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KBank Capital Market Perspectives                                                    Market Updates
                                                                                         Macro / FX / Rates
    Portugal in focus – problems, changes and possible impacts
                                                                                         23 April 2012



     Summary of author’s views                                                            Nalin Chutchotitham
                                                                                          nalin.c@kasikornbank.com
     •   Portugal’s debt problem is a result of rigid regulations in
         the product and labor markets, leading to continued
         deterioration of productivity and competitiveness

     •   Political risks are lower compared to other PIIGS and the
         new government indicated strong commitment to reforms

     •   Significant changes had been made with economic
         structure to restore competitiveness to Portugal, but more
         time is needed

     •   IMF assessed that existing financial assistance is
         adequate yet risks remain; additional funds from Europe
         could be warranted but funds are available

     •   Market likely to be more prepared after experience with
         Greece but by rising bond yields suggest continued
         skepticism

     •   Impacts on Thailand’s exports and financial market likely
         to be similar to the past – indirect negative impact on SET
         and Thai baht from global risk aversion



Stay worried about Spain but don’t forget Portugal

The market seemed to be somewhat forgetful. It is now worrying about Spain,
which is the fourth largest economy in the eurozone with a huge housing market
trouble. Yet, the concerns in Portugal remained and it is worth noting as well,
especially since the eurozone shares the same pool of limited emergency
funding e.g. EFSF and ESM. We gather here facts and recent data for readers to
understand the problems of the Portuguese economy better and finally reflect on
what could be the impacts on the financial markets.

First, we go back in time to review the Page 5 of the IMF’s report in June 2011
(two months after Portugal officially sought financial assistance). The aspects
mentioned below clearly illustrated the weaknesses in Portugal’s economy and
the dire situation that it must overcome over the next decade. Towards the end of
the report, we will discuss the IMF’s latest views reflected in its April 2012 report.
First, the early findings on Portugal’s economy below:




11

1
Table 1. IMF’s report on Portugal’s economic structure and weaknesses
           Topic                                                 Findings
                            Average GDP growth in Portugal during 2000-2010 is around 1.0%, compared to that
    Slow economic growth    of the euro area’s 1.5%

                            GDP per capita (income per head) rose very slowly during 2000-2010 period, falling
     Slow income growth     behind the euro-area average and even Greece.
                            Working-age population with upper secondary education and above is one of the
     Weaker labor force     weakest in Europe. The percentage of such population is < 30% while the average of
                            EU and OECD countries are well above 60%. (based on 2007 data)
                            According to 2008 data, Portugal has one of least flexibility with regards to the
      Product and labor     product market regulations and labor market regulations. Greece’s score is far worse
       market rigidity      than Portugal under IMF’s study but Portugal’s score is a far cry from the rest.
                            In this aspect, IMF showed that the PIIGS countries all have trouble, as real effective
 Real effective exchange    exchange rate had been on a relatively steady rise since 1995, in contrast to the euro
   rate (based on unit      area which fell. Higher REER means that exports are more costly and therefore less
       labor costs)         competitive. Italy is the worst among the PIIGS, with Portugal in the second place.
                            1994-2007 data (excluding those after the financial crisis since 2008) for
       Increase in          government’s primary expenditure showed that Portugal had been increasing its
 government’s spending      expenditure by nearly 10% of GDP during the period, on par with Greece. Spain and
                            Ireland saw declines of expenditure while Italy’s record was close to zero.
                            Once debts of corporate sector (non-financial) and household sector are added to
                            the government debt, Portugal’s indebtedness ranks among the worst-performing in
      Total debt to GDP     the euro zone at 300% of GDP. Ireland performs worse than Portugal in this aspect
                            but both are much worse off than Germany at 200% of GDP and France at 250% of
                            GDP.
                            A measure of banking sector’s indebtedness – loan-to-deposit ratio, indicates that
    Loan-to-deposit ratio   Portugal is again among the worst performers. Portugal’s LDR is around 140%
        (June 2010)         compared to most of the euro area that are below 120%.
 Source: IMF



Further illustrations of Portugal’s debt problems

First, let us look at the indebtedness of Portugal’s government. Portugal’s public
debt as a share of its economy (debt-to-GDP on Fig 2) had usually been lower
than that of the eurozone’s (EMU) average prior to the year 2007 with an
average of 64.5% during 2000-2007 compared to 71.3% of the EMU. However,
the ratio had significantly exceeded the EMU’s average afterwards and the main
reason was the government’s inability to reign in spending and fiscal budget
deficits in the later years.

In the year 2005 when it first missed the Maastricht Treaty’s deficit/GDP ratio
target of 3%, Portugal had recorded a fiscal shortfall of 5.9% but this figure
continued to rise to 9.8% in 2010 as a result of economic weakness. Clearly, the
2008 global financial crisis had deepened the economy’s existing problems.
Eventually, accumulated deficits led to a piling of debts until debt-to-GDP ratio
rose to 93%, compared to the 85% average of the eurozone. Despite such
weakness of fiscal health, the government’s borrowing costs remained relatively
on par with the eurozone members and only saw significantly increases in the
year 2010, as suggested by the bond yields. This reflects that refinancing costs
did not become more pronounced until recently (Fig 3).




22

2
Fig 1. Deficit-to-GDP ratio % Portugal vs. eurozone                                                                   Fig 2. Debt-to-GDP ratio % Portugal vs. eurozone
 deficit/GDP                                                                                                           Debt/GDP
     0                                                                                                                   100
              00       01       02       03         04       05       06         07      08       09        10
     -2                                                                                                                   90

                                                                                                                          80
     -4
                                                                                                                          70
     -6
                                                                                                                          60
     -8
                                                                                                                          50
  -10
                                                                                                                          40
  -12                                                                                                                                00      01      02      03        04   05    06        07      08      09        10
                       Portugal deficit/gdp ratio                          Eurozone deficit/GDP ratio                                        Portugal debt/gdp ratio                   Eurozone debt/gdp ratio

Source: Bloomberg, KBank                                                                                              Source: Bloomberg, KBank




Fig 3. 10-year government bond yields of Portugal                                                                     Fig 4. Private sector debt as a % of GDP
     %                                        Sovereign 10-year bond yields                                      %       %
                                                                                                                         350
  40                                                                                                             40                                                              Private sector debt as % of GDP (2010)
  35                                                                                                             35      300
  30                                                                                                             30      250
  25                                                                                                             25      200
  20                                                                                                             20      150
  15                                                                                                             15      100
  10                                                                                                             10       50
     5                                                                                                           5
                                                                                                                           0
     0                                                                                                           0
     Jan-08        Jul-08    Jan-09      Jul-09     Jan-10        Jul-10      Jan-11     Jul-11    Jan-12




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Source: Bloomberg, KBank                                                                                              Source: eurostat, KBank




 Apart from its government debt situation, Portugal’s private sector debt is also
 very high (Fig 4), crippling the household and business sector to provide stimulus
 to the economy and this also added to the banking sector’s weakness. (Recall
 ECON101: engines of growth of an economy include government’s spending,
 private consumption, private investment, and exports). Reuters reported in March
 2012 that, citing Portugal’s central bank, total private sector debt is close to three
 times of the country’s GDP (Eurostat reported private sector debt at 249% of
 GDP in 2010. Increased risks also came from the EUR31bn of corporate debt
 due this year - its size about 40% of what Portugal have secured in terms of
 financial aid from EU/IMF, which is EUR78bn.

 In fact, the economy in Portugal was not always in such a dire state. Portugal did
 benefit from becoming part of the European Union (EU) and the European
 Monetary Union (EMU) as there were improvements in terms of both economic
 growth and stability prior to the global financial crisis in 2008. Later in April 2007,
 The Economist magazine had entitled a report on the Portuguese economy “A
 new sick man of Europe”. The labels were a result of underperforming numbers
 in Portugal as compared the euro zone neighbors as well as the whole of the
 European Union (EU).




