A nice problem to have — for now

  • 23 May 2007
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The economies of euro zone countries are enjoying a resurgent spell, with Germany at the forefront. Solid growth and a rise in tax revenues have fortified fiscal positions, reducing borrowing requirements and consequently sovereign issuance. As Neil Day reports, that gives the treasuries of countries like Italy and Spain a nice problem — how to satisfy investors while trimming issuance. But underlying this sunshine is a darker picture — credit quality in Europe is diverging.

With a general election decided on the narrowest of margins in April and simultaneous downgrades from Standard & Poor’s and Fitch in October, what was the biggest challenge for the Italian Treasury’s funding team in 2006? You might be surprised at the answer.

"What really caused us problems was the gradual decline in our borrowing requirements, month by month," says Maria Cannata, director-general for public debt at the Italian Treasury in Rome. "The growth in the real economy and increase in tax revenues meant that we had to reduce our issuance activity a lot in the second half of the year."

According to S&P research, the Republic of Italy last year borrowed Eu19bn less than expected at the beginning of the year. For Cannata, an improved fiscal position was a nice problem to have.

Italy’s situation is more what you might expect in a country with the opposite rating dynamics, such as Spain.

Enrique Ezquerra, deputy director for debt at the Spanish Treasury in Madrid, was faced with a situation where an initial net increase in debt of Eu14bn, when the budget for 2006 was first passed in July 2005, had by the end of last year turned into a net decrease.

For a sovereign with smaller funding requirements than Italy — which will, according to S&P, this year account for 23% of all long term government borrowing in Europe (including everywhere from Iceland to Kazakhstan) — this is more of an issue.

"The challenge is how to cope with this reduction in our issuance strategy so that we can more or less provide the market with everything we promised," says Ezquerra. His long term gross borrowing requirement for 2007 is Eu31.6bn, compared to Cannata’s Eu200bn task.

Germany the difference

This challenge is only likely to get tougher in 2007, thanks to the continued resurgence of the euro zone economy, which appears even stronger today than it did only a few months ago at the beginning of the year.

"The euro zone’s growth euphoria continues," observed Marco Kramer, co-head of European economics at UniCredit in Munich, in the bank’s Eurozone Monthly Compass report at the end of April. "The consensus forecast for this year’s real GDP growth has, according to the monthly survey from Consensus Economics, risen from an average of 2.0% at the beginning of the year to 2.4% in April."

Some 97% of the participants in the April survey were forecasting GDP growth of more than 2% in 2007, up from only 52% in January. Kramer himself was even more bullish, expecting the euro zone economy to grow 2.6% year-on-year, only marginally slower than the 2.8% of 2006.

At the heart of Europe’s economic resurgence has been Germany. From GDP growth of 0.8% in 2004 and 1.1% in 2005, the continent’s largest economy powered ahead in 2006 with growth of 2.9%. While this rate is unlikely to be sustained — the consensus is around 2.1% for this year and next — optimism among German firms is approaching its highest level since reunification.

The 108.6 score on the Ifo Business Climate Index for German industry in April was only 0.1% lower than its record set in December 2006, which presaged last year’s surge in growth. The barometer of economic activity’s record low was set comparatively recently at the beginning of 2003.

"Germany is profiting from the extraordinary international investment boom, which due to Germany’s specialisation is having a stronger cyclical impact than in the other major European countries," said Hans-Werner Sinn, president of the Ifo Institute for Economic Research at the University of Munich, interpreting the benign picture.

The boom in the German economy has boosted tax revenues, and the effects have been felt at the Deutsche Finanzagentur in Frankfurt. "We saw the budgetary situation turning to the better from the end of 2005, due to improving tax revenues," says Gerhard Schleif, managing director of the Finanzagentur.

Euro zone borrowing falls

European governments across the continent are facing a similarly benign economic outlook and their improved fiscal health is borne out by a fall in net borrowing by European sovereigns to less than Eu200bn for the first time in five years, according to S&P.

The forecast for this year’s Eu198bn total is sharply lower than the Eu327bn aggregate net long term funding borrowed by European sovereigns in 2003, and down from Eu216bn last year.

