/// 23 December 2011 /// 11-46

Summary
2012. Cant be worse than 2011, can it?
In early 2011, we were hopping for the best and we got disappointed. Challenges for 2012 are numerous and all eyes will be on politics. Overview, page 2

2012, challenging times ahead

Fukushima, the Arab spring, the EMU crisis 2011 marked a turning point Challenges are numerous for 2012
Challenges are numerous for 2012. It will probably be a turning point in the European history, as we move closer to the make or brake moment. Growth prospects in the euro zone are bleak, as austerity is implemented rather universally, with fresh new measures announced this week in Spain. Germany could however surprise on the upside, as spelled out by recent surveys (manufacturing PMI, IFO Index) that could follow the US path (bottoming out before being translated into hard data). We tend to be more optimistic about US prospects as the Fed would launch QE3 were the Congress fail to extend the lowered rate of payroll tax. Growth in emerging countries will also be crucial, especially in Brazil and China. The former came to a stall in end-2011 and the latter face a great challenge in its housing sector. In this highly unsettled context, elections will be held in major countries, starting with Finland in January, followed by Russia in March, France (the President in April-May, the Parliament in June), Mexico (July), China (the National Congress of the Communist Party of China will be held in October), and the US in November. 2012 will definitely be about politics. Still, try and have fun and do not fear the end of the world. At least, there is one thing we can be sure about: it will not happen on December the 20th
THE EMU CALLED UPON CLOSE RANKS
10 year bond yield, % 10 8
6 4 2 0 janv-96 janv-01 janv-06 21-dc janv-11
IT-ES

The week in the US

Page 3 Page 4

The week in the Eurozone The other side of public deficits

FR AL

Reducing public deficits is unavoidable, but might not suffice. It is just as important to have macroeconomic policies that aim to stimulate short-term growth and to boost potential growth. Focus 1, page 6

Source : Thomson Datastream

Russias accession to the WTO

After 18 years of negotiations, Russia will become a 154th member of the WTO. Focus 2, page 10

THE WEEK ON THE MARKETS

Week 19-12 11 > 21-12-11
CAC 40 S&P 500 Volatility (VIX) Euribor 3m (%) Libor $ 3m (%) OAT 10y (%) Bund 10y (%) US Tr. 10y (%) Euro vs dollar Gold (ounce, $) Oil (Brent, $) 2 972 1 220 24.3 1.42 0.56 3.06 1.89 1.86 1.30 1 594 105.0 3 030 1 244 21.4 1.42 0.57 3.13 1.95 1.97 1.30 1 610 108.6 +2.0 +2.0 -2.9 -0.1 +0.8 +6.6 +6.6 +11.2 +0.0 +1.0 +3.4 % % % bp bp bp bp bp % % %

Economic indicators
Page 12 Page 14

Market overview

Also in

economic-research.bnpparibas.com

Alexandra Estiot

23 December 2011 11-46

Overview 2012. It cant be worse than 2011. Can it?

2011 was supposed to be the year of the undeniable recovery, after a sluggish exit from the great recession of 2008-2009. The Federal Reserve had launched a second wave of quantitative easing, the US Congress had passed additional fiscal support measures, and the sovereign debt crisis in Europe was easing. At that time, we were expecting global growth to be 4.2% in 2011. But stuffs happen Problems began with surging oil prices due to the Arab Spring that saw uprisings in North Africa and the Middle East. Then, Japan suffered a terrible earthquake and tsunami evolving into a nuclear catastrophe. Those two events proved to be strong supply shocks: global production chains were disrupted (especially in the car and IT industries) and prices for commodities surged. In the meantime, the debt crisis in the eurozone got worse: Portugal tried hard but could not afford to do otherwise than asking for help to the Troka and it became obvious that Greece was not suffering a liquidity crisis but a solvency problem. The response from European leaders was systematically too late and too limited, with scary evils hiding in the details, without mentioning the worst communication ever. The ECB warned but was not heard, and contagion effects began to ripple through financial markets. Spain and Italy were first hit, leading both countries to implement tough austerity measures, with collateral effects on their leaders. The summer was very hot and not just in Europe, with the US drama of the federal debt ceiling, which was finally resolved but at the expense of the countrys AAA. And then, came the autumn, with both good and bad news. The former came in the form of a resilient US economy, with the summer drop in surveys failing from materialising into hard data. The latter saw contagion spreading among non-German AAArated eurozone countries, with the threat from ratings agencies of stripping them all of the three holy letters. And yet, politicians, from both sides of the Atlantic, kept on delaying the necessary steps towards the end of the confidence crisis. Here we are. For sure, the worst has been avoided. The euro still stands and the US federal government was not shut down. But the US Congress has not yet found a way to reverse the fiscal tightening that will jeopardise the domestic economy in 2012. European leaders did agree on a bold plan that will undoubtedly avoid a sequel of the current crisis, but still did not manage to put an end to the current one. Challenges are numerous for 2012. It will probably be a turning point in the European history, as we move closer to the make or brake moment. Growth prospects in the euro zone are bleak, as austerity is implemented rather universally, with fresh new measures announced this week in Spain (see Box). Germany could however surprise on the upside, as spelled out by recent 2

