3 -9.6 -10.0 -10.0 -10.2 -9.3 -8.4 -8.0Gross Gov. Debt (% GDP) (3) 40.4 53.2 61.4 67.4 71.4 48.4 50.9 53.2 54.2 57.0 59.0 61.1 63.2 65.0 66.0 67.1 68.6 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (3) Fed Funds Rate (%) 0.25 0.25 0.25 0.25 2.00 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.253-Month Rate (%) 1.43 0.25 0.95 0.75 2.50 1.19 0.60 0.29 0.25 0.29 0.54 1.00 0.95 0.90 0.85 0.80 0.752-Year Rate (%) 0.77 1.14 0.75 2.00 3.00 0.80 1.12 0.95 1.14 1.02 0.68 0.75 0.75 0.85 1.00 1.25 2.005-Year Rate (%) 1.55 2.68 2.10 2.85 3.75 1.67 2.56 2.31 2.68 2.56 1.92 1.80 2.10 2.10 2.20 2.55 2.8510-Year Rate (%) 2.22 3.84 3.00 3.75 4.50 2.67 3.54 3.31 3.84 3.83 3.12 2.90 3.00 3.10 3.25 3.50 3.75EUR/USD 1.40 1.43 1.08 1.00 1.15 1.33 1.40 1.46 1.43 1.35 1.22 1.16 1.08 1.00 0.98 0.97 1.00USD/JPY 91 93 94 118 126 99 96 90 93 93 90 92 94 100 105 110 118Footnotes: (1) Forecast (2) Fiscal Year (3) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Equipment and Software Investment, and ISM New Orders

Source: Reuters EcoWin Pro, BNP Paribas

Businesses have sharply increased their investment in equipment and software. Rising new orders for capital goods indicate that business investment will remain robust.

Chart 2: Unprecedented Corporate Cash Flow Stimulates M&A Activity

52 56 60 64 68 72 76 80 84 88 92 96 00 04 08-4

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Bars Mark Recessions

+1 St.Dev

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Mean

Corporate Sector's Retained Earnings Less Capex (% GDP)


Business cash flow after investment remains extraordinarily high, reflecting high profitability, stingy dividend policies and low capital costs.

Chart 3: Ratio of Temporary to Total Private-Sector Employment Increase

-3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 12 14 16 18 20 2297.5

100.0

102.5

105.0

107.5

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112.5

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117.5

120.0

2009

1991

Ratio of Temporary to Private Payrolls

2001

Business Cycle Trough


Private-sector businesses have finally begun hiring. However, in this recovery, the percentage of new jobs that are temporary has been larger than in the last two recoveries.

Chart 4: Small-Business Hiring Plans Are Still Weak


In May, the confidence of small businesses rose from extremely low levels. However, sentiment and hiring intentions remain relatively weak.

Chart 5: Consumer Spending Improved as Labour Market Turns


Consumer spending has improved significantly in the past several months, reflecting both the use of the federal stimulus tax cuts and the rise in household income.

Chart 6: The Inventory of Existing Homes for Sale is Still Large

82 84 86 88 90 92 94 96 98 00 02 04 06 08 101.5

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New Homes (k)

Existing Homes (mn, RHS)

Inventories of Houses Available for Sale


The number of existing homes for sale remains high. Moreover, there is a large inventory of distressed or vacant existing homes adding to the stock of unsold homes.

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 1020

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Equipment and Software Investment(% q/q, saar)

ISM New Orders

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Single Most Important Problem: Poor Sales (Inverted)

Small Business Hiring Plans (RHS)

98 99 00 01 02 03 04 05 06 07 08 09 10-7.5 -5.0

-2.5 0.0 2.5

5.0 7.5

10.0 (3m/3m % Chg)

Real Consumption (3m/3m % Chg, saar)


Wage Proxy = Agg Hours Worked x Avg Hrly Earnings


Chart 7: Fiscal Stimulus Has Turned to Restraint


The effects of the federal fiscal stimulus are waning and soon fiscal thrust will turn to restraint, becoming a drag on future economic growth.

Chart 8: Global Growth Has Raised Demand for US Exports

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10-60

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Exports of Goods and Services(3m/3m % Chg, saar)


ISM New Export Orders (SA)


New export orders have continued to rise, according to the latest ISM survey, implying that manufacturing output in the US for export will remain a significant contributor to growth.

Chart 9: Bank Loans by Type of Borrower

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10-30

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10

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30

40

50

60 Home Equity

Consumer

Business

Real Estate

% y/y


Bank lending to all types of borrowers continued to decline throughout the first five months of this year. The spike in consumer loans was due to a change in accounting rules.

Chart 10: State and Local Governments Are in Fiscal Trouble

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-100

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-180-156-132-108-84-60-36-1212366084

108132156180

Net State and Local Government Saving (USD bn, RHS)


State and Local Government Payrolls (k, quarterly change)


The fiscal crisis affecting state and local government budgets is forecast to continue for the next two years, causing more layoffs and remaining a drag on economic growth.

Chart 11: Core Inflation Falls Close to Its All-Time Low

60 65 70 75 80 85 90 95 00 05 100.0

2.5

5.0

7.5

10.0

12.5

15.0

Core CPI (% y/y)


Record Low0.7% y/y

Nov 031.09% y/y

Current 0.92%


Core inflation has decelerated close to its all-time low and is expected to continue decelerating to zero over the next 12 months.

Chart 12: Fed Funds Futures Have Flattened Significantly (%)

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep10 11

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0.25

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1.00

1.25

1.50

1.75

May 21, 2010

Jan 04, 2010

Apr 28, 2010


As the European debt crisis has materialised, market expectations that the Fed funds rate will increase in the future have declined substantially.

04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20-1.50

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Budget (USD bn, RHS)

*Budget Thrust = Change in Federal Budget Relative to GDP

Restraint

Stimulus

Recession ForecastThrust (change %)

Ken Wattret July 2010Global Outlook 14 www.GlobalMarkets.bnpparibas.com

Eurozone: Double Dip? Activity: fiscal austerity will damage the already

fragile recovery, leading to a marked slowdown Since the eurozone emerged from its recession

in Q3 2009, the average growth rate in GDP has been a meagre 0.2% q/q. Q2 growth will pick up primarily due to strength in the industrial sector (Chart 1) and the reversal of the cold-weather effect, which dampened activity in Q1 especially in the construction sector.

Despite the pick-up forecast in Q2, 2010 growth is forecast to be a lacklustre 1.2%, with an even weaker growth rate likely in 2011 as the impact of the sovereign debt crisis bites.

Reliable leading indicators are already signalling a loss of momentum in the eurozone economy (Chart 2). Even sentiment in the manufacturing sector, the engine of the recovery to date, has begun to weaken. The manufacturing PMI’s ratio of new orders to inventories, a good guide to future activity in the sector, has fallen (Chart 3).

Domestic demand has been weak during the upturn so far and, given the fiscal tightening now in train, the economy will be heavily dependent on the evolution of external demand. The weaker exchange rate will help, but in the near term the bigger risk is that the crisis in eurozone markets damages confidence elsewhere and feeds back via weaker exports. Chinese demand has been key to recent export strength (Chart 4).

Private consumption continues to underperform (Chart 5), reflecting the weakness of the labour market and household income. The rate of unemployment will continue to trend higher as the labour market has yet to adjust fully to the past decline in output. Employee compensation growth will continue to slow as a consequence.

The financial sector will remain a key headwind to growth, with high uncertainty affecting the business sector’s willingness to invest. Capacity utilisation rates and profit trends also point to underlying weakness in investment (Chart 6).

Inflation: core rates will continue to head south given the demand and cost environment Headline inflation has risen markedly since the

beginning of the year, driven by food and energy price developments. The latter will continue to exert upward pressure over the remainder of the year and we look for headline inflation to rise above 2%, albeit only just, in Q4.

Core inflation, in contrast, has continued to fall, slipping to its lowest level since the start of EMU more than a decade ago (Chart 7).

That core inflation had continued to decelerate in 2009 when growth in unit labour costs was accelerating is remarkable. The combination of a rebound in productivity and slower compensation growth has seen unit labour costs fall in the latest quarter, adding to downward pressure on underlying inflation (Chart 8).

Unemployment will remain high and given the lagged impact on pay bargaining, the rate of increase in compensation is likely to continue to decelerate (Chart 9), causing unit labour costs to fall further in the coming quarters.

Surveys of consumers’ price perceptions have rebounded, reflecting higher energy prices and the pick-up in headline inflation. However, as with surveys of businesses’ pricing intentions, they are low by historical standards (Chart 10).

The depreciation in the EUR exchange rate is an upward pressure on inflation: a 10% fall in the effective rate is estimated to add around 0.7 of a percentage point to the HICP over the following two years. Weak demand and cost trends are, however, the dominant influence.

Policy: the ECB refinancing rate will stay lower for even longer given fiscal tightening In response to the debt crisis, the fiscal stance in

the eurozone is being tightened markedly. On the basis of current consolidation programmes, we estimate that the cyclically adjusted budget deficit for the eurozone is going to be reduced by in excess of 1% of GDP in 2011.

This reinforces the case for offsetting monetary policy accommodation in the eurozone, via the ECB’s policy action and a further depreciation of the exchange rate. We continue to forecast parity for the EUR/USD rate by early 2011. While financial and monetary conditions have eased, they are not exceptionally loose (Chart 11).

Given the backdrop for growth and inflation, we continue to believe that the ECB refinancing rate will stay very low for a long period. Our forecast for the timing of the first hike has been pushed back from Q4 2011 to the second half of 2012 in line with recent fiscal developments.

Continued stress in the financial sector suggests that unconventional stimulus measures will also be required for some time. We assume that the ECB will further extend its liquidity provision and also its government bond purchases. Divisions on the Governing Council are likely, however, which could delay the implementation of such policies and damage credibility.


Eurozone: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - -2.5 -0.1 0.4 0.1 0.2 0.6 0.3 0.2 0.1 0.0 0.1 0.2GDP 0.4 -4.1 1.2 0.6 1.0 -5.2 -4.9 -4.1 -2.1 0.6 1.4 1.3 1.4 1.2 0.6 0.4 0.4Final Domestic Demand 0.4 -2.5 -0.1 0.4 1.0 -2.9 -2.7 -2.7 -1.8 -0.6 -0.2 0.0 0.2 0.4 0.2 0.3 0.5Private Consumption 0.3 -1.2 -0.3 -0.3 0.8 -1.7 -1.2 -1.3 -0.5 0.0 -0.3 -0.3 -0.6 -0.6 -0.5 -0.2 0.1Public Consumption 2.2 2.7 1.6 1.0 0.8 2.8 2.8 3.0 2.1 2.0 1.7 1.2 1.4 1.1 1.0 1.0 1.0Fixed Investment -0.9 -10.9 -1.5 1.5 1.6 -11.4 -11.6 -11.4 -8.9 -5.0 -1.9 -0.5 1.4 2.8 1.3 1.1 0.9Stocks (Cont. to Growth, q/q) 0.1 -0.8 0.9 -0.1 -0.1 -1.1 -0.6 0.5 0.1 0.9 -0.3 0.0 0.0 0.0 0.0 -0.1 -0.1Exports (2) 0.7 -13.2 7.5 3.5 4.3 -16.4 -17.0 -13.6 -5.2 6.0 9.4 7.8 6.8 4.7 3.3 2.8 3.0Imports (2) 0.8 -11.9 6.5 2.5 4.0 -13.3 -14.7 -12.5 -7.0 5.3 8.7 6.4 5.8 2.2 2.5 2.6 2.8Industrial Production -1.8 -14.6 8.1 0.8 1.8 -18.1 -18.4 -14.7 -7.5 4.2 10.1 9.9 8.0 3.4 0.4 -0.2 -0.3


Inflation & Labour HICP 3.3 0.3 1.6 1.4 0.7 1.0 0.2 -0.4 0.4 1.1 1.5 1.8 2.1 1.9 1.4 1.2 1.2Core HICP 1.8 1.4 0.8 0.0 0.2 1.6 1.6 1.3 1.1 0.9 0.8 0.7 0.6 0.2 -0.1 -0.2 0.0Producer Prices 6.1 -5.1 3.3 2.3 2.5 -2.0 -5.7 -7.8 -4.6 -0.2 3.4 4.8 5.1 4.2 2.2 1.5 1.3Comp. per Employee 3.1 1.5 1.0 0.9 1.4 1.8 1.5 1.4 1.3 1.4 1.1 0.9 0.8 0.7 0.8 0.9 1.0Productivity -0.3 -2.2 1.6 0.6 0.7 -3.9 -3.1 -1.9 -0.1 1.9 2.0 1.3 1.1 0.9 0.5 0.5 0.5Unit Labour Costs 3.5 3.9 -0.5 0.3 0.7 5.9 4.7 3.5 1.3 -0.5 -0.9 -0.5 -0.3 -0.2 0.3 0.4 0.5Employment 0.7 -1.9 -0.4 0.1 0.3 -1.3 -1.9 -2.2 -2.1 -1.3 -0.7 0.0 0.3 0.3 0.1 -0.1 -0.1Unemployment Rate (%) 7.6 9.4 10.0 10.3 10.5 8.8 9.3 9.7 9.8 10.0 10.0 10.0 10.0 10.1 10.2 10.3 10.4 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (EUR bn, sa) -51 22 10 5 15 -4 5 6 10 4 5 3 -2 -2 0 2 5Current Account (EUR bn, sa) -154 -56 -30 -10 5 -30 -13 -8 -8 -5 -9 -6 -10 -7 -5 0 2Current Account (% of GDP) -1.7 -0.6 -0.3 -0.1 0.1 -1.3 -0.6 -0.4 -0.3 -0.2 -0.4 -0.3 -0.4 -0.3 -0.2 0.0 0.1 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (EUR bn) -185 -565 -600 -492 -404 - - - - - - - - - - - -Gen. Gov. Budget (% GDP) -2.0 -6.3 -6.6 -5.3 -4.3 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (3) 69.4 78.7 85.2 89.8 92.6 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (3) Refinancing Rate (%) 2.50 1.00 1.00 1.00 1.50 1.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.003-Month Rate (%) 2.89 0.70 0.70 1.00 2.00 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.002-Year Rate (%) 1.74 1.37 0.50 1.25 2.25 1.23 1.38 1.28 1.37 0.97 0.58 0.40 0.50 0.50 0.50 0.50 1.255-Year Rate (%) 2.35 2.45 1.20 2.00 2.75 2.24 2.51 2.42 2.45 2.15 1.55 1.30 1.20 1.25 1.30 1.35 2.0010-Year Rate (%) 2.95 3.40 2.00 3.00 3.75 3.00 3.38 3.23 3.40 3.10 2.65 2.20 2.00 2.10 2.25 2.60 3.00EUR/USD 1.40 1.43 1.08 1.00 1.15 1.33 1.40 1.46 1.43 1.35 1.22 1.16 1.08 1.00 0.98 0.97 1.00EUR/GBP 0.96 0.89 0.80 0.79 0.90 0.92 0.85 0.91 0.89 0.89 0.83 0.81 0.80 0.78 0.78 0.80 0.79EUR/JPY 127 133 102 118 145 131 135 131 133 126 110 107 102 100 103 107 118Footnotes: (1) Forecast (2) Includes intra-eurozone trade (3) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Industrial Orders and Output

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5 Orders (RHS)

% y/y Smoothed Output


After plunging during the financial crisis, orders and output have rebounded strongly, helped by external demand.

Chart 2: OECD Composite Leading Indicator

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% 6m/6m Annualised

% 3m/3m Annualised


While the ‘hard’ industrial sector data have been robust recently, eurozone leading indicators have been losing momentum.

Chart 3: Manufacturing PMI


The ratio of new orders to inventories, a good leading indicator for the manufacturing PMI, is down from its peaks.

Chart 4: Export Growth Contributions (y/y, pp)

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(Value Terms % y/y, Smoothed) UK

China

US


Export growth has been boosted by the strength of demand in Asian economies, from China in particular.

Chart 5: External and Internal Demand

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Private Consumption (% y/y)

Exports (% y/y, RHS)


The rebound in exports in recent quarters has been much more pronounced than for private consumption.

Chart 6: Investment Breakdown

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Machinery

Construction:HousingConstruction:

Other


Investment expenditure has been weak across all sectors. Capex has rebounded the most after a huge fall during the recession.


Chart 7: HICP Inflation Rates (% y/y)

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Headline


Headline inflation has been pushed up by energy and food price developments. The core rate has fallen to a record low.

Chart 8: Productivity and Unit Labour Costs

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Productivity% y/y

Unit Labour Costs


The rebound in productivity and moderation in compensation growth have led to falls in unit labour costs.

Chart 9: Unemployment and Labour Costs

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Unemployment Rate(1-Yr Change, 18-Mth Lag)

Hourly Labour Costs (% y/y, RHS)


The high level of unemployment is consistent with further downward pressure on pay trends.

Chart 10: Consumer Price Perceptions

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80EC Consumer Survey:Price Trends

Next 12 Months

Past 12 Months


Surveys of consumer price trends have picked up as headline inflation has risen, but they remain at relatively low levels.

Chart 11: Financial and Monetary Conditions

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2.5

3.0


The BNPP FMCI for the eurozone is loose but not exceptionally so in relation to macroeconomic conditions.

Chart 12: Effective Exchange Rate


The effective EUR exchange rate has fallen sharply but remains not far below its average, suggesting scope for a further fall.

Ryutaro Kono July 2010Global Outlook 18 www.GlobalMarkets.bnpparibas.com

Japan: Growth Still Firm, Deflation Easing

Activity: recovery continues Thanks to brisk exports to other Asian countries,

the domestic fiscal stimulus and the replenishment of inventory levels at home and abroad, the economy has expanded at the robust annualised pace of 4.2% since the recovery began in Q2 2009. Relative to its potential growth rate, Japan is growing the most strongly of the G3, thanks to its proximity to the booming economies of Asia and the absence of financial system woes.

Exports, the main growth engine, have now recovered to 88.5% of the March 2008 peak, up from a low of 58.5% in February 2009. However, while shipments to the booming Asian economies have already surpassed their previous high, exports to the balance sheet-afflicted US and EU remain much lower at 69.4% and 64.7% of their respective peaks.

EU economies’ sluggishness and the euro’s weak tone promise to further weaken exports to the EU, but the impact on Japan will be limited, as these shipments only account for 12.5% of Japan’s total exports.

Although growth is unlikely to remain as robust as it is now, as it will lose some steam when the effects of fiscal stimulus and inventory replenishment wane, the economy will be underpinned by brisk exports to the rest of Asia. What is more, a virtuous cycle of income and spending is gaining traction. The revival in corporate earnings has led to a rebound in producers’ capital investment that should strengthen further from Q3. And the bottoming out of household income should trigger a self-sustaining recovery in consumption from H2. As a result, annualised growth of more than 2% is forecast, which is well above the potential growth rate (estimated at slightly below 1%).

Inflation: deflation pressures ease The national core CPI fell 1.5% y/y in April, as

the decline deepened from March’s 1.2% drop due to policy-related factors (public high school tuition exemptions etc.), without which the fall in the CPI would have moderated to 1.0%.

Price declines are gradually easing thanks to the previous rise in commodity prices and Japan’s robust economic expansion, which has steadily narrowed the negative output gap.

But since Japan’s Phillips curve is essentially horizontal, the correlation between inflation and the output gap is no longer strong. Thus, the fact that disinflation did not match the widening of the

output gap during the recession suggests inflation may not pick up as much as the output gap narrows during the economy’s recovery.

Policy: continued super-low interest rates to stave off yen appreciation So long as deflation continues, the BoJ will have

to maintain its super-low interest rate regime. This is especially the case since the US and EU are still correcting their balance sheet problems and their currencies will be prone to weakening while the yen, given Japan's lack of balance sheet woes, will be prone to strengthening, adding to Japan’s deflation pressures. To keep currency appreciation in check, the BoJ will probably prolong its current interest rate regime, but additional monetary easing is unlikely.

Although there are growing calls for the BoJ to fight deflation by buying more long-term JGBs, the BoJ is unlikely to do so unless the government commits to long-term fiscal restructuring. Public debt is at unprecedented levels, tax revenue is falling and the government aims to finance new spending programmes with bonds. Thus, if the BoJ were to start buying more JGBs, market participants could misconstrue this as monetisation. But if the Kan government begins fiscal restructuring in the not-too-distant future and economic growth decelerates to some degree as a result, the BoJ would probably decide to step up its outright purchases of long-term JGBs.

The initial budget for FY 2010 calls for JPY 92.3trn in spending to be financed by JPY 44.3trn from bond issuance, JPY 37.4trn from tax receipts and JPY 10.6trn from special account transfers. If there are not any special account transfers in FY 2011, bond issuance could swell to JPY 51.5trn, or JPY 55.2trn if the spending programmes promised by the DPJ are not financed by permanent revenue sources.

Japan’s chronic budget deficits are due more to insufficient revenue than to substantial wastefulness. Unless the government embraces low-level social welfare, taxes will have to be raised to finance the current mid-level social welfare. Until recently, it had seemed that the DPJ-led government would be unlikely to reform social welfare quickly, due to an unwillingness to discuss a consumption tax hike with Upper House elections in July. But the possibility of significant reform has increased thanks to the appointment of Naoto Kan as prime minister, as he has advocated such a tax hike to put social welfare on a sound financial footing.


Japan: Economic & Financial Forecasts

Year 2009 2010 2011 '08 09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Components of Growth GDP (% q/q) - - - - - -4.2 1.7 0.1 1.1 1.2 0.5 0.8 0.7 0.5 0.5 0.5 0.5GDP (% q/q annualised) - - - - - -15.8 6.9 0.4 4.6 5.0 2.0 3.1 2.7 1.9 2.2 2.2 2.1GDP (% y/y) -1.2 -5.2 3.6 2.3 1.8 -8.9 -5.7 -5.2 -1.1 4.6 3.0 3.7 3.2 2.4 2.5 2.2 2.1Domestic Demand ex-Stocks -1.0 -3.6 1.4 1.9 1.9 -2.2 0.1 -0.1 0.6 0.4 0.3 0.4 0.4 0.5 0.5 0.5 0.5Private Consumption -0.7 -1.0 2.0 1.3 1.3 -1.2 1.0 0.6 0.7 0.4 0.1 0.3 0.3 0.3 0.4 0.4 0.4Government Expenditure -1.2 2.4 0.2 0.0 1.1 1.2 1.4 -0.1 0.4 0.3 -0.4 -0.5 -0.4 0.3 0.3 0.3 0.3Private Capital Spending 0.1 -19.3 1.6 6.7 5.2 -9.7 -3.8 -2.1 1.1 0.6 1.0 2.0 2.0 1.5 1.5 1.5 1.5Stocks (Cont. to Growth) -0.4 -0.4 0.1 0.1 0.0 -1.3 -0.2 -0.1 -0.2 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0Exports 1.6 -23.9 24.6 10.0 5.9 -24.8 10.1 8.6 5.8 6.9 3.5 3.5 3.5 1.8 1.8 1.8 1.7Imports 1.0 -16.7 8.5 10.1 8.5 -18.0 -3.5 5.7 1.0 2.3 2.2 2.2 2.5 2.5 2.5 2.5 2.5Industrial Production (% q/q) - - - - - -20.0 6.5 5.3 5.9 7.0 1.7 1.0 1.5 1.3 1.2 1.2 1.0Industrial Production (% y/y) -3.4 -21.9 18.6 5.3 3.7 -34.6 -27.4 -19.4 -4.3 27.5 21.4 16.5 11.7 5.7 5.2 5.4 4.8Savings Ratio (%) 2.3 0.8 1.0 1.0 0.7 - - - - - - - - - - - - Year 2009 2010 2011 (% y/y) '08 09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 1.4 -1.4 -0.6 -0.2 0.5 -0.1 -1.0 -2.2 -2.1 -1.2 -0.9 -0.5 0.2 -0.2 -0.2 -0.2 -0.2Core CPI 1.5 -1.3 -1.0 -0.4 0.5 -0.1 -1.0 -2.3 -1.8 -1.2 -1.3 -0.9 -0.5 -0.7 -0.3 -0.2 -0.2US-Like Core CPI (2) 0.0 -0.7 -1.4 -0.5 0.4 -0.2 -0.6 -0.9 -1.1 -1.2 -1.6 -1.5 -1.3 -1.2 -0.5 -0.3 -0.3Monthly Wages -0.3 -3.9 0.4 0.2 0.6 -3.0 -4.6 -3.6 -4.1 -0.0 0.8 0.0 1.0 0.0 0.2 0.2 0.3Employment -0.4 -1.6 -0.1 0.3 0.3 -0.8 -2.0 -1.8 -1.9 -1.0 -0.3 0.3 0.5 0.1 0.3 0.3 0.3Unemployment Rate (%) 4.0 5.1 4.8 4.2 3.6 4.5 5.1 5.4 5.2 4.9 5.1 4.8 4.6 4.4 4.3 4.1 4.0 Year 2009 2010 2011 '08 09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (JPY trn, sa) 4.0 4.0 11.1 10.7 9.0 -1.2 4.2 5.4 7.6 9.5 11.6 11.9 11.3 11.9 11.6 10.2 9.3Current Account (JPY trn, sa) 16.4 13.3 19.0 18.9 18.2 8.7 14.1 14.5 15.9 18.2 19.4 19.5 18.8 19.6 19.6 18.5 17.9Current Account (% GDP) 3.2 2.8 3.9 3.9 3.7 1.8 3.0 3.1 3.3 3.8 4.0 4.0 3.9 4.0 4.0 3.8 3.6 Year 2009 2010 2011 (% y/y) '08 09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Financial Variables Money Supply (M2) 2.1 2.7 3.1 3.4 3.6 2.1 2.6 2.8 3.3 2.8 3.0 3.2 3.3 3.4 3.4 3.4 3.5Gov. Budget (JPY trn) (3)(4) -24.3 -50.9 -44.8 -32.4 -33.0 - - - - - - - - - - - -Gov. Budget (% GDP) (3)(4) -4.9 -10.7 -9.4 -6.8 -6.8 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (3)(4) -155.8 -172.3 -180.8 -186.3 -191.5 - - - - - - - - - - - - Year 2009 2010 2011 '08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (5) O/N Call Rate (%) 0.10 0.10 0.10 0.10 1.00 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.103-Month Rate (%) 0.74 0.46 0.40 0.40 1.10 0.65 0.56 0.54 0.46 0.43 0.38 0.40 0.40 0.40 0.40 0.40 0.402-Year Rate (%) 0.40 0.15 0.25 0.75 1.15 0.41 0.32 0.25 0.15 0.18 0.16 0.20 0.25 0.30 0.35 0.55 0.755-Year Rate (%) 0.71 0.47 0.60 1.15 1.30 0.78 0.71 0.60 0.47 0.56 0.39 0.50 0.60 0.70 0.85 1.00 1.1510-Year Rate (%) 1.18 1.30 1.40 1.80 1.90 1.35 1.36 1.31 1.30 1.40 1.15 1.30 1.40 1.50 1.60 1.70 1.80USD/JPY 91 93 94 118 126 99 96 90 93 93 90 92 94 100 105 110 118EUR/JPY 127 133 102 118 145 131 135 131 133 126 110 107 102 100 103 107 118Footnotes: (1) Forecast (2) US-Like Core CPI: CPI excluding food (but including alcoholic beverages) and energy (3) FY (4) General government excluding social security funds (5) End period Figures are quarter-on-quarter percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Contribution to Real GDP (% q/q)

Source: Cabinet Office, BNP Paribas

Although the impact of the fiscal stimulus is fading, economic growth has remained robust on brisk exports to Asia, with real GDP expanding an annualised 5.0% q/q in Q1.

Chart 2: GDP Deflator (% y/y)


The rate of decline in the GDP deflator was unchanged at -2.8% y/y in Q1. The large decline was largely due to the base effect: after seasonal adjustment, the deflator rose 0.1% q/q, indicating that deflation pressure is easing.

Chart 3: Core CPI (% y/y)

Source: MIC, BNP Paribas

Price declines are gradually easing thanks to robust economic growth since Q2 2009. While the national core CPI’s fall accelerated in April, that was entirely due to one-off policy-related factors (such as public high school tuition exemptions).

Chart 4: Share of CPI Gainers vs. Decliners (%)


Just 25% of the goods and services within the CPI have seen a rise in price over the past year. However, the share of price gainers is no longer falling while the share of items with price falls has crested, indicating that deflation pressures are moderating.

Chart 5: Real Exports and Industrial Production (2005=100, sa)

Source: MOF, BoJ, METI, BNP Paribas

Led by shipments to Asia, Japan’s exports have expanded faster than expected, driving the recovery in production. In April, exports recovered to 88.5% of the March 2008 peak, while production recovered to 87.2% of its February 2008 peak.

Chart 6: Current Profits (JPY trn, sa)

Source: MOF, BNP Paribas

Ordinary profits on an all-industries basis grew 10.9% q/q in Q1, an advance that followed a 35.8% q/q surge in Q4 2009. The level has now rebounded to 74% of its Q1 2007 peak.


Chart 7: Real Private Capex (JPY trn, sa)


Capital investment grew a modest 0.6% q/q in Q1, after a 1.1% increase in the previous quarter. Investment has stabilised alongside the rapid recovery of corporate earnings, but a fully fledged recovery has yet to kick in.

Chart 8: Employment (mn, sa)


Companies cut working hours to keep payrolls relatively intact during the recession. Hence, now that the economy is growing, companies are responding by increasing working hours rather than employment and job growth remains slow to recover.

Chart 9: Total Cash Earnings (% y/y)

Source: MHLW, BNP Paribas

As the recovery in economic activity is leading to a sharp increase in the number of hours worked, wages are starting to pick up, led by overtime pay.

Chart 10: Real Consumption (JPY trn, sa)


Consumption continues to recover, led by stimulus-driven outlays for durable goods. But spending on goods and services not affected by the stimulus measures generally remains lacklustre.

Chart 11: New Car Sales (mn, sa)

Source: JMDA, BNP Paribas

In April-May the level of new car sales was slightly higher than in Q1. That said, in trend terms, sales have been basically flat since last October, suggesting that the impact of stimulative measures has faded.

Chart 12: Housing Starts (mn, saar)

mill

ions

Source: MLIT, BNP Paribas

Housing starts bottomed in August 2009 and then gradually picked up until stalling in the past three months. While the worst is over, housing starts remain at an extremely low level.

Chen Xingdong July 2010Global Outlook 22 www.GlobalMarkets.bnpparibas.com

China: Risks of a Sharp Slowdown Activity: we have lowered our growth forecast

for 2010 to 9.8%, and growth should slow to 8.4% in 2011 due to policy tightening In Q1, GDP rose 11.9% y/y. On a seasonally

adjusted basis, we estimate GDP rose 3.1% q/q, accelerating from Q4 2009. Output of the agricultural, industrial and service sectors rose 3.8%, 14.5% and 10.2% y/y in real terms. In terms of expenditure, we estimate private consumption contributed 6.2pp to GDP growth and capital formation 6.9pp, while net exports subtracted 1.2pp from growth.

However, Chinese growth has clearly peaked. Monetary quantitative tightening, controls to prevent large house price rises and regulation of local government investment are cooling domestic demand, especially in FAI, property and the consumption of durables. In addition, the euro sovereign debt crisis is undermining exports and the global recovery.

The argument that growth has peaked is supported by a fall in the official PMI to 53.9 in May from 55.7 in April. The new-orders PMI dropped 4.5 points to 54.8 while PMI stocks jumped 3.6 points to 48.3. The gap between the two indices is now the narrowest since Q2 2008, which suggests a deceleration in industrial production growth. We expect growth in value-added industrial output to slow from 19.6% y/y to 15.5% in Q2. GDP growth is on track to slow to 10.8% y/y in Q2 and 9.4% in H2 2010.

In Q1, FAI rose 26.4% y/y, though investment growth has clearly peaked due to sharp monetary tightening, government curbs on industrial over-capacity, the regulation of local government debt-financed investment and robust intervention in the property market. We expect growth in FAI to slow to 21% in H2 2010 and 18.9% in 2011.

Growth in domestic consumption is moderating, especially housing-related consumption and auto sales. We forecast that retail sales growth will slow to 14% in H2 2010 and 13.5% in 2011. We expect 2011 consumption to increase by 9.9% in nominal terms or 6.9% in real terms.

The eurozone’s debt crisis has clouded the recovery outlook. Although the five EU countries most affected account for less than 5% of China’s total exports, adjusted for re-exports through HK, the EU is China’s biggest export market, accounting for nearly 25% of the total. The surge in EU bond spreads has already resulted in effective monetary tightening and, in the medium term, fiscal consolidation will also

restrain the EU’s economic recovery. The plunge in EUR/RMB (and the rise in the RMB’s trade-weighted index generally) will further undermine exports.

We expect export growth to slow to 6.3% y/y in H2 2010 and remain relatively subdued at 12% in 2011. Net exports should deduct 0.8pp from 2010 GDP growth and add 0.6pp in 2011.

Inflation: risks have eased, but the CPI remains under pressure The sharp domestic tightening resulted in an

effective rate hike of more than 100bp, a sharp slowing in credit growth, a 20% drop in the stock market and an estimated 10-15% drop in house prices. Moreover, global commodity prices dropped 15-20% in May due to worries about global growth and the surging US dollar. As a result, overall inflation pressure is easing.

We have revised down our 2010 CPI inflation projection to 3.5% y/y from 4.9% and lowered our PPI projection to 4.8% from 5.9%. In May, the input price PMI plunged 13.7 points to 58.9, the biggest decline on record and similar to the fall seen in September 2008. After the 10-20% plunge in global commodity prices, PPI inflation should soon peak at around 7%.

However, the CPI faces lingering pressure due to food-supply concerns as a result of bad weather, an increase in labour costs, surging rents, imported inflation and higher tariffs on public utilities. We expect CPI inflation to rise above 4% before peaking in Q3.

Policy: RMB de-pegged with return to a managed float. The authorities are cautious about tightening further Structural tightening is likely to remain in place in

H2 2010 to curb over-capacity and surging house prices, and to address local fiscal risks.

However, the growth deceleration and the European crisis require policymakers to be cautious about further tightening and policy overkill.

The slowdown in domestic demand growth, the weak and uncertain external environment and the likely peaking of inflation in Q3 remove the need to raise official interest rates in 2010.

On 21 June, China returned to a managed float for the RMB, referencing a basket of currencies, but ruled out a one-off and large revaluation on the narrowing of the balance of payments and rising labour costs. We expect a limited RMB rise to the year end under a strong USD outlook.


China: Economic & Financial Forecasts


Components of Growth (2) Total GDP 9.6 8.7 9.8 8.4 9.0 6.1 7.9 8.9 10.7 11.9 10.8 9.5 8.7 8.0 8.1 8.5 8.8Consumption 15.8 9.0 13.3 9.9 10.5 8.5 8.5 8.9 10.1 14.9 14.5 13.1 11.2 10.2 9.9 9.5 10.0Capital Formation 24.7 17.3 19.4 14.1 14.3 16.0 23.0 20.4 11.7 22.3 20.9 19.7 16.6 12.8 13.2 14.1 15.5Exports 17.2 -16.0 14.0 12.0 14.0 -19.7 -23.5 -20.2 0.2 28.7 19.8 9.0 3.8 7.5 10.7 13.4 15.7 Imports 18.5 -11.2 27.0 14.0 16.0 -30.9 -20.4 -12.2 23.0 64.6 34.2 13.2 11.1 9.0 10.4 15.9 20.3 Industrial Output (3) 12.9 11.0 15.4 11.9 12.6 5.1 9.1 12.4 18.0 19.6 16.1 14.8 13.4 10.5 10.8 12.4 12.6 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation CPI 5.9 -0.7 3.5 3.0 3.6 -0.6 -1.5 -1.3 0.7 2.2 3.0 4.5 4.3 3.9 3.3 2.6 2.2PPI 6.9 -5.4 4.8 3.2 5.0 -4.6 -7.2 -7.7 -2.1 5.2 6.3 4.3 3.4 3.1 3.2 2.9 3.6 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (USD bn) (4) 298.1 195.7 92.3 77.8 59.6 62.3 34.8 39.3 59.3 14.5 7.0 30.8 40.0 11.1 8.7 26.9 31.2Current Account (USD bn) 426.1 297.1 199.5 187.9 207.9 - - - - 40.9 15.0 66.3 77.4 26.6 20.8 64.4 76.1Current Account (% GDP) 9.3 6.0 3.5 2.9 2.8 - - - - 3.5 1.1 4.9 4.4 2.0 1.4 4.2 3.7Memo: Nominal GDP (USD bn) 4595 4911 5634 6425 7474 1005 1132 1195 1580 1180 1320 1361 1772 1331 1496 1545 2052 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (% GDP) -0.4 -2.8 -1.1 -0.8 -0.6 - - - - - - - - - - - -Foreign Reserves (USD bn) (5) 1946 2399 2580 2723 2903 1954 2132 2273 2399 2447 2461 2521 2580 2586 2593 2643 2723 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (5) Official Interest Rate (%) 5.31 5.31 5.31 5.58 6.12 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.31 5.58 5.58USD/RMB 6.83 6.83 6.80 6.60 6.41 6.84 6.83 6.83 6.83 6.83 6.75 6.70 6.80 6.75 6.70 6.64 6.60Footnotes: (1) Forecast (2) Forecasts of GDP growth and industrial output are in real terms but, in the absence of data, forecasts of consumption, investment, exports and imports are in nominal terms (3) Industrial output for enterprises with annual revenue greater than RMB 5 million (4) Trade balance is customs merchandise trade balance (5) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Risk of a Sharp Slowdown has Risen (% y/y)

Source: CEIC

Q1 GDP growth of 11.9% y/y should prove the cyclical peak as policy tightening has begun to slow domestic investment andhousing demand while the euro sovereign debt crisis is clouding the outlook for exports.

Chart 2: Industrial Production Growth has Peaked (%)

Source: CEIC

The fall in the PMI, and the narrowing of the difference between the sub-indices for new orders and stocks in particular, suggests that the risk of a sharp deceleration of growth has risen.

Chart 3: GDP Contribution Breakdown (pp)

Source: CEIC

Net exports weighed on Q1 GDP growth. Fixed investment is poised to slow due to monetary tightening, the curb on property investment and local fiscal consolidation. There are also early signs of a peak in spending on consumer durables.

Chart 4: FAI Growth Breakdown (ytd, %)

Source: CEIC

All components of FAI face constraints. Credit growth has slowed sharply and industrial overcapacity persists while local fiscal consolidation will restrain infrastructure investment. Property construction will track plunging property sales in 2010.

Chart 5: Auto Sales are Peaking (% y/y)

Source: CEIC

In May, passenger car sales were 20% below March’s peak.

Chart 6: Property Sales have Fallen Sharply

Source: CEIC

In April, property sales were 30-50% below their peak before policy tightening. Property investment, especially land auctions and new starts, will slow in 2011.

4 6 8

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Value-Added Industrial Output

Real GDP (RHS)

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Consumption

Gross Capital FormationNew

Exports

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Auto Sales

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(ytd %)Property Investment

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Chart 7: CPI, Food CPI and Non-Food CPI (% y/y)

Source: CEIC

Inflation risk is easing due to the plunge in global commodity prices and sharp domestic tightening. However, the CPI faces lingering pressure due to higher food prices and property rents, and thefeeding through of labour costs.

Chart 8: Inflation to Peak Due to Sharp Tightening (% y/y)

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CPI

M1 (7-Month Lag, RHS)

Source: CEIC

CPI inflation should peak in Q3 2010.

Chart 9: Commodities Have Peaked (% y/y)

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PPICRB (RHS)

Source: CEIC

Global commodity prices have plunged by 20% due to China’s policy tightening, while the euro crisis has eased upstream price pressures. Against this backdrop, the rise in the PPI has already peaked.

Chart 10: Tighter Liquidity Conditions (% mm, saar)

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60

80

100

2005 2006 2007 2008 2009 2010

M1

M2

Loan

Source: CEIC

Liquidity conditions have tightened in China, tracking monetary tightening and the reversal of speculative capital inflows.

Chart 11: Tight Liquidity Boosts Market Rates (%)

0.5

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Nov 07 Feb 08 May 08 Aug 08 Nov 08 Feb 09 May 09 Aug 09 Nov 09 Feb 10 May 10

7 Day Repo

3M Shibor

PBOC 1 Year Bill Yield

Source: CEIC

Money-market rates have spiked as financial conditions have remained tight.

Chart 12: Managed Float Referencing Basket

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Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 106.6

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8.2USD IndexRMB/USD Spot (RHS)

Source: CEIC

On 21 June, RMB/USD returned to a managed float referencing a basket. The future move is likely to shadow the dollar index

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CPI

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CPI Non-Food


Germany: Still Outperforming

Activity: feeling industrious Surveys and ‘hard’ activity data are consistent

with a marked acceleration in GDP growth in Q2, driven in part by strength in the export-sensitive manufacturing sector. Manufacturing orders have surged by around 15% since the turn of the year and industrial production is on track to rise at a record q/q pace in Q2.

We see construction rebounding in Q2, after being depressed by bad weather in Q1. We also look for GDP growth of around 1% q/q in Q2, implying an average rate for H1 2010 of 0.6%.

However, the economy’s momentum is likely to fade from the second half of the year, given tighter fiscal policy in Germany and elsewhere in the eurozone, and continued weakness in consumer demand. Despite a surprisingly big decline in unemployment in recent months, the retail sales and private consumption data have continued to disappoint.

Leading indicators have already started to turn down, including, in particular, the manufacturing PMI’s ratio of new orders to inventories, which is a good predictor of future trends in the sector. Business sentiment has been slipping but remains high relative to the eurozone average.

Inflation: too low Underlying inflation pressures remain subdued in

line with weak consumer demand, contained pay growth and low capacity utilisation. Core HICP inflation has fallen well below 1%.