 33

 3
According to the U.S. government’s record:

              “Before the economic crisis, Portugal's membership in the EU had
              contributed to stable economic growth, largely through increased trade
              fostered by Portugal’s low labor costs and an influx of EU funds for
              infrastructure improvements. Portugal's subsequent entry into the EMU
              brought exchange rate stability, lower inflation, and lower interest
              rates. Falling interest rates, in turn, lowered the cost of public debt and
              helped the country achieve its fiscal targets. Until 2001, average
              annual growth rates consistently exceeded those of the EU average.
              However, a dramatic increase in private sector loans led to a serious
              external imbalance, with large capital account deficits that year. De-
              leveraging by Portuguese banks to meet the June 2011 EU
              requirement to increase core tier-one capital ratios above 9% has
              caused bank lending to tighten.”
              Source:http://www.state.gov/r/pa/ei/bgn/3208.htm



 We highlight further the degree of deterioration of the economy and
 competitiveness using the World Economic Forum’s Global Competitiveness
 Index. Portugal’s ranking has fallen from 22nd in the year 2005 (higher-ranked
 than Spain, Ireland, France and Hong Kong) to 40th (out of 131 countries) in the
 2007-2008 ranking and finally 46th (out of 139 countries) in the 2010-2011
 ranking.


Fig 5. World Economic Forum’s Global Competitiveness
                                                                                   Fig 6. Portugal’s GDP growth vs Eurozone’s
Index
 World competitiveness ranking                                                        %                                    GDP Growth % yoy
 90                                                                     Germany
                                                                                       8.0
 80                                                                                    6.0
                                                                        Greece
 70                                                                                    4.0
 60                                                                     Ireland        2.0
 50
                                                               46                      0.0
 40                                    40      43      43               Italy
                                 34                                                   -2.0
 30
         24                                                             Portugal      -4.0
 20                22
 10                                                                                   -6.0
                                                                        Spain
                                                                                         Mar-00     Mar-02        Mar-04       Mar-06         Mar-08     Mar-10
  0
       04-05      05-06      06-07    07-08   08-09   09-10   10-11   Year
                                                                                                          Spain               Portugal             Eurozone

Source: WEF, KBank                                                                 Source: Bloomberg, KBank




 No quick fix for Portugal’s economy

 Household spending: Household fixed consumption level, at the end of 2011, had fallen
 to the same level observed in 2006. The pace of decline is more significant in recent
 quarters, with Q4/2011 consumption dipping 6.6% yoy, a fourth straight quarter of
 contraction. This is a stark contrast to the average growth rate of 0.7% per quarter since
 the year 2000 and 1.5% if we exclude the period after 2007. Yet, given the high level of
 household debt and low levels of saving rate, it seems that households’ balance sheets
 does not accommodate increased spending either.




 44

 4
Fig 7. Household fixed consumption level and growth                                                      Fig 8. Household saving rate (2010)
 EUR mn                                                                                         % yoy       %
                                                                                                           20
 28000                                                                                             4

 27000                                                                                             2       15

 26000                                                                                             0
                                                                                                           10
 25000                                                                                             -2
                                                                                                            5
 24000                                                                                             -4
 23000                                                                                             -6       0

 22000                                                                                             -8




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     Jan-01         Jan-03          Jan-05          Jan-07          Jan-09             Jan-11




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                                                                                                                   m
              Household Fixed Consumption (LHS)           Household consumption growth % yoy

Source: Bloomberg, KBank                                                                                 Source: Eurostat, KBank




 Wage growth slowed. Another factor that had been a drag on the household
 consumption was the pace of wage increase. Furthermore, the economic recession made
 unemployment rate surge quickly from 7.5% in the first half of 2008 to 14.0% as of the
 fourth quarter of 2011. During the period between 2001 and 2003, Portugal’s
 unemployment rate had been well below the 6% mark. Notice that the poor labor market
 conditions and economic recession had also led to slower pace of real wage growth
 during 2008-2010 period, before rebounding to modest growth in 2011.

 Confidence level is also low: Confidence indicators helped to reflect on the reasons
 why household consumption had been falling. Consumer confidence in the year 2011 hit
 levels below that of the level observed during the 2008 financial crisis, although it had
 since rebounded, reflecting a dismal outlook. Meanwhile, the overall outlook on the
 economy remained depressing with the economic sentiment index (which includes
 service sector, industrial sector, and the household) sliding quickly in the year 2011 to
 levels near to the 2009 recession.

Fig 9. Real wage growth (using wage growth – inflation)                                                  Fig 10. Confidence levels near 2009 lows
 %
                                                                                                            120                                                                                     0
 2.0
 1.5                                                                                                        110                                                                                     -10

 1.0                                                                                                                                                                                                -20
                                                                                                            100
 0.5                                                                                                                                                                                                -30
 0.0                                                                                                         90
                                                                                                                                                                                                    -40
 -0.5                                                                                                        80
                                                                                                                                                                                                    -50
 -1.0
                                                                                                             70                                                                                     -60
 -1.5
 -2.0                                                                                                        60                                                                                     -70
    Jan-04    Jan-05    Jan-06      Jan-07     Jan-08     Jan-09      Jan-10     Jan-11         Jan-12        Jan-01          Jan-03        Jan-05          Jan-07       Jan-09        Jan-11

                         Difference between Portugal's and eurozone's inflation rate                              Portugal economic sentiment index (LHS)        Portugal consumer confidence index (RHS)

Source: Bloomberg, KBank                                                                                 Source: Bloomberg, KBank




 Improving exports and current account balance: There is some comfort in Portugal’s
 trade data and the current accounts. Exports had seen continued positive growth from
 2010-2012 while imports had declined, allowing for the trade balance record lower
 deficits in recent months. The 6-month moving average of current account deficit was
 EUR500bn in January 2012 and the same measure for the trade balance deficit narrowed
 to EUR720bn in February 2012 – both indicators improved by more than two-folds from
 two years ago.




 55

 5
Still, the major trading partners, both import and exports, of Portugal are the EU nations.
 Stricter fiscal spending rules within Europe this year and going forward poses risks to
 trading activities to Portugal and the region as a whole. Portugal’s improvement in its
 competitiveness, be it in terms of higher labor productivity or lower labor costs, would
 have to compensate for risks on its exports’ exposure to Europe as well and this depends
 heavily on the government to implement structural changes to the labor and product
 markets. In fact, Fig 13 below shows that the growth in labor cost (including costs for
 hiring workers other than wages) had slowed in the past couple of years, pointing to a
 favorable change. However, recent labor costs may be reflecting the consequences of
 the rising unemployment rate instead of significant adjustments in the labor market’s
 regulatory system. In any case, the IMF gave a positive comment on this change on
 Page 6 of its March 2012 report (after a Third Review of Portugal’s financial aid program):

              Competitiveness indicators have improved, albeit at a moderate pace. Wage
              moderation and higher productivity per worker have allowed for more favorable
              unit labor costs developments in Q4. There are also signs that the real exchange
              rate depreciation trend may be accelerating, while market shares of exports have
              remained broadly stable through September 2011.


                                                                                                   Fig 12. Closing gaps – deficits in current account
Fig 11. Exports outpacing imports growth
                                                                                                   balance
                                                                                                    EUR bn
   30                                                                                                      0
   20
                                                                                                      -500
   10
     0                                                                                               -1000
  -10
                                                                                                     -1500
  -20
  -30                                                                                                -2000

  -40                                                                                                -2500
     Jan-09     Jul-09       Jan-10       Jul-10         Jan-11         Jul-11       Jan-12              Jan-02          Jan-04          Jan-06          Jan-08           Jan-10        Jan-12
              Portugal imports % yoy                              Portugal exports % yoy                   Current account balance (6m moving average)        Trade balance (6m moving average)

Source: Bloomberg, KBank                                                                           Source: Bloomberg, KBank




                                                                                                   Fig 14. Labor cost adjustment had begun but only
Fig 13. Labor cost growth and unemployment rate
                                                                                                   slightly
 % yoy                                                                                        %      110
  10                                                                                          16
     8                                                                                        14     100

     6                                                                                        12
                                                                                                      90
     4                                                                                        10
     2                                                                                        8       80
     0                                                                                        6
                                                                                                      70
   -2                                                                                         4
   -4                                                                                         2       60
    Jan-01      Jan-03         Jan-05           Jan-07        Jan-09             Jan-11                        1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
               Labour cost growth % yoy (LHS)             Unemployment rate (RHS)                                       Eurozone             Ireland              Spain            Portugal

Source: Bloomberg, KBank                                                                           Source: Bloomberg, KBank




 66

 6
Table 2. Key fiscal austerity measures undertaken under the agreement of EU-
IMF loan
           Sector                                           Description
                              -   opening up of protected professions
                              -   Increased working hours by 30 minutes a day (for private sector)
                                  without increase in pay.(2012-2013)
                              -   Some bank holidays removed and some shifted to Mondays
                              -   Summer and Christmas bonuses (usually about a month’s pay)
                                  abolished for employees earning more than EUR1,000 a month.
       Labor market               (2012-2013)
                              -   Overtime pay to be halved
                              -   Reduce restrictions on worker dismissal for redundancy and
                                  unsuitability
                              -   Align severance payments to EU average
                              -   Introduced some decentralization in the wage-bargaining process.

