Credit Suisse - Comments on Italy

! There are three big advantages Italy has over the rest of peripheral Europe:
! (1) Italy has net foreign debt of only 21% of GDP (compared to 80% to 110% of GDP elsewhere in periphery). What does
this mean? It means that even if Italy left the Euro it would not need to default. As net foreign debt would rise but still rise to
levels that are relatively low.
! (2) Italy has a low loan-to-deposit ratio of 120% (ex retail bonds) and in particular only Eu41bn of funding from the ECB
(which amounts to 2.5% of GDP compared to 45% of GDP in Greece). Again this means that if Italy left the Euro, there
does not need to be as big a contraction in assets of banks as elsewhere in the periphery.
! (3) Most importantly, on IMF data, Italy is running a primary budget surplus of 0.2% of GDP and the IMF claim on a
cyclically-adjusted basis this would be 1.7% of GDP. Elsewhere in periphery there are big primary budget deficits.
! The other positives:
! (a) Italy had no housing or credit bubble (CAGR of private sector credit growth in the last decade is nearly half that of
Spain). Total leverage (private and government) is third lowest in Europe.
! (b) Italy's current account deficit is relatively small at 2.7% of GDP.
! (c) Average maturity of debt is one of the longest in Europe (7 years) and 50% of government debt is held domestically (one
of the higher numbers in Europe). Recall 50% of US debt is held by foreigners. On BIS data, core Europe has $211bn of
banking assets in Italy (compared to $717bn in the rest of the periphery and $372bn in Spain)- so surprisingly core Europe
is 57% less exposed via banks to Italy as Spain.
! We believe that the reasons investors have targeted Italy are: (a) last week's fiscal proposals were a bit disappointing
(Eu40bn of tightening but mostly post March 2013 elections); (b) the issue of Fininvest trying to limit paying its fine limits
credibility of the government; (c) if investors are looking to hedge against the Euro sustainability, then CDS are no longer
seen as worthwhile (there could be a non-CDS triggering default) and thus they short Italian bond spreads.
! Basically we believe that Italy is being used as a liquid proxy on a Euro break-up view. We would rather recommend (and
our fixed income team agrees) long Swedish bonds against French bonds (Sweden is not part of the Euro, government
debt c50% of GDP, a nearly balanced budget, current account surplus of 6% of GDP, net foreign debt of only 15% of GDP,
cheapish currency on PPP while France pays the bill for peripheral Europe and has a much worse budget and government
debt-to-GDP ratio) as a macro trade were the Euro to break up. We continue to believe that the end game is:
! (1) Some form of soft QE for the ECB (as if the euro were to break apart the ECB would have to probably print money to
recapitalise itself given that the ECB repos E300bn of peripheral European debt and owns close to another E75bn). If the
ECB is going to have to print if the Euro breaks apart, surely it will be inclined to do so to protect the Euro.
! (2) Some form of Brady plan. Could the ESFS be expanded to buy secondary market debt at close to market prices and
then issue a new AAA rated bond for the debt of the country concerned? Could the IMF/US be involved in this?
! (3) More deflation in peripheral Europe (to restore competitiveness).
! (4) Ultimately a weaker Euro as market senses point 1
! (5) More fiscal integration of Europe.
! We continue to believe that core Europe will end up bailing out peripheral Europe as the cost of not doing so is at least
double the cost of doing so (we estimate the direct cost is €€ 0.5trn compared to the cost of a bail out of €€ 0.23trn), the indirect
cost is a lot more (huge potential Deutsche Mark appreciation, trade-war, 20% plus fall in Greek and Portuguese GDP as
ECB no longer funds their deposit shortfall). We also believe that Spain, like Italy, does not need a default and recall
aggregate European government debtto-GDP is 83% cf to c100% in the US (where there is no plan to reduce the deficit as
yet).We believe that an actual default in periphery will be delayed until the ESM / ESFS is ratified (or a Brady bond plan as
above is in place) and the stress test of the banks is complete.
! How long it will take the troika to come up with all appropriate policies is open to debate but clearly the idea of coming back
with a Greece plan 'late summer' does not seem realistic. Clearly a move has to be made soon, if not very soon.