The very low level of core inflation in Germany raises the prospect of deflation in other eurozone member states, which need to regain the internal competitiveness lost in the past decade.

Policy: leading by example Germany’s fiscal position is relatively robust. The

budget deficit-to-GDP ratio has risen in 2010 but, as with the debt-to-GDP ratio, is well below the eurozone average. While we believe that fiscal stimulus in Germany would be a sensible offset to the tightening elsewhere, helping to address the imbalances within the eurozone, the German government has announced its own austerity programme.

The commitment to a balanced federal budget and the government's desire to lead by example when it comes to fiscal austerity suggest that German policy will not be the optimal one for the eurozone overall.

Chart 1: Industrial Orders and Output

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15 Manufacturing Orders (% y/y, 3Mth Lag, RHS)

Industrial Production (% y/y)


The year-on-year growth rates of manufacturing orders and industrial output have surged to record highs, albeit flattered by base effects.

Chart 2: Labour Market


Unemployment has been falling since mid-2009, initially due to falling participation and more recently due to a pick-up in employment.

Chart 3: Core HICP Inflation (% y/y)

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Core HICP inflation has typically been lower in Germany than for the eurozone as a whole, though the differential has narrowed.


Germany: Economic & Financial Forecasts


Components of Growth (2) GDP (% q/q) - - - - - -3.5 0.4 0.7 0.2 0.2 1.0 0.6 0.4 0.2 0.2 0.4 0.4GDP 1.0 -4.9 2.0 1.4 1.6 -6.7 -5.8 -4.8 -2.2 1.5 2.1 2.0 2.2 2.2 1.3 1.1 1.1Domestic Demand ex. Stocks 1.0 -1.3 -0.2 0.9 1.2 -2.0 -0.5 -1.3 -1.2 -0.7 -0.6 0.1 0.6 1.4 0.7 0.8 0.9Private Consumption 0.2 0.0 -1.4 0.3 0.6 -0.3 1.2 -0.5 -0.3 -1.5 -2.3 -1.0 -0.8 0.1 0.2 0.3 0.4Public Consumption 2.0 3.4 1.8 0.8 0.8 3.3 3.3 4.0 2.8 2.4 1.8 1.3 1.7 0.8 0.8 0.8 0.8Fixed Investment 2.3 -8.9 1.6 3.0 3.0 -11.3 -8.5 -8.4 -7.3 -1.1 2.1 1.9 3.6 5.7 2.0 2.2 2.2Stocks (Cont to Growth, q/q) 0.5 -0.5 0.8 -0.2 0.1 -0.2 -1.9 1.7 -1.2 2.0 -0.8 -0.2 0.0 0.0 0.0 0.1 0.1Exports 2.4 -14.5 9.8 5.2 5.4 -17.2 -18.2 -15.5 -6.2 7.2 11.5 10.7 9.7 7.7 5.3 4.1 3.9Imports 3.9 -9.5 7.6 4.1 5.2 -8.3 -11.5 -10.3 -8.0 4.0 10.4 6.7 9.5 4.1 3.9 4.0 4.2Industrial Production 0.0 -15.8 7.6 1.7 2.4 -7.5 -20.0 -19.1 -15.5 -8.4 5.4 10.1 7.9 7.2 5.8 1.1 -0.1Savings Ratio (%) 11.3 11.3 11.6 11.5 11.3 11.3 11.2 11.4 11.4 11.6 11.7 11.6 11.5 11.5 11.5 11.4 11.4 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour HICP 2.8 0.2 1.3 1.5 0.7 0.8 0.3 -0.4 0.3 0.8 1.0 1.4 1.9 1.9 1.6 1.4 1.3Core HICP 1.3 1.3 0.4 -0.3 0.2 1.3 1.6 1.3 1.2 0.8 0.4 0.3 0.1 0.0 -0.3 -0.4 -0.3PPI 5.5 -4.2 2.0 3.1 2.2 0.8 -3.6 -7.4 -6.2 -2.6 1.2 4.2 5.5 4.9 3.5 2.4 1.7Employment 1.3 -0.1 0.1 -0.1 0.3 0.3 -0.1 -0.3 -0.3 -0.2 0.1 0.2 0.2 0.1 -0.1 -0.2 -0.2Unemployment Rate (%) 7.8 8.2 7.7 7.7 7.5 7.9 8.3 8.3 8.2 8.1 7.7 7.5 7.5 7.6 7.7 7.7 7.7 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (EUR bn, sa) 176.6 135.2 151.7 166.3 179.8 24.6 31.3 33.0 46.3 33.9 38.0 39.5 40.3 40.7 41.0 41.6 43.0Current Account (EUR bn, nsa) 167.0 119.2 135.7 150.3 163.8 22.6 23.4 25.8 47.5 26.7 27.5 29.9 51.6 30.3 31.2 33.6 55.2Current Account (% GDP) 6.7 4.9 5.5 5.9 6.3 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Fed. Gov. Budget (EUR bn) -15 -41 -65 -64 -52 - - - - - - - - - - - -Gen. Gov. Budget (EUR bn) 0 -80 -124 -115 -92 - - - - - - - - - - - -Gen. Gov. Budget (% GDP) 0.0 -3.3 -5.0 -4.5 -3.5 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (3) 66.0 73.2 78.1 81.8 83.9 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest Rates (3) 3-Month Rate (%) 2.89 0.70 0.70 1.00 1.50 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.0010-Year Rate (%) 2.95 3.40 2.00 3.00 3.75 3.00 3.38 3.23 3.40 3.10 2.65 2.20 2.00 2.10 2.25 2.60 3.00Footnotes: (1) Forecast (2) Calendar and seasonally adjusted (3) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Dominique Barbet July 2010Global Outlook 28 www.GlobalMarkets.bnpparibas.com

Chart 1: GDP and Employment (% y/y)

Sources: INSEE, Reuters EcoWin Pro

In the two years to Q1 2010, employment declined 3.4% compared with a 2.8% fall in GDP, which suggests that companies are not overstaffed.

Chart 2: Household Confidence and Retail Sales

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Manufactured Goods Sales (excl. autos, % y/y, real)

Sources: INSEE, Reuters EcoWin Pro

The recent decline in confidence has had little impact on retail sales so far. However, the low level of confidence could restrain consumption ahead.

Chart 3: Stability Plan (% of GDP)

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GDP Growth

Structural Deficit

Cyclical Deficit

Sources: MoF, BNP Paribas

The growth assumption in the stability plan (2.5% per annum for 2011-2013) is too optimistic, but the projected decline in the cyclical deficit looks overly cautious.

France: Sorting Out Problems One by One

Activity: private consumption will remain key In Q1 GDP enjoyed its fourth consecutive

quarter of expansion in quarter-on-quarter terms. However, GDP was still 2.8% below the level of Q1 2008 as the rise in private consumption of 1.5% over the period was not enough to compensate for the contraction of exports, investment and inventories.

Exports and inventories have started to recover, but investment is lagging. The low capacity utilisation rate, huge uncertainties over future demand and the need to consolidate balance sheets do not favour a rapid recovery.

Moreover, government expenditure will have to be restrained in the future. Continued growth thus heavily relies on further gains in consumption. Since the start of the year, household confidence has been pushed down by rising retail prices. This is a threat for spending, but as the fall in employment is nearly over, consumption should hold up.

Inflation: energy is the only real concern The harmonised inflation rate rose from 0.1% y/y

on average last year to 1.9% in May. This is entirely due to energy prices: core inflation actually declined from 1.4% to 0.8% y/y over the same period. We expect the downward trend in core inflation to continue, driven by extremely low wage increases with the average increase forecast at 2.0% this year versus 3.0% in 2008.

However, a decline of headline inflation will be prevented by the weakening of the euro and a forecast rise in oil prices.

Consumers’ purchasing power will dominate the political debate and will dictate the capacity of the recovery to pick up its pace.

Policy: pensions first, deficit next The main priority for the government currently is

to proceed with the pension reform, without causing social unrest. The changes include unpopular structural reforms to restrain future deficits and an increase in social contributions, to reduce the present financing gap.

While the 2010 deficit could be slightly below the downward revised 8.0%-of-GDP target, the 2011 target of 6.0% of GDP is clearly more demanding requiring tough decisions.

However, slippage on the deficit is no longer an option. The government will have to manage both public sentiment and the market’s.

Dominique Barbet July 2010Global Outlook 29 www.GlobalMarkets.bnpparibas.com

France: Economic & Financial Forecasts


Components of Growth (2) GDP (% q/q) - - - - - -1.4 0.2 0.3 0.6 0.1 0.5 0.4 0.2 0.1 0.3 0.2 0.2GDP 0.1 -2.5 1.4 1.0 1.2 -3.9 -3.2 -2.6 -0.4 1.2 1.5 1.6 1.3 1.2 1.0 0.8 0.8Domestic Demand ex Stocks 0.7 -0.5 0.6 0.6 1.2 -1.0 -0.6 -0.5 0.3 0.6 0.6 0.7 0.3 0.4 0.5 0.6 0.7Private Consumption 0.5 0.7 1.3 0.8 1.1 0.0 0.4 0.6 1.6 1.6 1.4 1.5 0.7 0.7 0.8 0.8 0.8Public Consumption 1.4 3.1 1.6 0.8 0.2 2.7 3.2 3.3 3.1 2.4 1.8 1.3 0.8 1.0 0.9 0.7 0.6Fixed Investment 0.4 -7.0 -3.0 -0.4 2.4 -7.4 -7.1 -7.5 -6.1 -4.6 -3.4 -2.3 -1.7 -1.1 -0.9 -0.3 0.6Stocks (Cont to Growth, q/q) -0.3 -1.8 0.7 0.7 0.3 -0.9 -0.6 -0.2 0.6 -0.2 0.6 0.3 0.2 0.1 0.1 0.1 0.1Exports -0.7 -12.0 7.9 4.6 4.1 -16.2 -14.2 -12.2 -5.4 6.7 8.2 7.8 8.8 5.7 5.0 4.2 3.4Imports 0.4 -10.5 6.7 5.5 4.8 -10.9 -12.7 -12.3 -6.3 1.9 7.6 9.2 8.1 7.1 5.6 4.9 4.4GDP Unadjusted (3) 0.2 -2.6 1.4 1.0 1.3 -4.3 -3.3 -2.6 -0.4 1.2 1.5 1.6 1.3 1.2 1.0 0.8 0.8Industrial Production -2.5 -12.0 5.0 2.8 3.0 -15.8 -15.5 -11.5 -4.6 4.4 6.7 4.4 4.6 3.3 3.0 2.5 2.4Savings Ratio (%) 15.4 16.2 15.9 15.9 16.2 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour HICP 3.2 0.1 1.9 1.5 1.1 0.7 -0.2 -0.5 0.4 1.5 1.8 2.1 2.0 1.8 1.5 1.4 1.4Core HICP 1.8 1.4 0.9 0.8 1.0 1.6 1.5 1.5 1.1 1.0 0.8 0.9 0.9 0.7 0.8 0.9 0.9Monthly Wages 3.0 2.2 1.9 2.2 2.4 2.8 2.2 2.0 1.9 1.8 1.9 1.9 2.0 2.2 2.2 2.2 2.3Private NF Payrolls 0.1 -2.5 -0.1 0.2 0.2 -2.4 -2.7 -2.8 -2.1 -1.0 -0.3 0.4 0.5 0.4 0.2 0.1 0.0Unemployment Rate (%) 7.8 9.5 10.2 10.5 10.6 8.9 9.4 9.7 9.9 10.0 10.2 10.3 10.3 10.4 10.5 10.6 10.7 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (EUR bn, sa) -57 -43 -50 -62 -64 -12 -11 -7 -13 -11 -12 -13 -14 -15 -15 -16 -16Current Account (EUR bn, sa) -44 -42 -48 -56 -54 -13 -10 -7 -12 -12 -11 -12 -13 -14 -13 -14 -14Current Account (% GDP) -2.3 -2.2 -2.5 -2.8 -2.7 -2.8 -2.2 -1.5 -2.5 -2.4 -2.3 -2.5 -2.7 -2.9 -2.6 -2.8 -2.8 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Cen. Gov. Budget (EUR bn) -56 -118 -116 -89 -75 - - - - - - - - - - - -Cen. Gov. Budget (% GDP) -2.9 -6.2 -6.0 -4.5 -3.7 - - - - - - - - - - - -Gen. Public Budget (EUR bn) -66 -144 -151 -119 -102 - - - - - - - - - - - -Gen. Public Budget (% GDP) -3.4 -7.5 -7.8 -6.0 -5.0 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (4) 67.5 78.1 84.1 88.7 92.0 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest Rates (4) 3-Month (%) 2.89 0.70 0.70 1.00 2.00 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.0010-Year Rate (%) 3.41 3.60 2.60 3.50 4.10 3.62 3.73 3.55 3.60 3.42 3.09 2.70 2.60 2.65 2.75 3.10 3.50Spread Over Bund (bp) 46 21 60 50 35 62 35 32 21 33 44 50 60 55 50 50 50Footnotes: (1) Forecast (2) Calendar and seasonally adjusted (3) Unadjusted for calendar effects (BNP Paribas estimate) (4) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Luigi Speranza July 2010Global Outlook 30 www.GlobalMarkets.bnpparibas.com

Chart 1: Household Borrowing vs. Confidence


Growth in lending to households for both consumer credit and house purchases has accelerated recently. Consumer confidence, however, has fallen four times in the past five months and remains below its historical average.

Chart 2: HICP Core (% y/y)


The differential of core inflation with the eurozone has widened again recently. But we expect Italian core inflation to resume its downward trend over the next few months.

Chart 3: State Sector Borrowing Requirement (cumulative, EUR bn)

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In the period January-May, the cash deficit amounted to EUR 50bn, below the levels reached in the same period of 2009 and consistent with the deficit target of 5% of GDP.

Italy: Headwinds Still Blowing

Activity: slower growth from H2 2010 As the restocking cycle runs its course, we

expect growth to slow in H2 2010, reflecting among other factors: i) the negative impact on investment of low profitability and capacity utilisation rates; ii) the effect on consumption of higher unemployment; iii) the implications of the corrective fiscal measures; and last but not least iv) possible financing constraints due, among other things, to the need for banks to rebuild capital due to forthcoming new regulation.

Risks to this scenario are broadly balanced. The traditional strength of consumers’ balance sheets might lead to higher leverage, boosting consumption. The recovery in growth of loans for consumer credit is a positive omen but falling consumer confidence points in the opposite direction. Conversely, spillover from the eurozone debt crisis could lead to additional tightening of financial conditions, further limiting investment and consumption demand.

Inflation: resilient core inflation Core inflation has been more resilient than in

other eurozone countries, probably reflecting structural weaknesses and the slow reaction of wages to the deterioration in the labour market. With the unemployment rate likely to rise further and domestic demand remaining subdued, we continue to expect core inflation to slow further from current levels over the next few quarters.

Policy: a step forward but concerns persist Structural features of the Italian economy, such

as households’ strong balance sheets, the resilience of its banking sector and a relatively stable housing market have partially shielded Italian government bonds from the eurozone crisis so far. But Italy’s high debt-to-GDP ratio combined with poor long-term growth prospects could trigger a reversal in market sentiment. With the annual gross financing requirement amounting to around 25% of GDP, an increase in the risk premium would become self-fulfilling.

The announcement of detailed fiscal plans before the customary deadline was a positive development. However, the bulk of the corrective measures will be implemented only in 2011. Moreover, the risks to the growth forecasts underlying the fiscal targets are skewed to the downside. In the absence of a contingent fiscal plan and/or structural reforms aimed at boosting productivity and long-term growth, markets are likely to remain concerned about the long-term sustainability of Italy’s fiscal trends.


Italy: Economic & Financial Forecasts


Components of Growth) GDP (% q/q) - - - - - -2.9 -0.3 0.4 -0.1 0.4 0.4 0.1 0.0 -0.1 -0.1 0.1 0.2GDP -1.3 -5.1 0.9 0.2 0.7 -6.5 -6.1 -4.7 -2.8 0.5 1.1 0.9 1.0 0.5 0.0 0.0 0.2Domestic Demand ex. Stocks -1.1 -3.5 0.4 0.2 0.8 -4.6 -4.1 -3.5 -1.5 0.1 0.5 0.4 0.5 0.5 0.1 0.0 0.0Private Consumption -0.8 -1.8 0.5 0.4 0.7 -3.2 -2.0 -1.6 -0.2 0.7 0.7 0.2 0.4 0.4 0.3 0.3 0.4Public Consumption 0.8 0.6 -0.4 0.5 0.4 0.7 0.8 0.6 0.2 -0.3 -1.0 -0.4 0.0 0.6 0.6 0.5 0.4Fixed Investment -4.0 -12.2 1.0 -0.9 1.5 -13.7 -14.8 -13.1 -6.8 -1.2 1.7 2.0 1.6 0.5 -1.0 -1.5 -1.5Stocks (Cont. to Growth, y/y) -0.3 -0.4 0.5 -0.3 0.0 -0.5 -0.4 -0.2 -0.4 0.3 0.9 0.8 -0.2 -0.4 -0.5 -0.3 -0.2Exports -3.9 -19.1 5.9 2.7 5.8 -22.3 -23.0 -18.5 -11.8 5.0 7.5 4.9 6.0 1.5 2.3 3.1 3.9Imports -4.3 -14.6 5.5 1.2 5.7 -17.3 -17.6 -15.3 -7.7 4.5 8.1 6.3 3.3 0.0 0.6 1.7 2.4Industrial Production -3.9 -18.2 7.4 1.1 5.2 -22.0 -23.2 -17.4 -9.2 3.1 8.7 9.1 8.6 5.8 1.6 -1.6 -0.9Savings Ratio (%) 8.6 10.7 10.5 10.2 9.5 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour HICP 3.5 0.8 1.5 1.5 0.9 1.4 0.9 0.1 0.7 1.3 1.5 1.5 1.7 1.8 1.5 1.6 1.3Core HICP 2.2 1.6 1.2 0.2 0.4 1.6 1.8 1.4 1.6 1.5 1.6 1.1 0.7 0.5 0.0 0.2 0.0Monthly Wages 3.5 3.0 2.2 1.2 1.6 3.8 3.1 2.5 3.1 2.2 2.4 2.0 1.7 1.5 1.3 1.2 1.0Employment 0.8 -1.6 -0.5 -0.6 0.8 -0.9 -1.6 -2.0 -1.7 -1.1 -0.4 -0.1 -0.3 -0.6 -0.8 -0.7 -0.3Unemployment Rate (%) 6.8 7.8 8.7 9.5 9.5 7.3 7.6 8.0 8.3 8.4 8.6 8.9 9.1 9.2 9.5 9.7 9.7 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (EUR bn) -9.4 -8.7 -4.7 -1.9 -3.9 -6.4 0.5 2.6 -5.4 -5.4 1.5 3.6 -4.4 -4.7 2.2 4.3 -3.7Current Account (EUR bn) -54.5 -48.0 -41.1 -33.9 -39.9 -18.7 -12.6 -6.4 -10.3 -15.7 -11.3 -5.1 -9.0 -13.9 -9.5 -3.3 -7.2Current Account (% of GDP) -3.5 -3.2 -2.7 -2.2 -2.6 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (EUR bn) -42.6 -80.8 -77.9 -70.0 -56.0 - - - - - - - - - - - -Gen. Gov. Budget (% GDP) -2.7 -5.3 -5.0 -4.4 -3.9 - - - - - - - - - - - -Primary Budget (EUR bn) 38.6 -9.5 -1.6 13.9 25.8 - - - - - - - - - - - -Primary Budget (% GDP) 2.5 -0.6 -0.1 0.9 1.6 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 106.1 115.8 118.5 123.0 124.8 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.00 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.0010-Year Rate (%) 4.38 4.14 4.50 4.40 4.65 4.39 4.44 4.03 4.14 3.87 4.06 4.20 4.50 4.35 4.25 4.35 4.40Spread over Bund (bp) 143 74 250 140 90 139 106 80 74 77 142 200 250 225 200 175 140Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Doubtful Loans (% of total debts)

Source: Spanish Finance Ministry

Doubtful loans’ share of all loans has increased rapidly. With unemployment likely to rise further, we expect this trend to continue.

Chart 2: Money Growth (% y/y)


M3 is falling to the tune of 5% y/y. Savings banks, which are currently restructuring, are likely to keep rationing credit, with significant potential to damage small businesses.

Chart 3: HICP (% y/y)


We expect core inflation, at -0.1% y/y in April, to temporarily return to positive territory as a result of the VAT hike, which is effective from July. But the underlying trend remains downwards and we expect negative prints to resume by year-end.

Spain: Trouble Ahead

Activity: the economy is likely to return to recession in H2 2010 With the additional fiscal measures recently

approved, including a 5% cut in public wages, the overall fiscal adjustment targeted by the government over the next two years now amounts to 5% of GDP. We assume some slippage of the announced measures at the regional level but the correction will still be significant. With credit supply still constrained and limited flexibility in the nominal exchange rate, the fiscal multiplier is estimated to be around one, implying a significant drag on GDP as the measures are implemented.

After a short-lived rebound in H1 2010, GDP is therefore likely to contract again from H2. Some of the volatility in the profile for consumption reflects the assumption that some purchases were brought forward ahead of the implementation of the VAT hike in July.

Risks of an adverse feedback loop between public finances and the financial sector have increased. As a result of the debt crisis, borrowing costs for the private sector have increased. The potentially troubled exposure of the banking sector to the construction sector alone amounts to EUR 165.5bn (15% of GDP). Part of these potential losses has already been provisioned for but the amount is set to rise as the recession persists. Together with the restructuring taking place in the savings banks sector, this will increase pressure to ration the supply of credit, with fallout on activity.

Inflation: a protracted decline in core prices remains our central scenario The VAT hike effective from July will temporarily

boost core prices but the underlying trend in inflation remains downwards. With the unemployment rate above 20%, the wage cuts in the public sector will probably spill over into the private sector and will contribute to keep labour costs subdued. With consumer demand likely to fall further, negative prints in core inflation are likely to resume by year-end.

Policy: political uncertainty is mounting The announcement of additional fiscal measures

led to a collapse in the PM’s approval ratings. The 2011 budget is to be approved by year-end and, on paper, the government has not got the numbers needed to pass it. With labour reform currently under discussion, the call for early elections could intensify.


Spain: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - -1.7 -1.0 -0.3 -0.1 0.1 0.1 0.0 -0.3 -0.4 -0.1 0.1 0.1GDP 0.9 -3.6 -0.4 -0.6 1.2 -3.3 -4.2 -4.0 -3.1 -1.3 -0.3 0.0 -0.1 -0.7 -0.8 -0.7 -0.4Domestic Demand ex Stocks -0.7 -6.5 -2.4 -3.8 0.6 -6.4 -7.5 -6.7 -5.4 -2.8 -1.4 -2.2 -3.2 -4.1 -4.6 -4.0 -2.5Private Consumption -0.6 -4.8 0.1 -2.7 0.1 -5.3 -5.8 -4.8 -3.4 -0.5 1.1 0.5 -0.6 -1.8 -3.2 -3.4 -2.4Public Consumption 5.5 3.8 -0.5 -4.8 -1.0 6.0 4.7 4.1 0.8 1.5 0.6 -2.1 -1.9 -4.7 -5.7 -4.9 -3.9Fixed Investment -4.4 -15.3 -9.0 -6.5 3.3 -14.9 -17.0 -16.0 -12.9 -9.9 -8.1 -8.1 -9.7 -9.2 -7.9 -5.7 -2.9 - Construction -5.5 -11.1 -11.6 -8.3 3.8 -11.3 -11.6 -11.4 -10.2 -10.6 -11.1 -11.8 -12.9 -12.4 -10.2 -7.1 -3.3 - Other -2.7 -20.7 -5.0 -3.8 2.6 -19.7 -24.1 -22.3 -16.7 -8.9 -3.5 -2.5 -4.9 -4.6 -4.5 -3.8 -2.4Stocks (Cont. to Growth, y/y) 0.1 0.1 0.2 0.0 0.0 0.1 0.0 0.1 0.2 0.3 0.4 0.2 0.0 0.0 0.0 0.1 0.1Exports -1.0 -11.5 8.0 5.3 6.1 -16.6 -14.7 -10.8 -2.9 8.0 9.2 8.4 6.3 5.3 5.0 5.1 5.6Imports -4.9 -17.9 0.5 -7.3 3.9 -22.3 -21.7 -17.0 -9.6 2.6 4.8 -0.1 -5.0 -8.0 -9.6 -7.8 -3.5Industrial Production -7.5 -15.5 -0.4 -3.3 2.9 -21.6 -18.5 -14.7 -5.8 0.3 1.7 -0.5 -2.9 -4.4 -4.9 -3.0 -0.8 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour HICP 4.1 -0.2 1.6 1.2 0.2 0.5 -0.7 -1.0 0.2 1.2 1.6 1.7 2.0 1.8 1.4 0.8 0.6Core HICP 2.4 0.9 0.2 -0.9 -0.7 1.6 1.2 0.5 0.3 0.2 0.1 0.5 0.2 -0.2 -0.7 -1.2 -1.3Compensation of Employees 5.3 -3.1 -0.7 -2.3 0.6 -2.5 -3.2 -3.9 -2.7 -1.2 -1.0 -0.3 -0.3 -1.3 -2.4 -3.0 -2.7Employment -0.6 -6.7 -2.3 -2.9 0.0 -6.4 -7.1 -7.1 -6.0 -3.6 -2.6 -1.6 -1.3 -2.3 -3.0 -3.5 -3.0Unemployment Rate (%) 11.3 18.0 20.4 23.0 23.5 17.4 17.9 17.9 18.8 20.1 20.2 20.4 21.1 21.9 22.7 23.5 23.8 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (EUR bn) -94.1 -50.2 -44.1 -17.3 -6.4 -14.0 -10.1 -13.2 -12.8 -12.4 -10.7 -11.6 -9.4 -5.4 -3.2 -4.8 -3.9Current Account (EUR bn) -106.0 -57.2 -51.5 -25.0 -12.8 -22.1 -12.0 -10.1 -13.0 -17.4 -12.4 -10.8 -10.9 -11.1 -5.2 -3.1 -5.6Current Account (% of GDP) -9.7 -5.5 -4.9 -2.4 -1.2 -8.5 -4.5 -4.0 -4.8 -6.8 -4.6 -4.3 -3.9 -4.3 -2.0 -1.2 -2.0 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (EUR bn) -44.2 -117.6 -101.6 -72.2 -57.1 - - - - - - - - - - - -Gen. Gov. Budget (% GDP) -4.1 -11.2 -9.7 -7.0 -5.5 - - - - - - - - - - - -Primary Budget (EUR bn) -27.0 -98.8 -78.6 -45.4 -27.0 - - - - - - - - - - - -Primary Budget (% GDP) -2.5 -9.4 -7.5 -4.4 -2.6 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 39.7 53.2 64.8 72.8 77.9 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.00 1.51 1.10 0.75 0.70 0.63 0.74 0.85 0.70 0.65 0.70 0.80 1.0010-Year Rate (%) 3.82 3.99 5.50 4.90 5.15 4.06 4.14 3.81 3.99 3.82 4.59 4.80 5.50 5.20 4.95 4.90 4.90Spread over Bund (bp) 87 59 350 190 140 106 75 59 59 72 194 260 350 310 270 230 190Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Raymond van der Putten July 2010Global Outlook 34 www.GlobalMarkets.bnpparibas.com

Netherlands: Broad Support for Austerity

Activity: sub-par growth from tightening of purse strings Growth has returned thanks to expansionary

monetary and fiscal policies combined with the strong rebound of world trade. In the coming quarters, the impact of the former is likely to diminish.

Despite very low interest rates, the private sector’s financial surplus could be well above 10% of GDP in the coming years.

Households, worried about the outlook for employment and the housing market, and the effect of fiscal austerity on their disposable income, are holding back on spending.

Even though profits are improving, business investment is expected to remain sluggish, given substantial excess capacity.

The introduction of a short-time working scheme limited the number of layoffs during the recession. Unemployment is expected to remain high due to the expiration of these schemes and a relatively jobless recovery.

Inflation: limited impact of euro’s depreciation Since November, the euro has depreciated by

around 10%. The cumulative effect on prices could be around 1.5% after two years. However, ample spare capacity will limit the pass-through of higher import prices to domestic prices.

Moderate wage deals and cost-cutting measures will also restrain increases in consumer prices. In the latest collective agreements, pay rises were limited to only 1%.

Spending on healthcare is expected to increase substantially in the coming years, partly driven by higher co-payments in healthcare.

Policy: new government will present a substantial austerity package As the largest party after the general election,

the VVD (conservative liberals) is trying to form a new coalition government. The most likely outcome is a coalition with the Labour Party (PvdA) and some smaller parties.

All political parties agree on the necessity of budget consolidation. The next government is expected to present a substantial savings plan, probably close to EUR 15bn or 2.5% of GDP for the full four-year term (2011-2014).

Trade unions and employers’ organisations are close to an agreement on raising the statutory retirement age from the current 65 years to 66 by 2020 and to 67 by 2025.

Netherlands: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 2.0 -4.0 1.0 0.8 1.2Dom. Demand ex. Stocks 2.3 -3.4 -1.1 0.4 0.8Private Consumption 1.3 -2.5 0.2 0.2 0.5Public Consumption 2.0 3.2 1.0 0.2 0.0Fixed Investment 4.9 -13.0 -7.0 1.0 2.5Stocks (Cont. to Growth) 0.4 -0.5 0.3 0.0 0.0Exports 2.7 -8.2 6.0 3.0 5.0Imports 3.7 -8.7 4.3 2.8 5.0Industrial Production -0.7 -8.8 5.8 1.7 3.6Savings Ratio (%) 7.0 10.1 10.0 9.6 9.3 Inflation & Labour CPI 2.5 1.2 1.5 2.1 1.6HICP 2.2 1.0 1.3 2.1 1.4Core HICP 1.1 1.1 1.1 0.8 1.1Contract Wages 3.5 2.8 1.3 1.5 1.5Employment 1.9 -0.3 -0.8 -0.2 0.2Unemployment Rate (%) 3.9 4.9 5.8 6.1 6.1 External Trade Trade Balance (EUR bn) 38.8 34.2 39.1 38.8 39.4Current Account (EUR bn) 28.5 30.7 34.1 34.3 34.9Current Account (% GDP) 4.8 5.4 5.9 5.8 5.8 Financial Variables Gen. Gov. Budget (EUR bn) 4.2 -28.0 -37.9 -30.7 -26.4Gen. Gov. Budget (% GDP) 0.7 -4.9 -6.5 -5.2 -4.4Gross Gov. Debt (% GDP) (2) 58.2 61.8 66.5 68.5 71.8 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 3.55 3.56 2.50 3.30 3.95Spread over Bund (bp) 61 16 50 30 20Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Financial Balances (% of GDP)*

-8

-6

-4

-2

0

2

4

6

8

10

12

2006 2007 2008 2009

Government

Total Economy (Current Account)

Non-Financial Corporations

Financial Institutions

Households

Source: Statistics Netherlands *Balances are summed over four quarters

Since 2009, the government balance has deteriorated as a result of discretionary policy measures and automatic stabilisers. This has partly offset the increase in savings in the private sector. As a result, the surplus on the current account has improved.

Steven Vanneste July 2010Global Outlook 35 www.GlobalMarkets.bnpparibas.com

IMPORTANT DISCLOSURE: This analysis has been produced by Fortis Bank sa/nv and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is an indirect shareholder of Fortis Bank with a 74.96% stake. This analysis does not contain investment research recommendations.

Belgium: Decisive Times

Activity: questions about sustainability The economy expanded by only 0.1% q/q in Q1

2010, below the eurozone average. As expected, the severe winter played a significant role, leading to a sharp contraction in construction activity (-3.6% q/q). Furthermore, the strength of consumer demand and the rebuilding of inventories led to a sizeable leakage of demand towards foreign goods. Q2 should therefore witness a strong rebound in GDP.

Although buoyant car sales suggest the revival in consumption continued in Q2, questions arise as to how long this can last. Confidence remains fragile and the employment intentions of businesses are still too weak to ensure a self-sustaining recovery. In addition, the willingness of businesses to invest remains constrained by excess capacity.

On the bright side, the openness of the Belgian economy should ensure that exports benefit from a lower euro both directly and via the support it will give to Belgium’s close trading partners in the eurozone, particularly Germany.

Inflation: higher than the eurozone average The rise in inflation has exceeded expectations

in the past three months. Sharp increases in the price of energy and food are the main reason.

Core inflation is currently at 1.3% y/y. In the short run, there is still considerable downward momentum as wage growth is exceptionally low. However, inflation is likely to breach Belgium’s ‘pivot index’, triggering a wage hike at the beginning of next year. This would keep core inflation above the eurozone average.

Policy: towards a reform of the state The early elections resulted in two great winners:

the Flemish nationalist party, N-VA, in the northern part of the country and the socialist party, PS, in the southern part of the country. Although the parties have differing views on economic policy and state reform, the fact that the status quo was broken enhances the chances of a compromise being reached.

Apart from state reform, major policy decisions have to be made. In order to reach a balanced budget in 2015, a savings plan of around 5% of GDP has to be implemented. The main areas of reform will be pensions, healthcare, the labour market and government efficiency.

Belgium: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 0.8 -3.0 1.3 1.2 1.6Dom. Demand ex Stocks 2.1 -1.5 0.5 0.9 1.6Private Consumption 1.0 -1.6 1.2 0.8 1.2Public Consumption 3.3 1.6 1.2 1.0 1.2Fixed Investment 3.8 -4.5 -1.7 1.1 3.1Stocks (Cont. to Growth) -0.2 -1.0 0.4 0.0 0.0Exports 1.4 -10.8 7.4 4.2 4.4Imports 2.7 -11.0 7.0 3.9 4.5Industrial Production -0.5 -12.0 1.9 1.9 3.2Savings Ratio (%) 11.5 15.0 14.5 14.6 14.6 Inflation & Labour HICP 4.5 0.0 2.3 1.8 0.5Core HICP 1.8 2.1 1.0 0.7 0.7Wages 3.5 2.8 0.5 1.5 1.0Employment 1.5 -0.9 -0.7 0.0 1.0Unemployment Rate (%) 7.0 7.9 8.4 8.8 8.4 External Trade Trade Balance (EUR bn) 4 13 9 9 10Current Account (EUR bn) -9 2 3 3 3Current Account (% GDP) -2.9 0.5 0.9 1.1 1.0 Financial Variables Gen. Gov. Budget (EUR bn) -4 -20 -17 -16 -15Gen. Gov. Budget (% GDP) -1.2 -5.9 -4.8 -4.3 -4.1Gross Gov. Debt (% GDP) (2) 89.8 96.7 99.0 101.4 103.4 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 3.77 3.72 3.80 3.80 4.35Spread over Bund (bp) 82 32 180 80 60Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Wages and Core HICP (%, y/y)

0

1

2

3

4

5

6

97 98 99 00 01 02 03 04 05 06 07 08 09 100.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Belgian Core Inflation (RHS)

Manufacturing Sector Wages

Sources: Eurostat, OECD, Datastream

The slowdown in wage growth implies further downward momentum for core inflation for the time being. However, a renewed indexation of wages next year would keep core inflation above the eurozone average.

Catherine Stephan July 2010Global Outlook 36 www.GlobalMarkets.bnpparibas.com

Austria: Modest Growth

Activity: GDP growth should accelerate GDP decreased by 0.1% q/q in Q1 2010, after

having increased by 0.7% and 0.3% q/q in Q3 and Q4 2009 respectively. However, activity was restrained by bad weather in the winter.

The Austrian economy should benefit from the rebound in foreign demand, particularly from Germany, its main trading partner, in the coming quarters. Demand from abroad should be boosted by the euro’s decline against the US dollar since November. This depreciation is likely to offset partially the impact of the fiscal consolidation measures announced by the eurozone countries. Exports, which rose by 0.3% q/q in Q1 2010, should therefore rise further.

Thus investment should edge up gradually over the year in line with the increase in capacity utilisation, which has already risen by around 7pp since Q2 2009 (to 79.5% in Q1 2010).

Rising inflation and the deterioration of the labour market will restrain consumption in the coming quarters. Nevertheless, private consumption (which rose 0.3% q/q in Q1 2010) should again underpin GDP growth in 2010 because parts of the 2009 tax reform should come into force this year.

Overall, GDP is forecast to increase by around 1.3% in 2010, thanks mainly to the positive impact of net exports.

Inflation: core inflation will be flat Largely due to base effects linked to energy,

headline inflation has risen since the autumn. Inflation rose to 1.9% y/y in May after having reached a record low in July 2009.

Headline inflation should increase further in the coming months, reflecting base effects in energy prices. At the same time, core inflation will be flat on the back of the large amount of spare capacity in the economy.

Policy: uncertainty about fiscal policy The budget deficit should widen further in 2010

(to 4.9% of GDP from 3.2% in 2009) because of the effects of automatic stabilisers and the stimulus packages adopted in 2009 (an increase in family benefits and an income tax cut in 2009 and 2010).

Austria also plans to start gradually reducing its deficit from 2011, lowering it to below 3% of GDP in 2013. However, the Austrian government has yet to decide the measures to be adopted to reduce the deficit.

Austria: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 1.8 -3.4 1.3 1.2 1.9Dom. Demand ex Stocks 1.0 -1.1 0.5 0.9 1.2Private Consumption 0.5 0.8 1.2 0.6 0.7Public Consumption 3.0 0.9 1.8 0.5 0.6Fixed Investment 0.4 -7.5 -2.5 2.1 2.9Stocks (Cont. to Growth) -0.1 -0.4 0.0 0.1 0.1Exports 0.2 -15.0 4.6 4.1 4.0Imports -1.5 -13.0 3.2 4.1 3.1Industrial Production 1.5 -10.0 1.2 1.7 3.3Savings Ratio (%) 12.0 11.8 10.8 11.0 12.0 Inflation & Labour HICP 3.2 0.4 1.3 1.4 0.9Core HICP 1.8 1.7 1.0 0.5 0.8Employment 1.4 -1.4 -0.1 0.3 0.7Unemployment Rate (%) 3.9 4.8 5.0 5.3 5.1 External Trade Trade Balance (EUR bn) -0.6 -2.3 -2.3 -2.4 -2.5Current Account (EUR bn) 9.0 5.5 5.4 6.4 8.4Current Account (% GDP) 3.2 2.0 1.9 2.2 2.8 Financial Variables Gen. Gov. Budget (EUR bn) -1.1 -9.4 -13.9 -13.1 -11.4Gen. Gov. Budget (% GDP) -0.4 -3.2 -4.9 -4.5 -3.8Gross Gov. Debt (% GDP) (2) 62.6 66.1 69.4 72.2 77.1 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 3.85 3.89 3.40 3.50 4.15Spread over Bund (bp) 91 49 140 50 40Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Austrian GDP Growth and Exports (% q/q)

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Q1 92 Q1 94 Q1 96 Q1 98 Q1 00 Q1 02 Q1 04 Q1 06 Q1 08 Q1 10-8

-7

-5

-4

-2

-1

1

3

4

6GDP (%, q/q)

Exports (%, q/q) RHS

Source: Eurostat

Exports decreased at the beginning of the year. However, they should underpin GDP growth in the coming months thanks to a rebound in foreign demand and the depreciation of the euro against the US dollar.

Philippe Sabuco July 2010Global Outlook 37 www.GlobalMarkets.bnpparibas.com

Portugal: Recession Revisited

Activity: double-dip scenario GDP surprised to the upside in Q1, rising by

1.1% q/q. Private consumption and exports were the main growth drivers. Given the latest data and fiscal consolidation, we have revised our forecasts significantly since the last Global Outlook. We expect the economy to contract again in 2011.

Private consumption is expected to decrease in 2011 due to tight fiscal policy and unfavourable market conditions. High household debt and tight credit will weigh on consumer spending in 2011 and beyond.

Investment is likely to struggle in 2010 and 2011, due to ample spare capacity, challenging credit conditions and the poor outlook for demand. More generally, companies and households are expected to consolidate their finances, which will have a lasting impact on domestic demand.

In the short term, the outlook for exports is likely to be determined by the recovery of external demand. However, poor competitiveness will undermine the rebound in exports in the medium term. Fiscal tightening will limit imports.

Inflation: core inflation to decline Consumer prices are projected to increase in the

coming years, due to higher oil and commodity prices. The euro’s recent depreciation should also cause prices of imported goods to rise. However, Portuguese inflation should remain below the eurozone average.

VAT is set to increase, putting temporary upward pressure on core inflation. However, weak domestic demand, higher unemployment and low capacity utilisation will continue to weigh on wages and selling prices. Core prices are likely to decline in the coming years.

Policy: additional consolidation measures Growing concerns about sovereign risk led the

government to announce additional fiscal consolidation measures in April, such as the withdrawal of stimulus measures, further spending cuts and new tax increases. Personal and corporate direct taxes are expected to rise and VAT will increase by 1pp.

In 2010, the deficit is forecast to be around 7.7% of GDP, in line with the government’s fiscal target. On a short-term basis, market scepticism about the government’s consolidation plan is still the main downside risk. The government must stick to this plan if it is to enjoy better financing conditions and access to external financing.