Box : The austerity according to Rajoy

Spain's new leader Mariano Rajoy (Popular Party) gave his inaugural speech before the Parliament, announcing his top priorities: fiscal discipline, reducing unemployment and cleaning up banks balance sheets. With the severe economic downturn since summer and with leading indicators pointing to a contraction in Spain's Q4 GDP, an additional EUR 16.5 bn in savings will be needed to meet the 2012 budget deficit target of 4.4% of GDP. The savings will mainly be made through cutbacks in public spending. With the exception of pensions, whose purchasing power is to be maintained, all government budgets are open for cuts. Priority will be placed on restructuring public administrations, notably by eliminating certain regional organisations. Yet austerity would be harassing unless accompanied by a job stimulation plan. The battle against unemployment is the keystone of Mr. Rajoy's programme to pull the country out of the deep crisis. Greater flexibility will be injected into a notoriously rigid job market. A big overhaul in the wage negotiation system will be announced in Q1 2012. Some short-term support measures include the exemption of employer social contributions during the first year of hiring workers under age 30 and a EUR 3,000 tax subsidy for hiring a person entering the job market for the first time. Lastly, the government intends to clean up banks balance sheets. According to the Bank of Spain, the Spanish banking systems problematic exposure to real estate amounts to EUR 176 bn. Several solutions are being explored to encourage a complete write down of losses and to wipe the slate clean of the real estate excesses of the past decade. The creation of a "bad bank" like in Ireland and/or a new round of savings bank mergers are among the projects under consideration.
Thibault Mercier

surveys (manufacturing PMI, IFO Index) that could follow the US path (bottoming out before being translated into hard data). We tend to be more optimistic about US prospects as the Fed would launch QE3 were the Congress fail to extend the lowered rate of payroll tax. Growth in emerging countries will also be crucial, especially in Brazil and China. The former came to a stall in end2011 and the latter face a great challenge in its housing sector. In this highly unsettled context, elections will be held in major countries, starting with Finland in January, followed by Russia in March, France (the President in April-May, the Parliament in June), Mexico (July), China (the National Congress of the Communist Party of China will be held in October), and the US in November. 2012 will definitely be about politics. Still, try and have fun and do not fear the end of the world. At least, there is one thing we can be sure about: it will not happen on December the 20th

economic-research.bnpparibas.com

Alexandra Estiot

23 December 2011 11-46

The week in the US Weaknesses remain

Since the end of the summer, news from the US was released, rather systematically, on the bright side. In particular, GDP growth held up very well in Q3 (the final reading of the quarterly annualised rate was 1.8%) despite the drop in business surveys over the spring and the summer, which had led many to expect a double-dip recession. Furthermore, there is growing evidence that the US activity actually accelerated in Q4. However, the US economy still suffers from weaknesses. Namely, the job and the housing markets. Employment growth has been gaining momentum. The 3-month moving average accelerated from a cyclical low of 67 000 in July to 143 000 in November. The recent decline in weekly initial claims (dropping to 364 000 during the week ending on December the 17th) is further good news. However, monthly increases in non-farm payrolls remain too limited to lower the too-high for comfort unemployment rate. The US population is growing by an average 140 000-150 000 persons a month. This is the monthly gain in employment needed to stabilise the unemployment rate. But since the US economy peaked in 2007, the labour participation ratio lost 2 points (from 66% to 64%), meaning additional jobs will be needed in the future, when previously discouraged people come back on the labour market. Those 2 points actually represent 4.8 millions of people! For the labour participation ratio to come back to 66% by the end of 2015, without an increase of the unemployment rate, monthly job creations of 185 000 would be needed. To achieve a decline of the unemployment rate to 7%, employment would have to grow a very healthy 240 000 per month The housing bubble burst was the trigger of the great contraction of 2008-2009. The correction has been massive, and actually more severe than previously estimated. The number of existing homes sold was revised down by an average of 14.4% for the period of 2007-2010! The revisions come from a previous overestimation of homes sold directly by owners. With a very depressed market, a higher proportion than usual of homeowners decided to hire realtors to market their properties. However, this does not change the diagnosis of the US real estate market, since the number of homes for sale was revised downward accordingly: the inventory of homes for sale as a multiple of monthly sales remained unchanged, at 7 months. There are growing signs that the housing sector could have reached a bottom. Even if it does not rebound, it will probably no more be weighing on down activity. For one thing, at current monthly rates, the inventory of homes for sale is limited to 7 months. It was almost 12 in July 2010. Additionally, from peak (June 2006), the median price of existing homes is down by almost 30% (36.5% in real terms). Compared to households disposable income, prices for existing homes are not just down

Slacks on the labour market

Labour underutilisation, % Unemployment rate Labour participation ratio, r.h.s.
11 67

7 65 5

3 90 93 96 99 02 05 08 11

63

Chart 1

Source : US Bureau of Labor Statistics

Median sale price of existing homes / disposable income per household

2.8

Cheap !

2.5

2.2

1.9

1.6 66 71 76 81 86 91 96 01 06 11

Chart 2

Source : US Department of Commerce

from their exuberant highs of 2006, but 25% below their long-term average. The greatest weakness of all is however the Congress. We have been writing almost every week that reversing the planned fiscal tightening for 2012 was essential. This week-end, the Senate passed a law doing a sixth of the job (extending the lowered rate of the payroll tax for 2 months instead of for 2012 as a whole). This was insufficient, and above all, it was not lifting fiscal uncertainties. But it was still better than nothing. Whatever, the House of Representatives killed the project. Time is running out.

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Clemente De Lucia/Hlne Baudchon Frdrique Cerisier