The figure for 2006 was itself Eu16bn lower than S&P had forecast at the beginning of 2006, thanks mainly to the Eu19bn lower requirement of Italy, but also between Eu4bn and Eu7bn less than expected for Germany, Spain, Belgium and the Netherlands.

Euro zone governments have nevertheless maintained their profile in the primary markets so far this year. By the end of April they had raised some Eu86bn through syndicated issues, down only marginally from the Eu88bn for the same period in 2006, according to data from Société Générale, and given the frontloading of syndicated issuance by governments, the total figure for the year is unlikely to be too different from last year.

However, the fall in sovereign issuance through auctions has been more dramatic, with supply down 24% compared to the first four months of 2006. The effects of the lower supply have been felt by sovereign funding officials.

"Our feeling here is that the slightly lower auction sizes today are supporting their success," says Schleif. "At the top of the slowdown we had sizes of Eu8bn-Eu10bn per auction and in certain market situations we had the impression that we were testing the limits of the market.

"Now, looking back on this year’s Bobl auction, for example, it was Eu5bn and the lower size helped make it more successful."

But Schleif says that the lower funding volumes are not in any way restrictive — S&P forecasts Eu163.2bn of gross long term borrowing from the Federal Republic this year. "The German issuer has so much flexibility in its market operations that there is no reason for the reduced amounts to lead to, say, a lack of liquidity," says Schleif.

Further tightening expected

An inevitable and undoubtedly positive consequence of the lower supply, particularly given an apparently insatiable demand for fixed income products, is that the cost of funds for European governments in general — and Germany in particular — has fallen. After all, more cash than ever is chasing Eu129bn less of net issuance than four years ago.

"What we have seen over the last 18 months is an improvement in asset swap levels," says Zeina Bignier, head of sovereign debt capital markets at Société Générale in Paris. "Last year, for example, we saw the Bund trading at Euribor minus 12bp in the 10 year maturity and now we are at between minus 21bp and minus 25bp."

Minus 25bp was what several analysts had been forecasting for Bund-swap spreads and some are now looking for a further outperformance of government bonds, taking the differential towards 35bp. However, not everyone is convinced.

"My feeling from talking to the sovereign debt management officials is that we will reach a level of minus 25bp to minus 30bp, but perhaps not exceed that," says the head of frequent issuer debt capital markets at one bank. "The borrowing levels that we have come down to now are likely to stabilise and be sustained over the next couple of years because there is a big wall of redemptions coming up in 2008 and 2009."

That said, two factors could lead to a further move towards minus 35bp, according to the debt capital markets official.

The first of these would be if the euro zone economy once again exceeded expectations and/or governments managed to reduce their debt in other ways, so that their overall borrowing requirements fell. "Secondly, we could see more non-European investors increasing their exposure to the euro market," says the DCM official. "This would have a positive impact on the five to 10 year part of the euro government curve, although the 15 to 30 year segment would remain stable on an asset swap basis."

Any further tightening might also be less evenly shared between euro zone governments than it is now. "You get the feeling that the convergence process is finally over," says Schleif at the Finanzagentur. "Investors have since last year been telling us that they are not going underweight in Bunds any more, but are putting them at the core of their portfolios."

Tax revenues can cloud true picture

This talk of an end to convergence is clearly backed up by the rating agencies’ downgrades of Italy. And, perversely, the process may be pushed even further into reverse by the economic resurgence the euro zone is now enjoying.

Moritz Kraemer, managing director of sovereign and international public finance ratings at S&P, says that Italy now finds itself in a "treacherous situation".

"What helped in Germany’s case was that they had this long and drawn-out slowdown that really focused people’s minds, and a consensus emerged that things needed to change, both at the corporate level and also in the management of public finances," he says. "This is probably why the relatively drastic increase in VAT went through fairly calmly, with no big opposition in the streets or elsewhere.

"What is more difficult is the situation in a country like Italy, where many people now feel that the bad times are over. We would say that a 1.8% growth rate is actually pretty low, but the finance minister has declared the fiscal emergency to be over and this will actually make it harder for him to implement the changes he wants to in order to make the budget more robust for future downturns."