Portugal: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 0.0 -2.7 1.4 -0.5 0.8Dom. Demand ex Stocks 1.3 -2.5 -0.5 -2.5 -0.1Private Consumption 1.7 -0.8 1.4 -1.5 -0.4Public Consumption 1.1 3.5 -0.3 -0.7 0.3Fixed Investment 0.5 -12.6 -6.7 -7.9 0.8Stocks (Cont. to Growth) 0.3 -0.4 0.3 0.1 0.0Exports -0.5 -11.6 3.2 1.7 3.1Imports 2.7 -9.2 -1.3 -3.8 0.5Industrial Production -4.1 -8.3 1.8 0.1 1.9Savings Ratio (%) 6.4 8.8 8.1 8.3 7.8 Inflation & Labour HCPI 2.7 -0.9 1.0 1.1 0.5Core HCPI 1.6 0.5 -0.1 -0.4 -0.2Employment 0.5 -2.3 -1.0 -1.9 0.2Unemployment Rate (%) 7.6 9.5 11.3 12.7 11.9 External Trade Trade Balance (EUR bn) -21.3 -17.1 -16.3 -14.2 -13.4Current Account (EUR bn) -20.0 -16.8 -16.0 -13.9 -13.1Current Account (% GDP) -12.0 -10.3 -9.6 -8.2 -7.7 Financial Variables Gen. Gov. Budget (EUR bn) -4.5 -14.9 -12.6 -9.7 -7.0Gen. Gov. Budget (% GDP) -2.7 -9.3 -7.7 -5.9 -4.2Gross Gov. Debt (% GDP) (2) 66.3 76.8 82.8 88.1 91.2 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 3.96 4.08 6.50 6.10 6.25Spread over Bund (bp) 101 68 450 310 250Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Unit Labour Costs (2000=100)

95

100

105

110

115

120

125

130

135

2000 2001 2002 2003 2004 2005 2006 2007 2008

Portugal

Germany

Source: OECD

Unit labour costs remain low in Portugal, but they have risen rapidlysince the country joined the eurozone (compared with the trend in Germany, for example). As a result, Portugal has lost export market share during the last decade. Relative deflation seems to be a good way to regain external competitiveness in the coming years.

Caroline Newhouse-Cohen July 2010Global Outlook 38 www.GlobalMarkets.bnpparibas.com

Finland: Delayed Recovery

Activity: recovery from Q2 2010 After declining by 8% in 2009, its worst

contraction since 1918, the economy remained in recession at the start of the year. In Q1 GDP fell for the sixth time in seven quarters, dropping by 0.4% q/q. As a result, Q1 GDP was almost 10% below its pre-crisis level.

A recovery in the Finnish economy has thus been slow to materialise. Exports of investment goods are mainly to be blamed for this weakness, as export markets, especially in Europe, still have a large excess of industrial capacity.

However, consumer and business surveys are improving, pointing to gradual economic revival. The fallout from the current European debt crisis is, nonetheless, a major risk.

Inflation: above the eurozone average While steadily declining, inflation remained

above the eurozone average last year. As the economy gradually recovers, inflation should stop falling. The planned increase in the standard rate of VAT in Q3 2010, as well as higher commodity prices and the euro’s depreciation, should boost inflation temporarily.

Core inflation is thus unlikely to decelerate as previously expected and should remain above the eurozone average.

Policy: fiscal austerity to follow next year’s elections The authorities have supplemented the effect of

automatic stabilisers by implementing a discretionary stimulus fiscal package in order to lessen the impact of the crisis on the economy.

Altogether, the economic downturn and expansionary policies have turned the general government surplus from 4% of GDP in 2008 to a projected deficit of a similar size this year.

Consequently, the long-term fiscal position has weakened considerably. Therefore the authorities are likely to start a measured budget consolidation from 2011.

A general election will take place in March 2011 and thus the task of improving public finances will be the new government’s responsibility. We expect the fiscal adjustment efforts to focus on cutting expenditure and the broadening of the tax base.

Finland: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 1.5 -8.0 1.0 1.8 2.5Dom. Demand ex Stocks 1.7 -6.3 0.5 1.6 2.2Private Consumption 2.6 -2.2 0.8 1.6 2.0Public Consumption 2.6 0.7 1.0 0.8 0.8Fixed Investment 0.4 -16.2 -7.0 4.0 3.0Stocks (Cont. to Growth) -0.2 -1.7 2.1 1.8 1.6Exports 2.0 -24.2 2.0 3.5 3.5Imports 1.5 -22.0 2.0 3.0 3.0Industrial Production 0.5 -20.7 3.0 3.5 3.5Savings Ratio (%) -0.9 4.7 3.5 2.3 1.4 Inflation & Labour CPI 4.0 0.0 1.2 1.9 1.8HICP 3.9 1.6 2.2 2.1 1.8Core HICP 1.8 2.2 1.8 1.5 1.6Employment 1.6 -2.9 -1.9 0.5 0.5Unemployment Rate (%) 6.4 8.2 10.4 9.7 9.5 External Trade Trade Balance (EUR bn) 5.9 3.6 3.0 3.2 3.4Current Account (EUR bn) 5.6 1.7 1.7 2.3 2.3Current Account (% GDP) 3.0 1.0 1.0 1.3 1.3 Financial Variables Gen. Gov. Budget (EUR bn) 8.3 -6.7 -7.7 -5.2 -3.6Gen. Gov. Budget (% GDP) 4.2 -2.2 -4.5 -3.0 -2.0Gross Gov. Debt (% GDP) (2) 34.2 44.0 46.5 47.5 47.5 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 3.48 3.59 2.40 3.25 3.95Spread over Bund (bp) 53 19 40 25 20Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: The Trough is Behind Us

-10

-8

-6

-4

-2

0

2

4

6

8

Q1 00 Q1 01 Q1 02 Q1 03 Q1 04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10

GDP (% y/y)

GDP(% q/q)

Source: Statistics Finland

The GDP monthly indicator suggests that activity contracted markedly in January and then recovered in the two following months. GDP growth is likely to bounce back modestly in Q2.

Eoin O’Callaghan July 2010Global Outlook 39 www.GlobalMarkets.bnpparibas.com

Ireland: Past the Worst

Activity: subdued recovery ahead There are increasing signs that the Irish

economy bottomed out in early 2010. The recovery, however, is likely to prove subdued.

Retail sales have troughed but consumption will continue to be weighed down by the high level of unemployment and debt, limiting consumption’s contribution to the recovery.

Further fiscal tightening will also be a drag on growth.

The contraction in private-sector credit and the downward trend in the money multiplier highlight the risk that banks also impede the recovery by keeping credit tight.

Net trade, however, remains a bright spot for the economy. As one of the most open economies of the eurozone, with one of the highest ex-EMU trade ratios, Ireland stands to benefit from the combination of falling domestic prices and the weak euro.

Inflation: deflation to continue Ireland continues to regain competitiveness at a

striking pace – core inflation is still running nearly 4pp below the eurozone average.

This process has further to go. Ireland lost around 20% of its competitiveness relative to the euro area over the last decade and consumer prices started the adjustment around 20% higher.

The implications of this fast adjustment are not all positive. Deflation increases the real burden of households’ high debt level and is prolonging the fall in house prices. Both trends put the banks under more pressure.

The risk remains that Ireland will slip into a long period of deflation.

Policy: fiscal reforms on track The large revision to the fiscal deficit in 2009

reflected a reclassification of government support for Anglo Irish. Additional injections of capital to Anglo Irish and Irish Nationwide are likely to be recorded in the same way.

Reclassifications aside, the austerity programme is on track. Revenues are broadly on target and spending is well below projections.

The government is likely to come under more pressure for detail on how it will achieve the targeted deficit reduction between 2011 and 2014.

With sovereign and banking risk now almost indistinguishable, the recent widening of bank credit spreads is a worrying development.

Ireland: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP -3.0 -7.1 -0.5 1.8 3.7Dom. Demand ex Stocks -4.7 -12.0 -4.2 0.6 2.9Private Consumption -0.9 -7.2 -0.4 1.3 3.1Public Consumption 2.6 -1.3 -3.0 -1.6 1.0Fixed Investment -15.6 -29.7 -16.4 0.8 4.2Stocks (Cont. to Growth) 0.5 -1.4 0.2 0.0 0.0Exports -1.0 -2.3 2.4 4.5 5.3Imports -2.0 -9.3 -1.0 3.8 4.9Industrial Production -1.5 -4.0 2.0 3.5 5.0 Inflation & Labour CPI 4.1 -4.5 -1.0 0.8 2.0HICP 3.1 -1.7 -1.6 -0.1 -0.3Core HICP 1.6 -1.3 -2.6 -2.2 -1.3Employment -1.1 -8.2 -3.5 0.2 1.3Unemployment Rate (%) 6.3 11.8 13.3 13.4 13.0 External Trade Trade Balance (EUR bn) 28.6 38.7 41.7 44.5 47.9Current Account (EUR bn) -9.4 -4.8 -2.4 -1.1 1.0Current Account (% GDP) -5.2 -2.9 -1.5 -0.7 0.6 Financial Variables Gen. Gov. Budget (EUR bn) -12.9 -23.5 -31.6 -16.8 -12.6Gen. Gov. Budget (% GDP) -7.1 -14.3 -19.9 -10.6 -7.8Gross Gov. Debt (% GDP) (2) 43.9 64.0 86.3 96.6 101.4 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 4.44 5.76 6.30 5.90 6.05Spread over Bund (bp) 149 237 430 290 230Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated.

Source: BNP Paribas

Chart 1: Irish Banks’ CDS 5y Senior (bp)

0

100

200

300

400

500

600

700

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

Allied Irish

Bank of Ireland

Irish Life & P


With sovereign and banking risk now almost indistinguishable, the recent widening of bank credit spreads is worrying – particularly as the government already underwrites most bank liabilities.

Philippe Sabuco July 2010Global Outlook 40 www.GlobalMarkets.bnpparibas.com

Greece: Another Two Years of Recession

Activity: another two years of recession The economy remained in recession in Q1 2010

with GDP down by 1% q/q, after a fall of 0.8% in Q4 2009. Activity is projected to contract further in the next two years, due to restrictive fiscal policy, tight credit conditions and the weakness of business and consumer confidence.

Private consumption is likely to decrease further in both 2010 and 2011, undermined by higher unemployment, a deceleration in wage growth and still-tight credit conditions. Tax increases and cuts in public wages will also weigh.

Investment spending is set to decline sharply in the coming years, restrained by the downturn in the housing sector, financing conditions and the poor outlook for domestic demand and profits.

Exports will benefit from the recovery of world trade and the relative decline in unit labour costs. Meanwhile, imports will continue to decrease due to fiscal consolidation. Thus net exports should limit the fall in GDP, particularly in 2010.

Inflation: collapse in the core rate In 2010, headline inflation is forecast to jump to

3.0%, from 1.3% in 2009, due to higher oil prices. New taxes will also boost inflation in the following months. However, inflation is likely to fall below the eurozone average next year.

We expect the core HICP to fall in 2011, given Greece’s output gap and developments in the labour market. This will help Greece to regain some of its lost competitiveness against its European trading partners.

Policy: fiscal consolidation is a priority In early May, European leaders agreed a

EUR 750bn support package to cover peripheral countries’ needs over the next three years. Greece has already received funds to cover its financing needs for May and June. This support has enhanced the credibility of the fiscal adjustment.

According to the government, Greece is on track to reduce its deficit to 8.1% of GDP this year. While the 2010 fiscal target seems credible, the medium-term outlook remains uncertain, given the deterioration in growth prospects and the probability of social tensions.

As a result, Greece will have to continue its fiscal adjustment with great determination if it is to calm financial markets. Successful fiscal consolidation should eventually boost confidence and improve sentiment.

Greece: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 2.0 -2.0 -4.0 -3.2 0.7Dom. Demand ex Stocks 0.1 -2.5 -4.4 -5.7 -0.6Private Consumption 2.3 -1.8 -0.7 -4.0 -0.6Public Consumption 0.6 9.6 -6.8 -6.4 -0.4Fixed Investment -7.4 -13.9 -16.4 -13.2 -0.4Stocks (Cont. to Growth) 1.1 0.8 -1.2 -0.1 0.0Exports 4.0 -18.1 0.9 4.6 5.8Imports 0.2 -14.1 -5.8 -7.1 0.2Industrial Production -4.1 -9.5 -4.7 -5.2 0.2 Inflation & Labour HICP 4.2 1.3 3.0 1.6 1.0Core HICP 3.1 2.3 1.8 -0.2 -0.6Employment 1.1 -1.1 -1.3 -0.9 0.0Unemployment Rate (%) 7.7 9.5 12.7 14.5 14.2 External Trade Trade Balance (EUR bn) -44.0 -30.8 -29.2 -25.8 -25.2Current Account (EUR bn) -34.8 -26.6 -23.7 -20.0 -18.0Current Account (% GDP) -14.6 -11.2 -10.1 -8.6 -7.6 Financial Variables Gen. Gov. Budget (EUR bn) -18.4 -32.3 -19.1 -18.5 -16.4Gen. Gov. Budget (% GDP) -7.7 -13.6 -8.2 -7.9 -6.8Gross Gov. Debt (% GDP) (2) 99.2 115.1 134.2 146.7 149.8 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 5.20 5.76 11.00 10.50 9.75Spread over Bund (bp) 226 237 900 750 600Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated.

Source: BNP Paribas

Chart 1: Greek Fiscal Projections (% GDP) -16

-14

-12

-10

-8

-6

-4

-2

02000 2002 2004 2006 2008 2010 2012 2014

0

20

40

60

80

100

120

140

160

Gen. Gov. Budget

Gross Gov. DebtBNPP Forecasts

Source: Eurostat, BNP Paribas

Although the government deficit should improve substantially in the coming years, the level of public debt should remain higher than before the crisis. On our estimates, the debt-to-GDP ratio should stabilise in 2013 (at 149.8%) and start to fall slightly in 2014.

Michal Dybula July 2010Global Outlook 41 www.GlobalMarkets.bnpparibas.com

Slovenia: Back into Recession

Activity: large disappointment in Q1 The economy fell back into recession at the end

of last year with GDP falling in both Q4 2009 and Q1 2010.

The most important factor behind Q1’s disappointing drop in GDP was net trade’s very small contribution to activity, as a result of the slowness of the recovery in exports and the resilience of imports to the weakness of domestic demand.

We forecast that these developments will be reversed from Q2, supporting better GDP prints in the rest of the year. However, the risk remains that external competitiveness suffered more than we think and that our forecast for 0.8% y/y growth this year is too optimistic.

Moreover, we have revised down our medium-term forecasts for Slovenia’s GDP since the last Global Outlook due to the poor outlook for the eurozone’s economy. We now do not expect GDP growth to exceed 2.0% in either 2011 or 2012. A weaker profile for exports will prevent a faster rebound in investment, the labour market and consumption.

Inflation: headline rate boosted by energy Given the absence of demand pressure, core

inflation has only just remained above zero. Nevertheless, headline inflation surged to nearly 3.0% y/y in April before moderating to slightly below 2.5% in May.

The main factor pushing up HICP inflation has been higher fuel and energy prices. While their impact should gradually fade, the weakness of the euro will limit disinflation.

Our EUR/USD call and forecast for the real economy are consistent with HICP inflation of 1.5% y/y in the remainder of 2010 and in 2011.

Policy: too-tight fiscal policy won’t help Even though the economy contracted by nearly

8.0% y/y in 2009, fiscal policy was surprisingly tight, with the deficit widening to only 5.5% of GDP.

Given the government’s commitment to fiscal consolidation, we do not expect the deficit to widen further this year and expect it to gradually narrow in 2011-2012. However, fiscal policy keep GDP growth low and thus will not prevent further rises in the public debt-to-GDP ratio.

The return to a sustainable fiscal position in the long term will require a reform of pensions and a rise in the retirement age, as well as greater labour-market flexibility to raise competitiveness.

The government is currently discussing these issues with trade unions.

Slovenia: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 3.5 -7.8 0.8 1.2 1.6Dom. Demand ex Stocks 4.5 -6.4 -0.5 1.5 1.6Private Consumption 2.1 -1.3 0.3 1.1 1.2Public Consumption 5.8 2.7 2.5 4.5 2.0Fixed Investment 8.2 -21.5 -4.9 -0.2 2.2Stocks (Cont. to Growth) -0.7 -3.8 0.6 0.1 0.1Exports 2.9 -15.3 4.8 2.3 3.6Imports 3.1 -17.7 3.3 2.6 3.7Industrial Production 2.6 -17.0 5.0 0.8 2.5 Inflation & Labour HICP 5.2 1.0 1.8 1.5 1.1Core HICP 4.9 1.7 -0.3 0.1 0.7Employment 3.0 -2.4 -2.3 -0.1 0.0Unemployment Rate (%) 4.4 5.9 7.0 7.0 6.9 External Trade Trade Balance (EUR bn) -2.65 -0.62 -0.40 -0.42 -0.13Current Account (EUR bn) -2.29 -0.34 0.00 0.09 0.40Current Account (% GDP) -6.2 -1.0 0.0 0.3 1.1 Financial Variables Gen. Gov. Budget (EUR bn) -0.63 -1.92 -1.97 -1.80 -1.67Gen. Gov. Budget (% GDP) -1.7 -5.5 -5.5 -5.0 -4.5Gross Gov. Debt (% GDP) (2) 22.6 35.9 42.0 48.1 52.2 Interest Rates (2) 3-Month Rate (%) 2.89 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 4.57 4.87 4.10 4.40 4.85Spread Over Bund (bp) 162 147 210 140 110Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Growth Disappointed in Q1


Coincident indicators had pointed to a return of positive growth readings in Q1, but data surprised to the downside, as GDP fell in q/q terms again and Slovenia re-entered recession. Still, we see better numbers in the remainder of the year ahead.


Slovakia: How Robust is the Recovery?

Activity: surging on net trade GDP grew by 4.6% y/y in Q1, making Slovakia’s

recovery the strongest in the eurozone. The rapid acceleration in growth was primarily driven by net exports.

Domestic demand is lagging and we expect this underperformance to increase, as government spending will slow in the rest of the year, while private consumption will be constrained by a very weak labour market and the absence of credit growth.

Although output growth is accelerating, capacity utilisation is low which, together with the uncertain outlook for the eurozone economy, suggests that the rebound in investment will be shallow.

We expect growth in Slovakia’s major trading partners to moderate in the remainder of 2010, leading to a slowdown in exports. With domestic demand soft, we expect GDP growth to have fallen below 4.0% y/y by Q2. Our full-year forecast of 3.8% is in line with that of the central bank.

We forecast a further deceleration to below 1.5% y/y in 2011, due to weak growth in the eurozone and our expectation that the Slovakian government will be unwilling to soften its fiscal stance.

Inflation: falling on a still-wide output gap After briefly falling below zero, headline inflation

is rising again. While a weaker EUR points to further upside, the wide output gap will prevent excessive pressures from emerging.

We expect core inflation to remain below 1.0% y/y during our forecast period, which will help to keep HICP readings below 3.0% y/y.

Policy: fiscal policy to remain tight Centre- and right-wing parties won June’s

elections with 79 of parliament’s 150 seats. The new government is unlikely to change the

fiscal targets set by the previous government, including the aim of reducing the deficit to 5.5% of GDP this year.

A stronger economy should help, but the more disappointing economic performance that we forecast for next year suggests that the headline deficit will not fall by much more before 2012. Fortunately, a relatively low public debt-to-GDP ratio will not necessitate bolder and front-loaded tightening measures.

Slovakia: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 6.4 -4.7 3.8 1.4 3.1Dom. Demand ex Stocks 4.9 -2.8 1.1 1.1 2.4Private Consumption 6.1 -0.6 0.7 0.7 2.2Public Consumption 5.3 2.7 2.8 1.7 2.6Fixed Investment 7.0 -13.9 0.8 1.3 2.8Stocks (Cont. to Growth) 1.3 -3.6 0.0 -0.1 0.1Exports 3.6 -16.4 13.0 3.8 7.5Imports 3.6 -17.6 9.2 3.1 6.3Industrial Production 3.7 -13.8 13.4 1.2 5.8 Inflation & Labour HICP 3.9 0.9 1.0 2.9 2.6Core HICP 4.6 0.5 0.9 0.9 0.8Employment 3.2 -2.8 -2.0 0.0 -0.6Unemployment Rate (%) 7.7 11.4 12.5 13.0 13.5 External Trade Trade Balance (EUR bn) -0.45 1.18 1.97 1.92 2.05Current Account (EUR bn) -3.89 -1.62 -1.57 -1.62 -1.51Current Account (% GDP) -5.8 -2.6 -2.4 -2.4 -2.1 Financial Variables Gen. Gov. Budget (EUR bn) -1.55 -4.24 -3.52 -3.44 -2.91Gen. Gov. Budget (% GDP) -2.3 -6.7 -5.3 -5.0 -4.1Gross Gov. Debt (% GDP) (2) 27.7 35.7 39.4 43.0 44.7 Interest Rates (2) 3-Month Rate (%) 3.00 0.70 0.70 1.00 2.0010-Year Bond Yield (%) 4.65 4.37 3.80 4.10 4.65Spread Over Bund (bp) 170 97 180 110 90Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Growth Is Strong, But How Sustainable?


Growth surged to nearly 5.0% y/y in Q1 on a further improvement innet trade. However, the domestic economy continues to lag, reflecting an uncertain investment climate and a still-weak labour market. Given slowing growth across the rest of the eurozone, we expect Slovak growth readings to moderate from the middle of this year.

Gizem Kara July 2010Global Outlook 43 www.GlobalMarkets.bnpparibas.com

Denmark: Recovery Continues

Activity: growth to moderate next year The economic recovery continues, with domestic

demand showing further signs of improvement. But growth is likely to remain relatively weak in the next couple of years.

The consistent increase in private consumption since H2 2009 should continue. Disposable incomes are supported by lower taxes this year. Lower interest rates, which helped the turnaround in the housing market, should provide additional support to consumption.

An improvement in activity in the eurozone, US and main Scandinavian countries, which account for around 65% of Denmark’s export market, points to a further increase in exports this year. However, net trade’s contribution to growth is likely to turn slightly negative given our expectation that imports will rise faster than exports.

Next year, we expect growth to slow due to fiscal tightening. We also expect external demand to moderate, mainly in the euro area – again due to fiscal consolidation.

Inflation: headline rate to start drifting lower Due to higher energy prices, headline inflation

has remained on an upward trend so far this year, while core inflation has been steadily trending down since mid-2009.

The rise in economic growth has been achieved through a rise in productivity rather than increased employment. With growth forecast to slow, we expect unemployment to continue to rise, leading to slower wage growth.

Although survey evidence now points to an improvement in selling price expectations in both the manufacturing and the services sector, lower wage growth should ensure both headline and core inflation trend lower this year and next.

Policy: further rate cuts to come Given excess liquidity in the eurosystem due to

the ECB’s measures to stabilise financial markets, the rate differential between Denmark and the ECB is leading to hot-money inflows. Consequently, the krone is appreciating against the euro.

With FX reserves at an all-time high, we expect further deposit and policy-rate cuts, with the policy rate falling below the ECB refi rate. The timing will depend on developments in the krone and FX reserves.

Demark: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP -0.9 -4.9 1.3 1.0 1.4Dom. Demand ex Stocks -0.8 -4.4 1.6 1.6 2.2Private Consumption -0.2 -4.6 2.8 1.6 2.1Public Consumption 1.6 2.5 1.3 0.6 0.5Fixed Investment -4.7 -12.0 -0.8 3.3 5.0Exports 2.4 -10.4 6.8 4.5 5.5Imports 3.3 -13.2 7.2 5.1 6.1Manufacturing Production -0.2 -17.1 1.3 2.8 6.0 Inflation & Labour CPI 3.4 1.3 2.1 1.5 1.7Earnings 4.4 3.1 2.5 2.3 2.7Unemployment Rate (%) 1.8 3.5 4.4 5.2 5.1 External Trade Current Account (DKK bn) 38.0 67.2 50.0 46.0 40.0Current Account (% GDP) 2.2 4.1 2.9 2.6 2.2 Financial Variables Gen. Gov. Budget (DKK bn) 59.8 -46.7 -92.0 -79.0 -67.0Gen. Gov. Budget (% GDP) 3.4 -2.8 -5.4 -4.5 -3.7Gross Gov. Debt (% GDP) (2) 34.2 41.6 46.0 49.8 52.5 Interest & FX Rates (2) Lending Rate 3.75 1.20 0.95 0.90 1.7510-Year Bond Yield (%) 3.36 3.68 2.10 3.30 4.10Spread over Bund (bp) 41 28 10 30 35EUR/DKK 7.44 7.44 7.46 7.46 7.46

(1) Forecast (2) End period Source: BNP Paribas

Chart 1: Net Exports and GDP


Given an improvement in domestic demand, we expect net trade to subtract from year-on-year growth slightly in the coming quarters, after consistently positive contributions since Q1 2009.


Chart 1: Financial and Monetary Conditions Index and Manufacturing CIPS


Financial and monetary conditions are forecast to tighten, which suggests that the manufacturing CIPS survey will fall back in the months ahead.

Chart 2: CPI versus RPI


We believe that CPI inflation has peaked and will begin to trend lower over the next two years.

Chart 3: Bank of England Inflation Projection (based on market interest rate expectations)

Source: Bank of England

The MPC’s latest inflation projection is significantly below target at the two-year horizon and is likely to be lowered further now that additional fiscal tightening has been announced.

UK: As Good as it Gets

Activity: in a sweet spot We expect the sharp tightening in fiscal policy

announced in the Budget to exert a significant drag on GDP. The impact on activity will be especially marked during 2011 when growth should stall and activity could even drop slightly in quarter-on-quarter terms.

Between then and now, we expect a robust 0.7% q/q pace of GDP growth around the middle of the year. Near-term growth is likely to be supported by the tailwinds from the slower pace of destocking and the rapid growth of real disposable income.

However, these influences are fading and will be less supportive during H2 2010. Financial and monetary conditions have begun to tighten in recent months, not least due to financial market turbulence, pointing to a fall in CIPS surveys and a more pedestrian pace of GDP growth.

Inflation: high for now Persistent upward surprises have tended to be

associated with components of the CPI that are sensitive to exchange rates (e.g. clothing and AV equipment).

Although we forecast further GBP weakness, we do not expect this to match the near 20% pace of early 2009. The rise in components of the CPI sensitive to exchange rates should therefore slow.

We also believe that robust disposable income growth has maintained pricing power. We expect this effect to unwind ahead, making it harder for above-target inflation to be maintained.

We expect the downward trend in inflation to be reinforced by base effects (particularly when the VAT hikes drop out of the year-on-year comparison). We expect CPI inflation to fall below target by mid-2011.

Policy: prolonged pause The BoE’s forecasts do not yet take account of

the additional tightening in fiscal policy announced in the emergency Budget. When they do, we expect the downward shift in the outlook for inflation to reinforce the case for no change in Bank Rate until 2012.

Moreover, we believe that the extent to which the BoE’s inflation projection is below target will provoke the MPC to restart unconventional policy easing from August onwards.


UK: Economic & Financial Forecasts

Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 (2) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

GDP (% q/q) - - - - - -2.6 -0.7 -0.3 0.4 0.4 0.7 0.6 0.3 0.1 0.0 0.1 0.2GDP 0.7 -4.9 1.4 1.0 1.5 -5.3 -5.9 -5.3 -3.1 -0.1 1.3 2.2 2.1 1.7 1.0 0.6 0.5Domestic Demand ex Stocks 0.5 -5.2 2.1 0.7 1.4 -6.0 -6.6 -5.7 -2.7 0.4 2.4 3.0 2.5 1.8 0.7 0.3 0.2Private Consumption 1.4 -3.2 0.6 0.5 1.5 -3.2 -3.9 -3.6 -2.2 -0.7 0.8 1.2 1.1 1.1 0.4 0.2 0.2Public Consumption 3.5 2.2 2.5 -0.8 -1.1 2.1 2.2 2.2 2.2 3.2 2.8 2.5 1.4 0.5 -0.5 -1.5 -2.0Investment -3.1 -14.9 -0.3 2.8 4.2 -12.7 -19.1 -13.7 -14.0 -5.8 1.9 -0.5 3.1 2.2 2.5 3.0 3.4Stocks (Cont to Growth, q/q) -0.4 -1.2 1.3 0.0 0.2 -0.1 0.6 -0.6 0.7 0.4 0.5 0.2 0.0 0.0 0.0 0.0 0.0Exports -0.1 -10.5 5.2 6.0 6.0 -11.6 -13.4 -12.4 -4.8 2.9 6.3 7.0 4.7 5.9 5.9 6.1 6.0Imports -0.5 -11.8 7.5 4.7 4.9 -13.8 -15.7 -13.7 -3.8 4.3 10.0 9.8 6.1 5.7 4.3 4.5 4.4Services Output 1.3 -3.5 1.2 0.8 1.2 -3.6 -4.3 -3.9 -2.2 -0.1 1.2 2.0 1.8 1.5 0.9 0.5 0.4Industrial Production -2.9 -10.2 3.1 1.8 1.1 -12.4 -11.7 -10.6 -5.9 0.0 2.5 4.9 4.9 3.9 2.0 0.8 0.6Disc. Savings Ratio (%) -2.7 4.8 5.4 3.8 3.8 2.5 5.6 6.2 5.0 6.0 5.6 5.1 4.8 4.3 3.9 3.4 3.5 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour RPI 4.0 -0.5 4.6 2.9 3.1 -0.1 -1.2 -1.4 0.6 4.0 5.1 4.9 4.3 3.7 2.6 2.4 2.8RPIX 4.3 2.0 4.7 2.6 2.3 2.4 1.4 1.3 2.8 4.5 5.2 4.8 4.2 3.5 2.4 2.1 2.5HICP 3.6 2.2 3.1 2.0 1.6 3.0 2.1 1.5 2.1 3.3 3.4 2.9 2.7 2.3 1.9 1.9 1.8Core CPI 1.6 1.8 2.5 1.2 1.0 1.5 1.6 1.7 2.2 3.0 2.9 2.3 1.9 1.6 1.1 1.1 1.0Employment 0.7 -1.6 -0.3 -0.5 -0.2 -1.1 -2.1 -1.6 -1.6 -1.1 -0.1 0.1 0.1 0.1 -0.5 -0.7 -0.7Unemployment Rate (ILO, %) 5.7 7.6 7.8 8.0 7.8 7.1 7.8 7.8 7.8 8.0 7.8 7.7 7.6 7.7 7.9 8.1 8.3Headline Avg. Earnings 3.5 0.0 2.6 2.2 2.5 -2.6 1.2 0.7 0.6 4.3 1.4 2.1 2.5 2.0 1.9 2.3 2.5Avg. Earnings Ex-Bonuses 3.7 1.7 1.9 1.9 2.5 2.4 2.0 1.3 1.2 2.0 1.6 2.0 1.9 1.4 1.9 2.1 2.3 Year 2009 2010 2011 External Trade ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Trade Balance (GBP bn, sa) -93.4 -81.8 -74.0 -54.0 -41.0 -21.0 -19.8 -19.8 -21.0 -20.0 -19.0 -18.0 -17.0 -16.0 -15.0 -14.0 -12.0Current Account (GBP bn, sa) -22.0 -18.4 -16.5 -10.5 -4.5 - - - - - - - - - - - -Current Account (% GDP) -1.5 -1.3 -1.1 -0.7 -0.3 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables PSNB (GBP bn, FY) 98.0 156.0 146.0 118.0 90.0 - - - - - - - - - - - -PSNB (% GDP) 6.8 11.1 10.0 7.8 5.7 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (3) 55.6 71.3 78.0 84.0 87.0 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (3) Bank Rate (%) 2.00 0.50 0.50 0.50 2.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.503-Month Rate (%) 2.77 0.61 0.80 0.90 2.75 1.65 1.19 0.54 0.61 0.65 0.73 0.85 0.80 0.70 0.70 0.70 0.9010-Year Rate (%) 3.02 4.01 2.75 3.65 4.35 3.16 3.68 3.59 4.01 3.93 3.43 2.95 2.75 2.80 2.95 3.25 3.65Spread Over Bund (bp) 7 61 75 65 75 16 30 37 61 84 78 75 75 70 70 65 65EUR/GBP 0.96 0.89 0.80 0.79 0.90 0.92 0.85 0.91 0.89 0.89 0.83 0.81 0.80 0.78 0.78 0.80 0.79GBP/USD 1.46 1.62 1.35 1.27 1.28 1.43 1.65 1.60 1.62 1.52 1.47 1.43 1.35 1.28 1.26 1.21 1.27Footnotes: (1) Forecast (2) Although preliminary Q1 data have been released, we expect upward revisions (3) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Contributions to Growth


Both domestic demand and exports contributed to GDP growth in Q1. We expect these sectors to support a further rise in output in the coming quarters.

Chart 2: New Export Orders and Exports (% y/y)


The new export orders sub-index of the manufacturing PMI remains well above the 50 breakeven level, which suggests that exports will rise further this year.

Chart 3: Measures of Inflation (% y/y)


We expect core inflation to continue to moderate this year, given the still-considerable amount of spare capacity in the economy and a stronger currency.

Sweden: Gaining Momentum

Activity: recovery continues The Swedish economic recovery has gained

momentum, supported by the still-low level of interest rates domestically and an improvement in demand externally.

The strengthening in activity should continue to feed into the labour market. An increase in vacancies suggests the rise in employment will accelerate.

The pick-up in employment, combined with further income tax cuts, low interest rates and rising house prices, suggests that private consumption will become the main driver of growth this year.

Survey evidence suggests that the rise in exports will continue in coming months. Higher exports should improve firms’ confidence and hiring intentions further and lead to a continuation of the recent recovery in investment.

However, as the effects of the fiscal stimulus fade next year, growth in domestic demand is likely to slow. Moreover, fiscal consolidation in the eurozone, Sweden’s main trading partner, will restrain exports. Thus growth is likely to lose some momentum in 2011.

However, as the budgetary situation does not require a sharp tightening of fiscal policy, growth is likely to outperform that of the eurozone over the next few years.

Inflation: core inflation to trend lower The recent weakness of producer prices of

consumer goods, the continued wide output gap and a stronger currency point to a further fall in core inflation this year.

However, due to the improvement in the labour market, wage expectations are already showing some signs of increasing.

Overall, the rise in activity is expected to lead to a renewed rise in core inflation from Q2 2011.

Policy: rate hikes on the agenda Given a further improvement in economic

conditions, the Riksbank is likely to stick to its recent forecast that the first rate hike will come in the summer or early autumn.

Unless there is a sharp deterioration of concern over the eurozone, the strength of the economy suggests rate hikes will come soon. We expect the policy rate to reach 1.25% by the end of this year and 3.00% by end-2011.


Sweden: Economic & Financial Forecasts


Components of Growth Real GDP (% q/q) - - - - - -3.0 0.7 0.3 0.4 1.4 1.1 0.9 0.7 0.6 0.7 0.7 0.9GDP -0.6 -5.1 3.6 3.0 3.7 -6.7 -6.1 -5.8 -1.5 2.9 3.3 3.9 4.2 3.4 3.0 2.8 2.9Domestic Demand ex Stocks 0.5 -3.3 2.6 2.5 2.4 -4.5 -3.9 -3.4 -1.4 1.1 2.1 3.3 3.7 3.0 2.6 2.4 2.2Private Consumption -0.2 -0.8 4.3 3.0 2.7 -3.0 -1.4 -0.5 1.7 3.5 4.0 4.8 5.0 4.0 3.0 2.6 2.5Public Consumption 1.0 1.8 1.1 1.2 0.8 2.4 2.0 1.3 1.7 0.6 0.9 1.4 1.3 1.5 1.3 1.1 0.8Fixed Investment 1.4 -15.9 0.1 3.7 5.1 -16.6 -17.2 -16.3 -13.2 -4.1 -1.0 2.1 3.8 3.9 3.8 3.6 3.4Exports 1.0 -12.3 7.1 5.6 5.9 -15.5 -15.7 -11.6 -5.9 4.4 8.2 7.2 8.4 6.5 5.3 5.2 5.3Imports 2.4 -12.9 7.3 5.2 4.8 -13.2 -17.9 -13.6 -6.3 2.3 8.8 9.0 9.1 6.8 5.0 4.7 4.5Industrial Production -3.4 -19.3 3.9 2.8 5.0 -23.4 -21.9 -19.7 -11.5 2.2 5.0 3.2 5.1 3.9 1.0 2.7 3.5 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 3.4 -0.3 1.6 2.4 2.3 0.8 -0.4 -1.2 -0.4 1.0 1.1 1.7 2.6 2.2 2.5 2.4 2.3Core CPI (CPIF) 2.7 1.9 1.9 1.2 1.6 2.1 1.7 1.6 2.3 2.6 2.0 1.4 1.4 0.7 1.1 1.5 1.5Wages & Salaries/Hour 4.4 2.7 2.5 3.1 3.3 3.2 4.1 1.8 2.0 0.5 2.2 3.6 3.2 3.5 3.0 2.8 3.1Employment 1.1 -2.1 0.5 1.7 1.8 -1.2 -2.2 -2.8 -2.1 -0.7 0.0 1.2 1.5 1.6 1.7 1.8 1.8Unemployment Rate (nsa, %) 6.2 8.3 8.9 8.3 7.5 7.9 9.0 8.1 8.2 9.1 9.2 8.8 8.7 8.6 8.5 8.2 8.0 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (SEK bn) 96.5 87.3 88.6 102.8 119.0 23.3 32.9 18.4 12.7 16.9 44.0 15.5 12.3 19.8 47.5 18.5 16.9Current Account (SEK bn) 299.8 230.1 233.2 235.8 230.6 61.4 69.0 54.0 45.7 63.6 67.8 54.5 47.3 61.4 74.9 55.6 43.9Current Account (% of GDP) 9.3 7.4 7.1 6.8 6.3 8.2 8.7 7.2 5.6 8.2 8.2 6.9 5.4 7.5 8.6 6.7 4.8 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (% GDP) 2.5 -0.5 -1.0 -0.6 0.5 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 38.3 42.3 42.4 41.8 39.9 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest and FX Rates (2) Repo Rate (%) 2.00 0.25 1.25 3.00 4.50 1.00 0.50 0.25 0.25 0.25 0.25 0.75 1.25 1.50 1.75 2.25 3.003-Month Rate (%) 2.48 0.48 1.60 3.50 4.90 1.13 0.95 0.53 0.48 0.51 0.72 1.05 1.60 1.90 2.15 2.70 3.5010-Year Bond Yield (%) 2.43 3.40 2.20 3.70 4.65 3.00 3.48 3.33 3.40 3.18 2.69 2.35 2.20 2.45 2.75 3.20 3.70Spread over Bund (bp) -52 0 20 70 90 0 10 11 0 8 4 15 20 35 50 60 70EUR/SEK 10.92 10.24 9.10 9.30 9.70 10.92 10.81 10.20 10.24 9.75 9.50 9.30 9.10 9.20 9.10 9.30 9.30USD/SEK 7.81 7.16 8.43 9.30 8.43 8.25 7.71 6.96 7.16 7.20 7.79 8.02 8.43 9.20 9.29 9.59 9.30Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Mainland GDP and Employment


Employment has fallen with a lag in response to the decline in GDP. The slowness of the recovery in activity so far suggests that the improvement in employment in the next couple of quarters will be limited.

Chart 2: Mainland Investment and FMCI


Given lags, loose financial and monetary conditions point to a pick-up in mainland investment growth in the coming quarters.

Chart 3: Core Inflation Breakdown


A stronger currency should continue to put downward pressure on inflation. We expect core inflation to moderate for the rest of this year.

Norway: Growth Disappoints

Activity: weaker-than-expected growth Activity has been weaker than generally

expected in all sectors of the economy since the start of 2010, leading to a lowering of forecasts for the full year.

Higher interest rates pose some downside risks to consumption. However, historically high house prices, relatively low unemployment and strong consumer confidence point to an increase in spending. With the household savings ratio forecast to decline further, private consumption should be the main driver of growth for the forecast period.

Investment started 2010 very weak. Surveys such as the manufacturing PMI have failed to improve significantly since the start of the year. But exports picked up in Q2 and the recent regional survey reported that investment is expected to increase in export industries.

Loose financial and monetary conditions since the start of the year also suggest that mainland investment growth will pick up in the coming quarters.

The Norwegian export sector is dominated by oil and related activities. We expect the oil price to remain relatively high in the coming years which should stimulate Norwegian activity overall.

Inflation: both headline and core to trend lower Given base effects, the headline rate is set to

trend lower until the middle of next year. Core inflation has already decelerated in recent

months. Given the weakness of demand pressures, and as employment gains are likely to be limited, the downward trend in core inflation should continue.

In particular, moderate wage settlements and a stronger NOK suggest core inflation will continue to trend lower for the rest of the year.

Policy: further rate hikes to come gradually Given that economic activity has been weaker

than the Norges Bank expected, the Bank lowered its rate projections again at its June meeting.

Disappointing growth and uncertainty about the economic outlook due to developments in the eurozone also suggest that rate rises by the Norges Bank will be gradual. We expect the next hike to be delivered in Q4.