23 December 2011 11-46

The week in the Eurozone Boosting liquidity

On Wednesday 21 December, the ECB conducted its first special Longer Term Refinancing Operation (LTRO) with a 3-year maturity. The second operation of this type will be conducted at the end of February 2012. At 489bn, liquidity demand exceeded the consensus forecast, which averaged between 250bn and 350bn. This is the highest amount of liquidity the ECB has ever provided in a single operation. When the bank conducted its first 12-month LTRO in June 2009, demand was 442bn. Altogether, 523 bids were placed on the 3-year LTRO, almost three times the number of banks that participated on the latest 1-year LTRO in October 2011. On Wednesday, the ECB also conducted a 3month LTRO that allotted only 30bn, while around 140bn matured. This means that many banks decided to roll 3-month liquidity into the 3-year operation. Since the outbreak of the financial crisis, the ECB has been conducting all its refinancing operations at fixed rate with full allotment. Under this framework, liquidity was not an issue, at least not at very short maturities. However, tensions were more acute at longer maturities. In mid October, the average duration of liquidity was just 38 days. After the ECB conducted a special 1year LTRO at the end of October, the average duration of liquidity rose to 73 days. With this week's operations, the average duration of liquidity rose to 637 days. Note that the ECB's role is also to oversee the smooth operation of the payment system as specified in the Treaty (art. 105). Rising money market tensions have probably been hampering the interest rate transmission channel of monetary policy. Easing tensions in the money market is extremely important for each economies, especially for thee eurozone as a whole, given the importance of the banking sector as a source of external funding for non-financial corporations. Tensions in the financial markets are creating funding problems for banks. Next year around 720bn in debt securities will reach maturity. Rolling over such a huge amount could increase pressures in the financial markets, which are already highly distressed. The ECB is clearly acting to ease financial and monetary conditions (FMCs), which have tightened considerably in recent months and are nearing the stress levels that followed the collapse of Lehman Brothers. After this week's operations, excess liquidity has risen sharply. This should help ease tensions in the money markets and lower money market rates. The overnight Eonia is likely to trend towards the interest rate on the deposit facility, which is currently 75bp below the refi rate. Other policy rate cuts could also help ease financial and monetary conditions. Given the poor state of the economy and the low level of pricing pressures, the ECB might be inclined to lower the refi rate in Q1 2012. Lastly, lower interest rates and greater liquidity should
Excess liquidity has increased sharply
1000000 900000 800000 700000 600000 500000 400000 300000 200000 100000 0

Adding liquidity

Open market operations ; Coverd bonds Needs

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Chart 1

Source: ECB

Extremely tight financial and monetary conditions

Financial and monetary conditions indicator.
4 3 2 1 0 -1 -2 Easing conditions Tightening conditions

98 99

00

01

02

03

04

05

06

07

08

09

10

11

Chart 2

Source: BNP Paribas

reduce the external value of the euro, which should also help ease financial and monetary conditions.

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Clemente De Lucia/Hlne Baudchon Frdrique Cerisier

23 December 2011 11-46

Activity data
Fears about Italy have been confirmed. According to Istat, the national statistics institute, Italy slipped into recession as of last summer, with GDP down 0.2% QoQ. The only positive factor is that Italian exports maintained a relatively comfortable growth rate of 1.6% QoQ in Q3 2011 (5.7% yoy). The growth slowdown mainly reflects the sluggishness of domestic demand, which has begun to contract after stagnating in recent quarters. All components of demand are affected, including private and public consumption and investment. The decline in domestic demand is accompanied by a welcome decline in imports but also by massive destocking, a sign that business leaders have lost confidence in growth prospects. The drastic cutbacks in the budget deficit planned for 2012 do not raise hopes for an upturn in growth in the short term. The recession could extend at least until mid 2012, with real GDP contracting on average by about 0.8% next year. Various surveys released this week have on the contrary surprised positively and thus send out an encouraging message. After the upturn in French and German PMI in December, the IFO index and Belgian consumer and business confidence indices also unexpectedly improved. The business climate in Germany is up for the second consecutive month, with the IFO index rising to 107.2 in December from 106.6 in November. This improvement is driven by more favourable expectations in all business sectors, while assessments of the current situation did not change. According to the IFO, there is no danger of recession in Germany. This analysis is supported by the turnaround in household confidence over the past three months, according to the GfK survey. Yet this is not sufficient grounds to be fully reassured, and even less so to let up efforts to solve the crisis as quickly as possible. Of course, this is exactly the type of good news the economy needs, since it could trigger a potentially self-sustaining positive cycle. Yet the upturn in the surveys is still very small and fragile. At best, they signal that the economic situation has stopped deteriorating. In any case, that is where to start, and it validates the hypothesis of excessive pessimism, which shouldn't leave too many marks on growth. We do not think however the upturn will be strong enough to avoid an economic contraction as we move into the new year, but it should remain rather benign.

Germany business climate key index, seasonally adjusted, 2000=100

business expectations; IFO index; current situation

A promising though modest rise in the IFO

125 115 105 95 85 75 2007

Chart 3

2008

2009

2010

2011
Source: Ifo

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Thibault Mercier

23 December 2011 11-46

Focus 1 The other side of public deficits

Excessive public deficits can arise from macroeconomic imbalances in the private sphere, as illustrated by Ireland and Spain. Placing priority on reducing structural deficits implicitly means insisting on the importance of potential growth in questions of public financing. Today, the peripheral countries of the euro zone are implementing structural measures to improve the supply of goods and services. Convergence within the euro zone would accelerate if the countries with current account surpluses were to reduce these surpluses by stimulating domestic demand. In practice, the Maastricht criteria reduced the monitoring of public finances to just two criteria, public deficits and debt, and thus failed to prevent the formation of macroeconomic imbalances in the private sphere, even though these imbalances are often the source of excessive public deficits. Two striking examples are Ireland and Spain. Although Ireland is now in an IMF-EU emergency financing programme and Spain is experiencing major financial distress, both countries perfectly respected the Maastricht criteria between 2001 and 2007. During this period, Spain reported public surpluses in 2005, 2006 and 2007, and Ireland reported surpluses every year except 2002 (see chart 1). In the eyes of many observers, they were both prime examples of EMU integration and fiscal virtue. Yet by late 2010, the two countries had ran up the highest public deficits in the euro zone (12% excluding bank recapitalisation for Ireland and -9.2% for Spain). The bursting of the real estate and credit bubbles heavily strained their public accounts. A lasting clean up of public finances calls for the redefinition of growth models for certain countries in the euro zone, which need structural measures to rebalance current growth and to boost potential growth. Although there is no alternative to austerity to resolve the debt crisis, this solution alone is not enough since it ineluctably triggers a drop-off in domestic demand (and fiscal revenues) and often leads to recession, especially when austerity is widespread (as is currently the case in the euro zone). Shortterm economic stimulus measures would be welcome, for example, by stimulating demand in the countries of the euro zone with current account surpluses. This would also help accelerate convergence within the euro zone.
Ireland; Spain

Misleading solidity

Public surpluses and deficits (% of GDP)