                              -   Improve competition law and empower the Portuguese Competition
                                  Authority
                              -   Prices and rents in the product market have to be dealt with to
    Product and service
                                  improve productivity in the economy. The government is assessing
         market
                                  barriers to entry and excessive rents in network industries, especially
                                  electricity and telecommunications

                              -   Provision of healthcare are moved to larger and more specialized
         Healthcare               centers.
                              -   More contribution by patients
                              -   Portugal has 98 state-owned companies and accounts for 4.6% of
                                  GDP, 3.6% of the work force. Improving the efficiencies of the sector
                                  and improving their balance sheets are key to a reduction of
                                  government debt burden as well
                              -   public sector’s entities to be privatized or made into stand-alone
       Public sector
                                  corporations to improve efficiency
                              -   Examples: sale of government’s stake in a major player in the
                                  electricity sector – Energias de Portugal – which raised EUR2.7bn.
                                  sale of 40% stake in an energy network company REN at a premium,
                                  raising about EUR0.6bn.
                              -   value-added tax increase in several products
                              -   several tax benefits removed
          Taxation
                              -   increase resources for audit
                              -   enhance focus on large taxpayers
Source: EIU, Bloomberg, IMF




Political will for austerity and political risks ahead

Among the many debt-laden eurozone countries, e.g. PIIGS, several governments
continued to be faced with political threats from the public and their political opposition
but for the current situation in Portugal, such risks are mitigated after the June 2011
election. The present ruling parties in the government are the Social Democratic Party
(PSD) and the Popular party (CDS-PP). They came in to power after Jose Socrate’s
Socialist party’s defeat in Portugal’s general election back in June 2011 (the election was
triggered by Socrates’ resignation after his government failed to persuade the parliament
to pass its fiscal austerity package). Given such a recent election, major news agencies
had mentioned that they expect the two parties to see positive cooperation and remain in
the coalition for the next two years at least. The leader of the PSD and current prime
minister, Pedro Passos Coelho, also said that his government would carry on the
implementation of fiscal austerity measures and make sure that Portugal honor the terms
of its bail-out.




77

7
In its February 2012 report, the Economist Intelligence Unit said it believes “the
government will have the will to see through the reform programme but… …political
stability will come under pressure, given the expected steep drop in living standards.
Violence at demonstrations is unusual in Portugal, but could flare up.” The
abovementioned suggests that while there is an absence of uncertainty of a change of
the government in Portugal, unlike several countries in the eurozone this year (France,
Spain, Greece, just to name a few), political stability risks would unlikely disappear before
the economy and living standards see significant improvement.

IMF’s Third Review and recent concerns in the market

Portugal sought financial assistance from the IMF and EU back in March 2011. Last year,
Portugal was successful in cutting its deficit from 9.8% of GDP in 2010 to about 4.0% (vs.
initial target of 5.9%) but it will face increased pressure due to economic recession. Still,
the IMF remained optimistic that Portugal would meet its 4.5% deficit-to-GDP ratio in the
year 2012.

With regards to financing for Portugal, the IMF’s staff commented that the existing
program (EUR78bn) is adequate, given the positive structural reforms carried out in the
economy. Nevertheless, there are uncertainties with regards to the timing that Portugal
can return to the market for funding, especially after the recent downgrades of its credit
rating by the three key rating agencies (now non-investment grade by all three agencies).
The IMF’s report stated that “should recovery of market access in fact be delayed, it may
become necessary to call upon the pledges by European leaders to continue to provide
adequate support to Portugal as long as the program is on track”. We believe that such
statements of uncertainties and worries had been the cause of the recent up-tick in
Portugal’s bond yields, especially during the periods when yields of other countries such
as Spain and Italy, had been falling due to ECB’s LTRO (long-term refinancing
operations).


Table 3. IMF’s Projections of Portugal’s economy 2012-2017 (page 37 of report)
                          -   GDP may contract by 3.3% in 2012 vs. 2011’s contraction of 1.5%.
                              However, GDP will return to growth by 2013 but that growth would
              GDP             stay low at 1.5-1.9% going forward
                          -   Output gap is likely to return to positive territory only in 2016
                          -   Exports are projected to see positive growth rates of range 4.0-5.5%
                              through 2017
                          -   Imports are likely to see slightly slower growth, thus an improvement
    Exports and imports       in the trade balance and current account balance is expected.
                          -   Still, trade and current account balances are expected to remain in
                              the red of about 3-4.5% of GDP through 2017

                          -   Productivity expected to see positive growth from 2013-2017 but
 Labor productivity and       increases would be moderate at 0.7% - 1.1%
         costs            -   Unit labor costs are expected to see an average of 0% growth going
                              forward
                          -   Public debt-to-GDP ratio is expected to peak in 2013 at 115%. A
     Government debt          steady but slow decline is likely to follow with the ratio projected at
                              109% in 2017.
Source: IMF




88

8
Assessment for Portugal
      Credit Rating Scale
                                               Moody's                   S&P              FITCH
                                                   Aaa                    AAA              AAA
                                                   Aa1                    AA+              AA+
                                                   Aa2                     AA              AA
                                                   Aa3                    AA-              AA-
                                                   A1                      A+              A+
          investment grade
                                                   A2                      A                A
                                                   A3                      A-              A-
                                                  Baa1                   BBB+             BBB+
                                                  Baa2                    BBB              BBB
                                                  Baa3                   BBB-             BBB-


                                                   Ba1                    BB+              BB+
                                                   Ba2                     BB              BB
                                                   Ba3                    BB-              BB-
                                                   B1                      B+              B+
                                                   B2                      B                B
        non-investment grade                       B3                      B-              B-
                                                  Caa1                   CCC+             CCC+
                                                  Caa2                    CCC              CCC
                                                  Caa3                   CCC-             CCC-
                                                   Ca                     CC               CC
                                                    C                      C                C

   Color codes *Red: Current rating * Blue: end-2011 *Black: end-2010
   Source: Bloomberg


 Moreover, the banking system remained a concern, given high levels of private sector
 debt (households and non-financial corporate) and the declining in values of sovereign
 bonds’ on their balance sheets. Fig 15 shows that Portuguese banks are heavily reliant
 on the ECB’s cheap loans (source: IMF) and they have not been able to make adequate
 repayments, causing them to increase the tenors of the loans and a huge chunk of the
 loans were from the ECB’s 3-year LTRO.

Fig 15. Composition of Portugal’s banks borrowings
                                                                                          Fig 16. Portugal’s loan-to-deposit ratio is among the
from ECB (EUR bn): large increases in long-term loans
                                                                                          worst in Europe
after LTRO


                                                                                           LDR ratio
                                                                                             180
                                                                                             160
                                                                                             140
                                                                                             120
                                                                                             100
                                                                                              80
                                                                                              60
                                                                                              40
                                                                                              20
                                                                                                0


                                                                                                       Loans-to-deposit ratio (domestic banks)   Loans-to-deposit ratio (all banks)



Source: IMF Third Review report http://www.imf.org/external/pubs/ft/scr/2012/cr1277.pdf   Source: ECB, KBank




 99

 9
Fig 17. Portugal’s debt maturity profile (annual)                                                                                          Fig 18. Portugal’s debt maturity profile (monthly)
 EUR mn                                                                                                                                     EUR mn
 25,000                                                                                                                                     12,000
                                                                                                                                                                                                                                                        Principal
                                                                                                                     Principal              10,000
 20,000
                                                                                                                                             8,000
 15,000
                                                                                                                                             6,000
 10,000                                                                                                                                      4,000

  5,000                                                                                                                                      2,000