The outlook in Italy has also become muddied by an unexpected surge in tax revenues last year that has made it difficult for the government and observers to work out the extent to which the improved fiscal situation is the result of structural changes or merely the cyclical upturn.

"The elasticity of tax revenues seems to be higher in relation to the business cycle than what conventional models would suggest, and this was also borne out when revenue shortfalls surprised many governments on the negative side in the early years of the decade," says Kraemer. "This makes it harder for finance ministers to predict their real financing needs and we prefer to err on the side of caution before declaring victory and saying that it will happen again next year."

Instead, Kraemer argues, governments should be getting their public finances in shape during the good years, as Spain did — something he says will stand the Kingdom in good stead, should fears of a slowdown in the Spanish real estate market be realised and hit government revenues. He contrasts this behaviour with that of the Portuguese government.

"They enjoyed a similar boom until earlier this decade but when the recession hit the government already had a large deficit, which then blew out completely," he says. "They didn’t create the space to absorb this shock.

"Growth in Portugal is better than in recent years, but still very sluggish, in a corridor of 1.5%-2%, and as a result of the excesses of the late 1990s we see no sign of convergence between Portugal and the more prosperous European economies towards the end of this decade."

sovereign DEBT issuance and gdp growth in europe

sovereign DEBT issuance and gdp growth in europe

With a general election decided on the narrowest of margins in April and simultaneous downgrades from Standard & Poor’s and Fitch in October, what was the biggest challenge for the Italian Treasury’s funding team in 2006? You might be surprised at the answer.

"What really caused us problems was the gradual decline in our borrowing requirements, month by month," says Maria Cannata, director-general for public debt at the Italian Treasury in Rome. "The growth in the real economy and increase in tax revenues meant that we had to reduce our issuance activity a lot in the second half of the year."

According to S&P research, the Republic of Italy last year borrowed Eu19bn less than expected at the beginning of the year. For Cannata, an improved fiscal position was a nice problem to have.

Italy’s situation is more what you might expect in a country with the opposite rating dynamics, such as Spain.

Enrique Ezquerra, deputy director for debt at the Spanish Treasury in Madrid, was faced with a situation where an initial net increase in debt of Eu14bn, when the budget for 2006 was first passed in July 2005, had by the end of last year turned into a net decrease.

For a sovereign with smaller funding requirements than Italy — which will, according to S&P, this year account for 23% of all long term government borrowing in Europe (including everywhere from Iceland to Kazakhstan) — this is more of an issue.

"The challenge is how to cope with this reduction in our issuance strategy so that we can more or less provide the market with everything we promised," says Ezquerra. His long term gross borrowing requirement for 2007 is Eu31.6bn, compared to Cannata’s Eu200bn task.

Germany the difference

This challenge is only likely to get tougher in 2007, thanks to the continued resurgence of the euro zone economy, which appears even stronger today than it did only a few months ago at the beginning of the year.

"The euro zone’s growth euphoria continues," observed Marco Kramer, co-head of European economics at UniCredit in Munich, in the bank’s Eurozone Monthly Compass report at the end of April. "The consensus forecast for this year’s real GDP growth has, according to the monthly survey from Consensus Economics, risen from an average of 2.0% at the beginning of the year to 2.4% in April."

Some 97% of the participants in the April survey were forecasting GDP growth of more than 2% in 2007, up from only 52% in January. Kramer himself was even more bullish, expecting the euro zone economy to grow 2.6% year-on-year, only marginally slower than the 2.8% of 2006.

At the heart of Europe’s economic resurgence has been Germany. From GDP growth of 0.8% in 2004 and 1.1% in 2005, the continent’s largest economy powered ahead in 2006 with growth of 2.9%. While this rate is unlikely to be sustained — the consensus is around 2.1% for this year and next — optimism among German firms is approaching its highest level since reunification.

The 108.6 score on the Ifo Business Climate Index for German industry in April was only 0.1% lower than its record set in December 2006, which presaged last year’s surge in growth. The barometer of economic activity’s record low was set comparatively recently at the beginning of 2003.