5% 3% 1% -1% -3% -5% -7% -9% -11% -13% -15% 00 01 02 03 04 05 06 07 08 09 10 11

Graph.1

Source: IMF

Hidden imbalances
In Ireland and Spain, real estate and private-sector credit bubbles artificially stimulated public accounts during their formation phase and then created an enormous drain after they burst. For nearly a decade, public administrations benefited from abundant fiscal revenues, fuelled by taxes on real estate transactions and large VAT and income tax revenues, which largely pertained to the real estate boom. Symmetrically, with the downturn in real estate prices, fiscal revenues plunged while social welfare spending surged due to rising unemployment triggered by the abrupt halt in construction. Spain swung from a public surplus of 1.9% of GDP in 2007 to a deficit of 11.2% of GDP in 2009. This 13-point spread in GDP can be broken down as follows: 5 points for the impact of the recession and economic stimulation measures, and 8 points of GDP for the permanent loss of revenues due to the collapse of its growth model. Theoretically, by breaking down the public deficit into a structural deficit and a cyclical deficit, it should be easier to evaluate the degree of orthodoxy of public finance policies. The European summit on 8 and 9 December focused on introducing balanced budget rules, which are to be written into the constitutions of each member country to reduce structural deficits to less than 0.5% of GDP. This illustrates Europe's determination to better control fiscal policies, independently of the economic cycle.

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Thibault Mercier

23 December 2011 11-46

Yet balanced budget rules are intrinsically linked to a precise and reliable estimation of the country's potential growth1, which is often a subject of debate and revision. In spring 2007, the European Commission forecast Spain's structural budget surplus at 1.8% of GDP, down from 2.3% in 2006. According to the European Commission's latest estimates (fall 2011), the structural budget balance was retrospectively estimated at 1% of GDP in 2007 and +1.5% of GDP in 2006 (chart 2). These differences are derived directly from the downward revision of euro zone estimates for these years. At the time, when Spain was reporting growth rates of about 4%, the output gap was thought to be negative, which means the European Commission estimated that the observed level of activity in Spain was lower than its potential. In other words, the overheating of the Spanish economy was very largely underestimated and its potential growth highly overestimated. Today, the European Commission estimates that the output gap was positive in 2000-2007, which means economic activity was higher than its long-term potential. Fiscal revenues for the years 2005-2007 were retrospectively esteemed to be cyclical, which all other factors being equal, reduces the structural public surplus. The Spanish example shows that macroeconomic imbalances can lead to the overestimation of potential growth during the formation of bubbles.

Reducing external financing needs supposes a contraction in domestic demand (which is currently happening via the austerity plans), but also an increase and improvement in the supply of goods and services.

Approximate calculations
European Commission's outlook for Spain
Structural balance (fall 2011); Structural balance (spring 2007) Output gap (fall 2011); Output gap (spring 2007)

3 2 1 0 -1 -2 -3 -4 -5 2002 2003 2004 2005 2006 2007 2008

Rebalance current growth

An analysis of the current accounts of the peripheral countries of the euro zone provides an interesting picture of the imbalances of these economies. The large current account deficit observed in Spain, Greece and Portugal over the period 2001-2007 reflects a much faster increase in domestic demand than in revenues (or GDP, which is equivalent). In other words, the increase in domestic demand was largely financed by foreign capital. This trend was accentuated when these countries joined the euro zone: the apparent elimination of external financing restrictions encouraged massive recourse to external debt. This situation does not pose much of a problem as long as the foreign debt is used for productive investment, in which case it should boost future revenues. In the peripheral countries, however, foreign debt was mainly used to finance consumption (both public and private) and real estate investment. Without fiscal federalism, these economies were exposed to a drying up of available financial resources: foreign investors were increasingly less inclined to finance the deficits of Greece, Portugal and, to a lesser extent, Spain, forcing them to adopt restrictive fiscal policies.

Graph.2

Source: European Commission

Changing the growth models of the peripheral countries would also serve two purposes: avoiding the formation of bubbles in the private sphere that threaten public finances and promoting convergence within the euro zone in preparation for a politically acceptable fiscal union. So far, Ireland, and to a lesser extent Spain, have managed to gradually absorb the imbalances of the past decade2. Yet the generalisation of austerity policies throughout the euro zone and the global economic slowdown could slow current adjustments. During periods of austerity, unless exports provide a new source of growth, there is greater risk of recession, which makes fiscal consolidation even harder: structural efforts to reduce the deficit are partially cancelled out by wider cyclical deficits. Public finance reform in the euro zone would be made much easier through short-term stimulus measures in the countries where austerity is not urgently needed. The quasi equilibrium of the current account for the euro zone as a whole suggests that the EMU, despite its divergences, has sufficient savings to finance demand. The nations with major current account
Ireland had a smaller current account deficit and managed to swing into a current account surplus this year. In Spain, the deficit was cut in half over two years, from 10% of GDP to 4.5% of GDP in 2010.
2

The structural deficit is obtained by subtracting the cyclical deficit from the public deficit, which is calculated based on the estimated output gap. When the output gap is equal to 0, i.e. when the level of activity observed is the same as the estimated potential, the public deficit is equal to the structural deficit.

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Thibault Mercier

23 December 2011 11-46

surpluses (Germany, the Netherlands and Austria) could stimulate domestic demand and participate in the convergence movement, which has been borne so far solely by countries with current account deficits.

