Everyone knows who are the sick men of Europe, right? Just look at the CDS markets to see which countries have the riskiest debt profiles: Greece wins hands down followed by Ireland some way behind.
But CDS traders might be systematically underestimating the riskiness of some of the traditionally more fiscally heavy-weight nations, especially dear ‘Old Blighty’, according to a fascinating presentation given by the head of research at Natixis, Patrick Artus, at a conference in Paris yesterday.
Mr Artus looks at what he calls a measure of “fiscal solvency”, which combines public debt as a percentage of GDP with nominal long-run growth forecasts. The result is a number that he says shows the maximum fiscal deficit as a percentage of GDP a country can afford to run while ensuring its long-term solvency.
For the UK, the answer is bad. The projected fiscal deficits of 12.88 per cent of GDP last year and 13.16 per cent of GDP this year are way above Mr Artus’s fiscal solvency number of 3.34 per cent.
But the picture is only fully revealed when comparing the excess fiscal deficits countries are running over their fiscal solvency number with the CDS price traders are putting on their debt. By this measure, the UK is in the worst position of any of the countries considered, while the Greeks’ position is not much different to the US. The CDS markets of course tell a totally different story.
The positions of Turkey and Hungary are also interesting, with both seemingly having room to borrow money if needed – in Turkey’s case, much more. In fact, Mr Artus reckons that CDS markets are systematically over-estimating the riskiness of emerging market sovereigns and under-estimating developed nations.
Much of this might be down to a better track record with debt and fiscal management – which put another way is investors taking the past as a reasonable guide to future performance…
But there are other classic reasons we could call upon: for example, Greece and Ireland as eurozone members are less the masters of their own destinies than the UK, with its only quasi-independent central bank and nationally determined monetary policy.
Mr Artus reckons, however, there is one over-riding explanation which applies equally to Spain and the UK. These countries are having their public debt burden funded by their own banks – the question for governments, he says, is how far can they push deficits while keeping domestic banks happy to lend them the cash.
The full presentation can be found here.
It is also available in the Long Room on the Strategists’ table here.
Related links:
Consulting the Greek CDS oracle – FT Alphaville
Dεfαult risk – FT Alphaville