                                                                                                                                                   0
     0




                                                                                                                                                                    Aug-12




                                                                                                                                                                                      Feb-13




                                                                                                                                                                                                                    Aug-13




                                                                                                                                                                                                                                               Feb-14
                                                                                                                                                       May-12




                                                                                                                                                                             Nov-12




                                                                                                                                                                                                  May-13




                                                                                                                                                                                                                                   Nov-13




                                                                                                                                                                                                                                                             May-14
          2012
                  2013

                           2014
                                   2015

                                          2016
                                                  2017

                                                          2018
                                                                 2019

                                                                        2020
                                                                               2021
                                                                                        2022

                                                                                               2023
                                                                                                       2026

                                                                                                              2027
                                                                                                                     2030

                                                                                                                             2037
                                                                                                                                    2049
Source: Bloomberg, KBank                                                                                                                   Source: Bloomberg, KBank




 Going forward and possible impacts on the global financial market

 Current government debt outstanding of Portugal is EUR127.5bn and financing is
 covered from the EU-IMF bailout package until September 2013 when the initial plan was
 for Portugal to return to the market (Greece’s debt after haircut stays at EUR143bn while
 Ireland’s debt stood at around EUR84bn). Given the relatively small size of the economy
 and share of debt in the eurozone (Fig 20.), the impacts on the global financial markets
 could well be limited even if there is increased stress on Portugal’s financing. This is
 especially so since the European financial safety nets are now better-established and
 better-understood (EFSF and ESM). In addition, the “surprise” element has reduced with
 Greece’s debt haircut out of the way (recall: bond swap deal with investors in March
 2012), the market is likely to have a better idea of what could happen next in a haircut
 situation for a small economy.

 Nevertheless, risks remain with regards to Portugal’s banking sector and its economic
 growth. While the government has managed to regain some control over its spending,
 further losses in the financial sector could trigger a government’s bailout of the banks,
 thus effectively transferring a substantial amount of debt from the private sector into the
 public sector, a perfect case for Portugal’s bond yields to spike. The current three-year
 financial assistance program from the EU/IMF may have to be extended or more money
 would have to be provided to ease Portugal’s financial strains.

Fig 19. Government debt in nominal terms                                                                                                   Fig 20. Public debt of Portugal as a share of eurozone’s
 EUR bn                                     Government debt in nominal values                                                               30%
 2,500                                                                                                                                                                                                                                       Share of eurozone's
                                                                                                          2007              2010            25%
 2,000
                                                                                                                                            20%
 1,500
                                                                                                                                            15%
 1,000

  500                                                                                                                                       10%

    0                                                                                                                                        5%

                                                                                                                                             0%
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Source: Bloomberg, KBank                                                                                                                   Source: Bloomberg, KBank




 1010

 10
Fig 21. Comparison of financial safety net to PIIGS’                                                       Fig 22. Thailand’s trade (exports + imports) to EU and
debt repayment until end-2103                                                                              Portugal
                                                                                                            % of total trade                                                                  % of total trade
        Combined lending ceiling of the ESM and the                                                          16                                                                                         0.12
                                                                                                              14
                                                                                                                                                                                                       0.10
                                                                                                              12
                                                                                                                                                                                                       0.08
                                                                                                              10
        Bonds and loans due by end-2013                                                                        8                                                                                       0.06
                                                                                                               6
                                                                                                                                                                                                       0.04
                                                                                                               4
                                                                                                                                                                                                       0.02
                                                                                                               2
                                                                                             EUR bn
                                                                                                               0                                                                                       0.00
    0            100          200        300          400         500        600      700         800               2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
                  Ireland           Greece            Portugal           Spain       Italy                                               EU-27 (left axis)            Portugal (right axis)

Source: Bloomberg, KBank                                                                                   Source: BoT, KBank




 Concerns for Thailand: Financial stress in Portugal or any other smaller European
 economies would have indirect but significant impacts on Thailand’s financial markets but
 limited impacts on the real sector. In terms of exports, Portugal is not a major trading
 partner of Thailand but the European Union is. In the past three years, Thai exports
 managed to continue growing despite of several adversities and the decline in European
 markets’ exports had also been made-up for with exports growth in other markets.

 The financial impacts would come via impacts on the Thai baht and the stock market.
 According the EUR/THB data since mid-2009 to April 2012, the currency pair had moved
 from a minimum level of 38.9 to as high as 50.3 (standard deviation of 3.16). This reflects
 significant risks for exporters and imports alike, especially during periods when the
 correlation between USD/THB and EUR/USD movements seem to fluctuate i.e.
 sometimes highly-correlated movements, and sometimes positive/negative correlation is
 observed. We noticed also that Thai media often report the value of the Thai baht in
 terms of the greenback alone and so there is reduced attention of the EUR/THB
 movements. This seems to suggest that perhaps businesses dealing with the euro and
 European partners would have to be more alert on the changes in the market’s
 sentiments as well.

 Impacts from global risk aversion due to renewed concerns of Portugal’s and Spain’s
 debt problems could also lead to a decline in investment appetite for the local stock
 market. In fact, this is not surprising or limited to the SET index alone but also the
 majority of emerging markets. While local economic fundamental supports a steadier
 movement of the SET index vs the euro stoxx 600 index, it cannot be denied that major
 corrections in the global equity market could cause damages to equity value here as well.
 All in all, continued monitoring of European debt situation is warranted, despite of the size
 of individual economies’ sizes or trading relationship with the local business.

Fig 23. Impacts of USD/THB from EUR/USD volatility                                                         Fig 24. SET index vs. Euro Stoxx 600 index
                                                                                                            Euro Stoxx 600 index                                                                  SET index
  35                                                                                                  52
                                    Greece's                                                                 300                                                                                       1300
  34                                bailout                                                           50                                                                                                1200
                                                                 Portugal's          Greece's                 280
                                                Ireland's                                             48
  33                                                             bailout             haircut                                                                                                            1100
                                                bailout                                                       260
                                                                                                      46                                                                                                1000
  32
                                                                                                      44      240                                                                                       900
  31                                                                                                                                                                                                    800
                                                                                                      42      220
  30                                                                                                                                                                                                    700
                                                                                                      40
                                                                                                              200
                                                                                                                                                                                                        600
  29                                                                                                  38
   Jun-09            Dec-09          Jun-10           Dec-10          Jun-11       Dec-11                     180                                                                                       500
                                                                                                                Jun-09         Dec-09       Jun-10           Dec-10     Jun-11      Dec-11
                                    USD/THB                          EUR/THB (RHS)                                                 Euro Stoxx 600 index                   SET index

Source: Bloomberg, KBank                                                                                   Source: Bloomberg, KBank