At least two factors explain these feeble productivity gains. First, there is a deficit of human capital. The Spanish education system is characterised by a high drop-out rate with 31% of students leaving secondary school without a degree. This harms labour productivity. Increasing human capital will require further investment in education and R&D, which will be vital in the future, since the construction sector will no longer offer as many unskilled job opportunities as in the past. Second, Spain's low productivity can also be explained by the predominance of sheltered sectors (real estate, tourism, transport) in the value added chain. Traditionally, these sectors generate few productivity gains. Moreover, the lack of competition in sheltered sectors is a problem as it increases prices for these services for households and also industrial sectors. It also deters foreign investment which can bring innovation.

and boost potential growth

Potential growth is a key parameter for determining a country's solvency. Often assimilated with long-term growth, it serves as the basis for calculating future revenues that can be used to repay debt. The peripheral countries of the euro zone must now increase their potential growth. This is defined as the increase in production that would result from the optimum use of an economy's production factors (labour and capital). Broadly speaking, we can say that it is the product of the increase in the employment rate3 and productivity gains, the later of which implicitly includes capital intensity. Several economic policies can be followed to increase potential growth. They depend on the specific conditions of each country. Spain, for example, is handicapped by a low employment rate and feeble productivity. Consequently, its potential growth is very low. Raise the employment rate Spain's low employment rate is essentially due to its very high jobless rate, since it has a higher participation rate than the euro zone average. This suggests that the shortcomings of the job market are not due to incitements to find work but rather to the difficulties in matching companies' demand for labour with the supply of unemployed workers. On the one hand, job demand seems to be restricted by the rigidity of wage negotiations and the high cost of lay offs, and on the other, the supply of labour seems to be poorly adapted to the new needs of the job market after the bursting of the real estate bubble. Looking beyond feeble growth prospects (which explains cyclical unemployment), Spain's structural unemployment can be attributed to both the lack of wage flexibility and the low employability of former construction workers, most of whom are unskilled. The construction sector is expected to remain in a slump for several more years, which means unemployment can only be reduced significantly by retraining some of these jobless workers. This will require investment in education and training. Stimulate productivity

The big split

Spain
180 170 160 150 140 130 120 110 100 90 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Wages(1995=100)) ; per capita productivity (1995=100)

Graph.3

Source: Eurostat

Between 1995 and 2007, productivity per capita declined by an average of 0.4% a year while inflation-indexed wages rose very rapidly. The combination of these two factors drove up unit labour costs, which largely eroded Spain's competitiveness.

Belonging to an economically and financially integrated zone exacerbates this effect. In a monetary union, the elimination of foreign exchange risk fosters greater capital mobility, which encourages productive specialisation within the zone. Countries like Germany that already have big industrial sectors attract capital seeking economies of scale. Less industrialised countries like Spain tend to specialise in market services (tourism, transport, real estate, financial intermediation). This phenomenon creates zones of competitiveness and accentuates existing differentials.

The employment rate is the proportion of employed persons out of the total working aged population (ages 15 to 64).

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Thibault Mercier

23 December 2011 11-46

Starting with the principle that Spain is naturally more specialised in sheltered sectors, we can envision lowering entrance barriers to open up these markets to domestic competition, thereby stimulating the production of goods and encouraging innovation.

Sector weight as % of GDP Construction; Industry

20% 18%

Deindustrialisation

*** Reducing public deficits is unavoidable, but might not suffice. It is just as important to have macroeconomic policies that aim to stimulate short-term growth and to boost potential growth. Ideally, the ailing countries in the euro zone that are currently seeking to improve their supply policies would receive support from the countries with the resources to stimulate domestic demand. This would make the convergence process much easier.

16% 14% 12% 10% 8% 6% 4% 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Graph.4

Source: INE

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Anna Dorbec

23 December 2011 _ 11-46

Focus 2 Russias accession to the WTO: happy end of 18 years-long negotiations

After 18 years of negotiations, Russia will become a 154th member of the WTO. On December 16th the WTO Ministerial Conference approved the Working Party accession recommendation and accepted Russia as a WTO member. The entry of Russia will extend the application of the WTO rules to 97% of worlds trade. In the short term, WTO may reinforce Russias specialisation on low value-added exports. There is a consensus over the long-term benefits, notably in improving business environment, greater competition and economic growth. For sectors such as agriculture and automobile the opening of the Russian market to the foreign competition will be very gradual with 7-8 years transition period.

Last G-20 country to join the WTO

Russias share in global trade (%)
4% 3% 2% 1% 0% 99 00 01 02 03 04 05 06 07 08 09 10 11

Chart 1

Source : BNPP, IMF DOT

Russia agreed on the terms of its membership in the World Trade Organisation in November 2011. The formal procedures started with the approval of Russias application by the Ministers participating at the WTO Ministerial Conference in Geneva on December 16th. Russia has 220 days to ratify the agreement and the process is expected to officially end by Q3-2012.

H1-2011

Key Russias traded goods

Share in imports (%) Share in exports (%)

Energy raw materials

Machinery, equipment and vehicles

Long and painful road

Russia was the last G-20 country outside the WTO. Its entry will be most significant enlargement of the organization since China joined a decade ago. By including Russia, the WTO coverage of the world trade will attain 97%. The enlargement of the global free trade club is an important progress for the WTO in the current period when the calls to the protectionism are growing in developed countries that look to protect themselves from the social dumping from emerging countries. The road has been long and painful. The first application from Russia dates back to 1993, so the negotiations took 18 years, exceeding the previous record of China that needed 15 years to join. At the beginning of the process, Russia was penalised by its non-market economy that was going through the transition from planned to a market economy. The period was turbulent and unstable and there were little appetite from other GATT/WTO members to deal with cheap imports from the ex-Soviet republic with doubtful legal environment. Since the 2000, the main transition difficulties were overcame, but Russian authorities started to look for tools to support several sectors of the economy that suffered a lot during the 1990s, notably machinery and agriculture. Trade barriers, administrative regulations and, since the second half of 2000s, subsidies, became a mean of supporting the local industry that remained largely

Food products Metals Chemicals

Table 1

2.1 45.6 15.7 7.9 15.5

70.5 5.7 1.6 9.5 6.2

Source: Federal Customs Service, Bank of Russia

H1-2011
EU CIS China
Table 2

Key Russias trade partners

Share in imports (%) Share in exports (%) 41.5 15.0 15.3 53.2 15.4 6.5

Source: Federal Customs Service, Bank of Russia

uncompetitive comparing with its foreign peers. WTO does not regulate energy (70% of Russian exports, Table 1), so the better access to the export markets was not as strategic as one could expect. By contrary, the protection of the internal markets was actively lobbied by local producers. Thus, for almost ten years, Russia and its foreign partners were playing a kind of zero-sum game: the interests of Russian producers in reducing the competition from abroad were put in front of these of foreign companies and banks willing to obtain better conditions of access to Russian rapidly

