1

The Greek drama Outlook and market implications

Trading Strategy

Economic Research

2

Main scenario: IMF leads enlarged rescue package for Greece

� IMF can act more quickly than EMU-16 and is not restricted by domestic

policies

� IMF has large financial resources, currently in the neighbourhood of some

USD +500bn and they can be increased further by commitments also from

non-EU countries (e.g. China, Japan). The money will be paid out in

tranches over a long period and conditioned on adherence to the agreed

consolidation programme.

� Previous IMF led packages have amounted to between 20% and 40% of

GDP (e.g. Latvia, Hungary, Iceland). The Greek package will likely be

considerably larger. Current speculations range between a sizeable

increase to EUR 150bn (amounts to roughly 60% of GDP) and a more

modest increase by EUR 10bn.

� We see a large and credible IMF package as the most likely scenario. This

is also what is needed to calm markets. Recent comments from EU

officials also rules out debt restructuring for Greece. A proposal must be

presented within coming days to calm financial and political nervousness.

3

Greek credit downgrade to junkFacts and outlook

� Greece S&P downgraded three notches to BB+ (from BBB+) non-investment grade. Fitch and Moody’s retain investment grade rating with Moody’s still highest at A3 (equal to S&P A-) on review for further possible downgrade.

� Portugal S&P downgraded two notches to A- (from A+).

� ECB collateral rules state at least one official rating has to be investment grade for lending from the ECB.

� Trichet has stressed on several occasions that we will not see a default in Greece. Our interpretation is that the ECB will find a way to solve the problem, should ratings fall below the threshold.

� However, Greek banks should always have access to the short-term funding (lender of last resort) provided that they are deemed solvent.

4

Market implications of a new IMF package

Short-term effects

� USD, CHF have been the obvious safe haven currencies and would weaken somewhat on new IMF rescue package

� More muted reactions for SEK and NOK assets - upside pressure on Swedish bond yields

� German interest rates will rise - relief rally for PIIGS debt, especially shorter maturities (2Y)

� Stock market may recover, but declines have so far been fairly limited

Macro - longer term

� Double-dip risk has increased

� Policy stimulus will remain in place for a longer period

� Large divergence in European growth, downside risk for EMU growth

5

What could happen if Greece defaults?

� A default does not necessarily mean that Greece is forced to leave the

EMU but it may still opt to do so:

1. If Greece defaults on its debt, the cost of leaving the euro at the

same time is small. Greece can get an economic boost from a

currency devaluation when switching back to the drachma without

worrying about the increased cost of servicing its EUR debt (on

which it has already defaulted).

2. The pressure on the other PIIGS countries will increase

dramatically if Greece defaults and even more if it leaves the euro.

Concerns will increase about these countries' ability to acquire

funding in the market. Why should the other PIIGS get help from

the EU/IMF when Greece didn’t. Portugal will be the second

country cut off from private funding followed by Spain and Ireland,

possibly Italy as well.

3. If one country leaves the euro, the whole project risks crumbling.

6

Large exposure to PIIGS for core EMU banks

� While German, French banks have a

large exposure to Greece (including

French direct ownership of Greek

banks) it is a small share of their total

foreign claims (1.5%-2% of foreign

claims).

� Main risk is contagion to other PIIGS.

PIIGS amount to around 20-25% of total

foreign claims for German and French

banks (16 and 10% resp. excl. Italy).

� Also, large inter-linkage between PIIGS

with for example considerable exposure

to Portugal in Spanish banks.

