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PP 7767/09/2010(025354)

Economic Highlights
Global

MARKET DATELINE

7 September 2010

1 Investors Are Still Concerned Over Europe Banks’


Holdings Of Sovereign Debts

2 US Plans Stimulus Spending On Transportation


Infrastructure

3 Indonesia Raised Banks’ Reserve Ratio

Tracking The World Economy...

Today’s Highlight

Investors Are Still Concerned Over Europe Banks’ Holdings Of Sovereign Debts

Only seven out of 91 European Union banks that had subjected to stress tests failed with a combined capital shortfall
of €3.5bn (US$4.5bn) when the tests result was unveiled in late July. Investors greeted the data as a much-needed dose
of clarity since the uncertainty surrounding bank sovereign-debt holdings was fanning fears about the health of Europe’s
banking system.

However, fears have flared up again as economies and financial systems in heavily indebted countries continue to
struggle. Europe’s largest financial companies hold more than €134bn in Greek, Portuguese and Spanish government
bonds, according to Bloomberg’s compilation in May. Even after a €750bn (US$960bn) emergency bailout fund was set
up to help the weaker economies in the Euroland, investors are still skeptic about sovereign debt and especially the banks
that hold the region’s government bonds. This was because not all investors are convinced with the results of the stress
tests, as they argued that it was not stringent enough. Indeed, the stress test understated some lenders’ holdings of
potentially risky government debt, according to an analysis by the Wall Street Journal of banks disclosures.

As a result, investors are still demanding a high premium for buying Greek debt. As it stands, the yield of 10-year Greek
bonds was at 11.28% on 3 September, compared with 2.34% on similar German bonds. At the end of August, the gap
between the two, the yield spread, was the widest it has been since the peak in May, just before European leaders agreed
on the bailout. Similarly, Irish bonds yield spread versus German bonds climbed to the highest in at least 20 years, after
Standard & Poor’s on 24 August cut the country’s credit rating by one notch to AA-, citing concern that the rising cost
of supporting Ireland’s struggling banks will increase its budget deficit.

The hesitancy among investors also shows up in the spreads on bank bonds, with some European institutions paying
higher borrowing costs compared with their US counterparts. As of 2 September, buyers demanded an extra 383 basis
points over the yield on government debt to own 5- to 10-year bonds sold by Paris-based BNP Paribas SA, according
to Bank of America Merrill Lynch index data. The comparative premiums were 275 basis points for US based Citigroup
Inc. bonds and 192 basis points for JPMorgan Chase & Co. bonds.

With yields on European bank debt so high, the market has shrunk and lenders have been slow to raise the capital they
need. As a result, many European institutions continue to rely on central banks for funding. In July, the European Central
Bank (ECB) loaned €132bn for three months to 171 financial institutions. Wary of lending to each other, banks are also
keeping record amounts of their cash with the ECB. On 9 June, lenders in the Euroland deposited a record €369bn
overnight with the ECB, more than in October 2008, during the credit meltdown. Knowing the situation, the ECB on 2
September extended emergency lending measures for banks into 2011. The ECB will keep offering unlimited one-week
and one-month loans until at least 18 January, and will offer additional three-month funds in October, November and
December.
Peck Boon Soon
(603) 9280 2163
Please read important disclosures at the end of this report.
bspeck@rhb.com.my

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7 September 2010

The US Economy

US Plans Stimulus Spending On Transportation Infrastructure

◆ The US may announce a six-year plan to rehabilitate the nation’s transportation infrastructure with
an initial allocation of US$50bn to help spur economic activities that are slowing down. The US
President will work with Congress to ensure that the plan is fully funded, and a significant portion of the new
investments would be front-loaded in the first year to help create jobs starting in 2011. Construction jobs in the
US have declined by 940,000 since President Barack Obama took office in January 2009, even after a 19,000 gain
in August. The US government plans to pay for it by eliminating tax deductions for oil and gas companies. Much
of the economic stimulus package of US$787bn approved in early 2009 has already been spent, according to the
Congressional Budget Office. Of the total, US$223bn has gone to tax relief, about US$144bn has gone to states
to help prevent layoffs and provide health care and US$145bn has gone towards contracts, grants and loans. Of
the amount of US$38.6bn allocated for the Transportation Department, only US$18.5bn has been paid out thus far.

Asian Economies

Indonesia Raised Banks’ Reserve Ratio

◆ Bank Indonesia, on 3 September, ordered banks to increase their deposits with the central bank as
primary reserves to 8%, from 5% previously, in a move to absorb 50 trillion rupiah (US$5.6bn) of excess
liquidity from the system. The central bank, however, kept its benchmark interest rate unchanged at 6.5%. Bank
Indonesia indicated earlier that it may raise banks’ reserve requirement to absorb liquidity, while refraining from
raising its key policy rate, in a move to contain inflation. Indeed, the central bank has not changed its key policy
rate after reducing it to 6.5% in May 2009. Meanwhile, the country’s inflation accelerated to a 16-month high of
6.4% yoy in August, higher than the central bank’s target of 4-6% for two consecutive months. The new primary
reserve level will take effect on 1 November, and beginning in March next year, the central bank will introduce an
additional reserve requirement that is linked to how much of its funds a lender gives out in loans. It will impose
a penalty for banks whose loan-to-deposit ratio is below 78% or more than 100%. The additional reserve
requirement for banks whose loan-to-deposit ratio is above 100% will be waived if those banks also have a capital
adequacy ratio of at least 14 percent. Currently, 30 banks have loan ratios below 78 percent and no banks are
above 100%.

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