10

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Anna Dorbec

23 December 2011 _ 11-46

growing market. The negotiations with the EU, which is by far, the key Russias trade partner, covering about a half of its trade turnover (Table 2) continued until October 2011, before sides achieved a compromise, allowing Russia to secure domestic content in auto production, set specially agreed terms for agricultural imports and quote wood exports. While the USA formally agreed on Russia joining, the effective use of WTO norms in bi-lateral trade will wait until the abolition of JacksonVanik amendment1. The US administration reiterated its promises to rapidly abolish this regulation that dates from the Cold War, but in light of the electoral campaign in both countries and the recent cooling in bi-lateral relations, its abolition may take time.

international quality standards by Russian drug producers. By contrary, the personal vehicles market will be opened very gradually: for new cars the duties will be reduced only slightly, from the actual 30% to 25% and further to 15% after the 7 years transition period. Thus, in the short to medium term, Russian economys

Russias trade balance with key partners

12M cumulative flows (US$bn) Russia-Germany; Russia-China
10 5 USD bn 0 00 -5 01 02 03 04 05 06 07 08 09 10 11

Costs and benefits

Opening to the competition will be gradual. On average, Russian authorities committed to cut the custom duties from the current average of 10.3% to 7.1%. For manufactured goods the duty will be cut from 9.4% to 6.4% while for agricultural products will benefit from higher level of protection: the duty will be reduced from current average of 15.6% to 11.2%. The joining process envisages a 7-8 year transition period during which Russia will be allowed to protect several sectors, notably the automobile industry and agriculture. The entry barriers will also be lowered in services. While the opening of banks direct subsidiaries (i.e. w/o submitting to the regulation of Bank of Russia) will not be allowed, the insurance companies will be allowed to open subsidiaries since 2018. Costs and benefits for Russia vary a lot across the sectors and the time horizon. The short term impact differs across the sectors. The impact on key Russias exporting sectors (oil and gas and metals) may be negligible. Russian producers of steel and pipes may benefit from the WTO mechanisms to obtain the cancellation of the anti-dumping duties that restrict their access to several markets (notably the US). On the contrary, the agricultural sector, which has remained the most reluctant to the WTO accession, will benefit from the special regime mixing quotas and duties. The companies willing to modernise their production capacities will enjoy lower prices on imported equipment. Notably, the duties on tracks, agricultural and commercial vehicles will decline from 25-30% to 10-15% immediately after the WTO accession and three years later will be lowered to 5-10%, lowering investment costs for business. Consumers will rapidly gain from lower duties on imported medicines (from 10-15% to 5-6.5%) as well as from the adoption of the
The Jackson-Vanik amendment to the 1974 Trade Act denies permanent normal trade relations to non-market economies that restrict emigration. Despite the dismantlement of the Soviet Union in s the 1990 the and the disappearance of the emigration restrictions, amendment remains valid for Russian Federation, even though the United States has granted Russia a waiver every year since 1992. The amendment was levyed in 2005 for Ukraine. China was excluded from the amendment in the late 1990s, before joining the WTO in 2001.
1

-10 -15

Chart 2

Source : BNPP, IMF DOT

specialisation, which may be schematized as exports of commodities in exchange to the high value added machinery imports, may be reinforced. According to the World Bank (2010), the accession may provide additional 3.3%-11% per annum in the medium-long run. The key long term benefits from the membership will essentially be due to the improvement in the business environment, more stable and effective trade rules and increased competition in the markets for goods and services, encouraging productivity growth and lowering inflation. The WTO entry is expected to benefit Russias key trade partners, notably China and Germany (Chart 2). Thus, China, which exports mainly consumer goods may benefit from the substantial hike in public sector wages planned by Russian government for this year. Germany, which is specialized in equipment sales, will be more sensitive to the growing investment demand from Russian industry which is modernizing its production facilities. Russias access to the WTO will indirectly benefit to its Customs Union partners (Kazakhstan and Belarus). Both countries are not members of the WTO, but since July 2011, benefit from the customsfree trade regime with Russia which will allow them to benefit from the WTO conditions for goods transiting by Russia.

11

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OECD countries

23 December 2011 11-46

To watch from 22 December 2011 to 6 January 2012 United States

ISM surveys (December). The manufacturing sentiment probably kept on improving in December, as indicated by regional surveys and the November component for new orders. As for the non-manufacturing sector, after a surprise decline in November, we expect the composite index to have bounced back in December. The retail sector is sending very good signals, while the construction and government sectors will keep on weighing down on activity. Labour Market Report (December). Lately, the US labour market proved more surprising than usual. The latest sets of data have pointed to a broad-based strengthening according to the household survey, but to just a slight acceleration in hiring according to the establishment survey. Taking into account the continuing decline in initial jobless claims as well as the fast increase in federal government receipts on income taxes, we would tend to expect non-farm payrolls to keep on accelerating, with a possible strong upward revision in February. FOMC Minutes (December meeting). The latest FOMC meeting was unsurprising, with the expected lack of change in policy (conventional and unconventional). The breakdown of votes was unchanged, with one member dissenting. The focus will thus be on whether FOMC members are heading to a change in communication. Several of them have been discussing the need for clearer communication. They however seem to remain undecided on the means: long-term projections of the likely path of the Fed Funds Target? Numerical objectives (conditional or not) for inflation and/or the unemployment rate? A change in communication could help smooth the exit from quantitative easing: this is unlikely to happen in 2012, but still, it will eventually occur

Japan
Industrial production (November). Production is expected to decline by around 0.75% m/m, after a brief rebound in October (2.4%). Manufacturers are increasingly feeling the effect of the global economic slowdown and the appreciation of the yen. Moreover, in November, some car producers had to stop production because of lack of supplies of parts from Thailand (Publication 28 December). Labour market statistics (November). Despite slowing production, the labour market is expected to have tightened again November. This is in particular related to the withdrawal of the labour force of the post war baby-boomers. The unemployment rate might have edged down to 4.4% from 4.5% in October. Also to jobs-to-applicant ratio is expected to have inched up again (Publication 28 December). Consumer Prices (November, Tokyo: December). Consumer prices are expected to have declined by 0.4% in November after -0.2% in the previous month. Excluding food and energy, the rate of decline could be accelerating by 0.2 percentage point to -1.2%. We expect the economy to remain in deflation at least until 2013 (Publication 28 December).