Norway: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - -0.9 -1.1 0.5 0.1 -0.1 0.4 1.0 1.0 0.0 0.4 0.5 0.6Mainland GDP (% q/q) - - - - - -0.9 0.0 0.3 0.4 0.1 0.4 1.1 1.3 0.2 0.6 0.5 0.4GDP 1.6 -1.5 1.0 2.0 2.7 -1.2 -2.4 -1.2 -1.3 -0.5 1.0 1.4 2.3 2.4 2.4 1.9 1.5Mainland GDP 2.0 -1.5 1.8 2.7 2.8 -1.6 -2.3 -1.8 -0.1 0.9 1.3 2.1 3.0 3.1 3.3 2.7 1.8Domestic Demand ex Stocks 1.9 -0.8 0.6 3.9 3.4 -1.6 -1.0 -1.4 0.7 -0.3 -0.1 1.4 1.5 4.3 4.1 3.8 3.4Private Consumption 1.1 0.2 3.5 3.0 3.4 -2.7 -1.1 1.3 3.6 4.7 3.8 3.1 2.3 2.3 2.8 3.2 3.8Public Consumption 4.1 4.8 2.4 2.1 1.3 4.9 5.1 5.3 4.0 2.4 2.2 1.7 3.1 2.5 2.2 1.9 1.6Fixed Investment 1.3 -8.0 -7.1 8.0 6.0 -5.2 -6.2 -12.4 -7.8 -12.9 -10.4 -2.7 -2.0 11.2 9.3 7.3 4.5Exports 0.9 -3.9 2.8 3.4 2.8 -3.9 -8.4 -1.6 -1.8 0.2 5.4 2.8 2.8 3.9 3.3 3.2 3.1Imports 2.2 -10.2 2.7 4.8 4.2 -13.7 -11.2 -10.7 -4.6 2.5 1.7 2.5 3.9 5.3 5.4 4.9 3.8Manufacturing Production 2.9 -6.3 2.0 3.4 2.1 -4.2 -10.1 -7.1 -3.8 0.0 1.3 2.6 4.0 4.5 4.3 2.8 2.3 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 3.8 2.2 2.4 1.8 2.3 2.4 3.1 1.8 1.4 2.9 2.6 2.1 2.1 1.0 1.5 2.2 2.4Core CPI 2.6 2.6 1.5 1.6 2.3 2.8 3.0 2.4 2.3 2.0 1.4 1.4 1.1 1.3 1.6 1.7 2.0Wages & Salaries 5.1 3.4 3.3 4.1 4.5 4.0 3.4 3.4 2.7 3.9 2.7 3.0 3.5 3.9 4.1 4.2 4.3Unemployment Rate (sa, %) 2.5 3.2 3.8 3.6 3.3 3.0 3.1 3.2 3.3 3.5 3.8 4.0 4.0 3.9 3.7 3.5 3.3 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

External Trade Trade Balance (NOK bn) 455 324 413 468 466 101 67 74 82 95 92 111 115 117 110 115 125- Ex-Oil (NOK bn) -146 -127 -116 -136 -149 -32 -34 -29 -32 -25 -29 -26 -36 -30 -33 -32 -42Current Account (NOK bn) 473 337 418 466 474 73 91 72 102 98 95 111 115 117 110 115 125Current Account (% of GDP) 18.6 14.1 16.9 18.1 17.7 11.9 15.7 12.4 16.2 15.9 15.8 18.3 17.6 18.3 17.6 18.2 18.3 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Gen. Gov. Budget (% GDP) 19.1 9.7 10.2 11.0 12.2 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 49.9 43.7 43.2 41.6 40.9 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest and FX Rates (2) Repo Rate (%) 3.00 1.75 2.25 3.25 4.00 2.00 1.25 1.25 1.75 1.75 2.00 2.00 2.25 2.50 2.75 3.00 3.253-Month Rate (%) 3.97 2.19 2.75 3.65 4.30 2.97 1.96 1.94 2.19 2.34 2.69 2.60 2.75 2.90 3.15 3.40 3.6510-Year Bond Yield (%) 3.89 4.17 2.80 4.30 4.65 3.81 4.19 4.19 4.17 3.76 3.24 2.75 2.80 3.10 3.35 3.75 4.30Spread over Bund (bp) 94 77 80 130 90 81 81 97 77 67 59 55 80 100 110 115 130EUR/NOK 9.72 8.30 7.30 7.50 7.50 8.92 9.02 8.44 8.30 8.02 7.70 7.50 7.30 7.20 7.40 7.60 7.50USD/NOK 6.95 5.79 6.76 7.50 6.52 6.73 6.43 5.77 5.79 5.94 6.31 6.47 6.76 7.20 7.55 7.84 7.50Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Eoin O’Callaghan July 2010Global Outlook 50 www.GlobalMarkets.bnpparibas.com

Switzerland: Calm in the Storm Activity: still outperforming in Europe

The Swiss economy continues to outperform in Europe, with a much broader recovery than elsewhere.

In stark contrast to the euro area, there is genuine momentum in final domestic demand, particularly in consumption. Moreover, net trade’s contribution to growth has proven remarkably resilient to the strength of the franc.

While we are sceptical that the current pace of growth can be maintained, the Swiss economy is better positioned than most in Europe to recover over the coming years.

Switzerland does not have any pernicious debt dynamics to overcome – private or public. Moreover, the banking system will not impede growth – mortgage lending actually accelerated through the crisis. We expect loose policy to have a stronger effect on the Swiss economy than elsewhere.

Inflation: flirtation with deflation should prove temporary Core inflation continues to grind lower in a

lagged response to the slowdown in activity and the strength of the exchange rate.

A flirtation with negative core inflation should prove temporary, however. Given the absence of a credit crunch, the glut of narrow liquidity in the economy represents a significant risk to medium-term price stability.

Policy: in a bind Policy continues to look increasingly

inappropriate relative to domestic fundamentals. The SNB had been moving towards a first hike

which we had previously expected to happen this September. However, the fiscal crisis in Europe has thrown a spanner in the works for the normalisation of policy.

A new wave of upward pressure on the franc has prompted exceptionally large unsterilised FX purchases when the central bank had been backing away from intervention. The result has been a surge in the SNB’s FX investments and a rebound in the balance sheet and bank reserves.

We doubt the SNB has the stomach to continue intervening in such volumes, particularly when it has highlighted the risks associated with the excess supply of narrow money in the economy.

Given our view that Europe’s fiscal crisis will continue for some time, we now do not expect

the first hike to come until next March, with the timing sensitive to the exchange rate.

Switzerland: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 1.8 -1.5 2.2 1.9 2.4Dom. Demand ex Stocks 1.1 0.1 2.4 2.0 2.3Private Consumption 1.7 1.2 2.1 1.8 2.0Public Consumption -0.1 2.5 1.6 1.3 1.2Fixed Investment 0.4 -3.7 3.7 3.1 3.9Stocks (Cont. to Growth) -0.7 1.4 -1.4 0.4 0.0Exports 2.9 -9.9 7.8 4.4 6.5Imports 0.4 -5.9 6.3 6.2 7.2Industrial Production 1.5 -7.8 3.8 2.9 4.0Savings Ratio (%) 13.3 14.3 12.2 11.0 10.7 Inflation CPI 2.4 -0.5 1.2 0.9 1.0CPI (Ex-Petrol) 1.6 0.8 0.2 0.4 0.9Nominal Wages 2.1 2.1 1.2 1.4 1.5Unemployment Rate (%) 2.6 3.7 4.1 3.9 3.8 Financial Variables Current Account (CHF bn) 11.1 44.7 51.0 54.0 58.0Current Account (% GDP) 2.0 8.3 9.3 9.6 10.0Gen. Gov. Balance (CHF bn) 4.6 1.0 -1.6 -4.8 -4.0Gen. Gov. Balance (% GDP) 0.8 0.2 -0.3 -0.9 -0.7Gross Gov. Debt (% GDP) (2) 40.9 41.1 40.7 40.4 39.7 Interest & FX Rates (2) 3-Month Rate (%) 0.66 0.25 0.25 1.25 2.0010-Year Bond Yield (%) 2.23 2.02 1.00 2.00 2.50Spread over Bund (bp) -72 -138 -100 -100 -125EUR/CHF 1.49 1.48 1.34 1.33 1.40Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: Financial and Monetary Conditions Indices

Source: Reuters EcoWin Pro, BNP Parivbas

Despite the strength of the franc, Switzerland is experiencing some of the loosest financial and monetary conditions on record. Stronger fundamentals mean the domestic economy is better placed to respond to such loose conditions than other European countries.

Serhiy Yahnych July 2010Global Outlook 51 www.GlobalMarkets.bnpparibas.com

IMPORTANT DISCLOSURE: This analysis has been produced by JSCIB UkrSibbank and has been reviewed, but not amended, by BNP Paribas. BNP Paribas owns an 81% controlling stake in JSCIB UkrSibbank. This analysis does not contain investment research recommendations.

Ukraine: Steeled for a Slowdown Activity: impaired by steel

The ongoing economic recovery is set to slow somewhat against the backdrop of falling steel prices and with export receipts expected to be modest in Q3.

GDP growth is expected to remain around 5.0% y/y in Q2, reflecting favourable base effects, but should slow to 4.0% for the year as a whole.

The impact of the deceleration of the industrial recovery on domestic demand should be limited as the latter is supported by expansionary fiscal policy. Nominal wage growth has accelerated to nearly 15% y/y with real wages rising by 6.2%.

The current and capital accounts (excluding FX intervention) both went into positive territory in April, resulting in a balance of payments surplus of 1% of GDP. Although the performance of the external accounts has exceeded our expectation so far this year, recent turmoil should slow financial inflows.

Inflation: down sharply CPI inflation has slowed to 8.5% y/y due to

falling food prices over the last two months. We have lowered our full-year forecast to 9.0%.

The key (potential) inflation driver is the adjustment of energy prices and public utility tariffs. Public utility tariffs are to be revised partially, raising the CPI by around 1%.

The lion’s share of the price adjustment will probably be implemented next year after local authority elections, which are expected to take place in October.

Policy: budget deficit in spotlight The 2010 budget targets a deficit of 5.6% of

GDP, in line with the IMF’s requirements. However, the planned 20% y/y increase in

government expenditure in nominal terms raises doubts about the ability of the general government to meet the deficit target.

The IMF sees the need for a further reduction of the deficit and the start of reforms to alleviate pressure on public finances from the pension fund (deficit is projected at 7% of GDP) and subsidies in the energy sector (1% of GDP).

The UAH has been nailed to 7.92 by the CB’s buying of excess FX supply, pumping liquidity into the system. While we are generally optimistic about the currency, the risks are skewed to the downside.

Talks with the IMF are likely to resume in H2 and will probably result in a larger programme, provided the Ukrainian authorities’ commitment to reducing the budget deficit is strengthened.

Ukraine: Economic Forecasts 2008 2009 2010(1) 2011(1) 2012(1)

GDP (% y/y) 2.1 -15.0 4.0 3.5 3.7 CPI (% y/y) 22.3 12.3 9.0 11.5 10.5 Current Account (% GDP) -7.2 -1.7 -0.8 -1.5 -2.3 Budget Balance (% GDP) -1.1 -6.5 -5.6 -3.5 0.5 Gross Gov. Debt (% GDP) 20.0 33.0 37.5 39.5 37.5 Base Rate (%) (2) 22.0 10.3 9.5 9.5 10.0 USD/UAH (2) 7.8 8.0 8.0 7.7 7.5 (1) Forecast (2) End Period Source: UkrSibbank

Chart 1: Steel Prices and Industrial Production (% y/y)

-100

-50

0

50

100

150

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10-40

-30

-20

-10

0

10

20Steel Prices (RHS) Industrial Production

Source: SSC

Demand for steel has dried up as consumers reduce stocks,fearing global growth could falter. This fall in demand will have an immediate impact on Ukrainian industrial production.

Chart 2: Industrial Production and Real Wages (% y/y)

-40

-30

-20

-10

0

10

20

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10-20

-15

-10

-5

0

5

10

15

20

Industrial Production Real Average Wages (RHS)

Source: SSC

Real wages generally follow IP. The expansionary budget should prevent wages from falling, supporting domestic demand.

Julia Tsepliaeva July 2010Global Outlook 52 www.GlobalMarkets.bnpparibas.com

Chart 1: GDP Growth and Oil Prices

GDP (%y/y)

-15

-10

-5

0

5

10

15

1Q07 4Q07 3Q08 2Q09 1Q10

Oil Price (Urals, USD/bbl) - RHS

0

20

40

60

80

100

120

140

Source: FSSS, Bloomberg

High oil prices are essential to the economy’s recovery. Being optimistic about the price trend, we expect an acceleration in the pace of the recovery in Q2-Q4 2010.

Chart 2: Personal Income and Retail Turnover (% y/y)

Real Disposable Income

Retail Turnover

-15

-10

-5

0

5

10

15

20

25

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10

Real Wage

Source: FSSS, BNP Paribas

With solid rebounds in incomes, wages and pensions, consumption growth is likely to accelerate in Q2-Q4 2010 and continue in 2011.

Chart 3: Inflation and Policy Rate

CPI (% y/y)

5

7

9

11

13

15

17

Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10

Refi Rate (%)

Source: CBR, FSSS, BNP Paribas

The CBR could still cut the key rate to 7.25%. However, monetary tightening is set to begin in 2011 as inflation accelerates.

Russia: Recovery in Consumption Visible

Activity: recovery in consumption visible We are reducing our GDP growth forecast for

2010 from 4.9% to 4.7% while maintaining our projection for 2011 at 4.2%. Although we remain optimistic about oil prices (BNPP expects Urals to average USD 80/bbl in 2010), turbulence in the EU is likely to limit capital inflows into Russia, making us more bearish on the pace of recovery in the coming months. We are cutting our forecast for capital inflows in 2010 from USD 50bn to USD 20-25bn.

The recovery in industrial production accelerated in Q2. Furthermore, a recovery in consumption is now apparent, with retail turnover rising. We forecast further increases in consumption in H2 2010 and beyond. However, capital investment remains weak.

We believe that the recovery in inventories could be surprisingly solid. GDP growth of 2.9% y/y in Q1 suggests that the main rebound in inventories has not yet materialised and should occur in Q2-Q3. We flag up the low base of comparison and the large role of the government in investment plans.

Inflation: disinflation slowing but likely to continue CPI disinflation is continuing although its pace

slowed in May. We expect inflation to bottom in July before gradually starting to pick up. Nevertheless, we are revising our end-2010 inflation forecast down from 8.0% to 7.1%.

After the deceleration in disinflation, the CBR said that rates may remain unchanged in the coming months.

Nevertheless, we expect the refi rate to be cut to a low of 7.25% in July-August, with the CBR then leaving the rate unchanged for the rest of 2010. Monetary tightening will come on the heels of an acceleration in inflation in 2011.

Policy: fiscal easing calls for greater issuance After tapping the markets for USD 5.5bn in May

2010, the government may issue a further USD 5-12bn in September-November, provided global conditions have improved.

Higher oil prices have resulted in extra oil revenues for the budget. We expect this to prompt the government to increase the wages of public sector employees and pursue additional fiscal easing in 2010-11. The government has already announced that it will raise spending by RUB 300bn (0.7% of GDP) this year.


Russia: Economic & Financial Forecasts


Components of Growth GDP (% q/q) nsa - - - - - -23.5 7.4 13.8 4.7 -18.2 9.6 14.2 3.0 -19.8 10.5 14.4 3.0GDP (% q/q) sa - - - - - -9.0 -0.5 2.5 5.7 -2.7 1.6 4.0 2.6 -4.5 2.4 4.2 2.6GDP (% y/y) 5.6 -7.9 4.7 4.2 4.5 -9.8 -10.9 -8.9 -2.0 2.9 5.0 5.3 5.5 3.5 4.3 4.5 4.5GDP (USD bn) 1662.9 1225.8 1428.8 1642.3 2105.7 244.1 282.1 332.6 367.0 291.5 337.6 390.4 409.4 335.0 388.1 448.7 470.5Private Consumption 10.7 -8.1 4.0 4.0 4.5 -3.2 -7.0 -11.6 -10.2 1.5 3.3 5.8 5.5 3.9 3.6 3.1 5.0Public Consumption 2.9 1.9 1.5 0.3 0.0 1.3 2.0 1.5 2.9 1.0 1.5 1.2 2.4 0.1 0.1 0.3 0.5Fixed Investment 9.1 -18.2 4.0 8.0 7.0 -16.3 -21.7 -20.9 -14.0 -4.5 4.0 8.0 8.0 7.0 7.5 8.0 9.5Exports 0.6 -4.8 6.3 2.0 0.5 -14.5 -8.9 -2.1 4.5 7.5 6.9 5.6 4.7 1.0 2.0 2.0 3.0Imports 14.9 -30.9 8.0 12.0 14.0 -34.3 -37.9 -30.1 -21.2 3.5 6.5 10.0 12.0 12.0 14.0 15.0 15.0Industrial Production 2.1 -11.0 4.8 4.0 3.8 -14.3 -15.4 -11.0 -3.6 5.8 6.5 4.2 2.5 2.7 3.8 4.6 5.0Savings Ratio (%) 25.5 18.8 21.0 21.0 22.3 13.6 16.7 22.1 21.2 18.0 21.0 22.0 22.5 18.0 21.1 21.8 23.3 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 14.1 11.8 6.3 8.1 9.8 13.9 12.6 11.5 9.3 7.3 5.8 5.4 6.6 7.1 7.9 8.3 8.9CPI (2) 13.3 8.8 7.1 9.2 8.5 14.2 12.0 10.8 8.8 6.5 5.5 5.5 7.1 7.3 8.1 8.5 9.2Unemployment Rate (%) 6.7 8.2 8.0 7.5 7.0 9.2 8.3 7.6 8.2 8.6 8.0 7.5 8.0 8.0 7.8 7.3 7.5 Year 2009 2010 2011 External Trade ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Trade Balance (USD bn) 179.8 110.6 158.6 110.0 100.0 19.1 24.4 33.1 34.0 46.0 38.0 36.8 37.8 20.7 23.0 30.0 36.3Current Account (USD bn) 98.9 47.5 70.0 40.0 20.0 9.3 7.6 15.0 15.6 33.9 15.0 11.1 10.0 10.0 10.0 10.0 10.0Current Account (% GDP) 5.9 3.9 4.9 2.4 0.9 3.8 2.7 4.5 4.3 11.6 4.4 2.8 2.4 3.0 2.6 2.2 2.1 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Financial Variables Gen. Gov. Budget (% GDP) 4.1 -6.4 -4.5 -3.5 -3.0 -0.4 -4.0 -4.7 -6.4 -3.4 -3.8 -4.0 -4.5 -1.0 -1.5 -2.2 -3.5Gross Gov. Debt (% GDP) (2) 5.7 8.4 11.0 14.5 17.6 7.3 7.5 7.8 8.4 8.9 10.0 10.5 11.0 12.0 13.0 13.8 14.5 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (2) Official Interest Rate (%) 12.0 8.75 7.25 9.00 9.00 13.00 11.5 10.00 8.75 8.25 7.75 7.25 7.25 7.50 7.75 8.50 9.003-Month Rate (%) 21.8 7.05 5.80 6.00 6.0 16.50 11.8 10.50 7.05 5.00 4.7 5.00 5.80 6.00 6.00 6.50 6.00USD/RUB 29.38 30.24 31.37 30.00 30.14 34.01 31.29 30.09 30.24 30.51 30.48 30.78 31.37 32.00 31.28 30.41 30.00Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Kazakhstan: Oil-Driven Surprise

Activity: confidence in the recovery has risen The economic recovery has accelerated

sharply with GDP growth of 7.1% y/y in Q1 2010. This encouraged the government to raise its growth target to 7% for 2010 as a whole. Unfortunately, base effects will not be supportive for growth in H2 2010, affecting the final figure, in our view. We maintain our forecast of GDP growth of 4% and 5% for 2010 and 2011 respectively.

Industrial output, which rose 11.8% y/y in the first four months of the year, remains the main driver of growth. Meanwhile, we have already seen a sizable rebound in consumption (in January to April, retail turnover rose 10.8% y/y) supported by the 25% hike in the salaries of government employees in Q2.

We also expect a strengthening of the current account in 2010. High oil prices are very supportive for exports, while the rebound in imports has been modest.

Inflation: CPI inflation remains high Although CPI inflation started to slow in Q2, it

remained high at 7% y/y in May. We expect further gradual disinflation in the coming months. Thereafter, the rebound in consumer demand and reversal of base effects may lead to an acceleration in inflation from Q4 2010.

Policy: healthier fiscal policy With inflation relatively high and at risk of

accelerating, the NBK is likely to refrain from monetary easing (it prefers to keep real rates above zero). We see growing incentives for the NBK to allow tenge appreciation, especially if Urals oil moves and stays above USD 80/bbl.

The NBK has already become more tolerant of tenge strengthening, setting its corridor at KZT 127.5-165.0 against the USD. A current account surplus, combined with solid capital inflows, support a rise in the currency especially given the trend in the rouble (Russia is Kazakhstan’s main trading partner).

Fiscal stimuli remain high in 2010, which will raise the budget deficit to 4% of GDP. However, we see a strong political will to cut the budget deficit from 2011 onwards, limiting the size of the oil transfer to the budget. Therefore, the National Fund could reach USD 28bn by the end of 2010.

Kazakhstan intends to re-enter the eurobond market, issuing USD 0.5-0.7bn of bonds in H2 2010 to establish a benchmark for corporate-sector borrowing. A more careful policy towards borrowing should help to prevent an overheating of the economy in the future.

Kazakhstan: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 3.3 1.1 4.0 5.0 5.0 CPI (% y/y) 9.5 6.2 7.0 7.0 6.5 Current Account (% GDP) 4.7 -2.9 2.2 1.5 -0.5 Budget Balance (% GDP) -2.1 -3.0 -4.0 -3.6 -3.3 Gross Gov. Debt (% GDP) (2) 5.0 10.1 13.3 15.4 16.7 Base Rate (%) (2) 10.5 7.0 7.0 7.0 7.0 USD/KZT (2) 121 150 130 130 130 (1) Forecast (2) End Period

Source: BNP Paribas Chart 1: Oil Prices and the Recovery (% y/y)

-15

-10

-5

0

5

10

15

Jan 08 May 08 Sep 08 Jan 09 May 09 Sep 09 Jan 10

Retail Turnover

Industrial Production

0

20

40

60

80

100

120

140

160

Urals (USD/bbl) (RHS)

Source: KazStat, Bloomberg, BNP Paribas

High oil prices are stimulating the economic recovery. Industrial growth remains the main driver, while consumption has begun to recover.

Chart 2: Inflation Remains Relatively High (% y/y)

0

10

20

30

40

50

60

70

80

90

100

04 05 06 07 08 09 10

M3

CPI (RHS)

0

5

10

15

20

25

Source: MoF, BNP Paribas

With the inflation rate remaining relatively high, the NBK is likely to refrain from monetary easing.


Poland: Growth Momentum Slowing

Activity: signs of a slowdown While the economy continued expanding in

Q1, by a healthy 3.0% y/y, there are signs of a slowdown. Quarterly growth moderated to just 0.5% and was mainly driven by restocking.

A slump in investment was not merely driven by the harsh winter. The overall outlook for capital spending remains weak, given the uncertain prospects for the European economy, low capacity utilisation, the continuing credit crunch, and the Polish government’s inability to markedly increase investment in the public sector.

All this bodes ill for the labour market and we expect only soft disposable income growth ahead, preventing a sustainable recovery in consumption until late 2011 at the earliest.

The recent weakening of the zloty, if sustained, points to an improving outlook for net exports. However, with a stronger USD pushing up the prices of imports (for example, energy commodities), we expect the underlying trade and current account balances to deteriorate.

Inflation: heading below the target Dollar strength also points to higher food and

fuel prices ahead. We have revised up our inflation forecasts for 2010 by 0.2pp and for 2011 by 0.4pp.

However, the weakness of the labour market suggests second-round effects will be limited, so we expect inflation to stay below the central bank’s target of 2.5% y/y. We expect core inflation to fall below 1.0% y/y next year.

Policy: fiscal tightening must accelerate Elections have been brought forward after the

death of President Kaczynski in an air crash in April. The candidate of the ruling party, Bronislaw Komorowski, has won the first round on 20 June. Although his victory was narrower than polls suggested, he remains in pole position for the second round on 4 July.

His eventual victory should, hopefully, allow faster fiscal tightening. While Poland’s public debt-to-GDP ratio is still relatively modest, the budget deficit has surged on loose policy and weak growth.

Former PM and finance minister Marek Belka has become the new NBP governor. We

expect Mr Belka to be a highly pragmatic policymaker.

Our growth and inflation forecasts are consistent with unchanged policy rates until late 2011.

Poland: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 5.2 1.7 2.9 2.0 2.8CPI (% y/y) 4.1 3.5 2.3 1.9 1.5Current Account (% GDP) -5.1 -1.6 -1.1 -2.2 -2.3Budget Balance (% GDP) (2) -3.6 -7.0 -7.1 -6.6 -4.3Gross Gov. Debt (% GDP) (3) 47.2 51.0 54.6 59.0 59.5Base Rate (%) (3) 5.00 3.50 3.50 3.75 4.25EUR/PLN (3) 4.12 4.10 4.00 3.95 3.75(1) Forecast (2) ESA-95 (3) End Period

Source: BNP Paribas Chart 1: Slowing Growth Momentum


Coincident and leading indicators suggest that the momentum in the economy is slowing. We expect softer growth ahead.

Chart 2: Bold Disinflation Ahead


Despite its recent weakening, the zloty continues to show a rise in year-on-year terms. Together with a lack of demand pressure, the zloty’s appreciation argues for further disinflation over the next several months.


Hungary: Not Greece

Activity: growth is back Growth surprised greatly to the upside in Q1,

outpacing even our optimistic expectations. The economy expanded by nearly 1.0% q/q, which allowed GDP to rise in year-on-year terms. However, the outlook is uncertain as growth is mainly being driven by restocking. Furthermore, recent PMI readings have been disappointing.

However, strong carry-over effects argue for growth for the entire year, especially as consumption is set to improve in the second half of 2010. The fading impact of last year’s VAT hike will provide households with higher real disposable income, which should support spending.

Overall, we expect net exports to remain a significant contributor to growth, particularly given the recent weakening of the forint.

Inflation: disinflation to accelerate The strengthening of the dollar points to higher

food and fuel inflation ahead. However, a wide output gap suggests a further moderation in core readings.

We expect disinflation to continue, particularly from July onwards, once the impact of higher VAT fades. While we expect inflation to remain below the 3% target in 2011 and 2012, the risk of deflation has diminished markedly due to supply-side factors.

Policy: more rate cuts ahead The previous government delivered a

substantial tightening, despite the deep economic crisis. Hungary’s cyclically adjusted deficit has been one of the three lowest in the OECD countries, and the structural primary surplus surpassed 2.5% of GDP last year.

Details of the new government’s policy agenda are still unclear, but we expect prudent fiscal policy to continue.

A tight fiscal approach will also be necessary to sustain positive developments in the current account and to reduce the external debt-to-GDP ratio.

Given the absence of inflation pressure, and assuming no fiscal loosening, we expect the NBH to continue easing monetary policy. But given higher risk aversion, we are scaling back our rate-cut expectations and see a policy rate trough of 4.75% by Q4 2010 instead of the 4.50% in Q3 2010 we were previously looking for.

The main risk for our interest-rate call comes from further turbulence in Europe’s financial markets.

Hungary: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 0.8 -6.3 1.5 1.2 2.1CPI (% y/y) 5.6 4.3 4.2 2.5 1.4Current Account (% GDP) -7.1 0.2 0.7 0.3 -1.3Budget Balance (% GDP) (2) -3.7 -4.0 -4.5 -4.3 -3.4Gross Gov. Debt (% GDP) (3) 72.9 78.3 78.6 79.6 79.6Base Rate (%) (3) 10.00 6.25 4.75 4.75 5.25EUR/HUF (3) 264 270 270 265 245(1) Forecast (2) ESA-95 (3) End Period

Source: BNP Paribas

Chart 1: Hungary is the Regional Champion in Fiscal Consolidation, and is Certainly Not Greece

Source: Reuters EcoWin Pro, BNP Paribas, OECD

The previous government delivered substantial fiscal tightening and brought the public finances into a sustainable position. This has triggered a significant improvement in the current account.

Chart 2: Growth Has Returned


Growth will support a further reduction of the budget deficit and help the public debt-to-GDP ratio to move lower. An export-driven recovery should allow the external debt-to-GDP ratio to be reduced.


Czech Republic: Policy Coordination is Key

Activity: fragile recovery While GDP growth exceeded 1.0% y/y in Q1, the

pace of recovery stabilised at 0.5% q/q. Moreover, the economy was predominantly driven by the rebuilding of inventories, while net exports disappointed.

The performance of net exports suggests the growth momentum will slow in the second half of the year, especially since weaker demand in the eurozone will be coupled with relative koruna strength, further hurting exports.

With exports the key determinant of growth, slowing foreign sales mean soft growth in investment and consumption, despite recent signs of improvement in the labour market.

The expected fiscal tightening will also reduce growth, particularly next year. Although reduced government spending should have a small impact on GDP, it will prevent a deeper and more sustainable economic recovery until 2012.

On a positive note, low public and external debt ratios make the Czech Republic relatively immune to turbulence in the financial markets.

Inflation: falling core prices are the new reality We have revised up our CPI forecast for the rest

of the region, due to a stronger USD. We expect headline inflation in the Czech Republic to temporarily breach the CNB’s 2% target by late 2011 due to rising food and fuel prices.

However, underlying inflation pressure will be absent and we expect further core deflation, driven by a still-wide output gap and a relatively strong nominal effective exchange rate.

Policy: no need for a tighter policy mix Centre- and right-wing parties won May’s

parliamentary elections by a surprisingly large margin. The new government is committed to reducing the budget deficit over the coming years and we expect that this will be achieved mainly through spending cuts. Fortunately, a low public debt-to-GDP ratio will allow the government to take a gradual approach to reducing the deficit.

But as fiscal policy is tightened, monetary policy will have to stay loose or be eased even further to prevent adverse developments in the real economy.

However, with CPI inflation gradually inching higher while external accounts underperform expectations, we think currency intervention is much more likely than further rate cuts.

Czech Republic: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 2.3 -4.0 1.8 2.7 3.0CPI (% y/y) 6.0 1.1 1.3 2.0 2.0Current Account (% GDP) -0.6 -1.0 -1.0 -0.8 -1.7Budget Balance (% GDP) (2) -2.7 -5.9 -5.5 -4.2 -3.9Gross Gov. Debt (% GDP) (3) 30.0 35.4 39.3 41.9 43.8Base Rate (%) (3) 2.25 1.00 0.75 0.75 1.25EUR/CZK (3) 26.75 26.32 26.00 24.70 23.80(1) Forecast (2) ESA-95 (3) End Period

Source: BNP Paribas

Chart 1: Recovery Remains Shallow and Fragile


Although annual growth readings turned positive in Q1, the economic recovery remains shallow and fragile. Consumption and investment are continuing to fall and net exports have generally disappointed.

Chart 2: Core Prices Will Continue Falling Into 2011


Relative koruna strength coupled with a lack of demand pressure suggests further core deflation ahead. CPI inflation will be pushed higher by food and fuel prices, but should remain below the 2% targetin 2010.


Bulgaria and Romania: Vulnerable Again Bulgaria: the economy continues to contract

sharply due to the ongoing credit crunch. High external debt and the current account deficit make the country even more vulnerable The credit crunch is especially bad news for the

Bulgarian economy, as past growth has been particularly reliant on rapid loan growth. The weakness of the European banking industry and the fact that some 30% of the Bulgarian banking sector’s assets are held by Greek institutions point to an extremely subdued outlook for credit growth.

Although Europe is recovering, both investment and consumption continue to fall in Bulgaria – as does GDP, despite a strengthening of net exports. We expect the rebound in growth readings during the remainder of the year to be slow as, on top of a weak cyclical backdrop and the lack of credit, fiscal policy will have to be tightened. Thus we expect GDP to fall again in 2010.

While public debt remains among the lowest in the EU, the European Commission’s recent concerns about the quality of fiscal data will not help bond spreads, particularly in light of the private sector’s high debt burden and an external debt-to-GDP ratio of around 110%.

We remain concerned not only about this year’s growth performance, but also the outlook for 2011-2012, especially if the turbulence in Europe’s financial markets increases or liquidity problems in the banking sector re-emerge. On a more positive note, the improvement in net exports points to a further reduction of external imbalances.

Romania: the government survived a no-confidence vote, but must actually deliver fiscal tightening measures to reduce the budget deficit The government survived a no-confidence vote

in June. This victory gives the cabinet a stronger mandate to implement fiscal tightening and reduce the deficit – in line with the agreement with the IMF and EU.

However, the likely social protests against wage and pension cuts may make it difficult to fully implement the measures and thus threaten the success of the fiscal consolidation.

Given the ongoing credit crunch, discretionary fiscal tightening will further hurt growth.

We expect another year of GDP contraction in 2010 and only a soft recovery thereafter.

The fiscal tightening plan is based mainly on sharp spending cuts (especially on public sector pensions), which will strengthen deflation pressures. This points to a depreciation of the real exchange rate ahead, but without the need for a more marked weakening of the leu in nominal terms.

However, pressure on the currency will persist for some time, given the stress in financial markets, Romania’s relatively high external debt and the fact that the current account is still in deficit.

Bulgaria: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 6.1 -4.9 -2.5 1.8 4.1CPI (% y/y) 12.0 2.3 -0.3 1.6 1.2Current Account (% GDP) -24.5 -10.2 -2.8 -1.5 -2.8Budget Balance (% GDP) (2) 2.6 -3.6 -4.7 -2.7 -2.7Gross Gov. Debt (% GDP) (3) 14.1 14.8 19.3 20.7 22.13-Month Rate (%) (2) 7.61 4.67 4.10 4.05 4.25EUR/BGN (3) 1.96 1.96 1.96 1.96 1.96(1) Forecast (2) ESA-95 (3) End Period

Source: BNP Paribas

Romania: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 7.7 -7.1 -0.6 0.8 0.9CPI (% y/y) 7.7 5.6 4.0 2.3 1.0Current Account (% GDP) -12.3 -4.4 -4.8 -4.1 -4.2Budget Balance (% GDP) (2) -5.1 -8.3 -7.5 -5.8 -4.7Gross Gov. Debt (% GDP) (3) 13.3 23.7 29.7 34.8 38.4Base Rate (%) (3) 10.25 8.00 5.75 5.75 6.25EUR/RON (3) 4.03 4.23 4.40 4.05 3.80(1) Forecast (2) ESA-95 (3) End Period

Source: BNP Paribas

Chart 1: Both Economies Are Still Contracting

Source: Reuters EcoWin Pro, BNP Paribas Although Europe is coming out of recession, GDP in Bulgaria and Romania continues to contract. We expect both countries to underperform other CEE economies in 2010-2012.

Selim Çakır, Emre Tekmen July 2010Global Outlook 59 www.GlobalMarkets.bnpparibas.com

IMPORTANT DISCLOSURE: This analysis has been produced by Turk Ekonomi Bank A.S. (“TEB”) and has been reviewed, but not amended, by BNP Paribas. BNP Paribas is an indirect shareholder of TEB with a 42.125% stake. This analysis does not contain investment research recommendations.

Turkey: Robust Recovery

Activity: recovering on the back of strong domestic demand The bounce back in growth is strong. The

expansion is mainly being led by domestic demand. Since the beginning of the year, credit has increased at an annualised rate of around 25%, mostly on the back of mortgages and personal loans. The rise in consumption is boosting growth and imports, which, in turn, is putting pressure on the current account deficit and inflation.

Our forecast assumes a moderation of growth in the second half of the year in parallel with the slowdown of economic activity in Europe, the start of the CBT’s tightening cycle, pressure on banks’ balance sheets as public borrowing crowds out borrowing from the private sector, and the inventory cycle reaching an end.

However, a full-year growth rate below 6% for this year looks unlikely unless we see a fall in GDP later in the year. Accordingly, we forecast that growth will reach 7.0% this year and then moderate to 4.0%.

Inflation: the outlook remains challenging The narrowing of the output gap and the

behaviour of non-food prices suggest that the CBT will be unable to lower the inflation rate towards its medium-term target of 5% in the near term.

Indeed, we remain doubtful that the inflation rate will lastingly break below the 7-8% range with the recovery in domestic demand likely to keep core inflation at a high level.

Policy: rate hikes and tight fiscal stance needed In light of the strength of domestic demand, we

believe the CBT will start to hike rates in Q4. After the technical adjustment already seen with the switch of the policy rate to the one-week repo, we expect a rise of 100bp in Q4, dependent on inflation readings in the coming months.

Turkey’s fiscal performance has been strong since the start of the year. A tight fiscal stance is required to contain the current account deficit and inflation pressures.

However, the scheduled constitutional referendum in September 2010 and general elections in July 2011 could lead to a loosening of the fiscal stance in the second half of the year.

Although the government has adopted a sound fiscal rule, its implementation will be crucial to maintain investor confidence.

The structure of the current account deficit’s financing makes it vulnerable to changes in global risk sentiment. The deficit is mostly financed by the foreign exchange reserves of the banking system with additional inflows into the TRY-denominated bond market. Long-term inflows, such as FDI and external borrowing, have been limited so far.

Nevertheless, Turkey could benefit from the global carry trade in light of the expected low interest rate environment, particularly in Europe, and continue to attract portfolio inflows that could result in an appreciation of TRY.

Chart 1: Capacity Utilisation Rate (%)

55

60

65

70

75

80

85

2007 2008 2009 2010

Capacity Utilisation Rate

Capacity Utilisation Rate (sa)

55

60

65

70

75

80

85

2007 2008 2009 2010

Capacity Utilisation Rate

Capacity Utilisation Rate (sa)

Source: CBT

The capacity utilisation rate is approaching its pre-crisis level.

Turkey: Economic Forecasts 2008 2009 2010(1) 2011(1) 2012(1)

GDP (% y/y) 0.7 -4.7 7.0 4.0 4.0CPI (% y/y)(2) 10.4 6.3 9.0 7.5 6.7CPI (% y/y)(3) 10.1 6.5 8.0 7.7 6.9Current Account (% GDP) -5.7 -2.3 -5.0 -5.5 -5.7Budget Balance (% GDP) -1.8 -5.5 -4.3 -3.6 -3.0Gross Gov Debt (%GDP) 40.0 46.3 44.5 42.7 40.9Base Rate (%)(3) 15.00 6.50 8.00 10.00 9.00USD/TRY(3) 1.52 1.49 1.59 1.62 1.54(1) Forecast (2) Average (3) End Period Source: TEB Research

Dominic Bryant July 2010Global Outlook 60 www.GlobalMarkets.bnpparibas.com

Chart 1: Business Investment and Confidence


Surveys suggest that Q1 weakness in business investment will reverse in the coming quarters.

Chart 2: Underlying Inflation Rate (% y/y)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Q1 93 Q1 95 Q1 97 Q1 99 Q1 01 Q1 03 Q1 05 Q1 07 Q1 09 Q1 11

Underlying CPIBNPP

Forecast

RBA Target range

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Q1 93 Q1 95 Q1 97 Q1 99 Q1 01 Q1 03 Q1 05 Q1 07 Q1 09 Q1 11

Underlying CPIBNPP

Forecast

RBA Target range


The underlying inflation rate is likely to remain in the top half of the target range over the coming years.

Chart 3: GDP and FMCI


Financial and monetary conditions already point to a moderation in growth from late 2010.

Australia: Taking a Break

Activity: moderation in H2 2010 At 0.5% q/q, Australian growth disappointed in

Q1 relative to the strength of surveys and other indicators. In the near term, we expect some positive payback with a much stronger performance in Q2. Thereafter, growth will moderate, reflecting less accommodative policy and softer external conditions.

One reason for the soft reading in Q1 was slower consumption growth. However, the momentum in retail sales and car registrations picked up early in Q2, pointing to a better quarter for spending. Beyond Q2, consumption growth looks unlikely to accelerate. Consumer confidence has started to decline, probably reflecting the impact of 150bp of RBA rate hikes since October on mortgage payments.

Investment was also weak at the start of the year. Business investment fell by 3.0% q/q. This looks at odds with surveys and the boom in the mining sector. Therefore a rebound looks likely in Q2 with a shortage of housing and robust mining sector activity supporting strong private investment thereafter. However, public investment will start to slow through the year.

Net trade will remain a drag on GDP growth, reflecting more robust conditions at home than abroad. Demand for Australian commodities shows up in prices rather than volumes. On that score, the sharp increase in the terms of trade early in 2010 should support domestic income.

Inflation: top end of target range Underlying inflation should continue to moderate

as a result of the past economic slowdown and the emergence of spare capacity. However, the slack that appeared in the economy was limited, so underlying inflation is likely to remain near the top end of the target range.

With the labour market recovering quickly, unit labour costs, which had been depressed, are picking up, providing a further reason not to expect underlying inflation to fall substantially from its current rate.

Policy: on hold in the “near term” The RBA recently signalled its intention to keep

the cash rate unchanged in the “near term”. With financial and monetary conditions already restrictive and indicating slower growth ahead, there appears little need to tighten much further currently, especially against the uncertain global backdrop. One additional hike late this year and limited further tightening beyond looks sufficient.