"Germany is profiting from the extraordinary international investment boom, which due to Germany’s specialisation is having a stronger cyclical impact than in the other major European countries," said Hans-Werner Sinn, president of the Ifo Institute for Economic Research at the University of Munich, interpreting the benign picture.

The boom in the German economy has boosted tax revenues, and the effects have been felt at the Deutsche Finanzagentur in Frankfurt. "We saw the budgetary situation turning to the better from the end of 2005, due to improving tax revenues," says Gerhard Schleif, managing director of the Finanzagentur.

Euro zone borrowing falls

European governments across the continent are facing a similarly benign economic outlook and their improved fiscal health is borne out by a fall in net borrowing by European sovereigns to less than Eu200bn for the first time in five years, according to S&P.

The forecast for this year’s Eu198bn total is sharply lower than the Eu327bn aggregate net long term funding borrowed by European sovereigns in 2003, and down from Eu216bn last year.

The figure for 2006 was itself Eu16bn lower than S&P had forecast at the beginning of 2006, thanks mainly to the Eu19bn lower requirement of Italy, but also between Eu4bn and Eu7bn less than expected for Germany, Spain, Belgium and the Netherlands.

Euro zone governments have nevertheless maintained their profile in the primary markets so far this year. By the end of April they had raised some Eu86bn through syndicated issues, down only marginally from the Eu88bn for the same period in 2006, according to data from Société Générale, and given the frontloading of syndicated issuance by governments, the total figure for the year is unlikely to be too different from last year.

However, the fall in sovereign issuance through auctions has been more dramatic, with supply down 24% compared to the first four months of 2006. The effects of the lower supply have been felt by sovereign funding officials.

"Our feeling here is that the slightly lower auction sizes today are supporting their success," says Schleif. "At the top of the slowdown we had sizes of Eu8bn-Eu10bn per auction and in certain market situations we had the impression that we were testing the limits of the market.

"Now, looking back on this year’s Bobl auction, for example, it was Eu5bn and the lower size helped make it more successful."

But Schleif says that the lower funding volumes are not in any way restrictive — S&P forecasts Eu163.2bn of gross long term borrowing from the Federal Republic this year. "The German issuer has so much flexibility in its market operations that there is no reason for the reduced amounts to lead to, say, a lack of liquidity," says Schleif.

Further tightening expected

An inevitable and undoubtedly positive consequence of the lower supply, particularly given an apparently insatiable demand for fixed income products, is that the cost of funds for European governments in general — and Germany in particular — has fallen. After all, more cash than ever is chasing Eu129bn less of net issuance than four years ago.

"What we have seen over the last 18 months is an improvement in asset swap levels," says Zeina Bignier, head of sovereign debt capital markets at Société Générale in Paris. "Last year, for example, we saw the Bund trading at Euribor minus 12bp in the 10 year maturity and now we are at between minus 21bp and minus 25bp."

Minus 25bp was what several analysts had been forecasting for Bund-swap spreads and some are now looking for a further outperformance of government bonds, taking the differential towards 35bp. However, not everyone is convinced.

"My feeling from talking to the sovereign debt management officials is that we will reach a level of minus 25bp to minus 30bp, but perhaps not exceed that," says the head of frequent issuer debt capital markets at one bank. "The borrowing levels that we have come down to now are likely to stabilise and be sustained over the next couple of years because there is a big wall of redemptions coming up in 2008 and 2009."

That said, two factors could lead to a further move towards minus 35bp, according to the debt capital markets official.

The first of these would be if the euro zone economy once again exceeded expectations and/or governments managed to reduce their debt in other ways, so that their overall borrowing requirements fell. "Secondly, we could see more non-European investors increasing their exposure to the euro market," says the DCM official. "This would have a positive impact on the five to 10 year part of the euro government curve, although the 15 to 30 year segment would remain stable on an asset swap basis."

Any further tightening might also be less evenly shared between euro zone governments than it is now. "You get the feeling that the convergence process is finally over," says Schleif at the Finanzagentur. "Investors have since last year been telling us that they are not going underweight in Bunds any more, but are putting them at the core of their portfolios."

Tax revenues can cloud true picture

This talk of an end to convergence is clearly backed up by the rating agencies’ downgrades of Italy. And, perversely, the process may be pushed even further into reverse by the economic resurgence the euro zone is now enjoying.