12

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OECD countries

23 December 2011 11-46

Eurozone
France, households goods spending (November). After stalling in October, real households spending on goods is expected to increase slightly in November (+0.2%, figure to be released on 4 January). This seemingly positive figure masks several negative details, and in our opinion, struggling personal consumption, more shaky than resistant. If our monthly forecast is correct, the year-on-year decline will stand at 1.8%, hit by a very unfavourable basis of comparison (spending had increased by 1.1% m/m in November 2010). The monthly increase should get a lift from the expected technical rebound in vehicles purchases (consistent with the increase in car registrations), food and energy consumption, which declined in October. Other purchases of manufactured goods are likely to contract, undermined by extremely low consumer confidence and by tight budget ahead of the year-end holidays. The holiday season will reveal the state of mind of French consumers: will they disregard the prevailing pessimism and dip into savings, spending without sacrifice, or will they cut back their spending? Granted, in the past, households consumption has proven to be somewhat resistant to shocks, and spending has rarely declined over an entire quarter. Today, however, households are being sorely tested by the very low level of confidence, rising unemployment, fiscal austerity, financial stress and restricted access to credit. France, consumer confidence (December). In November, household confidence eroded sharply with the INSEE composite index shedding 3 points from 82 to 79, the lowest level since early 2009. With the exception of a possible technical rebound after such an abrupt drop, there is little chance that household confidence will pick up in December (figure to be released on Thursday, 5 January). The decline will be limited at most. We are looking for a 1-point decline to 78. This would be consistent with the INSEE business climate surveys and a natural reaction to the bad news on jobs and the unemployment rate in particular. The European sovereign crisis is also an important cause of concerns. Households should be more preoccupied about the general standard of living in France as well as their own individual prospects. We will closely watch the changes in their assessment of the unemployment outlook (a good leading indicator of the number of jobseekers, which points towards an ongoing increase) and the opportunity for making big-ticket purchases (a reliable indicator for estimating the impact of confidence and how people see the future, on consumption: a further decline would be another bad sign).

13

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OECD Team

23 December 2011 11-46

Markets overview
The essentials over the week
Week 19-12 11 > 21-12-11
CAC 40 S&P 500 Volatility (VIX) Euribor 3m (%) Libor $ 3m (%) OAT 10y (%) Bund 10y (%) US Tr. 10y (%) Euro vs dollar Gold (ounce, $) Oil (Brent, $) 2 972 1 220 24.3 1.42 0.56 3.06 1.89 1.86 1.30 1 594 105.0 3 030 1 244 21.4 1.42 0.57 3.13 1.95 1.97 1.30 1 610 108.6 +2.0 +2.0 -2.9 -0.1 +0.8 +6.6 +6.6 +11.2 +0.0 +1.0 +3.4 % % % bp bp bp bp bp % % %

CAC 40
4 200 4 000 3 800 3 600 3 400 3 200 3 000 2 800 2 600 2 400 21 Dec 2009 2010 2011 2012

10 year bond yield, %

4.00 3.75 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50

Euro Dollar
1.55 1.50 1.45 1.40 1.35 1.30 1.95 1.97 1.25 1.20 1.15 1.30

3 030

21 Dec 2009 2010 2011 2012

21 Dec 2009 2010 2011 2012

Bunds

US Treasuries

Money & Bond Markets

Interest Rates
BCE Eonia Euribor 3 month Euribor 12 Month $ Federal Reserve Libor 3 month Libor 12 month Bank of England Libor 3 month Libor 12 month Au 21-12-11 1.00 0.61 1.42 2.00 0.25 0.57 1.12 0.50 1.07 1.86

highest 11
1.50 1.72 1.62 2.20 0.25 0.57 1.12 0.50 1.07 1.86 le le le le le le le le le le 13/07 30/06 26/07 08/07 03/01 21/12 21/12 03/01 21/12 21/12

lowest 11
1.00 0.35 1.00 1.50 0.25 0.25 0.72 0.50 0.76 1.51 le le le le le le le le le le 03/01 07/02 10/01 03/01 03/01 15/06 13/06 03/01 03/01 03/01

2011
+0.9% +1.4% +2.0% +0.3% +0.8% +0.9% +1.6%

2011() Yield (%)

+0.9% +1.4% +2.0% +3.2% +3.7% Euro MTS 5-7y Bund 2 year Bund 10 year OAT 10 year Entreprises BBB $ Treasuries 2y Treasuries 10y Entreprises BBB 3.61 0.19 1.95 3.13 6.22 0.27 1.97 4.35 0.38 2.06

highest 11
4.72 1.91 3.49 3.79 6.72 0.85 3.72 4.76 le le le le le le le le 28/11 04/05 11/04 11/04 29/11 08/02 08/02 08/02

lowest 11
3.16 0.18 1.69 2.51 4.81 0.16 1.72 3.89 le le le le le le le le 18/08 20/12 22/09 09/09 26/05 19/09 22/09 04/08

2011 2011()
+0.3% +0.3% +2.6% +2.6% +12.5% +12.5% +6.1% +6.1% -1.1% -1.1% +1.4% +4.3% +15.9% +19.2% +7.8% +10.8%