Australia: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - 0.6 0.8 0.3 1.1 0.5 1.2 1.1 1.0 0.8 0.6 0.6 0.7GDP 2.3 1.3 3.4 3.3 3.3 0.7 1.0 0.9 2.8 2.7 3.1 4.0 3.8 4.1 3.5 3.0 2.8Dom. Demand ex Stocks 4.3 1.3 4.9 3.9 3.9 1.0 0.3 0.6 3.3 4.4 5.1 5.6 4.6 4.9 4.1 3.5 3.2Private Consumption 1.9 1.6 2.7 2.3 2.5 0.2 1.7 2.0 2.8 3.1 2.5 2.8 2.4 2.4 2.2 2.2 2.4Public Consumption 3.3 2.8 4.1 1.9 2.3 2.2 2.4 2.2 4.4 4.9 4.8 4.1 2.7 2.2 1.9 1.7 1.8Fixed Investment 9.7 -0.2 9.7 7.8 6.9 1.9 -3.4 -2.8 3.5 6.6 10.2 11.9 9.7 11.0 8.5 6.6 5.4Stocks (Cont. to Growth) -0.5 -0.5 0.8 -0.2 -0.2 -1.6 -0.9 -0.8 1.2 1.3 1.1 0.6 0.4 0.1 -0.1 -0.4 -0.6Exports 3.1 1.4 1.9 2.1 2.7 1.5 -0.4 0.4 4.1 1.8 0.8 3.3 1.8 2.7 2.1 1.8 1.9Imports 11.3 -7.8 14.9 5.2 5.5 -10.6 -14.3 -10.3 5.0 15.7 18.4 16.4 9.6 8.7 5.8 3.6 2.8Industrial Production 3.0 -2.8 4.2 1.8 2.4 -3.2 -4.2 -4.2 0.6 3.4 4.2 6.0 3.3 2.8 2.0 1.2 1.1Savings Ratio (%) 2.2 5.3 2.5 3.0 3.3 6.1 7.5 4.9 2.6 2.7 2.2 2.6 2.6 3.2 2.9 3.1 3.0 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation & Labour CPI 4.4 1.8 3.2 3.3 3.2 2.5 1.5 1.3 2.1 2.9 3.2 3.3 3.5 3.3 3.3 3.3 3.4Underlying CPI 4.4 3.7 2.8 2.9 2.9 4.2 3.9 3.5 3.4 3.1 2.7 2.6 2.7 2.7 2.8 3.0 3.0Employment 2.2 0.3 2.6 2.3 2.3 0.6 0.1 -0.1 0.6 1.8 2.6 3.1 2.9 2.6 2.4 2.2 2.1Unemployment Rate (%) 4.2 5.6 5.1 4.9 4.8 5.3 5.7 5.8 5.6 5.3 5.2 5.1 5.0 4.9 4.9 4.9 4.9 Year 2009 2010 2011 External Trade ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Trade Balance (AUD bn) -8.9 -6.8 -8.2 3.4 -16.4 3.6 -0.9 -3.9 -5.6 -4.6 -2.1 -1.6 0.0 1.3 1.7 1.1 -0.7Current Account (AUD bn) -54.4 -51.4 -57.6 -48.4 -70.6 -6.5 -12.7 -13.8 -18.5 -16.6 -14.4 -13.6 -13.0 -11.2 -11.5 -11.4 -14.3Current Account (% GDP) -4.4 -4.1 -4.3 -3.4 -4.6 -2.1 -4.1 -4.4 -5.8 -5.1 -4.3 -4.0 -3.8 -3.2 -3.2 -3.2 -3.9 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables(3) Gen. Gov. Budget (AUD bn) -29.7 -51.6 -33.3 -12.2 -1.9 - - - - - - - - - - - -Gen. Gov. Budget (% GDP) -2.4 -4.1 -2.4 -0.8 -0.1 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 19.5 23.7 24.4 24.2 23.7 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest & FX Rates (2) Cash Rate 4.25 3.75 4.75 5.00 5.25 3.25 3.00 3.00 3.75 4.00 4.50 4.50 4.75 4.75 4.75 5.00 5.003-Month Rate (%) 4.83 4.10 5.05 5.25 5.50 3.67 3.50 3.42 4.10 4.36 4.91 4.90 5.05 5.00 5.00 5.25 5.2510-Year Bond Yield (%) 4.00 5.73 5.20 5.80 6.00 4.61 5.62 5.40 5.73 5.79 5.34 5.15 5.20 5.25 5.40 5.60 5.80AUD/USD 1.41 0.90 0.90 0.95 0.90 0.69 0.81 0.88 0.90 0.92 0.84 0.86 0.90 0.94 0.97 0.97 0.95Footnotes: (1) Forecast (2) End period (3) Fiscal years Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Richard Iley July 2010Global Outlook www.GlobalMarkets.bnpparibas.com

62

Chart 1: Industrial Expansion Matures

03 04 05 06 07 08 09 10175

200

225

250

275

300

325

350 Industrial Production (BNPP, sa)

Post-2002 trend

03 04 05 06 07 08 09 10175

200

225

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275

300

325

350 Industrial Production (BNPP, sa)

Post-2002 trend


India’s recovery has been led by the industrial sector. Four successive quarters of booming, double-digit output growth have seen production first regain, then exceed, its pre-crisis peak.

Chart 2: Pipeline Inflation Pressures

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5 WPI BNPP Measures of Central Tendency (% 6-month annualised)

10% Trimmed Mean

US-Style ‘Core'


Our two bespoke gauges of core WPI inflation have signalled that generalised, demand-push manufacturing inflation pressures have been uncomfortably strong for at least six months.

Chart 3: ‘Calibrated’ Policy Tightening (%)

02 03 04 05 06 07 08 09 104.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Repo Rate

Cash Reserve Ratio


The RBI has been content to normalise policy at a leisurely pace so far in 2010. The combination of the European debt crisis and hopes for a normal monsoon should see ‘calibrated’ hikes continue.

India: Risky Business Activity: maturing expansion

GDP growth picked up to 8.6% y/y in Q1 2010 as agricultural production snapped back from 2009’s poor monsoon while non-agricultural output, still led by booming industrial production, improved by 10.0% y/y.

The expansion is expected to remain robust despite the fading of the fiscal stimulus. Monetary conditions remain supportive and lead indicators, such as cement dispatches and airport cargo, show buoyancy. The latest data show the manufacturing boom continuing in Q2 although output growth rates should fall into single-digit territory in H2 as base effects become more challenging.

Non-food credit growth has, encouragingly, continued to accelerate steadily, picking up to 18.5% y/y. Given India’s low trade shares, the fallout from the European debt crisis is expected to be slight. We forecast GDP growth of 9.2% in FY 2011 and 8.8% in FY 2012.

Inflation: core pressure WPI inflation briefly touched 11% y/y in March

before falling by around 1pp in recent months as food inflation (around 27% of the index) has subsided, dropping from a record 22.6% around the turn of the year to a still-high 12.1% in May.

Assuming a normal monsoon this year, food inflation should decline more rapidly in H2 2010.

Falling food prices are needed to offset uncomfortably strong core rates of manufactured inflation as demand-push inflation continues to build, a development that even the RBI has now recognised. With a normal monsoon, overall WPI inflation should subside to around 5.5% by Q1 2011 as the RBI expects. But if the monsoon disappoints again, all bets are off.

Policy: calculated gamble Despite the now-clear evidence of demand-push

inflation, the RBI has continued to normalise still-slack monetary policy at a leisurely or ‘calibrated’ pace. The uncertain global backdrop and the need to support the government’s heavy borrowing programme this year are explicit factors deterring the CB from raising rates more quickly. Implicit has been the gamble that a normal monsoon will muffle rising core inflation until the current calibrated pace of rate hikes turns policy restrictive in H1 2011.

Until a clearer picture of this year’s monsoon emerges, and given financial market volatility, policy rates will continue to be pushed up slowly.

Richard Iley July 2010Global Outlook www.GlobalMarkets.bnpparibas.com

63

India: Economic & Financial Forecasts

Fiscal Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Components of Growth GDP 9.2 6.7 7.4 9.2 8.8 5.8 6.0 8.6 6.5 8.6 9.5 8.3 9.6 9.5 9.0 9.0 8.7Final Domestic Demand 11.5 6.9 5.9 9.6 10.9 4.0 3.0 7.0 6.0 7.5 10.9 7.7 8.3 11.7 10.8 10.8 11.0 - Private Consumption 9.8 6.8 4.3 5.6 8.3 5.1 2.9 6.4 5.3 2.6 5.7 3.1 5.0 8.5 8.2 8.3 8.3 - Public Consumption 9.7 16.7 10.5 2.9 13.7 2.5 15.3 30.5 2.5 2.1 4.6 -8.0 -5.2 19.4 15.3 14.0 13.3 - Fixed Investment 15.2 4.0 7.2 19.3 14.1 2.7 -0.7 1.6 8.8 17.7 23.3 21.3 20.0 14.0 13.6 13.6 14.7Exports 5.2 19.3 -6.7 10.0 10.4 1.4 -16.0 -15.8 -7.5 14.2 11.8 13.0 12.7 3.9 9.8 10.6 10.7Imports 10.0 23.0 -7.3 11.5 13.5 -4.4 -8.5 -10.5 -5.8 -3.7 3.9 7.2 12.1 23.9 18.7 13.0 11.6Net Trade (Cont. to Growth, y/y) -1.4 -1.9 0.6 -0.9 -1.4 1.5 -1.6 -0.5 0.0 4.0 1.4 0.6 -0.7 -4.3 -2.8 -1.5 -1.0Industrial Production 8.5 2.7 10.4 11.2 9.2 0.5 3.8 9.0 13.4 15.1 14.7 11.2 10.3 9.2 8.7 9.2 9.5Agriculture & Allied Activities 4.6 1.6 1.6 6.3 4.5 2.8 2.7 2.3 -0.5 2.5 4.6 5.8 7.8 6.4 4.4 4.3 4.6 - Agriculture & Forestry & Fishing 4.7 1.6 0.2 6.1 4.5 3.3 1.9 0.9 -1.8 0.7 3.6 5.4 7.9 6.7 4.4 4.3 4.6 - Mining & Quarrying 3.9 1.6 10.6 7.5 4.6 -0.3 8.2 10.1 9.6 14.0 10.5 8.3 7.3 4.7 4.1 4.3 4.7Industry 10.1 4.1 9.2 11.6 9.0 2.4 4.3 7.6 11.3 13.2 13.0 11.5 12.0 10.0 9.5 9.1 8.8 - Manufacturing 10.3 3.2 10.8 12.0 9.9 0.6 3.8 9.1 13.8 16.3 15.8 12.1 10.7 9.8 9.4 9.8 10.2 - Electricity, Gas & Water Supply 8.5 3.9 6.5 6.3 5.5 4.1 6.6 7.7 4.7 7.1 6.9 4.8 8.0 5.6 5.4 5.4 5.7 - Construction 10.0 5.9 6.5 12.1 8.0 5.7 4.6 4.7 8.1 8.7 9.1 12.1 15.6 11.4 10.6 8.4 6.9Services 10.5 9.8 8.5 9.0 10.0 8.3 7.9 10.7 7.2 8.4 9.4 7.4 9.1 10.1 10.1 10.0 10.1 - Trade, Hotel, Transport & Comm. 10.7 7.6 9.3 11.1 9.8 5.7 5.5 8.5 10.2 12.4 12.2 10.4 12.3 9.6 9.6 9.8 10.0 - FIRE & Business Service 13.2 10.1 9.7 10.9 13.4 12.3 11.8 11.5 7.9 7.9 9.0 9.5 12.4 12.4 13.1 13.3 13.4 - Community, Social & Personal Ser. 6.7 13.9 5.6 2.4 5.8 8.8 7.6 14.0 0.8 1.6 4.1 -1.0 -1.3 8.1 6.4 5.9 5.6Memo Non-Agriculture GDP 10.2 7.7 8.8 9.8 9.6 6.2 6.8 9.7 8.4 10.0 10.5 8.7 10.0 9.9 9.7 9.6 9.5 Calendar Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation WPI 9.1 2.1 8.7 5.1 4.5 3.2 0.5 -0.1 5.0 10.2 10.0 8.3 6.6 5.4 5.2 5.1 4.8WPI (ex. Food & Energy) 9.5 -0.1 7.5 6.1 4.7 3.2 -0.7 -2.6 0.1 5.7 7.6 8.1 8.6 7.3 6.0 5.8 5.2CPI - Industrial Workers 8.3 10.9 10.8 5.8 5.5 9.4 8.9 11.8 13.3 15.3 13.4 9.0 6.3 5.1 6.0 6.0 5.9 Calendar Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 External Trade Trade Balance (USD bn) -124.5 -109.7 -125.4 -166.3 -199.7 - - - - - - - - - - - -Current Account (USD bn) -31.0 -31.5 -35.4 -51.3 -68.7 - - - - - - - - - - - -Current Account (% of GDP) -2.6 -2.7 -2.3 -2.7 -3.0 - - - - - - - - - - - - Fiscal Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Cen. Gov. Budget (INR tn) -1.3 -3.4 -4.1 -3.3 -3.8 - - - - - - - - - - - -Cen. Gov. Budget (% of GDP) -2.6 -6.0 -6.6 -4.6 -4.5 - - - - - - - - - - - -Gross Cen. Gov. Debt (% GDP) (2) 58.6 54.9 57.3 55.9 55.1 - - - - - - - - - - - - Calendar Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest and FX Rates (2) Repo Rate (%) 6.50 4.75 6.00 7.00 7.50 5.00 4.75 4.75 4.75 5.00 5.25 5.50 6.00 6.25 6.50 6.75 7.003-Month Rate (%) 8.45 4.18 6.35 7.70 7.60 7.07 4.35 4.26 4.18 5.00 5.90 5.75 6.35 6.70 7.05 7.35 7.70USD/INR 48.58 46.53 42.00 38.00 38.00 50.56 47.74 47.72 46.53 44.92 45.00 43.50 42.00 41.00 40.00 39.00 38.00Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Richard Iley / Mole Hau July 2010Global Outlook 64 www.GlobalMarkets.bnpparibas.com

Chart 1: Still Inventory Upside

97 98 99 00 01 02 03 04 05 06 07 08 09-4

-3

-2

-1

0

1

2

3Change in Real Inventories (% of GDP)


With inventories still falling, potentially there is significant upside from this area ahead. A levelling off in inventories would add 0.7pp to q/q GDP growth in Q2.

Chart 2: Core CPI vs. Output Gap

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11-12.5

-10.0

-7.5

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0.0

2.5

5.0

7.5

-7

-6

-5

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-2

-1

0

1

2

3

4 BNPP Forecast

* HP-Filter Method

4-Quarter Change, % Points

Output Gap* (lagged 4 quarters, %, RHS)

US-Style Core CPI y/y Inflation


With the excess capacity seen during the crisis having been eroded, demand pressures are likely to ensure that core inflation accelerates quite rapidly next year.

Chart 3: Policy Rates Too Low

02 03 04 05 06 07 08 09 10

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00-0.5

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0.5

1.0

1.5

2.0

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3.0

3.5

4.0

4.5

5.0

5.5

7-Day Repo Rate (%)

Unemployment Rate (%, inverted, RHS)


The strength of the labour market is a key factor behind the BoK’s move towards hiking. Unemployment has recovered from its distorted January print and now signals that the policy rate is too low.

South Korea: Barrelling Along Activity: barrelling along

The South Korean economy retains considerable thrust. Helped by record-low policy rates and the persistent undervaluation of the KRW, the economy continued to barrel along at an above-trend pace in Q1, booming by 8.8% q/q annualised, roughly twice its estimated trend growth rate.

Industrial production remains the main engine of growth, up 4.2% q/q in Q1. Given favourable base effects and sky-high manufacturing confidence, Q2 production growth looks likely to be at least 3% q/q.

By demand, household consumption has been solid as private-sector labour demand strengthens briskly. Exports have boomed and capex is showing welcome signs of revival as spare capacity shrinks. In contrast to figures from many other economies in the region, the Q1 data suggest considerable upside remains from the inventory cycle. A levelling off in inventories would add 0.7pp to q/q GDP growth in Q2. Q2 growth looks on course to be around 1.5% q/q, which would probably eliminate any residual spare capacity. A reduced contribution from inventories and more sluggish export markets may see growth slow somewhat in H2 but it should still reach a solid 6.2% for the full year.

Inflation: contained for now Headline CPI inflation remains within the BoK’s

target range but our US-style measure of core inflation is well below the lower band, reflecting the gradual appreciation of the KRW since early 2009 and the past weakness in activity. But with the economy now back to full capacity and growing strongly, domestically-generated inflation pressures will begin to build. Core price pressures are seen steadily building in H2 2010 and into 2011. Core inflation should pick up to around 3.25% in 2011, an uncomfortable rate for the BoK.

Policy: moving towards policy normalisation Muted current inflation and unusual political

pressure from the government, combined with heightened global financial market stress and tensions with the North, caused the BoK to back away from rate hikes in H1 2010. However, the June statement moved the BoK a step closer to hiking rates in Q3, noting the upward trend in activity, demand-pull inflation pressures and the importance of price stability. A July hike is likely.

Recent wild swings in the KRW could prompt new currency controls but it would be hard to justify a delay of the hike in the absence of a further heightening of the European debt crisis and geopolitical tensions. The delayed start to policy normalisation implies upside inflation risks in 2011 and could further jeopardise medium-term financial stability.

Richard Iley / Mole Hau July 2010Global Outlook 65 www.GlobalMarkets.bnpparibas.com

1

South Korea: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - 0.2 2.4 3.2 0.2 2.1 1.4 1.0 0.7 0.9 0.7 0.8 0.9GDP 2.3 0.2 6.3 3.5 3.8 -4.1 -2.1 1.1 6.1 8.1 7.0 4.7 5.3 4.0 3.4 3.2 3.4Domestic Demand ex. Stocks 0.8 0.7 4.9 3.6 3.8 -3.4 -0.5 1.0 5.9 7.1 4.8 3.6 4.3 3.5 3.5 3.7 3.6Private Consumption 1.3 0.2 3.8 3.9 4.0 -4.4 -0.9 0.7 5.8 6.3 3.5 2.3 3.0 3.4 3.8 4.3 4.2Public Consumption 4.3 5.0 4.8 3.3 3.7 7.2 6.3 5.3 1.1 3.9 4.0 4.0 7.3 2.5 2.7 3.8 4.2Fixed Investment -1.9 -0.6 7.4 3.0 3.4 -6.8 -3.2 -0.5 8.9 10.4 8.0 6.0 5.3 4.2 3.2 2.6 2.1Stocks (Cont. to Growth, y/y) 0.6 -3.8 2.6 0.6 0.0 -4.4 -5.8 -4.0 -1.0 2.0 3.8 2.5 2.2 1.4 0.8 0.2 0.2Exports 6.6 -0.8 9.8 7.1 8.8 -10.7 -3.1 1.3 10.0 17.1 8.5 5.8 8.5 7.3 6.8 7.0 7.5Imports 4.4 -8.2 14.4 9.3 9.2 -18.7 -12.9 -7.5 8.6 21.2 14.5 10.1 12.6 10.1 9.4 9.1 8.9Net Trade (Cont. to Growth, y/y) 1.1 3.0 -1.0 -0.5 0.3 3.0 4.1 3.9 1.2 -0.2 -1.6 -1.3 -1.0 -0.6 -0.7 -0.5 -0.2Industrial Production 3.4 -1.3 15.8 4.5 5.5 -16.2 -6.5 2.2 17.9 26.7 17.3 10.8 10.3 5.9 3.6 3.9 4.5 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation CPI 4.7 2.8 2.7 3.2 3.1 3.9 2.7 2.0 2.4 2.7 2.7 2.6 2.7 2.9 2.9 3.2 3.7Core CPI (ex. Food & Energy) 3.6 3.0 2.0 3.2 3.2 3.8 3.0 2.7 2.3 1.9 1.8 2.0 2.2 2.8 3.3 3.3 3.4 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 External Trade Trade Balance (USD bn) 5.7 56.1 34.2 26.6 28.3 - - - - - - - - - - - -Current Account (USD bn) -5.8 42.7 17.9 14.8 17.1 - - - - - - - - - - - -Current Account (% of GDP) -0.6 5.1 1.6 1.2 1.2 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Cen. Gov. Budget (KRW trn) 11.9 -17.6 11.0 14.0 16.0 - - - - - - - - - - - -Cen. Gov. Budget (% GDP) 1.2 -1.7 0.9 1.1 1.2 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 24.4 23.5 25.5 26.1 23.9 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest and FX Rates (2) 7-Day Repo Rate (%) 3.00 2.00 2.75 3.50 5.00 2.00 2.00 2.00 2.00 2.00 2.00 2.25 2.75 3.00 3.25 3.50 3.503-Month Rate (%) 3.93 2.86 3.05 3.70 5.40 2.43 2.41 2.75 2.86 2.90 2.70 2.75 3.05 3.30 3.50 3.65 3.70USD/KRW 1262 1164 1050 1000 1000 1372 1273 1175 1164 1120 1150 1100 1050 1030 1020 1010 1000Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Chart 1: Rapid Inventory Accumulation

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Q1 91 Q1 94 Q1 97 Q1 00 Q1 03 Q1 06 Q1 09

Change in Inventories/GDP (%)


Inventories were built at a rapid pace in Q1 2010. Such a pace is unsustainable, implying inventories will be a drag on growth in the remainder of the year.

Chart 2: GDP and Industrial Production


Industrial production has been soft in recent months such that the momentum for Q2 is negative. However, such weakness is likely to prove temporary.

Chart 3: Unemployment and Interest Rates (%)

0.00

0.50

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1.50

2.00

2.50

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4.50

5.00

Q300 Q302 Q304 Q306 Q308 Q310 Q312

-1.5

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1.0

1.5

Unemployment Gap (pp., Actual Rate minus Trend, Inverted, RHS)

Discount Rate (%)

BNPP Fcast

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Q300 Q302 Q304 Q306 Q308 Q310 Q312

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Unemployment Gap (pp., Actual Rate minus Trend, Inverted, RHS)

Discount Rate (%)

BNPP Fcast


Policy tends to lag unemployment. With the unemployment rate declining quickly, the CBC has started to raise rates.

Taiwan: Gradual Normalisation Activity: more than just a recovery

The bounce back in the Taiwanese economy has been phenomenal since the financial crisis. Output is now above trend, as the economy has moved from recovery into an expansion phase. The strength of the Taiwanese economy reflects strong export growth, driven primarily by China and other Asian economies, and robust domestic demand.

Growth remained strong in Q1 at 2.7% q/q. But the expenditure breakdown shows inventories contributed close to 2.5pp to the rise in GDP. With the rapid accumulation of inventories unsustainable, the change in inventories is likely to have weighed heavily on GDP growth in Q2.

Soft industrial production also suggests growth weakened in Q2. In fact, GDP could have stalled for a quarter. Temporary factors related to the seasonal adjustment of production data mean this figure will exaggerate the extent of the slowdown.

H2 2010 should see a renewed pick-up in growth, albeit with considerably less momentum than seen from Q2 2009 to Q1 2010. Taiwan is still heavily dependent on export developments. While the impact from problems in Europe should be limited, a moderation in demand from China on the back of policy tightening will lead to slower export growth.

A slowdown in export growth will have some knock-on impact on domestic demand, but with financial and monetary conditions still loose, domestic growth should remain robust. Overall, growth should be close to 9% in 2010 before experiencing a primarily inventory-induced softer patch in 2011.

Inflation: contained in 2010 and 2011 As the economy has normalised, Taiwanese core

inflation has picked up. At 0.3% y/y, it is close to its average of recent years. The slowing of growth in the near term, some limited spare capacity in the labour market and the impact of a strengthening TWD over the past year should cap core inflation into 2011. However, once the economy starts to grow above trend again, core pressures will build.

Policy: rate hikes have started Given the economy has normalised, monetary

policy now needs to do the same. The CBC took its first step with a 12.5bp hike at its late Q2 meeting. A further 12.5bp hike is likely at the late Q3 meeting. Thereafter, we see rates rising by 25bp per quarter over the following year. While this looks like a modest pace of increase, it is slightly quicker than seen in the previous upturn.


Taiwan: Economic & Financial Forecasts


Components of Growth GDP (% q/q) - - - - - -2.9 4.7 2.7 3.9 2.7 0.1 1.1 0.7 0.6 0.9 0.9 1.2GDP 0.7 -1.9 9.1 3.1 4.4 -10.1 -5.6 0.5 8.4 14.8 9.7 8.0 4.6 2.5 3.2 3.1 3.7Domestic Demand ex. Stocks -2.8 -1.2 5.6 3.3 3.7 -7.6 -4.7 0.8 7.2 7.2 7.4 5.7 2.2 3.9 3.3 3.1 3.1Private Consumption -0.6 1.4 2.3 3.4 3.1 -2.1 -0.6 2.4 6.0 3.1 3.1 3.0 0.1 3.5 3.5 3.3 3.1Public Consumption 0.7 3.6 1.5 1.9 2.0 4.9 2.9 3.7 3.1 1.5 1.8 1.5 1.4 1.7 1.8 1.9 2.0Fixed Investment -10.6 -12.0 19.8 4.1 6.3 -28.9 -21.1 -5.8 14.4 26.7 27.6 17.6 9.7 6.3 3.6 2.9 3.4Stocks (Cont. to Growth, y/y) 1.1 -2.4 2.3 -0.7 -0.1 -3.6 -1.7 -2.9 -1.5 4.9 1.7 2.1 0.7 -1.7 -0.5 -0.4 -0.3Exports 0.6 -9.1 25.4 7.7 11.1 -27.9 -16.5 -6.4 20.2 41.6 28.5 20.3 15.2 9.6 7.0 6.6 7.7Imports -3.1 -13.4 28.7 7.5 11.6 -33.1 -19.4 -11.9 16.7 48.8 32.7 23.6 15.6 8.9 7.1 6.6 7.4Industrial Production -1.8 -8.1 24.9 3.5 5.4 -29.6 -16.6 -6.1 29.5 48.6 27.5 19.3 10.4 2.7 4.0 3.8 3.6 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Inflation CPI 3.5 -0.9 0.9 0.6 1.2 0.0 -0.9 -1.3 -1.3 1.3 1.1 0.7 0.6 -0.1 0.3 0.8 1.3Core CPI (ex. Food & Energy) 1.3 -0.6 0.3 0.5 0.7 0.1 -0.5 -1.0 -0.8 0.2 0.4 0.4 0.3 0.3 0.4 0.5 0.6Employment 1.1 -1.2 1.9 1.2 1.3 -1.2 -1.6 -1.5 -0.4 1.3 2.0 2.3 2.0 1.6 1.2 1.1 1.1Unemployment (%) 4.1 5.9 5.2 4.9 4.8 5.6 5.9 6.0 5.9 5.7 5.2 5.1 5.0 5.0 4.9 4.9 4.8 Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 External Trade Trade Balance (USD bn) 584.5 1011.0 912.9 889.1 823.0 - - - - - - - - - - - -Current Account (USD bn) 794.3 1391.2 1221.8 1209.8 1162.3 - - - - - - - - - - - -Current Account (% of GDP) 6.3 11.1 9.0 8.6 7.8 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Financial Variables Cen. Gov. Budget (% GDP) -0.9 -3.8 -3.0 -2.3 -1.6 - - - - - - - - - - - -Gross Gov. Debt (% GDP) (2) 29.8 33.1 33.0 33.0 32.4 - - - - - - - - - - - - Year 2009 2010 2011 ’08 ’09 ’10 (1) ’11 (1) ’12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Interest and FX Rates (2) Discount Rate (%) 2.00 1.25 1.75 2.50 3.00 1.25 1.25 1.25 1.25 1.25 1.38 1.50 1.75 2.00 2.25 2.50 2.503-Month Rate (%) 1.78 1.37 1.75 2.33 2.65 1.28 1.25 1.29 1.37 1.41 1.53 1.65 1.75 1.93 2.15 2.33 2.3310-yr Bond Yield (%) 1.41 1.55 1.20 2.10 2.65 1.54 1.62 1.40 1.55 1.44 1.40 1.20 1.20 1.35 1.55 1.85 2.10USD/TWD 32.8 32.0 30.0 29.0 29.0 33.9 32.8 32.0 32.0 31.8 32.0 31.0 30.0 29.7 29.5 29.3 29.0Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

3

Chan Kok Peng/Dominic Bryant July 2010Global Outlook 68 www.GlobalMarkets.bnpparibas.com

Other Asia: Contagion but Containable

Indonesia: on the right path Among the ASEAN economies, Indonesia is

likely to be the least affected by the fiscal crisis in the EU given that it is the least export-dependent country and as its financial integration ratio, the ratio of the sum of its international assets and liabilities to GDP, is just 62%. In contrast, Singapore has a ratio of 929% (Table 1).

Foreign direct investment into the country got off to a flying start in 2010, amounting to an impressive USD 2.6bn in Q1 (up from USD 0.5bn in Q4 2009), the fastest pace since USD 3.4bn in Q3 2008. This should translate into jobs and help underpin private consumption.

We expect the economy to expand by 5.9% this year as consumers continue to borrow and spend. Credit rose by 15.0% y/y in April on the back of record-low interest rates.

Thailand: road remains rocky Although political tensions appear to have

abated for now (as the Prime Minister survived a censure debate in Parliament and reshuffled his cabinet), it will not be plain sailing for the current government. The task of reconciliation still lies ahead, while the tourism industry may take longer to recover after the most recent troubles.

The central bank is therefore right in delaying a rate hike as long as possible. A tame inflation rate helps. Although the headline inflation rate was 3.5% y/y in May, the core rate of inflation is still at the lower end of the BoT’s target range (Chart 2).

We now expect the central bank to start to raise its policy rate in Q3 2010.

Malaysia: a confident Bank Negara For the first time in a decade, the Malaysian

economy returned to double-digit growth, of 10.1% y/y, in Q1 2010. Against this backdrop, Bank Negara hiked its overnight policy rate by another 25bp to 2.5% in May. The central bank continues to emphasise that, at this new level, interest rates remain supportive of economic growth. We would agree that, as long as the overnight policy rate remains below 3%, Malaysian interest rates should be viewed as accommodative.

Given the continued output gap (Chart 2), we do not see rapid growth as a sign that the Malaysian economy is overheating.

Table 1: Financial Integration Implies Contagion is Inevitable*

2008 2003 Assets Liabilities Total Total

Singapore 517 412 929 909 Malaysia 104 86 190 175 Indonesia 15 47 62 9.3 Thailand 60 65 125 129 Philippines 47 66 112 132 * Ratio of total international assets and liabilities to GDP (%) Source: CEIC, IMF

Rising financial integration for the ASEAN economies suggests that financial contagion has become unavoidable with only the degree of contagion differing from country to country.

Chart 1: Thailand’s Inflation Rate is Still Manageable

-6

-4

-2

0

2

4

6

8

10

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

Headline Inflation

Core Inflation

BOT Core Inflation Target (Lower)

BOT Core Inflation Target (Upper)

(% y/y)

Source: Reuters EcoWin Pro We expect a slowing of the year-on-year rise in oil prices to put downward pressure on the inflation rate.

Chart 2: Malaysia’s Output Gap

-8

-6

-4

-2

0

2

4

6

8

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

(%)


Despite double-digit growth, the output gap for Malaysia remains negative. Concerns about overheating remain premature.

3


Nevertheless, we believe Bank Negara’s decision to hike rates faster than most of its regional peers will be well received by global investors, who are fearful of overheating and rising inflation concerns in the region.

Hong Kong: balancing risks The Hong Kong economy continues to grow

strongly, although growth in the remainder of the year should moderate from Q1’s 2.4% q/q gain. Inventories are now likely to be a drag on activity. We estimate that the inventory change-to-GDP ratio is at its highest since the early 1990s. This is unsustainable, so inventories should start to be accumulated at a slower pace, implying a negative contribution to growth.

Export growth should also moderate from its recent 7%-plus q/q rate as growth in China eases. With most exports related to processing industries, import growth will also slow. Nonetheless, loose financial and monetary conditions should support other areas of domestic activity and, overall, growth will remain robust. Credit growth is already picking up quickly.

The fragile global financial environment presents downside risks to Hong Kong’s outlook. However, super-abundant domestic liquidity and near-zero interest rates create upside domestic risks to money, credit and activity growth and, ultimately, inflation relative to our forecasts.

Singapore: fastest growth in the region Singapore saw the fastest growth rate in Asia in

Q1 when GDP rose at a spectacular rate of 15.5% y/y, up sharply from Q4 2009’s 3.8% rate.

As in Malaysia, we do not think the double-digit growth in Q1 shows that the economy is overheating. The output gap remains negative and unit labour cost pressures are still falling.

One of the key reasons why we remain bullish about the Singapore economy is our view that the MAS has maintained an extraordinarily expansionary policy stance since 2006. Even as the economy hit double-digit growth in some quarters during 2006-07, the MAS did not tighten as sharply as in previous overheating cycles. Thus excess liquidity has built up in Singapore’s economy, resulting in lower interest rates.

From a macroeconomic perspective, the key risk is if the fiscal problems in the EU translate into a double-dip recession for the global economy and liquidity contracts sharply.

Philippines: inflation is subdued Overseas remittances have been far more

resilient than anticipated, amounting to USD 4.3bn in Q1. This is keeping the economy buoyant through higher consumption spending.

The inflation rate was just 4.3% y/y in May – well below the consensus expectation of a 4.8% rate – even though the presidential election campaign must have stoked domestic demand.

As the country is a net food importer, the absence of a significant rise in food inflation suggests that earlier fears of a drought pushing up global food prices were overdone, though the strengthening of the peso has helped to restrain imported inflation.

The subdued rate is also in line with the below-trend output gap in the Philippines.

Chart 3: Hong Kong Credit Growth

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-30

-20

-10

0

10

20

30

40

Authorised Institutions Customer Loans (% y/y)


Abundant liquidity and near-zero interest rates are leading to a pick-up in lending growth.

Chart 4: MAS has Maintained an Accommodative Stance

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-1

-1

0

1

1

21990 1992 1994 1996 1998 2000 2002 2004 2006 2008

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0

2

4

6(% Change q/q)

Expansionary

Contractionary

(%)

Domestic Liquidity Indicator

Output Gap (RHS)


Although the economy was overheating in 2006-07, the MAS domestic liquidity indicator shows that liquidity has been expansionary in contrast to previous overheating cycles in 1995-96 and 2000.

3


Regional Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Asia ex-Japan GDP (% y/y) 7.2 5.9 8.9 7.6 8.0CPI (% y/y) 6.6 0.6 4.4 3.5 3.7Current Account (% GDP) 5.3 4.6 2.9 2.4 2.3Asia ex-Japan, ex-China GDP (% y/y) 4.8 2.9 7.9 6.6 6.8CPI (% y/y) 7.2 2.0 5.4 4.0 3.8Current Account (% GDP) 1.4 3.2 2.2 2.1 1.8(1) Forecast

Source: BNP Paribas

Thailand: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 2.5 -2.3 7.8 5.0 5.5CPI (% y/y) 5.5 -0.8 3.0 3.7 3.5Current Account (% GDP) -0.1 7.7 7.2 7.8 6.6Budget Balance (% GDP) -1.1 -4.4 -3.0 -1.1 -0.1Gross Gov. Debt (% GDP) (2) 38.25 43.88 42.55 40.46 37.41Interest Rate (%) (2) 2.9 1.4 2.0 2.5 3.0Official Benchmark Rate (%) (2) 2.8 1.25 1.8 2.5 3.0USD/THB (2) 34.93 33.36 32.00 31.00 31.00(1) Forecast (2) End Period

Source: BNP Paribas

Indonesia: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 6.0 4.5 5.9 5.8 6.0CPI (% y/y) 9.8 4.8 4.4 5.2 5.4Current Account (% GDP) 0.0 2.0 1.7 0.4 0.0Budget Balance (% GDP) -0.1 -1.6 -1.3 -0.8 -0.5Gross Gov. Debt (% GDP) (2) 33.2 31.1 31.0 30.4 29.8Interest Rate (%) (2) 12.1 7.1 7.7 8.3 9.1Official Benchmark Rate (%) (2) 9.3 6.5 7.0 7.5 8.5USD/IDR (2) 10950 9400 8600 8200 8000(1) Forecast (2) End Period

Source: BNP Paribas

Malaysia: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 4.6 -1.7 8.2 7.0 6.3CPI (% y/y) 5.4 0.6 2.0 2.6 2.5Current Account (% GDP) 17.5 17.1 15.1 17.4 16.6Budget Balance (% GDP) -4.8 -7.6 -5.3 -3.3 -2.5Gross Gov. Debt (% GDP) (2) 41.5 53.7 53.5 51.2 48.9Interest Rate (%) (2) 3.37 2.17 3.00 3.25 3.25Official Benchmark Rate (%) (2) 3.25 2.00 2.75 3.00 3.25USD/MYR (2) 3.50 3.40 3.10 3.00 3.00(1) Forecast (2) End Period

Source: BNP Paribas

Hong Kong: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 2.2 -2.8 6.9 4.8 5.5CPI (% y/y) 4.3 0.5 2.6 1.8 2.9Current Account (% GDP) 13.6 8.7 5.4 9.7 10.6Budget Balance (% GDP) 0.1 0.8 -0.9 0.0 0.8Gross Gov. Debt (% GDP) (2) 1.2 1.0 0.4 0.3 0.3Interest Rate (%) (2) 0.95 0.14 0.75 0.35 2.00Official Benchmark Rate (%) (2) 0.50 0.50 0.50 0.50 3.25USD/HKD (2) 7.75 7.80 7.80 7.80 7.80(1) Forecast (2) End Period

Source: BNP Paribas

Philippines: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 3.8 0.9 5.4 5.1 5.0CPI (% y/y) 9.3 3.3 4.0 3.5 3.4Current Account (% GDP) 2.7 5.1 3.9 4.3 4.6Budget Balance (% GDP) -0.9 -3.9 -3.1 -2.7 -2.0Gross Gov. Debt (% GDP) (2) 64.2 65.1 60.7 58.0 55.4Interest Rate (%) (2) 5.3 5.0 4.8 5.3 5.9Official Benchmark Rate (%) (2) 5.50 4.00 4.50 5.00 5.50USD/PHP (2) 47.5 46.4 43.0 41.0 41.0(1) Forecast (2) End Period

Source: BNP Paribas

Singapore: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

GDP (% y/y) 1.8 -1.3 8.6 5.8 6.5CPI (% y/y) 6.5 0.2 2.5 1.9 1.5Current Account (% GDP) 19.2 19.1 21.0 21.3 23.0Budget Balance (% GDP) 0.1 -1.1 -1.0 0.3 1.9Gross Gov. Debt (% GDP) (2) 95.9 112.2 102.7 95.1 86.1Interest Rate (%) (2) 1.0 0.7 0.7 1.2 2.0USD/SGD (2) 1.44 1.40 1.34 1.30 1.30(1) Forecast (2) End Period

Source: BNP Paribas

Anna Piretti July 2010Global Outlook 71 www.GlobalMarkets.bnpparibas.com

Canada: One Step at a Time

Activity: a strong beginning to the recovery should be followed by more moderate growth Monetary policy still works, at least in Canada.

Lured by record low interest rates, consumers have come back in full force, with personal spending increasing by an average of 3.6% q/q annualised over the past year. Residential investment has similarly benefited from stimulative policy, surging by an average of 25% q/q annualised over the past two quarters.

Nevertheless, with the unemployment rate still well above its natural rate, personal income has not kept pace with the increase in consumption. This, together with fading fiscal support, implies household spending and residential investment will moderate over the rest of this year. Part of this slowing should be offset by an expected rebound in business investment, supported by a recent increase in business lending.

Overall, while GDP should expand just in line with potential during H2 2010, the stellar Q1 performance should still leave Canadian GDP up by a solid 3.3% this year.

Inflation: opposing forces should leave inflation right on target Canadian inflation has been surprisingly sticky,

as wages have decelerated only slowly in response to the rising unemployment rate. In addition, the strong rebound in the housing market has caused CPI shelter prices to soar.

Upward pressures from strong domestic demand should be largely offset by further expected easing in wage growth. Moreover, the relatively strong CAD should weigh on import costs, limiting increases in core goods prices. On balance, these opposing forces should leave Canadian inflation close to the BoC’s 2% target for the forecast period.

Policy: tightening one step at a time While the BoC was one of the first of the G7 to

increase rates after the global financial crisis, ongoing uncertainties imply that further moves will be dependent on developments.

Given ongoing global uncertainties and a global move towards fiscal restraint, the BoC is worried about removing the monetary policy stimulus too soon and is mindful of the negative effects this could have on inflation.

Barring a re-intensification of global financial troubles, we expect the BoC to deliver an additional 75bp of tightening over the second

half of this year, raising the rate to 1.25% where we expect it to be held through most of 2011.

Canada: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Components of Growth Total GDP 0.5 -2.5 3.3 2.9 3.0Dom. Demand ex Stocks 2.8 -1.8 3.9 3.2 3.1Private Consumption 2.9 0.4 3.5 3.4 3.3Public Consumption 4.1 5.1 5.1 2.3 1.7Fixed Investment 0.8 -16.0 3.0 3.8 4.3Stocks (Cont. to Growth) -0.2 -0.6 0.9 0.0 0.0Exports -4.6 -14.2 7.5 5.9 6.0Imports 1.2 -13.9 10.9 6.1 5.6Industrial Production -5.3 -11.3 6.8 2.8 2.9Savings Ratio (%) 3.6 4.6 3.0 3.1 2.7 Inflation CPI 2.4 0.3 1.8 1.8 1.9Core CPI 1.7 1.8 1.9 1.7 1.8Unemployment Rate (%) 6.2 8.3 8.1 7.7 7.3 External Trade Trade Balance (CAD bn) 23.9 -27.2 -18.4 -21.3 -21.2Current Account (CAD bn) 6.9 -43.5 -35.0 -38.0 -37.9Current Account (% GDP) 0.4 -2.9 -2.1 -2.2 -2.1 Financial Variables Gen. Gov. Budget (CAD bn) -2.2 -47.0 -45.3 -32.0 -26.1Gen. Gov. Budget (% GDP) -0.1 -3.0 -2.7 -1.8 -1.4Gross Gov. Debt (% GDP) (2) 28.9 29.9 31.3 32.7 32.7 Interest & FX Rates (2) Call Rate (%) 1.50 0.25 1.25 1.50 3.0010-Year Bond Yield (%) 2.69 3.61 3.20 4.10 4.65USD/CAD 1.22 1.05 0.98 0.90 1.09Footnotes: (1) Forecast (2) End Period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Chart 1: On a Hiking Path, One Step at a Time (%)


While the Bank of Canada has embarked on a tightening path, ongoing global uncertainties suggest the pace of hiking will be moderate and rate increases will not necessarily be delivered at every meeting.

Diego Donadio July 2010Global Outlook 72 www.GlobalMarkets.bnpparibas.com

Brazil: Better Brake Than Skid

Activity: time to slow down Q1 GDP data confirmed that the economy

started 2010 firing on all cylinders. In fact, we have witnessed a sequence of stronger-than-expected activity indicators. We have revised up our 2010 GDP growth forecast sharply, from 4.9% to 7.2%, with a neutral balance of risks given the intensification of the European crisis.