 1111

 11
Table 3. Monthly Key Economic Indicators                    Aug 11     Sep 11     Oct 11     Nov 11     Dec 11     Jan-12     Feb-12    Mar-12
Manufacturing index                                          195.9      188.2      132.7      101.2      141.1      166.0      180.9
     % YoY                                                      6.8       -0.3      -30.1      -47.3      -25.3      -15.0       -3.4
Industrial capacity utilization rate (%)                       65.0       65.5       46.5       40.5       51.9       58.5       62.3
Retail sales (% YoY)                                           23.6       20.3       -1.7      -10.8        3.4        6.4       n.a.
Total vehicle sales (units)                                 79,043     87,012     42,873     25,664     54,575     76,246     90,461    110,928
Motorcycle sales (units)                                   194,586    168,783    126,339    124,031    133,300    153,732    195,918
Unemployed labor force ('000 persons)                          270        295        219        322        172        314        n.a.
Unemployment rate                                               0.7        0.8        0.6        0.8        0.4        0.8       n.a.
Consumer prices (% YoY)                                        4.29       4.03       4.19       4.19       3.53       3.38       3.35      3.45
     core consumer prices                                      2.85       2.92       2.89       2.90       2.66       2.75       2.72      2.77
Producer prices (% YoY)                                         6.0        5.6        4.2        3.5        4.5        3.6        1.8       1.8
External Accounts (USD mn, unless specified otherwise)
Exports                                                    20,940.0   21,259.0   17,019.0   15,287.0   16,856.0   15,520.0   18,621.0
     % YoY                                                     28.5       18.4       -0.2      -13.1       -2.1       -6.1        1.2
Imports                                                    20,235.0   18,840.0   16,006.0   15,068.0   17,094.0   14,998.0   16,569.0
     % YoY                                                     45.9       42.6       20.6       -1.9       19.6       -2.5        8.2
Trade balance                                                705.0     2,419.0    1,013.0     219.0      -238.0     522.0     2,052.0
Tourist arrivals ('000)                                      1,725      1,500      1,415      1,220      1,780      1,950      1,845
     % YoY                                                     36.0       23.0        4.0      -18.7       -3.3        7.7        1.3
Current account balance                                      -697.0     404.0        39.0     -136.0    1,940.0     981.0     1,092.0
Balance of payments                                           -556      -1,674     -1,886     -1,506     -1,029      -160      2,089
FX reserves (USD bn)                                         189.4      180.1      183.9      176.4      175.1      178.4      180.6
Forward position (USD bn)                                      26.3       27.3       28.9       30.4       31.2       31.1       29.7
Monetary conditions (THB bn, unless specified otherwise)
M1                                                          1,345.2    1,328.0    1,361.9    1,362.7    1,414.3    1,400.5    1,421.6
     % YoY                                                     13.9       13.0       13.3       10.3        8.6        5.6        5.6
M2                                                         12,874.3   12,912.3   13,151.1   13,330.5   13,566.0   13,693.4   13,807.6
     % YoY                                                     17.4       16.2       16.1       15.9       15.2       15.9       13.6
Bank deposits                                              11,152.5   11,080.5   11,363.3   11,461.7   11,634.5   11,810.5   11,964.3
     % YoY                                                     11.3        9.8       11.3       10.3        9.9       11.4       10.4
Bank loans                                                 10,899.7   11,079.9   11,209.6   11,309.8   11,558.9   11,702.4   11,789.4
     % YoY                                                     17.2       17.5       17.0       16.0       16.2       16.3       15.5
Interest rates (% month end)
BOT 1 day repo (target)                                        3.50       3.50       3.50       3.25       3.25       3.00       3.00      3.00
Average large banks' minimum lending rate                      7.19       7.25       7.25       7.25       7.25       7.22       7.13      7.13
Average large banks' 1 year deposit rate                       2.28       2.41       2.41       2.41       2.41       2.41       2.38      2.38
Govt bond yield 1yr                                            3.48       3.57       3.32       3.20       3.10       3.04       3.08      3.13
Govt bond yield 5yr                                            3.42       3.60       3.23       3.26       3.16       3.12       3.39      3.64
Govt bond yield 10yr                                           3.51       3.75       3.38       3.42       3.35       3.21       3.58      3.83
Key FX (month end)
DXY US dollar index                                          74.12      78.55      76.17      78.38      80.18      79.29      78.74      79.00
USD/THB                                                      29.93      31.19      30.71      30.87      31.55      30.99      30.46      30.83
JPY/THB                                                      39.06      40.50      39.29      39.80      41.02      40.63      37.54      37.18
EUR/THB                                                      43.01      41.76      42.56      41.51      40.90      40.55      40.58      41.13
Source: Bloomberg




1212

12
Disclaimer
 For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or
 sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we
 believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained
 herein. Further information on the securities referred to herein may be obtained upon request.


1313

13

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KBank Capital Market perspectives Portugal in focus