+3.7% Treasuries 2y +4.5% Treasuries 10y Capitaliss Au 21-12-11

1.55 le 09/02 3.97 le 09/02

0.32 le 16/12 +2.2% +5.2% 2.05 le 16/12 +17.6% +20.9% Perf. avec coupon rinvesti Greece (3511 pdb) Portugal (1103 pdb) Ireland (651 pdb) Italy (441 pdb) Spain (356 pdb) Belgium (238 pdb) France (117 pdb) Austria (108 pdb) Finland (48 pdb) Netherlands(34 pdb) Germany

Yield curve (%)

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1W 1M 3 6 12 2A 5 7 10 30

Base Rates (%)

2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0.00

2 year bond yield

2.00 1.75 1.50 1.25 1.00
1.00

10y bond yield & spreads

37.07% 12.99% 8.47% 6.37% 5.52% 4.34% 3.13% 3.04% 2.44% 2.30% 1.95%

0.75 0.50 0.25 0.00 0.19 0.27

0.25 21 Dec 2009 2010 2011 2012

21 Dec 2009 2010 2011 2012

21-12-11

21-12-10

BCE

Fed

Bunds

US Treasuries

Forex & commodities

EUR exchange rate versus
US Dollar Pound Sterling Suiss Franc Yen Australian Dollar Chinese Yuan Brazilian Real Russian Rouble Indian Rupee Au 21-12-11 1.30 0.83 1.22 101.74 1.29 8.27 2.42 41.39 68.51

highest 11
1.49 0.90 1.32 122.74 1.43 9.67 2.53 43.68 70.58 le le le le le le le le le 02/05 04/07 11/02 08/04 17/03 02/05 23/09 26/09 22/11

lowest 11
1.29 0.83 1.03 101.16 1.29 8.25 2.18 39.17 58.43 le le le le le le le le le 11/01 -2.7% 11/01 -2.8% 10/08 -2.4% 14/12 -6.5% 21/12 -1.1% 14/12 -6.4% 07/01 +8.9% 08/03 +1.1% 11/01 +14.2% Variations

Spot price in dollars Oil, Brent Gold (ounce) Metals, LMEX Copper (ton) CRB Foods wheat (ton) Corn (ton) Au 21-12-11 108.6 1 610.5 3 262.9 7 440.5 426.2 229.9 238.6

highest 11 126.6 le 28/04 1 898.3 le 05/09 4 478.4 le 14/02 10 179.5 le 14/02 513.6 le 05/04 329.1 le 09/02 307.5 le 10/06

lowest 11 93.8 le 04/01 1 325.9 le 25/01 3 096.8 le 20/10 6 721.5 le 20/10 422.8 le 15/12 212.2 le 30/09 225.0 le 07/01

2011() +20.3% +16.8% -20.4% -20.7% -0.5% -17.6% +5.5%

Variations

14

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OECD Team

23 December 2011 11-46

Markets overview -suiteOil, Brent ( $ )

130 120 110 100 90 80 70 60 50 40 30 21 Dec 2009 2010 2011 2012 109

CRB Foods ( $ )
540 510 480 450 420 390 360 330 300 270 21 Dec 2009 2010 2011 2012

Metals (LMEX, $)
4 800 4 400 4 000 3 600 3 200 2 800 2 400 2 000 1 600 21 Dec 2009 2010 2011 2012

Gold ( $ )
2 000 1 800 1 600 3 263 1 400 1 200 1 000 800 1 610

426

21 Dec 2009 2010 2011 2012

Equity indices
highest 11 World
MSCI World 1 164 1 244 219 3 030 5 792 8 378 5 390 508 726 916 2 191 15 685 56 653 1 383 1 392 le 02/05 1 364 le 29/04 297 4 157 7 528 11 113 6 091 le le le le le 18/02 18/02 02/05 17/02 08/02 1 074 le 04/10 1 099 le 03/10 201 2 782 5 072 7 641 4 944 le le le le le 22/09 22/09 12/09 12/09 04/10 -9.1% -1.1% -20.2% -20.4% -16.2% -15.0% -8.6% -18.9% -19.3% -6.5% +1.7% -20.2% -20.4% -16.2% -15.0% -6.0% -14.8% -13.7%

Performance by sector (DJStoxx Europe)

lowest 11 2011 2011()
Year 2011 to 21-12,
+8.6% +1.7% -2.3% -2.6% -8.8% -10.5% -12.7% -13.4% -15.2% -15.5% -15.8% -17.7% -18.9% -19.8% -22.8% -23.8% -23.9% -31.5% -33.8% Health Food industry Consumption Goods Oil & Gas Telecoms Retail Chemical Media Real Estate Insurance Technology Travel & leisure Industry Utilities Construction Financial services Car Commodities Banks

North America
S&P500

Europe
DJ Euro Stoxx France, CAC 40 Germany, DAX 30 Spain, IBEX 35 UK, Footsie 100

Asia
MSCI, loc. Japan, Topix 663 le 18/02 975 le 21/02 1 206 3 057 20 561 71 633 2 124 le le le le le 02/05 18/04 03/01 12/01 08/04 493 le 25/11 706 le 24/11 831 2 181 15 175 48 668 1 217 le le le le le 04/10 15/12 20/12 08/08 05/10

Emergents
MSCI Emergent ($) China, Shanghai comp. India, BSE 30 Brazil, Bovespa Russia, RTS Au 21-12-11 -20.4% -18.2% -22.0% -16.6% -23.5% -33.0% -18.3% -24.9% -21.9% -22.7% Variations

S&P 500
1 400 1 300 1 200 1 100 1 000 900 800 700 600 21 Dec 2009 2010 2011 2012 1 244

Volatiliy (VIX, S&P 500)

60.00 54.00 48.00 42.00 36.00 30.00 24.00 18.00 12.00 21.43

MSCI World ( $ )
1 400 1 300 1 200 1 100 1 000 900 800 700 600 21 Dec 2009 2010 2011 2012

MSCI Emergent ( $ )
1 300 1 200 1 100 1 000 900 800 700 600 500 400 21 Dec 2009 2010 2011 2012

1 164

916

21 Dec 2009 2010 2011 2012

15

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23 December 2011 11-46

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Economic Research Department

Philippe d'ARVISENET

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