We expect much slower growth rates for the coming quarters, starting in Q2. Previous quarters received significant support from tax exemptions, which led to consumption being brought forward. Together with the monetary tightening and the end of tax benefits, legal constraints on government spending in the second half of every presidential election year should also contribute to limit the pace of the economic expansion. We expect GDP growth to slow to just 0.9% q/q in Q2 and average 1% q/q in H2 2010 (Chart 1).

Inflation: balance of risks has deteriorated The inflation risks we mentioned in the last

Global Outlook have materialised. The faster pace of recovery has fuelled rises in the more structural elements of inflation (Chart 2). Real wages fell only briefly and the government has introduced a large unemployment insurance programme, sustaining consumption and putting pressure on inflation.

We have revised up our 2010 inflation forecast from 4.5% to 5.2%. In 2011, as the economy cools, we expect inflation to moderate and close the year on target at 4.5%. The main risk to inflation remains on the activity side, particularly if there is any delay in implementing the necessary fiscal adjustment in Brazil.

Policy: exit strategy in place There is no need for a further fiscal stimulus. Tax

benefits have finally ended for most sectors. In H2 2010, we will see tighter fiscal policy, even if only because of legal restrictions. However, the recent, larger than expected rise in retirement benefits is an additional risk to inflation. We maintain our forecast for the consolidated primary budget balance for this year of 2.7% of GDP, up from the 2.1% in 2009.

On the monetary policy side, the tightening had started even before the 75bp hike in April. The decision in February to normalise reserve requirements was the first step towards the exit strategy. We expect the BCB to hike rates further to 12.25%, with two additional hikes of 75bp and a final one of 50bp.

Chart 1: GDP Growth

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-5

0

5

10

15

Q1 00 Q3 01 Q1 03 Q3 04 Q1 06 Q3 07 Q1 09 Q3 10

GDP (% y/y , 4Q avg.)

GDP(% q/q , saar )

Forecasts

Source: BNP Paribas, IBGE

The current pace of growth is unsustainable and a sharp deceleration is expected. The several tax benefits that lasted up to Q1 caused consumption to be brought forward.

Chart 2: Services Inflation (%)

3%

4%

5%

6%

7%

8%

9%

10%

11%

Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10

Services(3-months M A; SAAR)

Services (y/y)

(3mma, saar)

3%

4%

5%

6%

7%

8%

9%

10%

11%

Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10

Services(3-months M A; SAAR)

Services (y/y)

(3mma, saar)

Source: BNP Paribas

The faster pace of growth has fuelled a rise in the more structural elements of inflation, notably services. The lower past inflation has not helped to limit pressure on this component.

Chart 3: Balance of Payments Flow (% GDP, 3mma, saar)

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-5

0

5

10

15

20

Jun 00 Dec 01 Jun 03 Dec 04 Jun 06 Dec 07 Jun 09

Private Capital Account

Current Account

Source: BNP Paribas, BCB

Contrary to fears that the current account deficit would reach unsustainable levels, the deficit has stabilised at around 3% of GDP in recent months, which we see as easy to finance.

Diego Donadio July 2010Global Outlook 73 www.GlobalMarkets.bnpparibas.com

Brazil: Economic & Financial Forecasts

Year 2009 2010 2011 Components of Growth 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

GDP (% q/q SAAR) - - - - - -6.0 5.9 8.7 9.0 11.0 3.4 3.4 4.4 5.0 5.0 4.6 4.4GDP 5.1 -0.2 7.2 4.6 4.4 -2.1 -1.6 -1.2 4.3 9.0 7.9 6.8 5.5 4.2 4.5 4.7 4.8Demand Side Private Consumption 7.0 4.1 7.7 4.7 4.7 1.5 3.0 3.9 7.7 9.3 8.5 7.6 5.8 4.9 5.0 4.6 4.4Public Consumption 1.6 3.7 2.6 3.0 3.4 4.3 3.9 1.6 4.9 2.0 3.1 2.8 2.5 2.7 2.5 3.0 3.5Fixed Investment 13.4 -9.9 22.4 10.8 8.1 -14.2 -16.0 -12.5 3.6 26.0 24.9 22.0 17.6 12.0 10.4 10.3 10.5Exports -0.6 -10.3 8.4 2.6 4.4 -15.4 -11.4 -10.1 -4.5 14.5 11.5 5.3 3.6 4.7 0.1 2.1 4.2Imports 18.0 -11.4 32.8 11.5 9.0 -15.8 -16.5 -15.8 2.5 39.5 45.3 29.8 20.3 15.8 9.8 10.1 10.7Net Exports (Cont. to Growth) -2.7 0.2 -3.5 -1.3 -0.7 0.1 0.4 0.6 -0.7 -3.2 -3.8 -3.0 -2.1 -1.4 -1.1 -1.0 -0.9Stocks (Cont. to Growth) 1.1 -1.9 0.8 0.0 0.0 -1.8 -2.2 -2.4 -1.4 1.1 1.5 0.0 0.0 0.0 0.0 0.0 0.0Supply Side Agricultural 5.7 -5.2 4.7 5.4 4.9 -2.8 -4.4 -9.0 -4.6 5.1 4.5 5.0 4.3 5.0 5.0 6.0 6.0Industrial 4.4 -5.5 9.8 4.7 4.3 -10.4 -8.6 -6.9 4.0 14.6 10.6 8.4 6.4 7.2 4.7 3.5 3.8Services 4.8 2.6 5.9 4.4 4.3 1.7 2.0 2.1 4.6 5.9 6.4 5.9 5.4 4.5 4.5 4.2 4.3Industrial Production 3.1 -7.4 13.1 5.0 4.5 -13.8 -11.6 -8.7 6.2 17.3 16.3 12.4 8.8 6.4 4.3 3.8 4.0Industrial Production (% q/q SAAR) - - - - - -26.1 15.5 19.7 17.0 13.0 11.9 5.8 3.6 3.8 3.8 3.6 4.4 Year 2009 2010 2011 Inflation & Labour 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

IPCA 5.9 4.3 5.2 4.5 4.5 5.6 4.8 4.3 4.3 5.2 5.0 5.3 5.2 4.7 4.6 4.4 4.5IPCA Core 4.8 4.3 5.2 4.6 4.5 4.8 4.5 4.2 4.3 4.5 5.0 5.1 5.2 5.3 4.7 4.6 4.6IGP-M 9.8 -1.7 8.7 4.8 4.6 6.3 1.5 -0.4 -1.7 2.0 5.3 7.3 8.7 7.2 5.2 4.6 4.8Employment 3.4 0.7 4.2 2.2 2.3 0.9 -0.1 0.6 1.4 3.8 5.0 4.8 3.7 2.5 1.8 1.9 2.1Unemployment Rate (%) 7.9 8.1 7.0 7.3 7.0 9.0 8.1 7.7 6.8 7.6 7.0 7.0 5.9 7.9 7.4 7.2 5.8Wages 9.9 8.4 7.4 7.4 6.9 11.4 8.1 6.5 4.8 7.0 7.5 8.1 8.4 7.7 7.5 7.2 7.1 Year 2009 2010 2011 External Trade (USD bn) 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Trade Balance 24.7 25.3 18.0 7.0 9.9 3.0 10.9 7.3 4.1 0.9 7.0 5.7 4.4 0.3 2.7 2.2 1.7Current Account -28.3 -24.3 -45.5 -72.6 -75.7 -4.9 -2.3 -4.9 -12.2 -12.2 -9.8 -8.4 -15.4 -19.4 -15.6 -13.5 -24.5Current Account (% GDP) -1.7 -1.5 -2.3 -3.2 -3.3 -1.3 -0.6 -1.2 -3.1 -2.5 -2.0 -1.7 -3.1 -3.5 -2.8 -2.4 -4.4FDI (% GDP) 2.8 1.6 1.8 2.1 2.2 2.7 2.8 2.2 1.6 1.5 1.4 1.7 1.8 2.0 2.2 2.1 2.1 Year 2009 2010 2011 Financial Variables 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

General Gov. Budget (% GDP) -2.0 -3.3 -2.6 -3.3 -2.8 -2.7 -3.1 -4.2 -3.3 -3.5 -3.1 -2.8 -3.0 -3.1 -3.2 -3.2 -3.3Gross Gov. Debt (% GDP) (2) 56.3 62.8 61.6 60.0 58.1 59.7 61.5 64.4 62.8 60.4 60.2 60.9 61.6 61.2 60.8 60.4 60.0 Year 2009 2010 2011 Interest Rates & FX Rates (2) 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

SELIC Rate (%) 13.75 8.75 12.25 11.25 11.25 11.25 9.25 8.75 8.75 8.75 10.25 11.75 12.25 12.25 12.25 11.75 11.25 1-Year Swap Rate (%) 12.20 10.50 12.80 12.00 12.10 9.79 9.24 9.67 10.51 10.90 11.90 12.80 12.80 12.80 12.80 12.40 12.00 USD/BRL 2.31 1.74 1.75 1.75 1.90 2.32 1.95 1.77 1.74 1.78 1.80 1.80 1.75 1.72 1.70 1.70 1.75 EUR/BRL 3.23 2.50 1.89 1.75 2.19 3.08 2.74 2.59 2.50 2.40 2.20 2.09 1.89 1.72 1.67 1.65 1.75 Footnotes: (1) Forecast (2) End period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas

Italo Lombardi July 2010Global Outlook 74 www.GlobalMarkets.bnpparibas.com

Mexico: Much Brighter Outlook

Activity: strong outlook The Mexican economy was one of the hardest

hit last year by the global financial crisis. Largely as a result of the downturn in the US economy, it suffered one of the worst recessions in its history. This year, the stars look aligned for a brisk recovery. Global trade and manufacturing are rebounding strongly, and the growth outlook in the US has also improved.

The manufacturing sector has already shown solid signs of a rebound, led by a strong recovery in auto and computer production. In fact, we expect manufacturing to grow by 10% this year. Even though the level of activity has already improved quite significantly, domestic demand is still lagging. Consumers have yet to regain confidence as wages are still below the levels needed to foster a recovery in the more domestic-driven sectors of the economy.

We expect domestic demand to begin driving growth more significantly in H2 2010. The labour market is likely to gain strength while better credit conditions will support consumption and investment.

We expect the economy to expand by 5.0% in 2010, but we remain less optimistic about growth beyond this year. The US economy’s sluggishness and Mexico’s inability to pass significant structural reforms remain long-term challenges.

Inflation: no significant pressures While inflation rose in Q1 2010 due to higher

VAT, excise taxes, and an unexpected rise in fruit and vegetable prices, inflation surprised to the downside in Q2. Core and services inflation remain muted, and fears of second-round effects from higher taxes have dissipated.

We expect inflation to end the year at 4.7% but to then converge to levels more consistent with the CB’s target of 3% +/-1pp in 2011.

Policy: remaining on hold in 2010 New CB President Carstens has brought a more

dovish tone to the bank’s rhetoric. In addition, the inflation outlook is much more benign than when the new taxes were announced and a lot of slack remains in the economy. We remain confident that the CB will stay on hold this year, with the first interest rate hike in January 2011.

With the economy growing and new taxes in place, Mexico’s fiscal accounts are set to improve, lowering the public-debt-to-GDP ratio.

Chart 1: IGAE (%)


Growth in the IGAE indicator of economic activity has shown a sharp acceleration in year-on-year terms.

Chart 2: Consumer Confidence (Index, sa)

75

80

85

90

95

100

105

110

115

Apr 03 Apr 05 Apr 07 Apr 09


The rebound in consumer confidence from last year’s depressed level has been restrained by the government’s introduction of new excise taxes and an increase in the VAT rate.

Chart 3: Headline and Core CPI (Biweekly, % y/y)


The higher VAT rate and new excise taxes pushed up both headline and core inflation in Q1 2010. However, inflation has already fallen back to January’s level and the inflation outlook remains benign.

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

H1 Jan 2002 H1 Jul 2004 H1 Jan 2007 H1 Jul 2009

Headline

Core

-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.52.0

Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10-15

-10

-5

0

5

10

3mma, m/m, sa

(RHS)


Mexico: Economic & Financial Forecasts

Year 2009 2010 2011 Components of Growth 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

GDP (% q/q SAAR) - - - - - -24.5 1.2 10.1 7.9 -1.4 4.1 5.3 1.2 1.2 8.2 4.9 2.0GDP (% y/y) 1.5 -6.5 5.0 3.7 3.3 -7.9 -10.0 -6.1 -2.3 4.3 5.5 5.7 4.5 3.8 4.5 3.3 3.3Demand Side Private Consumption 1.9 -6.1 3.3 3.0 2.5 -8.5 -7.7 -4.5 -3.8 2.5 4.1 3.6 3.7 3.6 4.0 2.3 2.2Public Consumption 0.9 2.3 2.7 1.2 0.8 4.2 1.4 2.2 1.4 0.5 3.0 3.2 2.9 1.3 2.0 0.8 0.8Fixed Investment 4.4 -10.1 2.3 5.2 5.7 -6.4 -14.3 -11.3 -8.1 -1.2 1.4 3.5 7.0 5.9 4.4 5.3 5.1Exports 0.5 -14.8 8.3 8.9 8.6 -23.3 -24.7 -15.8 7.3 23.6 9.2 5.4 7.2 5.6 8.6 9.1 8.8Imports 2.8 -18.2 10.6 7.1 7.2 -24.6 -27.6 -18.8 -0.1 19.3 14.4 9.5 9.3 8.9 6.9 6.6 6.3Supply Side Agriculture 1.2 1.8 2.4 2.5 2.5 0.1 3.4 1.3 2.1 -1.5 4.3 3.2 3.1 2.5 2.5 2.5 2.5Industry -0.6 -7.3 6.3 3.5 2.5 -9.6 -11.1 -6.3 -1.9 5.4 6.2 6.0 3.4 4.0 4.1 2.8 3.2Services 2.5 -6.6 4.6 3.9 3.7 -7.5 -10.2 -6.3 -2.7 4.1 5.2 5.8 5.2 3.8 4.7 3.5 3.4Industrial Production (% y/y) -0.6 -7.3 6.3 3.5 2.5 -9.6 -11.1 -6.3 -1.9 5.5 6.2 6.0 4.7 4.4 3.3 3.1 2.9Industrial Production (% q/q SAAR) - - - - - -20.1 -2.6 7.7 10.3 7.5 4.9 5.0 6.9 3.8 6.1 4.0 3.9 Year 2009 2010 2011 Inflation & Labour 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

IPC (% y/y) 6.5 3.6 4.7 3.7 3.9 6.0 5.7 4.9 3.6 5.0 4.0 4.1 4.7 3.0 3.6 3.7 3.7 IPC Core (% y/y) 5.7 4.5 3.8 3.4 3.4 5.8 5.4 4.9 4.5 4.4 4.0 3.9 3.8 3.4 3.4 3.3 3.4 Employment (% y/y) 0.1 -2.3 4.0 1.7 3.8 -2.3 -3.9 -3.8 -2.3 -1.5 0.4 2.3 4.0 3.9 3.1 2.5 1.7Unemployment Rate (%) 4.3 4.8 3.9 3.0 2.9 4.8 5.2 6.4 4.8 5.8 5.4 4.7 3.9 4.2 3.9 3.5 3.0 Year 2009 2010 2011 External Trade (USD bn) 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Trade Balance -17.3 -4.7 -10.7 -20.3 -29.7 -2.0 0.8 -3.1 -0.3 0.1 -0.3 -6.3 -4.3 -1.6 -2.2 -8.8 -7.6Current Account -16.2 -5.6 -13.8 -26.0 -38.8 -1.3 0.3 -3.9 -0.7 -0.8 1.2 -8.0 -6.3 -3.3 -1.1 -11.3 -10.3Current Account (% GDP) -1.4 -0.6 -1.4 -2.3 -3.2 -1.3 -1.4 -1.4 -0.6 -0.6 -0.4 -0.8 -1.4 -1.6 -1.7 -2.0 -2.3 Year 2009 2010 2011 Financial Variables 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 (1) Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Public Balance (% GDP) (2) -0.1 0.4 1.8 1.5 1.4 -1.2 -0.9 -0.6 0.4 1.9 3.2 3.3 1.8 1.3 2.7 2.6 1.5Gross Gov. Debt (% GDP) (3) 35.7 39.6 38.0 36.9 36.1 36.7 37.7 38.6 39.6 39.2 38.8 38.4 38.0 37.7 37.5 37.2 36.9 Year 2009 2010 2011 Interest Rates & FX Rates (3) 08 09 10 (1) 11 (1) 12 (1) Q1 Q2 Q3 Q4 Q1 Q2 (1) Q3 (1) Q4 (1) Q1 (1) Q2 (1) Q3 (1) Q4 (1)

Benchmark Overnight Rate (%) 8.25 4.50 4.50 6.75 6.75 6.75 4.75 4.50 4.50 4.50 4.50 4.50 4.50 5.25 6.00 6.75 6.75 Cetes 1m 7.96 4.52 4.73 7.10 7.10 6.40 4.76 4.51 4.52 4.73 4.73 4.73 4.73 5.44 6.23 7.02 7.10 USD/MXN 13.65 13.06 11.90 11.60 12.00 14.18 13.19 13.50 13.06 12.38 12.50 12.20 11.90 11.70 11.50 11.40 11.60MXN/EUR 19.08 20.11 12.85 11.60 13.80 18.79 18.50 19.97 20.11 16.45 15.25 14.15 12.85 11.70 11.27 11.06 11.60(1) Forecasts (2) Public balance excluding PEMEX investment and other off-balance sheet items (3) End of period Figures are year-on-year percentage changes unless otherwise indicated

Source: BNP Paribas


Other Latam: Got Legs?

Argentina: bad timing The pace of the economic recovery remained

quite strong in the first half of the year with industrial production benefiting from strong domestic sales and exports of autos. In addition, exports of soft commodities have been an important source of growth and dollars.

Inflation remains an issue at 22-25% y/y according to unofficial estimates. INDEC continues to underestimate inflation while the economy is adjusting wages to the tune of 30-40% y/y, entrenching inflation.

The combination of high inflation and the strengthening of activity has boosted government revenues.

This serves as a relief for a government that has basically failed in its two latest ambitions. First, while the debt swap met its modest forecast of acceptance (60%), it failed to achieve the market’s estimate of 75-80%. Second, the issuance of USD 1.0bn of 2017 bonds was postponed as spreads skyrocketed with the EU crisis, frustrating the government’s intent to make a comeback in the international capital markets.

Chile: rebuilding well on track The earthquakes that struck Chile at the end of

February caused serious destruction of physical capital, shrinking the output gap.

The impact on GDP looks bigger than initially estimated and we have revised down our growth forecast once more for 2010 – from 4.9% to 4.7% – but expect GDP growth to accelerate to 5.4% for 2011.

Domestic consumption remains strong, which, combined with all the reconstruction efforts, will result in a less favourable inflation outlook for this year.

The CB has already started to normalise rates, hiking by 50bp in June, and rates are likely to reach 3.0% by year-end. The normalisation of monetary policy will be relatively aggressive as the CB will want to anchor inflation expectations in the face of the increase in economic activity and a drift in inflation towards the target.

The government’s share of reconstruction spending is largely based on tax revenues and spending cuts. The sale of assets could generate some dollar inflows, but the only direct offshore funding will come from USD 1.5bn in bonds. Thus the impact on the CLP should be much less than initially thought.

Colombia: lagging but not much The Colombian economy is experiencing the

weakest recovery in the region. The 72.8% collapse in exports to Venezuela (the

result of a trade conflict between the two countries, the large devaluation of the VEF and Venezuela’s recession) is taking its toll on Colombia’s economy. However, some offset is provided by the increase in commodity prices which has kept exports to the US very strong.

The poor performance of the manufacturing sector has negative implications for employment and consumption. At 12.4%, Colombia’s official unemployment rate is the highest in the region.

The benign inflation outlook and the weakness of the economy prompted the CB to cut rates unexpectedly in April, when most economies were looking to normalise monetary policy.

After June 20th presidential election, the new administration will have to deal with the largest Latam fiscal deficit of 5% of GDP.

Venezuela: stagflation While most Latam economies are enjoying a

recovery, Venezuela is experiencing stagflation with GDP shrinking by 5.8% y/y in Q1.

Venezuela’s electricity rationing and the government’s takeovers continue to suppress investment, putting a toll on production. Oil production fell 5.0% y/y in Q1 while production in non-oil industries declined by 4.9% y/y.

The economy’s poor performance has put pressure on the fiscal accounts, which has been aggravated by lower oil prices and production.

In response to fiscal problems, the government started the year with a substantial 40% devaluation of the currency and the introduction of a dual exchange-rate regime.

This devaluation will provide fiscal relief for the government in the short term but fiscal problems could lead to a further devaluation by the government, which, in turn, would put more pressure on inflation.

Although the government is repressing inflation through price controls, shortages will force an upward adjustment of prices.

Recently, the government has attempted to regulate the black market for dollars, another attempt to break one of the most powerful indexation vehicles in the economy. These measures continue to hurt investment sentiment.


Argentina: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Real GDP (% y/y) 6.8 0.9 4.9 4.0 3.5CPI (% y/y) 7.2 7.7 19.6 14.4 10.6Trade Balance (USD bn) 12.6 17.0 13.8 13.8 9.8Current Account (USD bn) 7.0 11.3 3.5 0.8 -6.5Current Account (% GDP) 2.4 3.7 1.2 0.2 -2.0Budget Balance (% GDP) 1.3 -0.6 -0.8 0.6 -0.2Gross Gov. Debt (% GDP) (2) 48.8 48.6 49.1 48.7 49.1Interest Rate (%) (2) 19.8 10.0 9.5 10.0 10.0USD/ARS (2) 3.45 3.80 4.20 4.50 4.90(1) Forecast (2) End Period

Source: BNP Paribas

Chile: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Real GDP (% y/y) 3.7 -1.5 4.7 5.4 5.1CPI (% y/y) 7.1 -2.6 3.4 3.4 3.2Trade Balance (USD bn) 8.8 14.0 13.0 9.0 7.5Current Account (USD bn) -2.5 4.2 -1.3 -4.3 -6.2Current Account (% GDP) -1.5 2.5 -0.7 -2.1 -2.8Budget Balance (% GDP) 5.2 -4.6 -3.3 -2.6 -2.9Gross Gov. Debt (% GDP) (2) 5.3 5.8 7.9 9.4 9.6Interest Rate (%) (2) 8.25 0.50 3.00 5.00 5.00USD/CLP (2) 636 507 510 495 515(1) Forecast (2) End Period

Source: BNP Paribas

Colombia: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Real GDP (% y/y) 2.4 0.4 3.0 3.8 4.4CPI (% y/y) 7.7 2.0 3.7 3.5 4.2Trade Balance (USD bn) 0.5 1.7 1.5 2.1 3.2Current Account (USD bn) -6.9 -5.1 -6.6 -6.2 -5.0Current Account (% GDP) -2.9 -2.2 -2.4 -2.2 -1.7Budget Balance (% GDP) 0.9 -4.1 -5.6 -5.2 -2.8Gross Gov. Debt (% GDP) (2) 31.0 39.7 42.5 45.0 46.2Interest Rate (%) (2) 9.50 3.50 4.50 6.00 6.00USD/COP (2) 2246 2040 1925 1925 1960(1) Forecast (2) End Period

Source: BNP Paribas

Venezuela: Economic Forecasts

2008 2009 2010 (1) 2011 (1) 2012 (1)

Real GDP (% y/y) 4.8 -3.3 -2.0 -1.0 1.4CPI (% y/y) 30.9 25.1 39.4 34.9 56.2Trade Balance (USD bn) 45.7 19.2 36.8 30.6 35.1Current Account (USD bn) 37.4 8.6 26.9 18.5 21.6Current Account (% GDP) 10.8 2.6 9.6 6.3 14.9Budget Balance (% GDP) -2.6 -6.5 -2.5 -6.5 -2.0Gross Gov. Debt (% GDP) (2) 12.8 12.8 14.0 17.3 18.3Interest Rate (%) (2) 19.8 10.0 9.5 10.0 10.0USD/VEF Priority (2) 2.14 2.14 2.59 2.59 5.30USD/VEF Oil (2) 2.14 2.14 4.29 4.29 8.80(1) Forecast (2) End Period

Source: BNP Paribas

Chart 1: Latam Manufacturing Production (Trough=100, sa)

Source: BNP Paribas

Brazil, Peru and Mexico remain at the forefront of the recovery in manufacturing in Latin America. Argentina is also showing clear signs of strength. In Chile, the earthquakes led to a sharp drop in production but the recovery in April was remarkable.

Chart 2: Latam Consumer Credit (3m, % m/m, sa)

Source: BNP Paribas

Growth in consumer credit across the region has shown signs of recovering. Credit growth remains strongest in Brazil but a clear upward trend is now apparent in Colombia and Chile. Mexicoremains the laggard, although signs of improvement are increasingly evident.

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Colombia

Mexico

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Chile

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-20 -15 -10 -5 0 5 10Months from Trough

Brazil

Peru

Argentina

Mexico

Colombia Chile

Gizem Kara/Alan Clarke/Mole Hau July 2010Global Outlook 78 www.GlobalMarkets.bnpparibas.com

Financial and Monetary Conditions Indices FMCI Model Details

BNP Paribas’ Financial and Monetary Conditions Index gives a summary of how tight or slack monetary policy is in an economy by looking beyond the nominal interest rate and exchange rate. Specifically, the index is a weighted sum of the following components: Equity prices (% y/y); Government yield spread (10y-2y rates in developed

countries, weighted in the eurozone case, and 10y-3m rates in China, India and South Korea);

Real corporate bond yields (using core inflation in developed countries, real government bond yields and headline inflation in China, India and South Korea);

Broad nominal money supply growth; Real interest rates (using core inflation in developed countries

and headline inflation in China, India and South Korea); TED spread proxy (3-month MIBOR/Repo spread in India,

1-year KIBOR/OIS spread in South Korea); and Level of real effective exchange rate (deviation from

trend). The weighted sums are normalised so that their mean equals zero and their standard deviation is one. The result is that a reading below zero represents relatively loose financial and monetary conditions, and above zero is tighter than normal.

Table 1: FMCI (Standard Deviations From Avg)

May Apr Mar Feb Jan Low

Since 1990

US -0.7 -1.7 -1.9 -2.2 -2.0 -2.5 Eurozone -1.1 -1.0 -1.5 -1.2 -0.6 -2.3 Japan 0.2 -0.5 -0.6 -0.5 -0.4 -2.2 China -0.7 -1.2 -1.3 -1.4 -1.7 -2.4 India -0.8 -1.4 -2.1 -2.5 -2.4 -2.5 S. Korea -0.5 -0.7 -0.8 -0.7 -0.9 -2.5 UK -2.2 -2.6 -3.2 -2.6 -2.3 -3.2 Canada -1.2 -1.2 -1.4 -2.1 -1.3 -2.7 Australia 0.3 0.6 0.4 -0.2 0.1 -3.1 Sweden -0.3 -0.7 -1.3 -1.1 -1.5 -2.6Source: BNP Paribas

Chart 1: US FMCI

Source: BNP Paribas SD from average

The US FMCI has risen by 1.8 points from its all-time low of -2.5 seen in November 2009. The main driver of the rise has been the appreciation relative to trend in the effective USD exchange rate.

Chart 2: Eurozone FMCI


The eurozone FMCI is only 0.4 of a point above its March low, pointing to the loosest financial and monetary conditions in the main advanced economies after the UK.

Chart 3: Japanese FMCI


The Japanese FMCI points to tighter-than-average conditions for the first time since November 2009. At 0.2, the index is 0.8 of a point higher than the March low.

Chart 4: Chinese FMCI


Although the Chinese FMCI still points to looser-than-average conditions, it has risen by 1.3 points since its December 2009 low, partly due to slower broad money growth (in % y/y terms).

Gizem Kara/Alan Clarke/Mole Hau July 2010Global Outlook 79 www.GlobalMarkets.bnpparibas.com

Chart 5: Indian FMCI


While still low in absolute terms, the Indian FMCI has been on a rising trend since its trough in December 2009, due to an appreciation relative to trend in the effective INR exchange rate and a slower pace of increase in equities (in % y/y terms).

Chart 6: South Korean FMCI


At -0.5, South Korea’s FMCI suggests that conditions remain looser than average. However, it has risen by 1.9 points since its all-time low in March 2009, mainly due to an appreciation relative to trend in the effective KRW exchange rate.

Chart 7: UK FMCI


The UK FMCI, at -2.2, is now a point higher than its all-time low in March. But it still points to the loosest financial and monetary conditions among the main advanced economies.

Chart 8: Canadian FMCI


Financial and monetary conditions have been loose since October 2008. But, the Canadian FMCI has risen by 0.9 of a point since February, driven by a slower pace of increase in equities (in % y/y terms).

Chart 9: Australian FMCI


The Australian FMCI has pointed to tighter-than-average conditions since March. At 0.3, it points to the tightest financial and monetary conditions among the main advanced economies.

Chart 10: Swedish FMCI


Although the Swedish FMCI still points to looser-than-average conditions, it has risen by 1.6 points since its recent low in November 2009, mainly due to a narrowing in the 10-year/2-year spread.


Global Liquidity Global narrow money growth has been range

bound Global narrow liquidity has rebounded in recent

months to the top end of its range of the past two years (Chart 1).

The reacceleration in recent months has been due to a jump in foreign exchange reserves offset, to some extent, by slowing narrow money growth in the advanced economies.

Although advanced economy narrow money growth has slowed, it continues to exceed 15% y/y, albeit well down on the near 50% y/y pace of mid-2009. By contrast, growth in foreign exchange reserves has accelerated to around 20% y/y from a low single-digit rate in late 2009.

Broad money growth is showing tentative signs of stabilising at very depressed levels… Despite rapid growth in narrow liquidity, broad

money growth remains extremely depressed, although there have been tentative signs that the growth rate has stopped falling.

Broad money growth across the G7 has stabilised at around 2% y/y, the lowest for at least 25 years. The combination of fast narrow money growth and sluggish broad money growth has translated into a continued slide in the money multiplier.

Smaller falls in broad money in the eurozone and a modest reacceleration in Japanese and Canadian broad money growth are the key reasons for the recent stabilisation. More specifically, the pace of decline in eurozone broad money growth has slowed to -0.1% y/y compared with -0.6% y/y at the start of the year. US broad money growth has stabilised at around 1½% y/y, down from 6% y/y in late 2009.

…and it is a similar story for credit growth The counterpart to slower money supply growth

(i.e. the liability side of the balance sheet) has been a slump in credit growth (the asset side of the balance sheet).

This has been particularly the case for credit to the private sector, which is down 1-2% y/y. Total credit growth has slowed, though to a lesser extent: it is down to around 2½% y/y, reflecting increased lending to government.

Chart 1: Global Narrow Liquidity (% y/y)


Chart 2: Advanced Economies’ Broad Liquidity (% y/y)


Chart 3: Advanced Economies’ Credit (% y/y)



Long-Term Economic Forecasts

The tables on the following pages provide our forecasts for the main economic and financial variables for the major advanced and BRIC economies over the next ten years.

US We believe that the economy will expand at a solid, if unspectacular, pace over the next two years. The effect of the continuing credit crunch – particularly on housing – will prevent growth from rising much above potential over this period. We expect growth to eventually accelerate to 4% in 2013, helping unemployment to head down more quickly. This is likely to be accompanied by a rise in headline inflation to 4%. We expect this inflation rate to provoke an aggressive response from the Fed, taking the Fed funds rate above 5%, temporarily choking off the rebound in growth and lowering inflation. Once this interruption has passed and central bank credibility has been restored, interest rates can be reduced. This easing will allow growth to exceed potential slightly for a short time, eventually helping to close the output gap. In turn, this will help to reduce the unemployment rate back to the NAIRU and restore inflation to more desirable levels.

Eurozone Recent financial market turbulence, particularly in peripheral eurozone economies, points to a long and painful period of fiscal consolidation. Consequently, the eurozone recovery is likely to be less vigorous than that in the US. It will take longer for the economy to return to its potential growth rate. Moreover, even when above-trend growth is achieved, it is likely to be around a percentage point slower than in the US. Given the persistent output gap and more sluggish growth, deflation is an ongoing risk in the eurozone. We expect the ECB to eventually begin raising the refi rate during 2012, to reach 3.5% during 2013.

Japan A period of above-potential growth in 2010-11 will help to reduce unemployment and slow the pace of deflation, eventually provoking the BoJ to normalise policy. After a temporary pause in 2013, amid sharp monetary policy tightening overseas, we expect above-trend growth to continue to erode the output gap.

China The high growth rate we forecast for 2010 should prove the peak, as the boost to growth from excessive fiscal

and monetary stimuli will prove transient. Over the coming decade, especially its second half, China’s potential growth rate will fall to, and stay at, 6-8% (from 10% pre-crisis). This is due to a smaller contribution from exports and a peaking in the demographic dividend (the expansion of the working-age population, a higher savings rate etc). We expect growth to become more dependent on household consumption. Overall, inflation should remain in a benign 3-5% range as rising productivity due to heavy capital investment should offset upstream price pressure. After the return to a managed float, the RMB should move towards 6 eventually.

Brazil After rapid GDP growth during 2010 (above 7% y/y), monetary policy tightening is likely to lead to stabilisation of growth in the 4.0%-4.5% range. Brazilian macroeconomic policy (inflation target, fiscal austerity and a floating exchange-rate regime) will keep future growth at around potential. Structural improvements in the country in recent years will allow real interest rates to continue drifting lower, approaching levels more comparable to those in other EM countries. Inflation should also ease, as the economy becomes increasingly open and linked to international developments. Falling nominal rates are the natural outcome.

India Strong domestic demand will see a period of robust growth in 2010-2012 before tighter policy causes growth to slow in 2013 and 2014. However, India has an impressive trend growth rate, reflecting the scope for income growth to catch up, for structural reforms and for a continued expansion of the working-age population. Solid fundamentals and high interest rates imply an appreciation in the INR.

Russia Although the recovery is solid now, Russia is unlikely to return to its pre-crisis growth rates of above 7% y/y. GDP growth will be heavily dependent on the price of oil. We expect the oil price to provide Russia with an opportunity to grow by around 4% y/y and to gradually diversify its economy. Prudent monetary policy will help to suppress inflation in the medium term. However, CPI inflation is unlikely to drop below 6% y/y as the government will continue to hike the domestic tariffs of natural monopolies to increase the incentives for economic modernisation.


Long-Term Economic Forecasts Table 1: Long-Term Forecasts

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

USGDP (% y/y) 0.4 -2.4 2.9 2.8 3.2 4.0 2.0 3.0 3.0 3.0 2.5 2.5 2.5

CPI (% y/y) 3.8 -0.3 1.7 1.0 1.0 4.0 2.5 2.0 1.8 2.2 2.0 2.0 2.0

Core CPI (% y/y) 2.3 1.7 0.8 0.0 0.5 2.5 2.2 2.0 1.6 2.0 2.0 2.0 2.0

Unemployment Rate (%) 5.8 9.3 9.6 8.5 6.9 6.5 6.5 6.2 5.9 5.5 5.2 5.0 5.0Fed Funds Rate (%) (2) 0.25 0.25 0.25 0.25 2.00 5.50 4.50 4.50 4.50 4.50 4.50 4.50 4.503-Month Rate (%) (2) 1.43 0.25 0.95 0.75 2.50 5.50 4.75 4.75 4.75 4.75 4.75 4.75 4.752-Year Rate (%) (2) 0.77 1.14 0.75 2.00 3.00 5.10 4.75 5.00 4.80 4.90 5.00 5.00 5.005-Year Rate (%) (2) 1.55 2.68 2.10 2.85 3.75 5.50 5.00 5.25 5.10 5.15 5.10 5.10 5.1010-Year Rate (%) (2) 2.22 3.84 3.00 3.75 4.50 5.80 5.25 5.75 5.50 5.40 5.25 5.25 5.25EUR/USD (2) 1.40 1.43 1.08 1.00 1.15 1.22 1.23 1.16 1.10 1.11 1.19 1.30 1.33USD/JPY (2) 91 93 94 118 126 116 109 111 117 119 114 110 112

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

EurozoneGDP (% y/y) 0.4 -4.1 1.2 0.6 1.0 2.2 1.0 1.5 1.5 1.5 1.2 1.2 1.2

CPI (% y/y) 3.3 0.3 1.6 1.4 0.7 1.8 1.5 1.5 1.5 1.5 1.5 1.5 1.5

Core CPI (% y/y) 1.8 1.4 0.8 0.0 0.2 1.0 1.2 1.4 1.4 1.4 1.4 1.4 1.4

Unemployment Rate (%) 7.6 9.4 10.3 10.3 9.6 9.0 8.5 8.0 7.5 7.0 7.0 7.0 7.0ECB Refinancing Rate (%) (2) 2.50 1.00 1.00 1.00 1.50 3.50 3.00 3.00 3.25 3.25 3.25 3.25 3.253-Month Rate (%) (2) 2.89 0.70 0.70 1.50 2.00 3.50 3.25 3.25 3.50 3.50 3.50 3.50 3.502-Year Rate (%) (2) 1.74 1.37 0.50 1.25 2.25 3.25 3.40 3.50 3.60 3.60 3.60 3.60 3.605-Year Rate (%) (2) 2.35 2.45 1.40 2.10 2.75 4.00 3.80 3.80 4.00 4.00 4.00 4.00 4.0010-Year Rate (%) (2) 2.95 3.40 2.00 3.00 3.75 4.50 4.25 4.25 4.50 4.50 4.50 4.50 4.50EUR/JPY (2) 127 133 102 118 145 142 134 129 129 132 136 143 149

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

JapanGDP (% y/y) -1.2 -5.2 3.6 2.3 1.8 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.7

CPI (% y/y) 1.4 -1.4 -0.6 -0.2 0.5 0.8 3.7 1.9 1.0 1.0 1.0 1.0 1.0

Core CPI (% y/y) 1.5 -1.3 -1.0 -0.4 0.5 0.8 3.7 1.9 1.0 1.0 1.0 1.0 1.0

Unemployment Rate (%) 4.0 5.1 4.8 4.2 3.6 3.2 3.1 3.0 3.0 3.0 3.0 3.0 3.0O/N Call Rate (%) (2) 0.10 0.10 0.10 0.10 1.00 1.50 2.00 2.50 2.50 2.50 2.50 2.50 2.503-Month Rate (%) (2) 0.74 0.46 0.40 0.40 1.10 1.70 2.20 2.70 2.70 2.70 2.70 2.70 2.702-Year Rate (%) (2) 0.40 0.15 0.25 0.75 1.15 1.80 2.30 2.75 2.75 2.75 2.75 2.75 2.755-Year Rate (%) (2) 0.71 0.47 0.60 1.15 1.30 1.90 2.40 2.80 2.80 2.80 2.80 2.80 2.8010-Year Rate (%) (2) 1.18 1.30 1.40 1.80 1.90 2.50 3.00 3.00 3.00 3.00 3.00 3.00 3.00

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

UKGDP (% y/y) 0.7 -4.9 1.4 0.9 1.3 3.5 1.7 2.2 3.0 3.0 2.7 2.7 2.7

CPI (% y/y) 3.6 2.2 3.2 1.7 1.6 4.0 2.7 2.0 2.0 2.0 2.0 2.0 2.0

Core CPI (% y/y) 1.6 1.8 2.7 0.8 1.0 3.0 2.3 1.7 2.0 2.0 2.0 2.0 2.0

RPI (% y/y) 4.0 -0.5 4.6 2.8 3.1 5.5 1.5 3.0 2.5 2.5 2.5 2.5 2.5

Unemployment Rate (%) 5.7 7.6 7.8 8.0 7.8 8.0 7.9 7.7 7.2 7.0 6.8 6.5 6.5Bank Rate (%) (2) 2.00 0.50 0.50 0.50 2.50 5.25 4.00 4.00 4.50 4.75 4.75 4.75 4.753-Month Rate (%) (2) 2.77 0.61 0.60 0.90 2.75 5.25 4.00 4.25 4.75 5.00 5.00 5.00 5.002-Year Rate (%) (2) 1.05 1.35 1.10 1.75 2.75 5.25 4.00 4.75 5.00 5.00 5.00 5.00 5.005-Year Rate (%) (2) 2.05 2.50 2.15 2.75 3.35 5.50 5.00 5.50 5.50 5.25 5.25 5.25 5.2510-Year Rate (%) (2) 3.02 4.01 2.80 3.75 4.45 5.75 5.50 5.50 5.75 5.50 5.50 5.50 5.50EUR/GBP (2) 0.96 0.89 0.80 0.79 0.90 0.87 0.84 0.82 0.79 0.79 0.83 0.87 0.87GBP/USD (2) 1.46 1.62 1.35 1.27 1.28 1.40 1.46 1.41 1.39 1.41 1.43 1.49 1.53

Source: BNP ParibasFootnotes: (1) Forecast (2) End period

Year

Year

Year

Year


Long-Term Economic Forecasts (Continued)

Table 2: Long-Term Forecasts

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

ChinaGDP (% y/y) 9.6 8.7 9.8 8.5 9.0 8.2 7.8 7.3 6.6 6.4 6.2 6.0 6.0

CPI (% y/y) 5.9 -0.1 3.5 3.0 3.6 4.0 4.5 3.0 3.0 3.0 3.0 3.0 3.0Policy Rate (%) (2) 2.25 2.25 2.25 2.52 3.06 4.14 4.14 3.87 3.60 3.33 3.06 3.06 3.0610-Year Rate (%) (2) 2.76 3.64 3.81 4.12 4.59 5.04 4.89 4.62 4.35 4.08 3.66 3.66 3.66USD/RMB (2) 6.83 6.83 6.80 6.60 6.41 6.54 6.50 6.40 6.30 6.20 6.10 6.00 6.00

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

BrazilGDP (% y/y) 5.1 -0.2 7.2 4.6 4.4 4.3 4.3 4.3 4.3 4.3 4.3 4.3 4.3CPI (% y/y) 5.9 4.3 5.2 4.5 4.5 4.3 4.0 3.8 3.5 3.3 3.0 3.0 3.0Policy Rate (%) (2) 13.75 8.75 12.25 11.25 11.25 10.25 9.75 9.25 8.75 8.25 7.75 7.25 7.25USD/BRL (2) 2.31 1.74 1.75 1.75 1.90 1.93 1.96 1.98 2.00 2.02 2.03 2.05 2.0

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

IndiaGDP (% y/y) 9.2 6.7 7.4 9.2 8.8 8.7 8.8 9.0 9.0 8.9 8.9 8.8 8.8WPI (% y/y) 9.1 2.1 8.7 5.1 4.5 4.5 4.5 5.0 5.0 4.8 4.5 4.5 4.5Policy Rate (%) (2) 6.50 4.75 6.00 7.00 7.50 7.50 7.50 7.75 7.75 7.75 7.50 7.50 7.5010-Year Rate (%) (2) 5.26 7.68 7.45 7.75 8.25 8.00 8.00 8.25 8.25 8.25 8.00 8.00 8.00USD/INR (2) 48.6 46.5 42.0 38.0 38.0 37.0 35.0 34.0 33.5 33.0 32.5 32.0 32.0

’08 ’09 ’10 (1) ’11 (1) ’12 (1) ’13 (1) ’14 (1) ’15 (1) ’16 (1) ’17 (1) ’18 (1) ’19 (1) ’20 (1)

RussiaGDP (% y/y) 5.6 -7.9 4.7 4.2 4.5 4.5 4.0 4.0 3.5 3.5 3.5 3.5 3.5CPI (% y/y) 13.3 8.8 7.1 9.2 8.5 8.5 8.0 8.0 7.5 7.0 6.5 6.0 6.0Policy Rate (%) (2) 12.00 8.75 7.25 9.00 9.00 8.50 8.00 7.50 7.00 7.00 6.00 6.00 6.0010-Year Rate (%) (2) 14.00 8.56 7.00 8.00 7.75 7.50 7.25 7.00 6.75 6.50 6.00 6.00 6.00USD/RUB (2) 29.4 30.2 31.4 30.0 30.1 26.5 25.5 26.7 27.1 26.5 25.5 25.3 25.0

Source: BNP ParibasFootnotes: (1) Forecast (2) End period

Year

Year

Year

Year

Chart 2: BNP Paribas’ Long-Term Inflation Forecasts

-1.0

0.0

1.0

2.0

3.0

4.0

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6.0

’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

US

Eurozone

China

Brazil

-1.0

0.0

1.0

2.0

3.0

4.0

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6.0

’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

US

Eurozone

China

Brazil

Source: BNP Paribas

While emerging markets are likely to outpace growth in developed economies, this is likely to be reflected in higher inflation.