  • 1. KBank Capital Market Perspectives Market Updates Macro / FX / Rates Portugal in focus – problems, changes and possible impacts 23 April 2012 Summary of author’s views Nalin Chutchotitham nalin.c@kasikornbank.com • Portugal’s debt problem is a result of rigid regulations in the product and labor markets, leading to continued deterioration of productivity and competitiveness • Political risks are lower compared to other PIIGS and the new government indicated strong commitment to reforms • Significant changes had been made with economic structure to restore competitiveness to Portugal, but more time is needed • IMF assessed that existing financial assistance is adequate yet risks remain; additional funds from Europe could be warranted but funds are available • Market likely to be more prepared after experience with Greece but by rising bond yields suggest continued skepticism • Impacts on Thailand’s exports and financial market likely to be similar to the past – indirect negative impact on SET and Thai baht from global risk aversion Stay worried about Spain but don’t forget Portugal The market seemed to be somewhat forgetful. It is now worrying about Spain, which is the fourth largest economy in the eurozone with a huge housing market trouble. Yet, the concerns in Portugal remained and it is worth noting as well, especially since the eurozone shares the same pool of limited emergency funding e.g. EFSF and ESM. We gather here facts and recent data for readers to understand the problems of the Portuguese economy better and finally reflect on what could be the impacts on the financial markets. First, we go back in time to review the Page 5 of the IMF’s report in June 2011 (two months after Portugal officially sought financial assistance). The aspects mentioned below clearly illustrated the weaknesses in Portugal’s economy and the dire situation that it must overcome over the next decade. Towards the end of the report, we will discuss the IMF’s latest views reflected in its April 2012 report. First, the early findings on Portugal’s economy below: 11 1
  • 2. Table 1. IMF’s report on Portugal’s economic structure and weaknesses Topic Findings Average GDP growth in Portugal during 2000-2010 is around 1.0%, compared to that Slow economic growth of the euro area’s 1.5% GDP per capita (income per head) rose very slowly during 2000-2010 period, falling Slow income growth behind the euro-area average and even Greece. Working-age population with upper secondary education and above is one of the Weaker labor force weakest in Europe. The percentage of such population is < 30% while the average of EU and OECD countries are well above 60%. (based on 2007 data) According to 2008 data, Portugal has one of least flexibility with regards to the Product and labor product market regulations and labor market regulations. Greece’s score is far worse market rigidity than Portugal under IMF’s study but Portugal’s score is a far cry from the rest. In this aspect, IMF showed that the PIIGS countries all have trouble, as real effective Real effective exchange exchange rate had been on a relatively steady rise since 1995, in contrast to the euro rate (based on unit area which fell. Higher REER means that exports are more costly and therefore less labor costs) competitive. Italy is the worst among the PIIGS, with Portugal in the second place. 1994-2007 data (excluding those after the financial crisis since 2008) for Increase in government’s primary expenditure showed that Portugal had been increasing its government’s spending expenditure by nearly 10% of GDP during the period, on par with Greece. Spain and Ireland saw declines of expenditure while Italy’s record was close to zero. Once debts of corporate sector (non-financial) and household sector are added to the government debt, Portugal’s indebtedness ranks among the worst-performing in Total debt to GDP the euro zone at 300% of GDP. Ireland performs worse than Portugal in this aspect but both are much worse off than Germany at 200% of GDP and France at 250% of GDP. A measure of banking sector’s indebtedness – loan-to-deposit ratio, indicates that Loan-to-deposit ratio Portugal is again among the worst performers. Portugal’s LDR is around 140% (June 2010) compared to most of the euro area that are below 120%. Source: IMF Further illustrations of Portugal’s debt problems First, let us look at the indebtedness of Portugal’s government. Portugal’s public debt as a share of its economy (debt-to-GDP on Fig 2) had usually been lower than that of the eurozone’s (EMU) average prior to the year 2007 with an average of 64.5% during 2000-2007 compared to 71.3% of the EMU. However, the ratio had significantly exceeded the EMU’s average afterwards and the main reason was the government’s inability to reign in spending and fiscal budget deficits in the later years. In the year 2005 when it first missed the Maastricht Treaty’s deficit/GDP ratio target of 3%, Portugal had recorded a fiscal shortfall of 5.9% but this figure continued to rise to 9.8% in 2010 as a result of economic weakness. Clearly, the 2008 global financial crisis had deepened the economy’s existing problems. Eventually, accumulated deficits led to a piling of debts until debt-to-GDP ratio rose to 93%, compared to the 85% average of the eurozone. Despite such weakness of fiscal health, the government’s borrowing costs remained relatively on par with the eurozone members and only saw significantly increases in the year 2010, as suggested by the bond yields. This reflects that refinancing costs did not become more pronounced until recently (Fig 3). 22 2
  • 3. Fig 1. Deficit-to-GDP ratio % Portugal vs. eurozone Fig 2. Debt-to-GDP ratio % Portugal vs. eurozone deficit/GDP Debt/GDP 0 100 00 01 02 03 04 05 06 07 08 09 10 -2 90 80 -4 70 -6 60 -8 50 -10 40 -12 00 01 02 03 04 05 06 07 08 09 10 Portugal deficit/gdp ratio Eurozone deficit/GDP ratio Portugal debt/gdp ratio Eurozone debt/gdp ratio Source: Bloomberg, KBank Source: Bloomberg, KBank Fig 3. 10-year government bond yields of Portugal Fig 4. Private sector debt as a % of GDP % Sovereign 10-year bond yields % % 350 40 40 Private sector debt as % of GDP (2010) 35 35 300 30 30 250 25 25 200 20 20 150 15 15 100 10 10 50 5 5 0 0 0 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 ly um l ain K. k ce en y d ce ay s ga ar an I ta l an nd U. ee an ed rw r tu Sp lgi nm rm r la Ir e Fr Gr No Sw Be Po De th e Ge Germany Spain Portugal Greece Ne Source: Bloomberg, KBank Source: eurostat, KBank Apart from its government debt situation, Portugal’s private sector debt is also very high (Fig 4), crippling the household and business sector to provide stimulus to the economy and this also added to the banking sector’s weakness. (Recall ECON101: engines of growth of an economy include government’s spending, private consumption, private investment, and exports). Reuters reported in March 2012 that, citing Portugal’s central bank, total private sector debt is close to three times of the country’s GDP (Eurostat reported private sector debt at 249% of GDP in 2010. Increased risks also came from the EUR31bn of corporate debt due this year - its size about 40% of what Portugal have secured in terms of financial aid from EU/IMF, which is EUR78bn. In fact, the economy in Portugal was not always in such a dire state. Portugal did benefit from becoming part of the European Union (EU) and the European Monetary Union (EMU) as there were improvements in terms of both economic growth and stability prior to the global financial crisis in 2008. Later in April 2007, The Economist magazine had entitled a report on the Portuguese economy “A new sick man of Europe”. The labels were a result of underperforming numbers in Portugal as compared the euro zone neighbors as well as the whole of the European Union (EU). 33 3
  • 4. According to the U.S. government’s record: “Before the economic crisis, Portugal's membership in the EU had contributed to stable economic growth, largely through increased trade fostered by Portugal’s low labor costs and an influx of EU funds for infrastructure improvements. Portugal's subsequent entry into the EMU brought exchange rate stability, lower inflation, and lower interest rates. Falling interest rates, in turn, lowered the cost of public debt and helped the country achieve its fiscal targets. Until 2001, average annual growth rates consistently exceeded those of the EU average. However, a dramatic increase in private sector loans led to a serious external imbalance, with large capital account deficits that year. De- leveraging by Portuguese banks to meet the June 2011 EU requirement to increase core tier-one capital ratios above 9% has caused bank lending to tighten.” Source:http://www.state.gov/r/pa/ei/bgn/3208.htm We highlight further the degree of deterioration of the economy and competitiveness using the World Economic Forum’s Global Competitiveness Index. Portugal’s ranking has fallen from 22nd in the year 2005 (higher-ranked than Spain, Ireland, France and Hong Kong) to 40th (out of 131 countries) in the 2007-2008 ranking and finally 46th (out of 139 countries) in the 2010-2011 ranking. Fig 5. World Economic Forum’s Global Competitiveness Fig 6. Portugal’s GDP growth vs Eurozone’s Index World competitiveness ranking % GDP Growth % yoy 90 Germany 8.0 80 6.0 Greece 70 4.0 60 Ireland 2.0 50 46 0.0 40 40 43 43 Italy 34 -2.0 30 24 Portugal -4.0 20 22 10 -6.0 Spain Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 0 04-05 05-06 06-07 07-08 08-09 09-10 10-11 Year Spain Portugal Eurozone Source: WEF, KBank Source: Bloomberg, KBank No quick fix for Portugal’s economy Household spending: Household fixed consumption level, at the end of 2011, had fallen to the same level observed in 2006. The pace of decline is more significant in recent quarters, with Q4/2011 consumption dipping 6.6% yoy, a fourth straight quarter of contraction. This is a stark contrast to the average growth rate of 0.7% per quarter since the year 2000 and 1.5% if we exclude the period after 2007. Yet, given the high level of household debt and low levels of saving rate, it seems that households’ balance sheets does not accommodate increased spending either. 44 4