Consolidated foreign claims of reporting banks, bn EUR

Claims vis-à-vis Ger Fra Gre Ire Ita Port Spa

Greece 45 79 … 9 7 10 1

Ireland 184 52 1 … 17 9 15

Italy 190 508 1 46 … 5 47

Portugal 47 45 0 5 7 … 85

Spain 238 211 0 32 31 29 …

Total 704 895 2 91 62 53 148

Source: BIS, Dec 2009, ultimate risk basis

PIIGS share of Euro-zone GDP, %

2008

Portugal 1.8

Spain 11.8

Greece 2.6

Italy 16.9

Ireland 2.0

7

PIGS 2010-11 Debt maturities

Greece• May 19, 2010 - EUR 8.5bn

• July 23, 2010 - EUR 2.4bn

• Oct 15, 2010 - EUR 1.3bn

• Mar 20, 2011 - EUR 8.8bn

• May 18, 2011 - EUR 6.5bn

• Aug 20, 2011 – EUR 6.0bn

• Dec 29, 2011 – EUR 4.6bn

Italy

• Q2 2010 - EUR 80bn

• Q3 2010 - EUR 102bn

• Q4 2010 - EUR 72bn

• Q1 2011 - EUR 73bn

• Q2 2011 - EUR 35bn

• Q3 2011 – EUR 71bn

• Q4 2011 – EUR 16bn

Portugal• May 20, 2010 - EUR 5.6bn

• July 23, 2010 - EUR 4.5bn

• Sep 17, 2010 - EUR 2.7bn

• Nov 19, 2011 - EUR 2.6bn

• Jan 21, 2011 - EUR 2.1bn

• Feb 18, 2011 - EUR 1.8bn

• Mar 18, 2011 - EUR 2.0bn

• Apr 15, 2011 – EUR 4.7bn

• Jun 15, 2011 – EUR 5.0bn

Spain• Q2 2010 - EUR 21bn

• Q3 2010 - EUR 40bn

• Q4 2010 - EUR 18bn

• Q1 2011 - EUR 19bn

• Q2 2011 - EUR 26bn

• Q3 2011 – EUR 21bn

• Q4 2011 – EUR 21bnSource: Bloomberg

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The risks for other PIIGS - Focus on Portugal and Spain

� Portugal is likely to need financial support, probably of the same size

as for Greece

� For the other PIIGS, the picture is somewhat more mixed

– Spain has a large budget deficit and the banking sector is heavily

exposed to the troubled housing/construction markets. On the other

hand, Spanish households have a high saving ratio and reasonable

low indebtedness. Moreover, Spain has experienced quite

substantial improvements in the current account.

Portugal Bond maturities (EUR, bn)

16

9 8

14

10

6 6 78

18

0

2

4

6

8

10

12

14

16

18

20

20102011

20122013

20142015

20162017

20182019

0

2

4

6

8

10

12

14

16

18

20

Spain Bond maturities (EUR, bn)

77

84

61

5247

25

16

30

17

29

0

10

20

30

40

50

60

70

80

90

2010

20112012

2013

2014

2015

20162017

2018

2019

0

10

20

30

40

50

60

70

80

90

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Government finances

� High debt levels for Greece and Italy, other PIIGS not that far from Euro-zone average

� Large budget deficits in Greece and Ireland. Spain and Portugal slightly higher than Euro-zone average. Less of a problem in Italy

Government deficit,% of GDP

GreeceItaly

SpainPortugal

Ireland

02 03 04 05 06 07 08 09 10 11

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

-15.0

-12.5

-10.0

-7.5

-5.0

-2.5

0.0

2.5

5.0

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The root of the PIIGS countries problems

� Greece has lost more

than 50% of its

competitiveness vs.

Germany since the

start of EMU

� The other PIIGS are

almost as worse off

� Internal devaluations

are needed to restore

competitiveness.

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Small export sectors in PIIGS

� Correction of current account balance will have to come from

low domestic demand

� Private consumption in Spain and Ireland has declined by 7-

8% in 2008-09, investments by more than 30%

90

80

70

60

50

40

30

20

10

90

80

70

60

50

40

30

20

10

Export, % of GDP

Greece

Sweden

Belgium

Austria

Spain

Portugal

Finland

Denmark

France

Germany

Ireland

UK

Netherland

Italy

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Low Swedish exports to PIIGS

Goods export to PIIGS countries % of total goods export Ire. Gre, Spa. Ita. Por. PIIGS

Ireland - 0.4 4.2 3.5 0.5 8.6 Greece 0.4 - 2.9 11.5 0.7 15.5 Spain 0.5 1.4 - 8.1 9.1 19.0 Italy 0.4 2.1 6.5 - 1.0 10.0 Portugal 0.6 0.4 25.6 3.7 - 30.2 France 0.7 0.9 8.3 8.8 1.3 19.9 Sweden 0.5 0.5 2.3 3.1 0.5 7.0 UK 7.5 0.7 4.1 3.8 0.6 16.6 Germany 0.6 0.8 4.3 6.3 0.8 12.8

=

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Inverted yield curve as markets are pricing a Greek default

� When a default is becoming priced by the market the market is effectively pricing in a haircut on the bonds

� For an investor to still get his money back (after a hair cut) the shorter the maturity of the bond the higher the interest rate needs to be.

� Thus the yield curve gets inverted with the 2Y yield much higher than the 10Y

� If a sizable financial aid package is delivered which covers the Greek debt maturing in the coming 2 years as well as expected budget deficits until 2011 then the 2Y bonds should strongly outperform

Greece/German rate spreads

10Y CDS spread5Y CDS spread

10Y Gov spread2Y Gov spread

Jan

10

Feb Mar Apr0

250

500

750

1000

1250

1500

1750

0

250

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1750

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Disclaimer

� This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted forany direct or consequential loss resulting from reliance on thisdocument. Changes may be made to opinions or information contained herein without notice.