Chart 1: BNP Paribas’ Long-Term GDP Growth Forecasts (% y/y)

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

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Eurozone

China

Brazil

-6.0

-4.0

-2.0

0.0

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6.0

8.0

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12.0

’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

US

Eurozone

China

Brazil

Source: BNP Paribas

Eurozone GDP growth is likely to be the weakest of the major economies. While China will continue to outpace the rest, we believe that the potential growth rate will slow over time, not least due to demographics.

Contacts July 2010Global Outlook 84 www.GlobalMarkets.bnpparibas.com

Global Outlook Team: Contacts International Paul Mortimer-Lee Summary, Long-Term Forecasts London 44 20 7595 8551 Europe Ken Wattret Eurozone, Germany London 44 20 7595 8657 Luigi Speranza Eurozone, Italy, Spain London 44 20 7595 8322 Dominique Barbet France Paris 33 1 4298 1567 Philippe Sabuco Portugal, Greece Paris 33 1 4316 9554 Raymond van der Putten Netherlands Paris 33 1 4298 5399 Steven Vanneste Belgium Brussels 32 2 312 12 10 Catherine Stephan Austria Paris 33 1 5577 7189 Caroline Newhouse-Cohen Finland Paris 33 1 4316 9550 Alan Clarke UK, Medium-Term Rate Forecasts London 44 20 7595 8476 Eoin O’Callaghan Switzerland, Ireland London 44 20 7595 8226 Gizem Kara Scandinavia, FMCI London 44 20 7595 8783 US Brian Fabbri US New York 1 212 841 3633 Julia Coronado US New York 1 212 841 2281 Anna Piretti US, Canada New York 1 212 841 3663 Yelena Shulyatyeva US, Canada New York 1 212 841 2258 Japan Ryutaro Kono Japan Tokyo 81 3 6377 1601 Hiroshi Shiraishi Japan Tokyo 81 3 6377 1602 Azusa Kato Japan Tokyo 81 3 6377 1603 Emerging Markets Richard Iley Asia Hong Kong 852 2108 5104 Dominic Bryant Asia, Australia Hong Kong 852 2108 5105 Mole Hau Asia, FMCI Hong Kong 852 2108 5620 XingDong Chen China Beijing 86 10 6561 1118(1217) Chan Kok Peng Asia Singapore 65 6210 1946 Michal Dybula CEE Warsaw 48 22 697 2354 Julia Tsepliaeva Russia, Kazakhstan Moscow 74 95 785 6022 Serhiy Yahnych Ukraine Ukraine 38 044 537 49 17 Selim Cakir Turkey Turkey 90 212 251212(1671) Emre Tekmen Turkey Turkey 90 212 251212(1604) Italo Lombardi Latin America, Latam Currencies New York 1 212 841 6599 Diego Donadio Latin America, Latam Currencies Sao Paulo 55 11 38413421 Currencies Hans Redeker Global London 44 20 7595 8086 Ian Stannard G20 London 44 20 7595 8086 Sebastien Galy G20 New York 1 212 841 2408 Chin Loo Thio Asia Singapore 65 6210 3263 Robert Ryan FX & IR Asia Strategist Singapore 65 6210 3314 Shahin Vallée FX & IR CEEMEA Strategist London 44 20 7595 8306 Elisabeth Gruié FX & IR CEEMEA Strategist London 44 20 7595 8492 Bartosz Pawlowski FX & IR CEEMEA Strategist London 44 20 7595 8195 Interest Rate Strategy Cyril Beuzit Global London 44 20 7595 8639 Bülent Baygün US New York 1 212 841 8043 Patrick Jacq Eurozone Paris 33 1 4316 9718 Hervé Cros Inflation London 44 20 7595 8419 Ioannis Sokos Flows, Supply London 44 20 7595 8671 Matteo Regesta Euro Option London 44 20 7595 8607 Koji Shimamoto Japan Tokyo 81 3 6377 1700 Hidehiko Maejima Japan Tokyo 81 3 6377 1701 Credit Vivek Tawadey Global London 44 20 7595 8894 Mehernosh Engineer Global London 44 20 7595 8338 Andrea Cicione Global London 44 20 7595 8296 Commodities Harry Tchilinguirian Oil Strategist London 44 20 7595 6485 Anne-Laure Tremblay Precious Metals Strategist London 44 20 7595 6714 Stephen Briggs Base Metals Strategist London 44 20 7595 8774 Philippe d’Arvisenet Group Chief Economist Paris 33 1 4316 9558 Guy Longueville Head of Country Risk Paris 33 1 4316 9540 Eric Vergnaud Structural Issues Paris 33 1 4298 4980

Interest Rate Strategy July 2010Global Outlook i www.GlobalMarkets.bnpparibas.com

Global Bonds: Lower Yields Ahead

OVERVIEW Uneven recovery, uneven behaviour

The economic recovery that started last year has gained momentum in Asia, remains solid in the US (although a modest deceleration is likely in the coming months) and has remained very slow in most European countries. Moreover, the recovery in the euro area is uneven and will be restrained by fiscal tightening. In the US, the Federal Reserve has taken note of signs of an improvement in economic activity. However, it has only changed its rhetoric slightly, keeping a very accommodative stance, which clearly highlights the Fed’s uncertainties about the return to a long-term trend of robust growth. Job creation remains well below the levels required to lower the unemployment rate significantly. In addition, core inflation has been moderating for months and BNP Paribas forecasts that it will fall even closer to zero in the coming quarters. This situation is unlikely to lead the Federal Reserve to speed up its exit strategy from accommodative policy. In Japan, the economic situation shows signs of improvement earlier than generally expected a few months ago. However, this situation is not leading to any inflation pressures and therefore the Bank of Japan is not on the verge of tightening. Monetary policy will also remain very accommodative in the UK. Indeed, as the financial situation remains very fragile and the massive fiscal tightening announced in the emergency Budget puts growth at risk, we may even see the Bank of England resuming quantitative easing. In the euro area, the economic recovery will remain very fragile without a significant rebound in lending to companies and households and, to date, bank loans to the economy have only stabilised and show no sign of increasing. Risks to growth are still to the downside and the ECB remains concerned about signs of weakness. Although the EUR’s weakness has seen headline inflation rebound, driven by commodity prices, core inflation remains subdued and the prospect in the coming months is of further disinflationary – if not deflationary – pressures. Against this backdrop, the ECB will have to delay its exit from non-standard policies. In contrast, in Asia, economic activity is solid and the risk there is that overheating will fuel inflation pressures. Several central banks have already started to tighten monetary conditions. The global situation is, therefore, far from being homogeneous. In that respect, while signs of strength in some areas are likely to support risk appetite, weakness in Europe will prevent safe-haven assets from suffering. The search for safety and risk appetite are likely to live alongside each other for months. While

risk appetite could develop in Asia and in the US, safety investments are likely to be favoured in Europe as long as financial and sovereign risks remain high. This global situation could allow stocks and commodities to remain in healthy territory while core sovereign debt continues to see firm demand. From Asia to Europe, from hedge funds to central banks, investors will exhibt different behaviour, explaining the apparent contradiction of lower yields in an environment of higher risk appetite.

EUROPE Exit strategy: false start

At the end of last year and early this year, the ECB signalled that 2010 would be the year of the exit strategy. The flood of liquidity was expected to be gradually drained along with the removal of exceptional liquidity measures. The first step was the interruption of very long-term tenders (the last 1-year tender was held in December and the last 6-month one at the end of

Table 1: Yield Forecasts End-Q3 2010 (%) Current 23 June 2010 USD EUR JPY

Curr. End Q3 Curr. End Q3 Curr. End Q3

2-year 0.70 0.75 0.59 0.40 0.15 0.20 5-year 1.96 1.80 1.57 1.30 0.40 0.50 10-year 3.17 2.90 2.67 2.20 1.20 1.30 30-year 4.10 3.80 3.40 2.85 2.00 2.10 Spreads 2/5-year (bp) 126 105 98 90 25 30 5/10-year (bp) 121 110 110 90 80 80 10/30-year (bp) 93 90 73 65 80 80 2/10-year (bp) 247 215 208 180 105 110 10y swap spd 6 15 25 35 7 5 Source: BNP Paribas

Chart 1: No Decoupling Between US and Eur Markets and Lower Yields Ahead

9 8 0 0 0 2 0 4 0 6 0 8 1 0-0 .7 5

-0 .5 0

-0 .2 5

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-1 .5

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-0 .5

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2 .0

C o re In f la t io n (U S -E U R , % R H S )

1 0 -Y r (U S -E U R , % )

B N P PF c a s t


Interest Rate Strategy July 2010Global Outlook ii www.GlobalMarkets.bnpparibas.com

March). Furthermore, the ECB decided to shift back to a variable rate for the 3-month tender in April. However, the sharp deterioration of several EMU sovereign debts, as well as renewed pressure on liquidity, led the ECB to resume exceptional liquidity measures. The ECB decided to keep a fixed rate and full allotment for 3-month tenders at least until the end of the third quarter, as well as for the 1-week MRO and 1-month tender. This could limit tensions as banks are certain about their ability to find liquidity up to three months over the next quarter. But this is far from being enough to reduce pressure. Indeed, for a growing number of banks in the eurosystem, the situation is worsening and the rise in the number of bidders at the ECB’s tenders is evidence that an increased number of banks have no choice other than to roll near-term liquidity instead of funding the medium- and long-term exposure of their balance sheets. Given the global environment, banks’ financial situation is unlikely to improve in coming months unless the ECB adopts further non-standard measures. Either the ECB resumes very long-term tenders during the second half of the year, or stress will remain high. This does not mean that, without further 6-month or 1-year tenders, tensions in money markets will intensify, but that stress will remain high enough to prevent a gradual return to normal funding conditions. Whatever the ECB decides on tenders, the exit strategy from non-standard policy is postponed at least until early next year. In the meantime, while the covered bond purchase programme that started a year ago has been completed (EUR 60bn), the ECB will probably continue to buy assets under the Security Market Programme, aimed at providing support to sovereign debt under attack. The ECB has already bought more than EUR 51bn in six weeks (compared with the EUR 60bn covered bonds bought over the past year). However, in order to prevent a rise in liquidity, the SMP is sterilised by the ECB on a weekly basis using term deposits. As a result, from the start of the second half of 2010, liquidity will be provided with open market operations.

Stress on liquidity will keep the front end steep Pressure on liquidity is likely to persist in the coming months. This has two important implications. First, it will prevent the ECB from starting its exit strategy. Accommodative measures are likely to be maintained for a while. We would not be surprised to see the ECB announcing the extension of existing non-standard measures (fixed rate and full allotment of operations from one week to three months), and we think longer tenders (six months, one year) would be welcome in order to restore confidence. This will keep rates at the very front end close to lows. The Eonia fixing will remain close to the rate on the deposit facility, preventing the front end from flattening. The second implication is that high stress can only fuel wider OIS/BOR spreads beyond the 3-month maturity.

This could fuel a steepening of the ER curve in the coming months.

Bond curve: flatter Projected macro-economic conditions in the months ahead clearly favour a flatter curve. Economic growth is likely to remain subdued, especially as US growth is likely to slow by the end of the year. Meanwhile, inflation in the eurozone will remain low and core inflation is set to moderate further. Under this scenario, bull-flattening pressures could develop. In addition, the situation in sovereign debt is unlikely to improve sharply in the next few months. Against this backdrop, the benchmark curve is likely to be firmly received by investors in search of safety, such as central banks and pension funds. But the environment will be marked by pressure on liquidity and short-term swap spreads have the potential to rise further during the third quarter. This could add to the flattening bias on the swap curve, though amid less bullish conditions. Should global economic conditions improve faster than we expect, then bear-flattening pressures, coming from the US for instance, will affect the EUR curve and can only add to the flattening bias of the curve. As a result, and whatever the economic scenario, flattening pressures will mount in the coming months/quarters on the bond market curves.

Risks of wide(r) spreads are high As noted above, stress on liquidity is unlikely to decrease significantly in the coming months and the risk is that there will be tensions in money markets linked to poor funding conditions in the 1-3y area. Primary activity has not really resumed in the financial sector and has only been related to a few major banks. For most, the situation is, rather, worsening as far as the funding of their balance sheets is concerned. Such a situation can only exert upward pressure on short-term swap rates. The ASW spread is mainly driven by liquidity conditions in the euro area and we see scope for paying interest during Q3.

Chart 2: Japanese-Style Flattening Starting?

Nov07 08

Mar Jul Nov09

Mar Jul Nov10

Mar-100

-50

0

50

100

150

200

2500.0

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2/10yr Swap Spread (RHS)

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Interest Rate Strategy July 2010Global Outlook iii www.GlobalMarkets.bnpparibas.com

When it comes to intra-EMU spreads, the euro area must be split into two groups. In core markets, liquidity and volatility are the main drivers. We do not see any room for a significant compression between core EGBs and benchmarks in Q3. When it comes to peripheral markets, concerns about sovereign debt and deficits lie behind price action. Thanks to the EFSF, the risk of a surge in spreads has diminished. But the situation remains very fragile and evidence of this will keep intra-EMU spreads on the wide side in coming months, although supply concerns will ease.

57% of expected 2010 EGB gross issuance and 66% of net issuance was done in H1 2010 With the first half of the year behind us, we already have a good sample of auction behaviour and investor appetite for various EGBs. 57% of the expected 2010 issuance has been conducted and we expect a further EUR 390bn until the end of the year. Slovenia, Ireland and the Netherlands are ahead of others in terms of completing their issuance programmes, while Spain and Portugal are lagging slightly. Greece is a special case as it has issued EUR 20.4bn of GGBs in 2010 but is not expected to issue more since it is under the umbrella of the EU/IMF EUR 110bn support, with the first disbursement of EUR 20bn already made. Core countries, such as France and the Netherlands, are ahead of peripherals, such as Italy and Spain, in their programmes since flight-to-quality flows and increased risk aversion made core states’ auctions quite successful in the first half of the year. Of course, we must mention the two ‘technically failed’ German auctions on the 5y and 30y sectors, which we see as an indication that investors occasionally find German yields too low around current levels and would rather wait for the extra yield offered by other core states such as France and the Netherlands. However, the timing of each auction is key with low German yields looking less attractive during periods when risk appetite is rising (not too often in H1) and we have also seen some very successful German auctions, even in Schatz, with yields at all-time lows. Spain and Italy, the two countries in the eurozone where demand is most strongly biased toward domestic bonds, have seen good bid-to-cover auctions and are expected to continue to do so in H2 2010. Domestic support has become a key issue in terms of funding and we expect this theme to become even more important. Another pattern that we saw develop in H1 2010 was the longer duration of core versus peripheral issuance. In times of crisis, peripheral countries find it easier to issue shorter-dated bonds while core countries take advantage of the low yields and issue at the longer end. In total, across all EGBs, 21% of the issuance took place on the 2-3y sector, 24% on the 5y, 6% on the 7y, 33% on the 10y, 8% on the 15y and 8% on the ultra-long end.

In terms of net supply, EUR 257bn of redemptions out of a total of EUR 510bn in 2010 have already occurred. This means that 66% of the total net supply of EUR 413bn has already taken place in H1. We expect a further EUR 140bn in H2, suggesting that pressure on yields stemming from large supply should ease in the second half of the year. Finally, note that there will not be any more significant redemptions in Greece, Portugal and Ireland until year-end, while Spain faces EUR 17bn of SPGB redemptions at the end of July and nothing thereafter. Investors have started looking at the redemption profiles of peripheral countries, searching for potential pressure points on relative spreads.

Inflation: lower real yields and BE in Q3 After a mixed performance in Q2, inflation-linked assets will start Q3 on the cheap side. That said, over the past five years, linkers have outperformed nominals only once during the summer and that was in 2005. Given tight levels on real yields, and based on our expectation that nominal yields will fall, we expect both real yields and breakevens to fall by around 25bp in Q3. In this context, FRF breakevens, which will also benefit from an increase in the Livret A rate, should continue to outperform EUR ones.

EUR vol: a steeper implied volatility term structure Delivered interest rate volatility at the front end of the curve has almost continuously decreased since the start of the year: over the period the six-month rolling values of the 3m2y implied/realized ratio have been bounded below by 1. As a result, the top-left corner has softened by 15%, on average, in the year to date. In contrast, implied volatilities of gamma options at the long end have moved higher over the period. In fact, despite always trading at a premium versus realised volatility, the latter has increased sharply over the past two months as a result of the adverse feedback loop between liability and exotic hedging/front running at times when risk aversion has risen. Assuming the ECB keeps interest rates low for a long period as data continue to suggest downside risks to inflation in both the eurozone and the US, realised volatility in the top left corner will continue to decline. For instance, 1y2y realized vol at 58bp (6m rolling window), is still 13bp above the record low reached in May 2007. In turn, we expect delivered volatility to move up the curve. Overall, the scenario of anaemic growth in the eurozone should exert steepening pressure on the implied volatility term structure as well as on the tenor term structure. Moreover, the decline of forward rates is likely to set the scene for a steeper skew in coming months. We also expect the macro environment to support flows looking to exploit the fading of the current richness of CMS spreads. In turn, the convexity of the smile is bound to normalise further from current levels.

Interest Rate Strategy July 2010Global Outlook iv www.GlobalMarkets.bnpparibas.com

US Treasury yields settle into a lower range as

investors grow sceptical of European debt The US economic backdrop continues to be soft and the housing sector stagnant, while inflation has declined further and eased the perceived risk of runaway inflation down the road (Chart 3). By our reckoning, the Fed is still a long way from tightening monetary policy, with a rate hike certainly off the table in 2010 and probably for 2011 too. As a result, we expect little movement in short-end rates. In longer maturities, we see the 10y yield staying below 3.5% (as it has since the euro debt crisis unfolded) and probably making a new low in the high-2% area. The overall economic backdrop will be a large factor driving the 10y. With core inflation forecast to head even lower, it will require a significant fall in Treasury demand or a worsening in the budget outlook for long-end rates to rise. We see these as unlikely scenarios and feel the risks are skewed toward even lower rates. Having said that, there is no denying that the Fed had been taking deliberate steps toward removing liquidity and will probably continue to do so at a measured pace. The Fed’s game plan for reverse repos, increasing the repo rate, the term deposit facility, etc. is more likely to be simply delayed than altered. However, this should not prevent front-end carry trades from performing well and we recommend continuing to capture the carry and roll-down at the front end on any backup to the levels seen just a few months ago, with the 2y Treasury above 1.00%.

10y swap spreads likely to widen gradually With rates likely to be range bound in the coming months, 5y and 10y swap spreads should not rise substantially from the current lows. There are several factors that have kept spreads low: lack of balance sheet room, tight credit spreads, low vol and a bloated debt-to-GDP ratio. Some of these factors look to be reversing, particularly the supply factor as cuts in Treasury issuance have begun and will continue for at least a few more months. With that, we see a moderate upward bias to swap spreads (Chart 4).

2y TIPS BEs look cheap Although the TIPS market has shown some early signs of recovery, Q3 is likely to be challenging for a few reasons. The seasonality of inflation, for one, will weigh on the carry profile. There is also our forecast for a gradual 30bp drop in the 10y nominal rate in Q3, which may compress breakevens in that sector by around 10bp if nom/real beta holds up. Finally, there is the continuing deceleration of inflation to contend with. That said, we still like 2y breakevens, which look around 15bp cheap adjusted for the level of rates, the curve and the price of oil (Chart 5). They also look cheap versus BNPP’s inflation forecast. Furthermore,

in contrast to longer maturities, we do not expect pressure on breakevens in this sector due to a nominals rally as we project that the 2y Treasury will remain near current levels throughout Q3. Finally, the flattening view in Q3 lends itself well to a 2s5s BE flattener, which gives exposure to the cheap 2y versus slightly rich 5y sector.

(Callable) Agencies to benefit from yield grab We expect agency spreads to stay stable throughout Q3 as investors look for a yield pick-up over Treasuries. The net supply of agencies is likely to be flat to slightly lower in Q3 as funding needs will be relatively low. Meanwhile, redemptions will stay high as bonds are called away, and we assume that money will be reinvested in agency paper. We prefer paper in the belly of the curve, including longer maturity, 1 to 2 year lockouts such as 5nc1 and 7nc2. These structures offer a better pick-up in yield in a range-bound environment compared with 2nc3m, where gamma has really sold off.

Chart 3: 5y5y BE Inflation and 10y Treasury Rate

2

2.5

3

3.5

May-09 Aug-09 Nov-09 Feb-10 May-103

3.3

3.6

3.9

4.2

5y5y Breakeven

10y Rate ( RHS )

2

2.5

3

3.5

May-09 Aug-09 Nov-09 Feb-10 May-103

3.3

3.6

3.9

4.2

5y5y Breakeven

10y Rate ( RHS )

Source: BNP Paribas, Bloomberg

Chart 4: Year-on-Year Change in Treasuries Outstanding and 10y Swap Spread

-20%

0%

20%

40%

60%

Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11

-30

10

50

90

130YoY Change in 1+ Yrs Debt Outstanding

Forecast10y Swap Spread (RHS, Inv.)

Source: BNP Paribas

Interest Rate Strategy July 2010Global Outlook v www.GlobalMarkets.bnpparibas.com

MBS We had expected mortgages to widen after the Fed ended its MBS Purchase Programme against a backdrop of an overall increase in risk premia. While risk premia did increase, triggered by events in Europe, and mortgages did widen initially, they have since come in considerably (Chart 6). We think that, unlike the 2007-2008 financial crisis, when risk premia increased across the board, this time the market is differentiating between credit (or economic) and non-credit risk. As the market becomes increasingly comfortable with lower rates, due to the poor economic outlook, the demand for convexity products has intensified. Within the spectrum, agency credit risk is an acceptable risk given the three-year unlimited capital commitment, leading agency MBS to trade purely as a convexity product devoid of credit risk. Vol has also fallen from the recent peak reached in early May, consistent with selling vol as part of MBS to earn non-credit carry. Furthermore, the actual convexity of mortgages has been muted with significant burnout, and mortgages have even traded with positive empirical convexity. As tightening MBS is a pain trade for money managers underweight MBS and underinvested banks, we recommend being overweight MBS but, given the magnitude of the recent tightening, only modestly.

2y vol to remain depressed, 10y vol risks skewed to the upside With our expectation that rates will settle into a new range at lower levels, we also expect implied volatility to fall gradually, especially in the upper left corner. Since the Fed is completely out of the picture, short maturities have little chance of selling off briskly. At the same time, any further rally in Treasuries in a flight-to-quality episode is likely to cause a widening in front-end swap spreads. Even if the markets stabilise, with 2y Treasury rates making new lows due to the lack of inflation, we find it difficult to envisage 2y spreads revisiting the sub-20bp area after the financial market scare of Q2, which reminded everyone that this is not an environment that justifies historically low risk premia. Therefore, there is little room for the front end to move, which explains our bearish stance on the upper left of the vol grid despite its already depressed levels (Chart 7). While gamma vol on 10y tails could also decline as the 10y hovers around 3%, this drop in volatility is likely to be gradual. After all, markets will probably be nervous on an ongoing basis about deflation setting in Japan-style as long as the picture in Europe remains murky. Furthermore, the implied to realized vol ratio in 10y tails is 90% and it tends to fall below this level only during times of extreme delivered vol, in which case implieds rise too. In other words, even though the emergence of a new rate range and a lack of mortgage convexity hedging put downward pressure on gamma vol on 10y

tails, the risks are to the upside. For longer expiries, e.g. 1 and 2y on 10y tails, we expect payer skew to be supported since investors will be interested in buying protection against higher rates while rates are still low.

Chart 5: TIPS Breakeven Inflation Rich/Cheapness

-15

-10

-5

0

5

10

2y B

E

3y B

E

5y B

E

7y B

E

10y

BE

15y

BE

20y

BE

30y

BE

Ric

h/C

heap

(bp)

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Cheap

Source: BNP Paribas

Chart 6: Mortgage Current Coupon-Libor Spread

50

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90

100

110

120

130

140

150

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09

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09

Mar

-09

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Nov

-09

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-09

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10

Feb-

10

Mar

-10

Apr-

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-10

Jun-

10

Source: BNP Paribas, Bloomberg

Chart 7: 3m2y and 3m10y Swaption Implied Vol

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3m2Y

3m10Y

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3m2Y

3m10Y

Source: BNP Paribas

Interest Rate Strategy July 2010Global Outlook vi www.GlobalMarkets.bnpparibas.com

JAPAN Several tailwinds pushed yields down in Q2

The JGB market tested the upside in Q2. Yields declined substantially across long maturities, due to several factors. Firstly, there was a global flight to quality as a result of the European fiscal crisis. Secondly, Japan’s new DPJ government, led by Naoto Kan, emphasised the importance of fiscal discipline and predicted a hike in the consumption tax in the next two to three years. Finally, investors, who had been stockpiling funds because long yields had risen in the second quarter of the past two years, ultimately had to jump into the market, which remained firm. That said, the yield on the 5y, which is favoured by local banks, fell below the Tibor 3m (their benchmark funding rate), and the yield on the 20y, which is preferred by insurers, fell below the 2.0% threshold. These moves caution against toppish prices, limiting the market’s upside.

Supply/demand conditions should deteriorate in H2 2010 Supply-demand conditions remain supportive. Many local investors have been holding on to their surplus funds of the new FY, waiting to buy on dips. With price levels shifting upward due to unexpected tailwinds, investors are becoming increasingly impatient to buy. However, we expect supply-demand conditions to deteriorate from early H2 2010. Although the European fiscal crisis has yet to be resolved, the Japanese economy continues to recover steadily, led by robust growth in Japan’s Asian neighbours. Furthermore, the RMB’s shift to a managed floating exchange-rate regime will increase Chinese purchasing power, supporting commodity prices and the Japanese economy. Moreover, although the Kan government has emphasised its fiscal tightening stance, it will struggle to achieve its target to keep JGB issuance in FY 2011 below that of the current FY.

Steepening trend clearly established Steepening pressure is likely to persist. Stress in the financial markets due to the European fiscal crisis should oblige the BoJ to prolong its quantitative easing. Moreover, putting aside the ongoing economic recovery, the fiscal situation in Japan will inevitably deteriorate over the medium term, and domestic savings, which are needed to compensate for the fiscal deficit, are expected to dry up gradually. While Japan will continue to enjoy a current account surplus and abundant liquidity, the surplus on the investment income balance, which is the foundation of the current account surplus, is expected to shrink because of lower foreign interest rates. The decline in savings, due to the rise in the average age of the Japanese population, is the main fundamental factor behind these phenomena. The retirement of Japan’s baby boomer generation has promoted a shift from savings to consumption and

capital expenditure. A steepening trend beyond the 5y has clearly been established on the curve. Such steepening pressure should persist on the curve in the medium term.

Swap spreads will normalise, particularly in the belly of the curve Swap spreads will normalise, albeit gradually. In the super-long sector, JGB yields and swaps rates have tended to trade at similar levels. The upside of cash bond prices will remain limited, reflecting the poor fiscal outlook. In the medium sector, however, the swap spread is likely to narrow, after having widened rapidly due to heavy buying of JGBs by local banks. On the other hand, conditions in inflation-linked JGBs are improving thanks to the reflationary policy measures adopted by major governments, though fluctuations in the CPI for technical reasons and speculation about buy-backs will remain destabilising factors in the near term. Although the rebound in linkers has been slower in Japan, where deflationary pressure is stronger than in other countries, linkers will face tailwinds from the possible moderation in the year-on-year decline in the core CPI after the recent rebound in oil prices.

Chart 8: JGB Yield and the Stock Market

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2007 2008 2009 20106000

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Nikkei 225 (RHS)

Source: BNP Paribas

Chart 9: JGB Curves

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2007 2008 2009 2010

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2007 2008 2009 2010

10- to 20-year (bp)

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Source: BNP Paribas

Alan Clarke July 2010Global Outlook vii www.GlobalMarkets.bnpparibas.com

Eurozone Rates: Medium-Term Forecasts Chart 1: ECB Policy Rate (%) Chart 2: 3-Month Rate and ECB Policy (%)

92 94 96 98 00 02 04 06 08 10

Perc

ent

-2-10123456789

10

EONIA

Real

BNP ParibasForecast

Nominal

92 94 96 98 00 02 04 06 08 10

0369

ECB Repo RateBNP Paribas

Forecast

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3m Rate minus ECB Repo


We expect the ECB to leave the refi rate unchanged until H2 2012, as inflation remains well below 2%.


The ECB deposit rate is 75bp below the refi rate. This has pushed 3-month interest rates below the refi. We expect the undershoot to narrow in the near term due to financial market tensions.

Chart 3: 2-Year – ECB Policy Spread (%) Chart 4: 10-Year – 2-Year Spread (%)


We expect the spread between the 2-year yield and the refi rate to be broadly stable until late 2011 before widening in anticipation of ECB rate hikes during late 2012.


The 10-year – 2-year yield differential is likely to narrow in the near term as peripheral eurozone sovereign jitters increase demand for Bunds, pushing longer-term yields down.

Chart 5: 10-Year – 3-Month Spread (%) Chart 6: US – Europe 10-Year Spread (%)

92 94 96 98 00 02 04 06 08 10048

ECB Repo Rate

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Forecast

Eurozone 10y - 3m

BNP Paribas


We expect the 10-year – 3-month differential to narrow, reflecting a combination of higher 3-month rates and falling Bund yields.


EGBs are likely to outperform US Treasuries, reflecting differing growth and inflation prospects between the two regions.

Alan Clarke July 2010Global Outlook viii www.GlobalMarkets.bnpparibas.com

US Rates: Medium-Term Forecasts Chart 1: Fed Funds Target Rate (%) Chart 2: 3-Month Rate and Fed Funds (%)

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With the Fed funds rate on hold until 2012 and inflation falling, real interest rates will continue to rise.

Source: Reuters EcoWin Pro, BNP Paribas The spread between the 3-month rate and the Fed funds rate is likely to widen in the coming quarter, reflecting further financial market tensions, before narrowing during 2011 as these tensions subside.

Chart 3: 2-Year – Fed Funds Spread (%) Chart 4: 10-Year – 2-Year Spread (%)


We expect the spread between 2-year yields and Fed funds to remain close to current levels over the coming year. Thereafter, we expect the spread to re-widen as the market prepares for interest rate hikes in 2012.


We expect the 10-year – 2-year spread to narrow in the near term as the flight to quality pushes down longer-term yields. Further ahead, we expect renewed flattening as shorter-term yields rise in anticipation of the first Fed hike.

Chart 5: 10-Year – 3-Month Spread (%) Chart 6: 10-Year Swap Spread (%)

90 92 94 96 98 00 02 04 06 08 1002468 Fed Funds Target Rate

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2

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BNP ParibasForecast

US 10y - 3m

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

0246 Fed Funds Target Rate

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BNP ParibasForecastUS 10y Swap - 10y Govvie


We expect the spread between 10-year bond yields and the 3-month rate to narrow slightly over the coming quarters as sovereign debt fears push down US Treasury yields.


The swap spread to Treasuries is directional. We expect spreads to be broadly stable in the near term before rising yields from mid-2011 drag swap spreads higher.

Credit Portfolio Strategy July 2010Global Outlook ix www.GlobalMarkets.bnpparibas.com

Corporate Bonds: Glass Half Full

The volatility within markets stemming from sovereign risk has begun to taint the technical backdrop for credit, despite a fundamental picture of gradual global growth supported by emerging markets and manufacturing. We believe the volatility within the credit market has two sources, namely, differing growth expectations due to austerity measures, and a lack of trading liquidity. While austerity measures will undermine domestic demand, they will also serve to restrain government yields, thus making credit an attractive asset class. From a medium-term investment perspective, we see the glass as half full and are positive on credit, expecting it to continue to outperform both government paper and equities. From a macro perspective, we expect global GDP growth of 4.5% in 2010 and 3.8% in 2011, largely led by emerging markets, especially Asia outside of Japan, coupled with an improvement in growth prospects in the US and Japan. In contrast, Europe will lag significantly (with growth of just 1.2% in 2010 and 0.6% in 2011). On the liquidity front, we expect the ECB to expand its quantitative easing measures, which should not only put a ceiling on sovereign yield levels, but also reduce the risk premium on Financial CDS, which have served as a sovereign hedge for risk managers. The weakening of the euro on the back of the ECB’s measures should help to boost exports and hence growth too.

Credit versus governments With the ECB on hold, credit continues to offer significant value versus cash and government paper, offering a yield between 3% and 12% and a credit spread to Bund yield ratio similar to the refinancing crisis of late 2008, though non-financial refinancing risk remains negligible due to the significant pre-funding of debt maturities undertaken in 2009.

Credit versus equities Equity valuations assume EPS growth of 20-25% per annum sustained over a two-year period. This appears unlikely given that GDP growth in the developed world remains sub-par. Moreover, companies’ pricing power will remain limited, given large output gaps. A failure to meet these expectations could lead to a 15-20% correction on equities, which may weigh on credit indices, especially high yield. Note that credit continues to offer better value than equities, particularly in the US, when evaluated from a credit yield versus dividend yield perspective. Taxation (corporate and consumer) is another factor being ignored by equities, which could affect EPS growth negatively and significantly over the medium term.

Credit default premium Long-term credit investors are being adequately compensated for default risk. Non-financial BBBs are currently pricing in a five-year cumulative default rate of

Chart 1: Snr Fins Have Underperformed SovX and Main on the Back of Hedging Activity

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0

20

40

60

80

Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10

Sen Fins - Sovx WE Sen Fins - Main

Source: BNP Paribas

Chart 2: Credit Spread / Bund Yield Ratio is Attractive

0%

50%

100%

150%

200%

250%

00 01 02 03 04 05 06 07 08 09 10

5yr Non-Fins A 5yr Non-Fins BBB

Average BBB

Average A

Source: BNP Paribas, iBoxx

Chart 3: Credit Yields Have Remained Steady Due to Lack of Refinancing Risk, While Bund

Yields Have Fallen

23456789

10

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

Non-Fins A Non-Fins BBB German sov

.

Yield, %

Source: BNP Paribas, iBoxx

Credit Portfolio Strategy July 2010Global Outlook x www.GlobalMarkets.bnpparibas.com

about 12%, when the long-run average has been about 2%, with a peak of 5.8%.

Credit selection is starting to play a key role We expect the remainder of 2010 to be challenging as increased sovereign risk concerns lead to low economic growth due to austerity programmes – making a fundamentals-driven approach essential for alpha generation via sector and credit selection. Revenue growth and the geographical distribution of revenues will, we believe, be key factors in determining the winners and losers across sectors. We provide details of our key asset allocation themes for out-performance below.

We prefer financials to non-financials With financials and non-financials widening by similar amounts since the beginning of the year, the spread differential remains almost unchanged at around 140bp in favour of financials. We believe, the excess carry provided by financials compensates for the volatility. Riding out volatility, which is likely to remain high, will continue to be a challenge over the medium term but therein lies the value within financials. From a fundamental perspective, banks continue to deleverage as well as recapitalise, which should help to reduce risk premia. Stringent regulation, including increased capital requirements, implicit and explicit support from sovereigns, ample liquidity and low rates should all help financial spreads narrow over non-financials, once the ECB steps in to curtail sovereign risk. Here we favour subordinated financials, especially LT2 paper and insurance sub-debt.

Value in BBs We see value in BB rated credits. The average spread differential between BB/BBB rated companies is around 400bp, which should compensate investors for the incrementally higher default risk in the near term, especially given lower refinancing risk and default rates.

Prefer EM credits Although EM credits have performed strongly over the past six months, we believe that there is still some value to be extracted from the better-quality names in the oil and gas, steel, metals and mining, telecoms and utilities sectors – which continue to offer investors some upside compared with both sovereigns and relative to other western European companies.

Technical considerations Corporate issuance has withered since the pick-up in volatility in early April. May saw EUR 3.6bn of corporate investment-grade issuance – the lowest monthly issuance since August 2005. Cumulative issuance this year (EUR 85bn) much better resembles the run rate of 2006 through to 2008. We have reduced our FY

forecast for European IG corporate issuance to EUR 150-170bn from EUR 235bn at the beginning of the year. With a lower net supply than in previous years, supply-demand technicals should be positive for spreads.

Risks to our central scenario Sovereign risk to weigh on IG credit: Public

finances have deteriorated extremely rapidly over the past two years, more so in advanced economies than in emerging markets. While a part of this can be explained by cyclical factors such as falling tax revenues and rising unemployment benefits, a significant portion is due to discretionary measures, which are likely to become more permanent, leading to a decline in potential growth. With sovereign spreads acting as a floor for credit spreads, a material improvement in the former (possibly on the back of support measures for weaker countries) will be a prerequisite for spread tightening in the IG market. With Spain and Italy facing significant refinancing over the summer, sovereign risk and volatility will continue to plague markets with bouts of increased risk.

Higher regulation: We believe that greater regulation of the financial sector is on its way (Basel 3, US Financial Regulation Bill). While the moves serve to de-risk the financial system over the medium term, in the near term we expect them to lead to additional costs (via higher credit spreads and wider bid-offer spreads) and less liquidity. New issuance will be priced at the wider end of the market clearing level, as a relative lack of liquidity will force investors to hold paper for longer periods, leading to higher compensation not only for default risk, but also mark-to-market risk. If implemented in their current format, the rules could restrain growth significantly.

Table 1: Model portfolio allocation Overweight Neutral Underweight

LT2 Banks ( ) Senior Banks ( ) Utilities ( ) T1 Banks ( ) Senior Insurance ( ) Telecoms ( )

Sub Insurance ( ) Non-cyclicals ( ) Cyclicals ( ) Autos ( )

( ) increased allocation, ( ) lowered allocation, ( ) no change Source: BNP Paribas

Table 2: BB Eurozone High-Yield Corporate Picks Bond Sector

CHK 6.25% 01/17 (Ba3/BB/BB) Oil and gas STENA 6.125% 02/17 (Ba2/BB+/BB) Industrials FREGR 5.25% 01/16 (Ba1/BB/BB) Healthcare BARY 6% 07/17s (Ba1/BB+/BB+) Consumer Goods HEIGR 8% 01/17 (B1/BB-/BB-) Construction NEXANS 5.75% 05/17 (BB+) Industrials RIFP 4.875% 03/16 (Ba1/BB+/BB+) Consumer Goods Source: BNP Paribas

Hans Redeker July 2010Global Outlook xi www.GlobalMarkets.bnpparibas.com

FX: Fiscal Concerns Keep EUR Pressured

Capital flows will follow return expectations Global rebalancing and deleveraging, including fiscal consolidation, will be the theme dominating markets. The rebalancing of the global economy suggests Western economies will have to shift from being demand driven to becoming more supply driven, while Asian countries in particular will have to dedicate more of their production capacity to satisfying their own demand. Hence, domestic demand in the West will no longer be the engine of global growth, implying that the return on investment in Western economies will decline. The opposite will hold true for Asian countries, where stronger domestic demand will offer higher returns on investment. Since the real side and the financial side of economies should operate at the same risk-adjusted yield level, at least when compared over the long term, we expect the shift of domestic demand growth from the West towards emerging Asia to result in higher financial market yields in Asia compared with advanced economies. Capital flows will follow this trend, keeping Asian currencies top of our recommendation list.