  • 5. Fig 7. Household fixed consumption level and growth Fig 8. Household saving rate (2010) EUR mn % yoy % 20 28000 4 27000 2 15 26000 0 10 25000 -2 5 24000 -4 23000 -6 0 22000 -8 Es al S l an d S p re a rm ) xe c e S w ia d ep ds Un Hu nia S l ium C y ly ia A u rg Cz e th kia m in g y I re n Be ny P o b li c E u -27 F in s G e (2 lan g d K ar str e It a u en do u L u F ra n h R an rt u a ed pr a to N ova a in bo l it e ng EU lg u ov e c er l Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 ro m Household Fixed Consumption (LHS) Household consumption growth % yoy Source: Bloomberg, KBank Source: Eurostat, KBank Wage growth slowed. Another factor that had been a drag on the household consumption was the pace of wage increase. Furthermore, the economic recession made unemployment rate surge quickly from 7.5% in the first half of 2008 to 14.0% as of the fourth quarter of 2011. During the period between 2001 and 2003, Portugal’s unemployment rate had been well below the 6% mark. Notice that the poor labor market conditions and economic recession had also led to slower pace of real wage growth during 2008-2010 period, before rebounding to modest growth in 2011. Confidence level is also low: Confidence indicators helped to reflect on the reasons why household consumption had been falling. Consumer confidence in the year 2011 hit levels below that of the level observed during the 2008 financial crisis, although it had since rebounded, reflecting a dismal outlook. Meanwhile, the overall outlook on the economy remained depressing with the economic sentiment index (which includes service sector, industrial sector, and the household) sliding quickly in the year 2011 to levels near to the 2009 recession. Fig 9. Real wage growth (using wage growth – inflation) Fig 10. Confidence levels near 2009 lows % 120 0 2.0 1.5 110 -10 1.0 -20 100 0.5 -30 0.0 90 -40 -0.5 80 -50 -1.0 70 -60 -1.5 -2.0 60 -70 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Difference between Portugal's and eurozone's inflation rate Portugal economic sentiment index (LHS) Portugal consumer confidence index (RHS) Source: Bloomberg, KBank Source: Bloomberg, KBank Improving exports and current account balance: There is some comfort in Portugal’s trade data and the current accounts. Exports had seen continued positive growth from 2010-2012 while imports had declined, allowing for the trade balance record lower deficits in recent months. The 6-month moving average of current account deficit was EUR500bn in January 2012 and the same measure for the trade balance deficit narrowed to EUR720bn in February 2012 – both indicators improved by more than two-folds from two years ago. 55 5
  • 6. Still, the major trading partners, both import and exports, of Portugal are the EU nations. Stricter fiscal spending rules within Europe this year and going forward poses risks to trading activities to Portugal and the region as a whole. Portugal’s improvement in its competitiveness, be it in terms of higher labor productivity or lower labor costs, would have to compensate for risks on its exports’ exposure to Europe as well and this depends heavily on the government to implement structural changes to the labor and product markets. In fact, Fig 13 below shows that the growth in labor cost (including costs for hiring workers other than wages) had slowed in the past couple of years, pointing to a favorable change. However, recent labor costs may be reflecting the consequences of the rising unemployment rate instead of significant adjustments in the labor market’s regulatory system. In any case, the IMF gave a positive comment on this change on Page 6 of its March 2012 report (after a Third Review of Portugal’s financial aid program): Competitiveness indicators have improved, albeit at a moderate pace. Wage moderation and higher productivity per worker have allowed for more favorable unit labor costs developments in Q4. There are also signs that the real exchange rate depreciation trend may be accelerating, while market shares of exports have remained broadly stable through September 2011. Fig 12. Closing gaps – deficits in current account Fig 11. Exports outpacing imports growth balance EUR bn 30 0 20 -500 10 0 -1000 -10 -1500 -20 -30 -2000 -40 -2500 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Portugal imports % yoy Portugal exports % yoy Current account balance (6m moving average) Trade balance (6m moving average) Source: Bloomberg, KBank Source: Bloomberg, KBank Fig 14. Labor cost adjustment had begun but only Fig 13. Labor cost growth and unemployment rate slightly % yoy % 110 10 16 8 14 100 6 12 90 4 10 2 8 80 0 6 70 -2 4 -4 2 60 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Labour cost growth % yoy (LHS) Unemployment rate (RHS) Eurozone Ireland Spain Portugal Source: Bloomberg, KBank Source: Bloomberg, KBank 66 6
  • 7. Table 2. Key fiscal austerity measures undertaken under the agreement of EU- IMF loan Sector Description - opening up of protected professions - Increased working hours by 30 minutes a day (for private sector) without increase in pay.(2012-2013) - Some bank holidays removed and some shifted to Mondays - Summer and Christmas bonuses (usually about a month’s pay) abolished for employees earning more than EUR1,000 a month. Labor market (2012-2013) - Overtime pay to be halved - Reduce restrictions on worker dismissal for redundancy and unsuitability - Align severance payments to EU average - Introduced some decentralization in the wage-bargaining process. - Improve competition law and empower the Portuguese Competition Authority - Prices and rents in the product market have to be dealt with to Product and service improve productivity in the economy. The government is assessing market barriers to entry and excessive rents in network industries, especially electricity and telecommunications - Provision of healthcare are moved to larger and more specialized Healthcare centers. - More contribution by patients - Portugal has 98 state-owned companies and accounts for 4.6% of GDP, 3.6% of the work force. Improving the efficiencies of the sector and improving their balance sheets are key to a reduction of government debt burden as well - public sector’s entities to be privatized or made into stand-alone Public sector corporations to improve efficiency - Examples: sale of government’s stake in a major player in the electricity sector – Energias de Portugal – which raised EUR2.7bn. sale of 40% stake in an energy network company REN at a premium, raising about EUR0.6bn. - value-added tax increase in several products - several tax benefits removed Taxation - increase resources for audit - enhance focus on large taxpayers Source: EIU, Bloomberg, IMF Political will for austerity and political risks ahead Among the many debt-laden eurozone countries, e.g. PIIGS, several governments continued to be faced with political threats from the public and their political opposition but for the current situation in Portugal, such risks are mitigated after the June 2011 election. The present ruling parties in the government are the Social Democratic Party (PSD) and the Popular party (CDS-PP). They came in to power after Jose Socrate’s Socialist party’s defeat in Portugal’s general election back in June 2011 (the election was triggered by Socrates’ resignation after his government failed to persuade the parliament to pass its fiscal austerity package). Given such a recent election, major news agencies had mentioned that they expect the two parties to see positive cooperation and remain in the coalition for the next two years at least. The leader of the PSD and current prime minister, Pedro Passos Coelho, also said that his government would carry on the implementation of fiscal austerity measures and make sure that Portugal honor the terms of its bail-out. 77 7
  • 8. In its February 2012 report, the Economist Intelligence Unit said it believes “the government will have the will to see through the reform programme but… …political stability will come under pressure, given the expected steep drop in living standards. Violence at demonstrations is unusual in Portugal, but could flare up.” The abovementioned suggests that while there is an absence of uncertainty of a change of the government in Portugal, unlike several countries in the eurozone this year (France, Spain, Greece, just to name a few), political stability risks would unlikely disappear before the economy and living standards see significant improvement. IMF’s Third Review and recent concerns in the market Portugal sought financial assistance from the IMF and EU back in March 2011. Last year, Portugal was successful in cutting its deficit from 9.8% of GDP in 2010 to about 4.0% (vs. initial target of 5.9%) but it will face increased pressure due to economic recession. Still, the IMF remained optimistic that Portugal would meet its 4.5% deficit-to-GDP ratio in the year 2012. With regards to financing for Portugal, the IMF’s staff commented that the existing program (EUR78bn) is adequate, given the positive structural reforms carried out in the economy. Nevertheless, there are uncertainties with regards to the timing that Portugal can return to the market for funding, especially after the recent downgrades of its credit rating by the three key rating agencies (now non-investment grade by all three agencies). The IMF’s report stated that “should recovery of market access in fact be delayed, it may become necessary to call upon the pledges by European leaders to continue to provide adequate support to Portugal as long as the program is on track”. We believe that such statements of uncertainties and worries had been the cause of the recent up-tick in Portugal’s bond yields, especially during the periods when yields of other countries such as Spain and Italy, had been falling due to ECB’s LTRO (long-term refinancing operations). Table 3. IMF’s Projections of Portugal’s economy 2012-2017 (page 37 of report) - GDP may contract by 3.3% in 2012 vs. 2011’s contraction of 1.5%. However, GDP will return to growth by 2013 but that growth would GDP stay low at 1.5-1.9% going forward - Output gap is likely to return to positive territory only in 2016 - Exports are projected to see positive growth rates of range 4.0-5.5% through 2017 - Imports are likely to see slightly slower growth, thus an improvement Exports and imports in the trade balance and current account balance is expected. - Still, trade and current account balances are expected to remain in the red of about 3-4.5% of GDP through 2017 - Productivity expected to see positive growth from 2013-2017 but Labor productivity and increases would be moderate at 0.7% - 1.1% costs - Unit labor costs are expected to see an average of 0% growth going forward - Public debt-to-GDP ratio is expected to peak in 2013 at 115%. A Government debt steady but slow decline is likely to follow with the ratio projected at 109% in 2017. Source: IMF 88 8