Moritz Kraemer, managing director of sovereign and international public finance ratings at S&P, says that Italy now finds itself in a "treacherous situation".

"What helped in Germany’s case was that they had this long and drawn-out slowdown that really focused people’s minds, and a consensus emerged that things needed to change, both at the corporate level and also in the management of public finances," he says. "This is probably why the relatively drastic increase in VAT went through fairly calmly, with no big opposition in the streets or elsewhere.

"What is more difficult is the situation in a country like Italy, where many people now feel that the bad times are over. We would say that a 1.8% growth rate is actually pretty low, but the finance minister has declared the fiscal emergency to be over and this will actually make it harder for him to implement the changes he wants to in order to make the budget more robust for future downturns."

The outlook in Italy has also become muddied by an unexpected surge in tax revenues last year that has made it difficult for the government and observers to work out the extent to which the improved fiscal situation is the result of structural changes or merely the cyclical upturn.

"The elasticity of tax revenues seems to be higher in relation to the business cycle than what conventional models would suggest, and this was also borne out when revenue shortfalls surprised many governments on the negative side in the early years of the decade," says Kraemer. "This makes it harder for finance ministers to predict their real financing needs and we prefer to err on the side of caution before declaring victory and saying that it will happen again next year."

Instead, Kraemer argues, governments should be getting their public finances in shape during the good years, as Spain did — something he says will stand the Kingdom in good stead, should fears of a slowdown in the Spanish real estate market be realised and hit government revenues. He contrasts this behaviour with that of the Portuguese government.

"They enjoyed a similar boom until earlier this decade but when the recession hit the government already had a large deficit, which then blew out completely," he says. "They didn’t create the space to absorb this shock.

"Growth in Portugal is better than in recent years, but still very sluggish, in a corridor of 1.5%-2%, and as a result of the excesses of the late 1990s we see no sign of convergence between Portugal and the more prosperous European economies towards the end of this decade."

sovereign DEBT issuance and gdp growth in europe

Year
20032004200520062007
Net medium and long term borrowing of 42 rated sovereigns327290253216198
Real GDP growth rate — EU (27 countries) 1.32.51.73.02.9
  • 23 May 2007

Bookrunners of International Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 37,598.23 170 9.46%
2 HSBC 34,028.88 217 8.57%
3 JPMorgan 26,223.43 127 6.60%
4 Standard Chartered Bank 24,311.57 151 6.12%
5 Deutsche Bank 21,898.85 77 5.51%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 11,343.89 36 17.74%
2 HSBC 7,749.23 19 12.12%
3 JPMorgan 6,116.80 30 9.57%
4 Deutsche Bank 5,950.19 7 9.31%
5 Bank of America Merrill Lynch 4,165.66 17 6.51%

Bookrunners of CEEMEA International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 14,691.58 46 11.05%
2 Standard Chartered Bank 13,765.00 47 10.35%
3 JPMorgan 11,619.88 47 8.74%
4 Deutsche Bank 11,156.18 26 8.39%
5 HSBC 9,244.84 41 6.95%

EMEA M&A Revenue

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 02 May 2016
1 JPMorgan 195.08 50 10.55%
2 Goldman Sachs 162.26 37 8.77%
3 Morgan Stanley 141.22 46 7.64%
4 Bank of America Merrill Lynch 114.20 33 6.18%
5 Citi 95.36 35 5.16%

Bookrunners of Central and Eastern Europe: Loans

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 UniCredit 4,103.45 23 14.66%
2 ING 2,532.09 20 9.04%
3 Credit Agricole CIB 2,151.31 8 7.68%
4 MUFG 1,818.52 8 6.50%
5 Credit Suisse 1,802.80 1 6.44%

Bookrunners of India DCM

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 AXIS Bank 5,129.62 95 22.25%
2 HDFC Bank 2,824.94 59 12.25%
3 Trust Investment Advisors 2,595.43 82 11.26%
4 ICICI Bank 1,758.86 60 7.63%
5 AK Capital Services Ltd 1,501.06 69 6.51%