China puts funds into Africa Booming Asia will keep commodity markets underpinned. Producing one unit of GDP growth in Asia consumes about two and half times as much energy as in the efficient economies of the West. Although Asia and other emerging markets will increase their efficiency with respect to energy and commodities, the shift of global growth contributions from Western to emerging-market economies will keep commodity prices supported. Another emerging growth region should also be considered. Africa is resource rich and China has not been shy about increasing its investment in the continent. China, which has been recycling its surpluses into Western bond markets, is likely to change its investment behaviour. Increasing mistrust of Western assets may be good news for Africa, which is likely to benefit from Asian and in particular Chinese investment over the next decade. As African economies expand, they will consume more commodities, with soft commodities and water becoming an increasingly interesting area for long-term asset allocation.

Long positions in commodity currencies challenged by European contagion Attention will remain on commodity currencies. Australia and Canada are quasi Chinese growth and global liquidity plays. As long as Asia and China offer a positive growth outlook and global liquidity conditions remain supportive, commodity currencies will continue to perform. However, the volatile trading performance seen between April and June, with AUD/USD declining

12%, illustrated the currency pair’s relationship with liquidity. These concerns had their foundation in Europe, with its fragile and undercapitalised banking sector and, of course, they could return at any time if Europe fails to deal with this issue. Our working assumption is that Europe will act to restore order to its banking sector. But, if it fails to do so, resulting in weakening liquidity conditions driving Libor rates up, commodity currencies will be hit. The second risk factor potentially challenging our bullish commodity play is related to Asian inflation and the eventual monetary policy response from central banks in the region. Asia’s shift from demand towards supply-driven growth will be inflationary. As long as this development remains moderate, there will be few risks in the short term. However, over time, Asia’s and other emerging markets’ nominal GDP growth will increasingly shift from income and demand towards inflation, which will reduce the scope for central banks to act against slowing growth tendencies. We see this

BNP Paribas’ End-Quarter Foreign Exchange Forecasts

Spot* Q3 End Q1 Q2 End

’10 2010 ’11 ’11 2011

EUR/USD 1.23 1.16 1.08 1.00 0.98 1.00

USD/JPY 91 92 94 100 105 118

USD/CHF 1.11 1.16 1.24 1.33 1.35 1.33

GBP/USD 1.47 1.43 1.35 1.28 1.26 1.27

USD/CAD 1.02 1.02 0.98 0.95 0.90 0.90

AUD/USD 0.88 0.86 0.90 0.94 0.97 0.95

NZD/USD 0.71 0.71 0.74 0.78 0.78 0.73

EUR/JPY 111 107 102 100 103 118

EUR/GBP 0.83 0.81 0.80 0.78 0.78 0.79

EUR/CHF 1.36 1.35 1.34 1.33 1.32 1.33

EUR/SEK 9.55 9.30 9.10 9.20 9.10 9.30

EUR/NOK 7.91 7.50 7.30 7.20 7.40 7.50

Source: BNP Paribas *23 June

Chart 1: China has Recycled its Surpluses Into US Securities


Hans Redeker July 2010Global Outlook xii www.GlobalMarkets.bnpparibas.com

development as a long-term risk; it is not one that troubles us at present. China has the desire and the means to grow at an annual rate of at least 8% for a number of years. Each time China’s authorities see growth weakening, they will take decisive action to prop it up. As long as the inflation rate remains contained, monetary policy will remain relatively loose while the authorities have ample fiscal ammunition to support the economy. Remember, China runs a budget deficit of less than 4% of GDP and the public debt level is at a comfortable 20% of GDP. Some gloomily accuse China of a gigantic misallocation of capital into real estate, including commercial property. In addition, about 10% of outstanding loans are non-performing. By Western standards this number is high, but as long as the Chinese economy can maintain its momentum, the issues of non-performing loans and an overextended real estate sector will be kept in check by rising income and growth. China has the resources to support its economic expansion and, as long as these resources are available, the country’s risk to the global economic outlook, commodity prices and our call for strong emerging market and commodity currencies will remain negligible.

Euro decline: orderly or disorderly? Meanwhile, we remain EUR bearish and underline our EUR/USD parity call for Q1 2011. We hope that the EUR can decline under orderly market conditions, but make it very clear that the risk to our forecast is not that EUR/USD could regain strength. Rather, the risk to our forecast is that the EUR collapses in a context of disorderly market conditions. This will happen if European banks are unable to restore trust, pushing money-market funding rates higher. Unlike in the US, European bank funding via the ECB has remained artificially high. At the same time, banks have increased their deposit holdings with the ECB, accepting a negative carry. A rigorous bank stress test to restore confidence and the ECB keeping the flood gates of its monetary policy open may be required to normalise money market conditions.

EMU: competitiveness gap needs to be closed For most of the past decade, the EUR has traded at overvalued levels. Indirectly, the overvaluation of the EUR has contributed to Europe’s development of current-account and wealth divergences. Global currency reserve growth has dramatically accelerated; up to the end of last year, some 75% of incoming reserves were reallocated out of the USD into other currencies. Hence, there was a tight relationship between the pace of the increase in reserves and EUR/USD’s appreciation. But as the EUR was moving into overvalued territory, the competitive northern-European economies were boosting their position in intra-EMU trade. This trend was supported by rising inflation and cost differentials among EMU countries,

causing the real effective exchange rates of peripheral European countries to increase against the real effective exchange rates of Germany, the Netherlands and Finland among others. Now, the competitive and current account divergence has resulted in an unsustainable wealth gap. In order to rebalance EMU, the competitiveness gap needs to be closed. The resulting deflationary shock will require a weaker exchange rate as a buffer. Europe can only avoid seeing its peripheral countries fall into a debt spiral if it combines its fiscal consolidation with a pro-growth strategy. Since interest rates are fixed across EMU, the pro-growth strategy will have to be supply oriented and helped by a weak exchange rate. For some time to come, EMU will be a region of low inflation and interest rates. Its ailing financial sector will be slow in providing credit, suggesting that Europe will have to borrow credit multipliers from other regions. A way of doing so is by exporting central bank liquidity, pushing the EUR lower. EUR liquidity will stoke global growth and the boost to EMU growth will have to come from rising exports. This outcome would favour core European export-oriented economies such as Germany. Consequently, core European countries will be the EMU growth leaders, with peripheral countries well behind.

Table 1: Deficit and Debt Levels

2007 2009 2010e 2014e 2007 2009 2010e 2014eAustralia 1.5 -4.3 -5.3 -1.1 10 17 23 28China 0.9 -3.9 -3.9 -0.8 20 20 22 20France -2.7 -8.3 -8.6 -5.2 64 78 85 96Germany -0.5 -4.2 -4.6 0 63 79 85 96India -4.4 -10.4 -10 -5.7 81 85 86 79Italy -1.5 -5.6 -5.6 -5.3 104 116 120 129Japan -2.5 -10.5 -10.2 -8 188 219 227 246U.K. -2.6 -11.6 -13.2 -6.8 44 69 82 98U.S. -2.8 -12.5 -10 -6.7 62 85 94 108G-20 -1 -7.9 -6.9 -3.7 62 75 80 86Advanced -1.9 -9.7 -8.7 -5.3 78 99 107 118Emerging 0.3 -5.1 -4.1 -1.3 37 39 40 36

Fiscal deficits (% of GDP) Public debt (% of GDP)2007 2009 2010e 2014e 2007 2009 2010e 2014e

Australia 1.5 -4.3 -5.3 -1.1 10 17 23 28China 0.9 -3.9 -3.9 -0.8 20 20 22 20France -2.7 -8.3 -8.6 -5.2 64 78 85 96Germany -0.5 -4.2 -4.6 0 63 79 85 96India -4.4 -10.4 -10 -5.7 81 85 86 79Italy -1.5 -5.6 -5.6 -5.3 104 116 120 129Japan -2.5 -10.5 -10.2 -8 188 219 227 246U.K. -2.6 -11.6 -13.2 -6.8 44 69 82 98U.S. -2.8 -12.5 -10 -6.7 62 85 94 108G-20 -1 -7.9 -6.9 -3.7 62 75 80 86Advanced -1.9 -9.7 -8.7 -5.3 78 99 107 118Emerging 0.3 -5.1 -4.1 -1.3 37 39 40 36

Fiscal deficits (% of GDP) Public debt (% of GDP)

Source: IMF

Chart 2: Real Effective EUR Divergence


Hans Redeker July 2010Global Outlook xiii www.GlobalMarkets.bnpparibas.com

Sovereign accounts feel betrayed Meanwhile, official accounts have reduced their EUR purchases to a small fraction of last year’s buying activities. US custody holdings have increased significantly at the same time. Non-homogeneous European bond markets and the difficult credit outlook for peripheral EMU countries will leave risk-averse official accounts on the sidelines for some time. A lot of trust in EUR-denominated assets has been destroyed, while at the same time currency reserves are still rising by a record USD 75bn a month. Unlike in the past, most of this currency reserve growth has been in USD, absorbing USD supply. Since the EUR no longer benefits from reallocation-related demand, the cause of the EUR’s overvaluation is no longer in place. Our fair-value model projects EUR/USD at 1.14. However, after years of seeing overvaluation of up to 40%, we expect EUR/USD to move into undervaluation territory – and to stay there for several years.

Four reasons for USD bullishness Of course, it could be argued that the USD is rising just on the back of EUR weakness. Indeed, US debt and deficit levels relative to GDP are higher than aggregate EMU numbers. The US debt portfolio runs at an average maturity of five years, suggesting that refinancing pressure will be high. Furthermore, US private households run higher debt levels than their EMU counterparts. All these factors speak against the USD. However, there are four reasons why the US is strong not only by default: The US’s fiscal authority keeps its bond market

homogeneous; Its corporate sector runs very low debt levels

compared with all other countries. Corporate profitability and cash flow conditions are even stronger than during the exceptional early 1980s, when high corporate cash flows triggered a wave of equity raiding, causing strong capital inflows into the US; Over the past one and half decades, the US has

been importing long-term capital at a rate that exceeds its foreign funding needs. Nonetheless, the USD depreciated during most of this period as US banks became the global provider of USD liquidity. Regulation and weaker bank balance sheets will prevent US banks from continuing to export USD liquidity. Hence, the main reason for USD weakness, namely US banks exporting USD liquidity at cheap rates, is no longer in place; and The US economy is likely to grow by around 3% this

year and next, reducing the chance of a debt spiral developing. However, we emphasise that, when US growth falters, the USD will run into difficulties. But that seems to be the story for tomorrow and not for today.

Sterling: fiscal versus growth threats Sterling will remain a mixed bag as the Conservative/Lib Dem coalition government increases

efforts to decrease the budget deficit. The emergency Budget has been relatively well received by markets and with the extent of the fiscal tightening exceeding initial assumptions, the rating agencies have also provided a favourable assessment. Sterling enjoyed an immediate rebound after the Budget. However, sterling’s recovery is likely to prove short lived given that the extent of the fiscal tightening will weaken the economy (the growth forecasts that accompanied the Budget are still too optimistic in our view). Once the slowdown becomes evident, sterling will face a substantial risk – especially if the slowdown becomes much more marked than the deficit reduction. While British deficit and debt levels are higher than the eurozone average, sterling has the advantage that the BoE can be recapitalised by the taxpayer. The ECB is in a more difficult position given that its balance sheet is increasingly taken up by loans and peripherals’ bonds. The BoE’s balance sheet has been increased by Gilt purchases, making it look conservative compared with the ECB’s challenging balance sheet. Should the ECB have to book losses against that position, requiring a recapitalisation of the Bank, this equity will have to be contributed from the budgets of the individual EMU member countries.

Chart 3: The US Had Been Over-Funding its Current Account Deficit Over the Past Decade


Chart 4: Euro Declines as European Banks’ Funding Position Weakens


Chin Loo Thio July 2010Global Outlook xiv www.GlobalMarkets.bnpparibas.com

Asian Markets: Volatile ST, but Steady LT

Asian currencies tumbled in May All was going well for Asian currencies until May, when the deepening debt crisis in Europe saw a liquidation of risk across Asian assets and currencies, despite growing signs of economic recovery. The Asian Dollar Index lost 4% between April and May. With the USD still buoyant, the bias remains to the downside. However, even as Asian currencies lost ground against the USD, they continued to outperform against other currencies. The trade-weighted stability of Asian currencies and moderate inflation in the region have allowed central banks to ease off on monetary tightening, a policy that suits them well given the increasingly uncertain environment outside Asia.

FX and capital controls in Korea and Indonesia The fallout from the risk trade hurt the KRW due to the importance of Korea’s banking sector – in the same way that USD demand was hit hardest by the US credit crisis. Koriea’s banks account for nearly 80% of the country’s total short-term debt, making it the most exposed to FX risk. That the bulk of this debt belongs to domestic branches of foreign banks engaged in FX business in Korea has once again attracted the wrath of the authorities, and talk of restrictions on forward FX exposures of both domestic and foreign banks led to a firmer USD/KRW. Since then, new regulations to reduce banks’ exposure to FX risk proved less damaging to the KRW than feared. The unwinding of long USD/KRW trades saw the KRW strengthen sharply, so we keep our forecast for medium-term KRW strength. Indonesia, too, has imposed curbs on short-term trading of short-dated Indonesian central bank debt (SBIs). It has imposed a minimum one-month holding period for SBIs in both primary and secondary markets, extended the maturity profile of SBIs to nine and twelve months from the current three and six months, and widened the overnight interbank money-market rate corridor to 1.0% from the current 0.5%. Indonesia has also abolished the on balance sheet FX net open positions (NOP) limit of a maximum of 20% of capital, but maintained the overall NOP limit at 20% of capital. This move is designed to increase the number of transactions in the IDR, deepening the domestic FX market. The IDR has since strengthened, aided by Moody’s upgrade of Indonesia’s sovereign rating outlook to positive in recognition of the macro improvements in the country. A break of USD 9,000 is only a matter of time.

Long-term positives remain The fundamentals for Asia remain strong: debt levels are relatively low; trade balances have returned to

surplus; and both portfolio and foreign direct investment flows are positive. Changes made since the Asian crisis mean the region is in relatively good health and there is room for manoeuvre in both monetary and fiscal policy. Investors have taken note. We thus tinker little with our long-term positive forecast for Asian currencies, adjusting only the short-term forecasts to take into account renewed USD demand.

RMB returned to managed float. VND devaluation Our long-held forecast for an adjustment in the RMB’s value in Q3 came early – by about two weeks. Although China announced it was returning to a currency basket with two-way risk in the unit, the fact that onshore USD/RMB was allowed to trade up to the limit of the 0.5% daily range suggested that the bias remains to allow greater RMB appreciation. A stronger RMB not only appeases China’s foreign trade partners but, more importantly, is in line with China’s aim to rebalance growth away from exports to domestic demand. A stronger currency will also encourage greater productivity and efficiency gains from exporters, forcing them to move up the value-added chain and to develop the service industry. However, with external conditions uncertain and the structural shift from exports to domestic demand likely to take some time, Chinese policymakers will probably only sanction small appreciations in the RMB. NDFs are pricing in a 3% appreciation in a year’s time, a realistic target, we believe. The VND is at the other end of the spectrum, plagued by Vietnam’s rising trade deficits, inflation problems and investors’ persistent lack of confidence in the currency. If macro management remains poor, another devaluation cannot be ruled out.

Table 1: BNP Paribas’ End-Quarter Foreign Exchange Forecasts


’10 2010 ’11 ’11 2011

USD/SGD 1.38 1.36 1.34 1.33 1.32 1.30

USD/MYR 3.21 3.15 3.10 3.07 3.05 3.00

USD/IDR 9,015 8,800 8,600 8,500 8,400 8,200

USD/THB 32.32 32.30 32.00 31.70 31.50 31.00

USD/PHP 45.85 44.00 43.00 42.50 42.00 41.00

USD/HKD 7.77 7.80 7.80 7.80 7.80 7.80

USD/RMB 6.81 6.70 6.80 6.75 6.70 6.60

USD/TWD 32.08 31.00 30.00 29.70 29.50 29.00

USD/KRW 1,182 1,100 1,050 1,030 1,020 1,000

USD/INR 46.20 43.50 42.00 41.00 40.00 38.00

USD/VND 18,940 20,000 20,500 20,500 20,500 20,500


Shahin Valleé July 2010Global Outlook xv www.GlobalMarkets.bnpparibas.com

CEEMEA: Between a Rock and a Hard Place

European crisis is being addressed slowly, but is still weighing on sentiment, growth and prices The European debt crisis is being addressed slowly and the most recent set of measures – the European Financial Stability Facility, the ECB Securities Market Programme, bank stress tests and fiscal austerity plans – are helping to stabilise markets. However, the crisis is still weighing on sentiment and there are substantial risks to the European growth outlook, which will restrain investment flows to, and the growth potential of, CEE. As a result, although systemic risk concerns are gradually being depriced, the scope for rapid rises in CEE assets remains limited. The depressed state of the Hungarian and Czech economies argues for continued monetary easing, which will limit currency gains. However, further easing in Hungary and the Czech Republic depends on their governments’ fiscal policies. We believe Hungary’s Fidesz party understands that there is little scope for fiscal slippage. While Fidesz might negotiate new targets with the IMF, it will maintain a relatively tight fiscal stance in 2010 and 2011, constraining growth, but limiting risks of abrupt currency moves. However, the HUF’s rise will weigh on households’ balance sheets. We expect NBH rates to reach a record low. In Poland, fiscal consolidation remains non-existent and weaker growth is likely to make that even more apparent. The central bank’s new governor, former prime minister Marek Belka, will improve the credibility of economic policy. However, fiscal policy will need to tighten, which could be difficult in an election year. The situation suggests there is a higher risk of a disorderly unwinding of positions here than elsewhere in CEE. Romania has been sheltered by its IMF programme so far, but has been having difficulty executing it. We see substantial risks to the RON, and although the NBR will try to contain any move in the currency, it will not be able to avoid further weakening. Bulgaria is very dependent on external sentiment and needs to issue a successful Eurobond or the fiscal deficit will run reserves to a dangerously low level. We see Bulgaria and Romania as Europe’s most vulnerable to difficulties with external financing.

Turkey in a sweet spot Turkey’s economy is rebounding vigorously and its policy framework is stronger than those of its peers. Domestic demand is very strong as consumer and business confidence are improving. In addition, exports to the Middle East, Central Asia and North Africa are compensating for weaker European demand. Moreover, the economy is benefiting from relatively loose monetary conditions and the credible fiscal rule now in place. Turkey could therefore be upgraded to investment grade status by the end of the year.

Looser monetary policy to tame rand strength Despite the World Cup, growth in South Africa’s economy is slow. Demand for commodities should boost the rand in the short term, although we maintain that looser monetary policy will eventually tame any excessive rand strength.

Effect of political troubles in CIS mitigated by robust commodity prices Troubles in Uzbekistan and Kyrgyzstan will be monitored closely, but will not derail the broader strength of domestic currencies as commodities remain supported. We expect the CBR to increase its purchases of hard currency to avoid an excessive loss of competitiveness, which would be detrimental to the revival of the non-oil economy. However, the RUB and the KZT will remain strong.

Some upside in the UAH, despite IMF talks Ukraine has embarked on talks with the IMF, and it will take some time to reach an agreement. However, the external accounts have improved and any shortfall in them will be met by additional loans from Russia. This limits the IMF’s bargaining power and could further delay a deal. That said, the UAH is tilted more towards the upside than the downside.

Divergence in the Middle East and ongoing restructuring concerns The announcement of Dubai World’s debt restructuring provided some relief for the region, but Dubai Holding is at risk of following in its footsteps and we expect further balance sheet deterioration going into the year-end. In contrast, Qatar looks like a safe haven, thanks to its liquefied natural gas reserves. Although the risks of a devaluation are limited, further stress could weigh on FX forwards. Thus we like long a QAR exposure versus the AED.



’10 2010 ’11 ’11 2011

EUR/PLN 4.05 4.20 4.00 4.20 4.15 3.95

EUR/CZK 25.76 26.50 26.00 25.80 25.50 24.70

EUR/HUF 279 275 270 275 270 265

EUR/RON 4.23 4.50 4.40 4.35 4.25 4.05

EUR/RSD 104.0 110.0 110.0 105.0 115.0 100.0

USD/RUB 30.89 30.78 31.37 32.00 31.28 30.00

USD/UAH 7.91 7.90 8.00 7.50 7.70 7.50

USD/TRY 1.56 1.56 1.59 1.60 1.60 1.62

USD/ZAR 7.52 7.80 8.00 7.90 8.20 8.00

USD/EGP 5.67 5.55 5.46 5.38 5.30 5.14

USD/ILS 3.83 3.88 3.95 3.85 3.80 3.65


Italo Lombardi / Diego Donadio July 2010Global Outlook xvi www.GlobalMarkets.bnpparibas.com

Latam Markets: Keep Them on Your Radar

Latam: selective rallies After the correction seen during Q2, technicals have improved significantly in the most liquid currencies in the region, namely the BRL and the MXN. As a result, and in addition to sound fundamentals, technicals will boost the strengthening of both. In particular, the MXN remains cheap against its Latam peers. The COP and CLP are currencies with a very low carry and where officials have been acting more decisively to curb appreciation, particularly in Colombia. Therefore, we are neutral on both. On rates, the region is normalising monetary policy with Brazil, Peru and Chile having already started to hike. Mexico remains comfortable keeping rates stable while, in Colombia, the CB has cut rates with the main goal of preventing the COP from rising. Foreigners have maintained a strong appetite for long-dated bonds in Brazil and Mexico, pushing premiums down. We expect such dynamics to persist.

Brazil: BRL to resume upward trend Nothing has changed in terms of fundamentals. The country has USD 250bn of international reserves, the improvement in the terms of trade is providing a boost to the trade balance, growth is solid and banks’ balance sheets are strong. Concerns about the widening of the current account deficit have eased as the deficit has recently stabilised at 3% of GDP, which we consider to be relatively easy to finance. However, the currency will remain volatile as the capital account is becoming more dependent on portfolio flows than (primarily) direct investment. The BRL continues to offer value against the USD and especially against European currencies, notably the EUR and GBP.

Mexico: we remain positive Despite the recent turbulence in markets, we remain very positive on the MXN. Fundamentals will continue to improve with economic growth likely to top expectations as the recovery becomes increasingly broad-based when consumption and investment pick up in the second half of the year. The strengthening of the USD as a consequence of the EU crisis and the resurgence of risk aversion makes the EUR a much better funding option to trade our positive MXN view. We expect the peso to strengthen against the USD to 12.00/USD by year-end.

Colombia: neutral in the short run The Colombian peso is likely to be well supported throughout the year as the overall inflow of dollars from abroad is expected to be strong. The government has implemented a daily dollar purchase mechanism, which is relatively small given our estimates for the balance of

payments. We expect the COP to end the year at 1900/USD. Further ahead, investment should continue to flow in, giving support to the COP.

Chile: still a strong story The earthquakes initially led to expectations of strong dollar inflows as analysts assumed that the government would bring in funds from its Stabilisation Fund to finance the reconstruction of infrastructure. Later, the government unveiled plans to finance most of the estimated USD 20bn reconstruction via higher taxes and spending cuts, with only a small part coming from abroad. After this disappointment, the EU crisis triggered further weakness against the dollar. We remain of the view that the CLP will slowly appreciate towards the end of the year as the external environment improves and the country resumes its economic recovery, which had been only interrupted by the earthquakes.

Argentina: strong external sector The government is likely to continue to manage a moderate depreciation of the ARS over the coming quarters. The external sector remains very strong and the economy is now recovering at a solid pace. A managed weakening of the peso will guarantee the competitiveness of Argentine exports without destabilising the economy. Argentina has been running with inflation rates of around 22-25% y/y on unofficial estimates.

Venezuela: control The devaluation of the currency at the beginning of the year has triggered higher inflation, which is now running at around 35% y/y. The government is now trying to take more control of the parallel exchange rate market, known to be an important protection vehicle from the highly inflationary environment.


Spot* Q3 End Q1 Q2 End ’10 2010 ’11 ’11 2011 USD/ARS 3.93 4.10 4.20 4.25 4.35 4.50 USD/BRL 1.76 1.80 1.75 1.72 1.70 1.75 USD/CLP 533 520 510 500 490 495 USD/MXN 12.50 12.20 11.90 11.70 11.50 11.60 USD/COP 1,881 1,950 1,925 1,925 1,900 1,925 USD/VEF P (1) 2.59 2.59 2.59 2.59 2.59 2.59 USD/VEF O (2) 4.29 4.29 4.29 4.29 4.29 4.29 USD/PEN 2.82 2.80 2.80 2.75 2.75 2.70

(1) Priority (2) Oil *23 June Source: BNP Paribas

Commodity Markets Strategy July 2010Global Outlook xvii www.GlobalMarkets.bnpparibas.com

Oil: Long-Dated Backwardation First

Maintaining our view Oil prices since the last Global Outlook have been range-bound as expected, unable to sustain advances above USD 80/bbl while holding above a floor of near USD 70/bbl. So far in Q2, NYMEX WTI has averaged near USD 78.15/bbl, compared with our expectation of USD 78/bbl in the last Global Outlook. As we had argued, the near-month contango in the forward curve persisted, and at the time of writing, was standing near USD 1.00/bbl. Downward revisions to Europe’s economic outlook do not present enough risk to global oil demand growth to warrant a notable downward revision to our view on crude prices. So we maintain our 18 March forecast that NYMEX WTI will average USD 82/bbl in 2010, with the price rising for the rest of the year toward an average of USD 89/bbl in Q4. Our view for 2011 is only marginally changed from USD 91/bbl to USD 89/bbl, while 2012 is held at USD 98/bbl.

Oil price drivers are broadly unchanged The factors keeping oil range-bound in H1’10 have yet to come undone. From a fundamental perspective, these factors are OPEC’s weak compliance with targeted supply cuts, still-strong yearly growth in non-OPEC supply, and high oil inventories in the OECD. From a non-fundamental perspective, strength in the USD relative to a number of currencies is a bearish factor. As such, it will not be until well into Q3 that oil decisively breaks above USD 80/bbl when the influence of fundamental and non-fundamental factors changes. Equally, the current western monetary policy stance, supportive of risky assets and an upward trend in oil prices, will most likely be prolonged in view of recent trends in US labour markets and sovereign debt concerns in Europe. Inflation pressures may be building in the East, but in terms of the countries that matter for oil demand growth, we are not expecting any acceleration in the pace of monetary policy tightening in China.

Oil demand reflects economic geography Our economic outlook assumes a divide in the pace of recovery between the East and West, and the oil demand outlook mirrors this split. World demand is expected to grow by 1.6 mb/d in 2010. The recovery in activity, thus oil demand, in the US, Japan and Korea mitigates weakness in Europe, keeping OECD demand flat in 2010 and leaving emerging markets to account for the bulk of world oil demand growth in 2010. Asia, Latin America and the Middle East together contribute nearly 1.1 mb/d of this growth, of which China accounts for 670 kb/d and the Middle East 290 kb/d. Growth in global oil demand in Q3’10 will come to 1.4 mb/d y/y, easing to 1.3 mb/d in Q4’10. On a quarterly basis, world oil demand is expected to rise 300 kb/d in Q3’10 and 420 kb/d in Q4’10.

The ‘call’ on OPEC crude oil, or the amount of oil that OPEC would need to supply to balance the market without a stock change, is around 29.1 mb/d in Q3’10 and 28.5 mb/d in Q4’10. The cartel has been poor at achieving its production cuts and was supplying 29 mb/d (including Iraq) in May, some 300 kb/d above the call for Q2’10. Should compliance improve after the May price correction below USD 70/bbl, a decline in crude supplied by OPEC versus the call should favour a decline in OECD oil stocks during the rest of 2010.

Table 1: BNP Paribas Crude Oil Price Forecast WTI Brent(1) Q1 10 (actual) 78.71 77.24 Q2 10 78.00 79.00 Q3 10 81.00 79.00 Q4 10 89.00 88.00 Q1 11 83.00 82.00 Q2 11 85.00 86.00 Q3 11 90.00 89.00 Q4 11 97.00 97.00 2009 (actual) 61.79 62.51 2010 82.00 81.00 2011 89.00 89.00 2012 98.00 98.00 Source: BNP Paribas (1) Brent is derived from an assumed spread. 2012 is based on the forward curve spreads at 15 June, 2010.

Chart 1: NYMEX WTI

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USD/bbl

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ContangoWTI (LHS)

WTI M th1-M th3 (RHS)

Source: Bloomberg and BNP Paribas.

Chart 2: OPEC Crude Oil Supply vs. Call*

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OPEC Crude Supply

Source: IEA and BNP Paribas. *The call on OPEC crude oil is the amount of oil required to balance world oil demand and supply without a change in stocks.

Commodity Markets Strategy July 2010Global Outlook xviii www.GlobalMarkets.bnpparibas.com

Non-OPEC supply slipping in H2 2010 A better-than-expected non-OPEC supply performance has been a key feature of the oil market for the first half of this year, notably the ramp-up in supply in eastern Russia. The y/y growth in total oil supply (including processing gains and NGLs) was, with the exception of February, above 1 mb/d between December 2009 and June 2010. Non-OPEC total oil supply will average about 52.3 mb/d in 2010 according to the IEA, or up 800 kb/d on 2009, a level of growth not witnessed since 2004. However, y/y growth in non-OPEC supply will abate in H2’10, partly as base effects kick in and partly as declines in mature field production subtract from growth in new supply sources. In the Gulf of Mexico (GOM), the loss of supply as a result of the moratorium on drilling after oil spills appears contained for 2010, but, depending on legislation, could defer production from the region by nearly 200 kb/d in 2011. Losses of output associated with the hurricane season in the GOM are impossible to predict, but the first estimates for the number of hurricanes this season are alarming.

OPEC: defending USD 70/bbl The 11 quota-bound members of OPEC, after cutting over 3 mb/d of crude supply y/y in June-July 2009, loosened the spigot in the second half of 2009 and into 2010. Relative to a targeted 4.2 mb/d cumulative cut begun in late 2008, the cartel was thought to be 52% compliant in April. Compliance improved in May with outages in Nigeria and Angola, and crude production stood 1.8 mb/d above OPEC’s target of 24.845 mb/d. Crude oil production may now be running at nearly 500 kb/d above last year, but beyond the headline numbers, some countries such as Iran have diverted significant amounts of oil into floating storage. Saudi Arabia may be producing above its quota but the country’s use of oil in direct-burning utilities has been steadily rising, and with the summer season ahead, the power sector is only likely to take in more oil. We think the recent dip in the oil price below USD 70/bbl (Saudi’s preferred floor) will prompt the cartel to adhere more closely to its announced cuts. With Saudi Arabia often accounting for the bulk of OPEC cuts, it would not surprise us if it took the lead. However, the impact of cuts always comes with a lag on the amount of oil in transit and, in due course, on oil inventories in consuming countries.

Non-fundamental factors: upward support In terms of non-fundamental influences on the oil price, the trends are supportive. Monetary policy is expected to remain accommodative and decisions to lift policy rates in the West are very unlikely until much later next year. Developments on the US payroll front are lagging those in the leading activity indices, while the ECB has moved to unconventional monetary policy by purchasing government debt. Finally, if inflationary pressures rise in China, government declarations suggest that if it had to choose between inflation and growth, China would come down on the side of growth.

In terms of FX, EUR/USD is seen as weakening for the rest of 2010 and beyond, offering at face value a bearish bias to oil prices. However, strength in commodity currencies from Q3’10 onward provides an offsetting factor, particularly considering that oil’s correlation with the EUR/USD pair appears to diminish when EUR/USD weakness is euro-driven.

Backwardation, first in long-dated prices We expect the near-month contango on the WTI curve to persist, potentially into Q4’10. Oil stocks need to decline significantly from current levels, as does spare production capacity within OPEC (5.5 mb/d in May) as oil demand recovers before the front-month spread can flip into backwardation. Most of the balance of 2010 appears to lack the sufficient shift in fundamentals that led the oil market to backwardation in the front of the curve back in July 2007. In the meantime, our view for a rise in the oil price combined with contango persistence at the front of the curve implies that long-dated prices could move higher, from the estimated range of USD 70 to USD 80/bbl for the marginal cost of a new barrel of oil supply. As such, heightened producer hedging, through futures or out-of-the money puts options, could produce a flattening of Dec to Dec spreads in the longer-dated prices and lead to backwardation. In 2007, long-dated spreads moved into backwardation before the prompt segment of the forward curve.

Chart 3: Liquidity and Oil Prices

Source: Reuters EcoWin Pro and BNP Paribas.

Chart 4: Oil, Equities and FX Correlation* (%)

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Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10

WTI vs EURUSD

WTI vs AUDUSD WTI vs S&P 500

Source: Reuters EcoWin Pro. * Based on daily returns, 30-day window.

Commodity Markets Strategy July 2010Global Outlook xix www.GlobalMarkets.bnpparibas.com

Metals: Gold to the Fore, Base More Cautious

Precious metals overview While gold started a new rally at the beginning of the second quarter, rising from USD 1,087/oz on 24 March to USD 1,265/oz on 21 June, the other precious metals sold off along with equity markets and most of the commodity complex. However, on a YTD basis, precious metals continue to perform well.

Gold: the outperformer Gold’s safe-haven demand surged in May on increasing sovereign risk, particularly in Europe, and its impact on the euro. Despite the measures taken by the authorities to prevent contagion from the Greek crisis to other peripheral countries of the eurozone, risk aversion remained high. The VIX index, a measure of the volatility of equity markets, was above 30 for most of May and into early June. As a result, flows into physical gold rebounded sharply. ETF inflows totalled nearly 177t in May compared with 8t in Q1 2010. Anecdotal evidence suggests that physical demand for coins and bars also rose strongly. As risk aversion surged, the usual negative correlation between the USD and gold broke down. The 30-day correlation between the two assets moved from -41% in mid-April to +57% in mid-June. The positive correlation between the two assets may continue in the short term as both enjoy safe-haven status.

Silver Silver traded in choppy waters in Q2 2010. While the price of silver is historically strongly correlated to that of gold, its safe-haven status is not as firmly established. As such, its performance has been net flat since April, while the gold price has surged. The gold/silver ratio has been on an upward trend since the beginning of April, currently standing at around 67.

Platinum and Palladium (PGMs) Both platinum and palladium had near-uninterrupted rallies from end-2008 to late April 2010. Demand for PGMs was supported by restocking in the automobile industry as well as solid investment demand at the beginning of the year. The panic on the markets finally took its toll on platinum and palladium, however, and their prices retreated sharply, falling 12% and 20% respectively from their peaks at the end of April. Investment demand subsided, with, notably, NYMEX net non-commercial futures positions in platinum dropping by 35% in the week to 25 May before recovering.

Outlook Our price profile for all precious metals has become even more positive for 2010/11. We expect gold to continue outperforming its peers, as the price will be

supported by sovereign risk and related safe-haven demand. We have raised our forecast on that basis. The silver price should stand to benefit from the gold rally but we will have to see a rebound in risk appetite for the gold/silver ratio to retreat. Now trading at prices more in line with their fundamentals, platinum and palladium prices should be well supported, notably from the supply side, for the rest of 2010 and through 2011. Uncertainty surrounding the level of Russian stockpiles may provide additional support to the palladium price.

Table 1: Precious Metals Prices (USD/oz) Spot Price(1) 2009(2) 2010(3) 2011(3) Gold 1,245 974 1,190 1,245 Silver 18.71 14.70 18.00 19.00 Platinum 1,577 1,209 1,585 1,650 Palladium 482 265.0 465 520 (1) As at 17 June 2010. (2) Annual average. (3) Average price forecasts.Source: BNP Paribas

Chart 1: Precious Metal Prices (Index 1/6/2009 =100)

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Source: Bloomberg, BNP Paribas

Chart 2: Gold’s Correlation with USD Index (%)

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Source: Bloomberg. The Bloomberg DXY index is the weighted average of the following currencies: 57.6% EUR, 13.6% JPY, 11.9% GBP, 9% CAD, 4.2% SEK, 3.6% CHF.

Commodity Markets Strategy July 2010Global Outlook xx www.GlobalMarkets.bnpparibas.com

Base metals overview Base metals have performed poorly since early in Q2. In the year to date, the worst performers are lead and zinc, down 25-30%. The nickel price, which had shot up by 60%-plus between early February and mid-April, had lost almost all the gains by early June. Investor sentiment turned bearish in late April, on industrial metals as well as broader financial markets, as concerns about sovereign debt and the euro mounted. Price declines were exacerbated by weak fundamentals. Inventories remain high, demand is still below pre-crisis levels in most developed countries, and production recovered markedly in H1 2010.

Demand: fresh uncertainty Restocking and a seemingly brighter economic outlook underpinned the continued rebound in base metals demand at the start of 2010. But uncertainty about the solidity of the recovery in developed nations persisted, even before the recent turmoil, thus limiting the extent of restocking. The economic newsflow has deteriorated of late, while the construction sector in the US remains depressed. In Europe, this sector’s prospects look better, especially in Germany, but consumer demand is, and is likely to remain, weak, which will have an impact on most industrial metals. The Chinese economy has continued to boom, but growth does appear to be peaking. We expect the pace of growth in the demand for base metals to decelerate in China in H2 2010. This may particularly be the case with metals used heavily in construction, such as copper and zinc. The Chinese government is taking measures to cool the property market, which has been overheating in the past year. Although the government should maintain its supportive policy in relation to infrastructure and the automobile industry, we may see a deceleration in the pace of growth there as well. Chinese base metal imports remained high in H1 2010 but they could well ease off in the months ahead.

Supply: recovering strongly, notably in China While the growth in demand for base metals may be more muted and fragile than previously expected, production has been recovering strongly since the start of 2010 as cutbacks have been unwound. This is especially true of aluminium, and particularly (but not exclusively) in China. Although there are serious long-term supply constraints (particularly for copper), a great deal of idle capacity remains and underlying surpluses are likely to persist in most metals markets this year, which may continue to weigh on prices into H2 2010.

Outlook: we remain cautious More positively, the build-up in visible stocks seems to have halted and even reversed for most metals (although we strongly suspect that unreported inventory is still accumulating). Moreover, the recent decline in prices may prompt renewed discipline among

producers. A prominent case in point is the aluminium industry, where, in addition, Chinese production costs have been rising as power prices have been raised. Nevertheless, we retain a cautious outlook on base metals for the remainder of 2010. We continue to contend that, structurally, copper has the strongest fundamentals; it is the only metal where China is still a large net importer, and it faces more pressing supply constraints than most.

Chart 3: Base Metal Prices (Index 1/6/09 = 100)

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Source: Bloomberg, BNP Paribas

Chart 4: LME/SHFE Base Metal Inventories

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Source: LME, SHFE, Reuters EcoWin Pro

Chart 5: Chinese Base Metal Imports (gross)

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Source: Chinese General Administration of Customs, Bloomberg

RESEARCH DISCLAIMERS:

IMPORTANT DISCLOSURES: Please see important disclosures in the text of this report.

Some sections of this report have been written by our strategy teams. These sections are clearly labelled and do not purport to be an exhaustiveanalysis, and may be subject to conflicts of interest resulting from their interaction with sales and trading which could affect the objectivity of thisreport. (Please see further important disclosures in the text of this report). These sections are a marketing communication. They are not independent investment research. They have not been prepared in accordance with legal requirements designed to provide the independenceof investment research, and are not subject to any prohibition on dealing ahead of the dissemination of investment research. The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but norepresentation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be reliedupon as such. This report does not constitute an offer or solicitation to buy or sell any securities or other investment. Information and opinionscontained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for theexercise of judgement by any recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. To the fullestextent permitted by law, no BNP Paribas group company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material contained in this report. All estimates and opinions included in this report aremade as of the date of this report. Unless otherwise indicated in this report there is no intention to update this report. BNP Paribas SA and its affiliates (collectively “BNP Paribas”) may make a market in, or may, as principal or agent, buy or sell securities of any issuer or personmentioned in this report or derivatives thereon. BNP Paribas may have a financial interest in any issuer or person mentioned in this report,including a long or short position in their securities and/or options, futures or other derivative instruments based thereon, or vice versa. BNPParibas, including its officers and employees may serve or have served as an officer, director or in an advisory capacity for any personmentioned in this report. BNP Paribas may, from time to time, solicit, perform or have performed investment banking, underwriting or otherservices (including acting as adviser, manager, underwriter or lender) within the last 12 months for any person referred to in this report. BNPParibas may be a party to an agreement with any person relating to the production of this report. BNP Paribas, may to the extent permitted by law, have acted upon or used the information contained herein, or the research or analysis on which it was based, before its publication. BNPParibas may receive or intend to seek compensation for investment banking services in the next three months from or in relation to any person mentioned in this report. Any person mentioned in this report may have been provided with sections of this report prior to its publication in orderto verify its factual accuracy. BNP Paribas is incorporated in France with limited liability. Registered Office 16 Boulevard des Italiens, 75009 Paris. This report was produced by a BNP Paribas group company. This report is for the use of intended recipients and may not be reproduced (in whole or in part) or delivered or transmitted to any other person without the prior written consent of BNP Paribas. By accepting this document you agree to be bound by theforegoing limitations. Certain countries within the European Economic Area: This report is solely prepared for professional clients. It is not intended for retail clients and should not be passed on to any such persons. This report has been approved for publication in the United Kingdom by BNP Paribas London Branch. BNP Paribas London Branch is authorised by CECEI and AMF and authorised and subject to limited regulation by the Financial Services Authority. Details of the extent of ourauthorisation and regulation by the Financial Services Authority are available from us on request. This report has been approved for publication in France by BNP Paribas, a credit institution licensed as an investment services provider by theCECEI and the AMF, whose head office is 16, Boulevard des Italiens 75009 Paris, France. This report is being distributed in Germany either by BNP Paribas London Branch or by BNP Paribas Niederlassung Frankfurt am Main,regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). 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