  • 9. Assessment for Portugal Credit Rating Scale Moody's S&P FITCH Aaa AAA AAA Aa1 AA+ AA+ Aa2 AA AA Aa3 AA- AA- A1 A+ A+ investment grade A2 A A A3 A- A- Baa1 BBB+ BBB+ Baa2 BBB BBB Baa3 BBB- BBB- Ba1 BB+ BB+ Ba2 BB BB Ba3 BB- BB- B1 B+ B+ B2 B B non-investment grade B3 B- B- Caa1 CCC+ CCC+ Caa2 CCC CCC Caa3 CCC- CCC- Ca CC CC C C C Color codes *Red: Current rating * Blue: end-2011 *Black: end-2010 Source: Bloomberg Moreover, the banking system remained a concern, given high levels of private sector debt (households and non-financial corporate) and the declining in values of sovereign bonds’ on their balance sheets. Fig 15 shows that Portuguese banks are heavily reliant on the ECB’s cheap loans (source: IMF) and they have not been able to make adequate repayments, causing them to increase the tenors of the loans and a huge chunk of the loans were from the ECB’s 3-year LTRO. Fig 15. Composition of Portugal’s banks borrowings Fig 16. Portugal’s loan-to-deposit ratio is among the from ECB (EUR bn): large increases in long-term loans worst in Europe after LTRO LDR ratio 180 160 140 120 100 80 60 40 20 0 Loans-to-deposit ratio (domestic banks) Loans-to-deposit ratio (all banks) Source: IMF Third Review report http://www.imf.org/external/pubs/ft/scr/2012/cr1277.pdf Source: ECB, KBank 99 9
  • 10. Fig 17. Portugal’s debt maturity profile (annual) Fig 18. Portugal’s debt maturity profile (monthly) EUR mn EUR mn 25,000 12,000 Principal Principal 10,000 20,000 8,000 15,000 6,000 10,000 4,000 5,000 2,000 0 0 Aug-12 Feb-13 Aug-13 Feb-14 May-12 Nov-12 May-13 Nov-13 May-14 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2026 2027 2030 2037 2049 Source: Bloomberg, KBank Source: Bloomberg, KBank Going forward and possible impacts on the global financial market Current government debt outstanding of Portugal is EUR127.5bn and financing is covered from the EU-IMF bailout package until September 2013 when the initial plan was for Portugal to return to the market (Greece’s debt after haircut stays at EUR143bn while Ireland’s debt stood at around EUR84bn). Given the relatively small size of the economy and share of debt in the eurozone (Fig 20.), the impacts on the global financial markets could well be limited even if there is increased stress on Portugal’s financing. This is especially so since the European financial safety nets are now better-established and better-understood (EFSF and ESM). In addition, the “surprise” element has reduced with Greece’s debt haircut out of the way (recall: bond swap deal with investors in March 2012), the market is likely to have a better idea of what could happen next in a haircut situation for a small economy. Nevertheless, risks remain with regards to Portugal’s banking sector and its economic growth. While the government has managed to regain some control over its spending, further losses in the financial sector could trigger a government’s bailout of the banks, thus effectively transferring a substantial amount of debt from the private sector into the public sector, a perfect case for Portugal’s bond yields to spike. The current three-year financial assistance program from the EU/IMF may have to be extended or more money would have to be provided to ease Portugal’s financial strains. Fig 19. Government debt in nominal terms Fig 20. Public debt of Portugal as a share of eurozone’s EUR bn Government debt in nominal values 30% 2,500 Share of eurozone's 2007 2010 25% 2,000 20% 1,500 15% 1,000 500 10% 0 5% 0% e l ce d ain e um y ly ga ag lan an c I ta an ee rtu Sp lgi er rm Ire Fr Gr av Be Po Ge e l ce d a in ce y um ly ga on lan an It a an ee rtu z Sp lg i rm ro Ire Fr Gr Be Po Eu Ge Source: Bloomberg, KBank Source: Bloomberg, KBank 1010 10
  • 11. Fig 21. Comparison of financial safety net to PIIGS’ Fig 22. Thailand’s trade (exports + imports) to EU and debt repayment until end-2103 Portugal % of total trade % of total trade Combined lending ceiling of the ESM and the 16 0.12 14 0.10 12 0.08 10 Bonds and loans due by end-2013 8 0.06 6 0.04 4 0.02 2 EUR bn 0 0.00 0 100 200 300 400 500 600 700 800 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Ireland Greece Portugal Spain Italy EU-27 (left axis) Portugal (right axis) Source: Bloomberg, KBank Source: BoT, KBank Concerns for Thailand: Financial stress in Portugal or any other smaller European economies would have indirect but significant impacts on Thailand’s financial markets but limited impacts on the real sector. In terms of exports, Portugal is not a major trading partner of Thailand but the European Union is. In the past three years, Thai exports managed to continue growing despite of several adversities and the decline in European markets’ exports had also been made-up for with exports growth in other markets. The financial impacts would come via impacts on the Thai baht and the stock market. According the EUR/THB data since mid-2009 to April 2012, the currency pair had moved from a minimum level of 38.9 to as high as 50.3 (standard deviation of 3.16). This reflects significant risks for exporters and imports alike, especially during periods when the correlation between USD/THB and EUR/USD movements seem to fluctuate i.e. sometimes highly-correlated movements, and sometimes positive/negative correlation is observed. We noticed also that Thai media often report the value of the Thai baht in terms of the greenback alone and so there is reduced attention of the EUR/THB movements. This seems to suggest that perhaps businesses dealing with the euro and European partners would have to be more alert on the changes in the market’s sentiments as well. Impacts from global risk aversion due to renewed concerns of Portugal’s and Spain’s debt problems could also lead to a decline in investment appetite for the local stock market. In fact, this is not surprising or limited to the SET index alone but also the majority of emerging markets. While local economic fundamental supports a steadier movement of the SET index vs the euro stoxx 600 index, it cannot be denied that major corrections in the global equity market could cause damages to equity value here as well. All in all, continued monitoring of European debt situation is warranted, despite of the size of individual economies’ sizes or trading relationship with the local business. Fig 23. Impacts of USD/THB from EUR/USD volatility Fig 24. SET index vs. Euro Stoxx 600 index Euro Stoxx 600 index SET index 35 52 Greece's 300 1300 34 bailout 50 1200 Portugal's Greece's 280 Ireland's 48 33 bailout haircut 1100 bailout 260 46 1000 32 44 240 900 31 800 42 220 30 700 40 200 600 29 38 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 180 500 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 USD/THB EUR/THB (RHS) Euro Stoxx 600 index SET index Source: Bloomberg, KBank Source: Bloomberg, KBank 1111 11
  • 12. Table 3. Monthly Key Economic Indicators Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Jan-12 Feb-12 Mar-12 Manufacturing index 195.9 188.2 132.7 101.2 141.1 166.0 180.9 % YoY 6.8 -0.3 -30.1 -47.3 -25.3 -15.0 -3.4 Industrial capacity utilization rate (%) 65.0 65.5 46.5 40.5 51.9 58.5 62.3 Retail sales (% YoY) 23.6 20.3 -1.7 -10.8 3.4 6.4 n.a. Total vehicle sales (units) 79,043 87,012 42,873 25,664 54,575 76,246 90,461 110,928 Motorcycle sales (units) 194,586 168,783 126,339 124,031 133,300 153,732 195,918 Unemployed labor force ('000 persons) 270 295 219 322 172 314 n.a. Unemployment rate 0.7 0.8 0.6 0.8 0.4 0.8 n.a. Consumer prices (% YoY) 4.29 4.03 4.19 4.19 3.53 3.38 3.35 3.45 core consumer prices 2.85 2.92 2.89 2.90 2.66 2.75 2.72 2.77 Producer prices (% YoY) 6.0 5.6 4.2 3.5 4.5 3.6 1.8 1.8 External Accounts (USD mn, unless specified otherwise) Exports 20,940.0 21,259.0 17,019.0 15,287.0 16,856.0 15,520.0 18,621.0 % YoY 28.5 18.4 -0.2 -13.1 -2.1 -6.1 1.2 Imports 20,235.0 18,840.0 16,006.0 15,068.0 17,094.0 14,998.0 16,569.0 % YoY 45.9 42.6 20.6 -1.9 19.6 -2.5 8.2 Trade balance 705.0 2,419.0 1,013.0 219.0 -238.0 522.0 2,052.0 Tourist arrivals ('000) 1,725 1,500 1,415 1,220 1,780 1,950 1,845 % YoY 36.0 23.0 4.0 -18.7 -3.3 7.7 1.3 Current account balance -697.0 404.0 39.0 -136.0 1,940.0 981.0 1,092.0 Balance of payments -556 -1,674 -1,886 -1,506 -1,029 -160 2,089 FX reserves (USD bn) 189.4 180.1 183.9 176.4 175.1 178.4 180.6 Forward position (USD bn) 26.3 27.3 28.9 30.4 31.2 31.1 29.7 Monetary conditions (THB bn, unless specified otherwise) M1 1,345.2 1,328.0 1,361.9 1,362.7 1,414.3 1,400.5 1,421.6 % YoY 13.9 13.0 13.3 10.3 8.6 5.6 5.6 M2 12,874.3 12,912.3 13,151.1 13,330.5 13,566.0 13,693.4 13,807.6 % YoY 17.4 16.2 16.1 15.9 15.2 15.9 13.6 Bank deposits 11,152.5 11,080.5 11,363.3 11,461.7 11,634.5 11,810.5 11,964.3 % YoY 11.3 9.8 11.3 10.3 9.9 11.4 10.4 Bank loans 10,899.7 11,079.9 11,209.6 11,309.8 11,558.9 11,702.4 11,789.4 % YoY 17.2 17.5 17.0 16.0 16.2 16.3 15.5 Interest rates (% month end) BOT 1 day repo (target) 3.50 3.50 3.50 3.25 3.25 3.00 3.00 3.00 Average large banks' minimum lending rate 7.19 7.25 7.25 7.25 7.25 7.22 7.13 7.13 Average large banks' 1 year deposit rate 2.28 2.41 2.41 2.41 2.41 2.41 2.38 2.38 Govt bond yield 1yr 3.48 3.57 3.32 3.20 3.10 3.04 3.08 3.13 Govt bond yield 5yr 3.42 3.60 3.23 3.26 3.16 3.12 3.39 3.64 Govt bond yield 10yr 3.51 3.75 3.38 3.42 3.35 3.21 3.58 3.83 Key FX (month end) DXY US dollar index 74.12 78.55 76.17 78.38 80.18 79.29 78.74 79.00 USD/THB 29.93 31.19 30.71 30.87 31.55 30.99 30.46 30.83 JPY/THB 39.06 40.50 39.29 39.80 41.02 40.63 37.54 37.18 EUR/THB 43.01 41.76 42.56 41.51 40.90 40.55 40.58 41.13 Source: Bloomberg 1212 12
  • 13. Disclaimer For private circulation only. The foregoing is for informational purposes only and not to be considered as an offer to buy or sell, or a solicitation of an offer to buy or sell any security. Although the information herein was obtained from sources we believe to be reliable, we do not guarantee its accuracy nor do we assume responsibility for any error or mistake contained herein. Further information on the securities referred to herein may be obtained upon request. 1313 13