FEBRUARY 4, 2011

GLOBAL CREDIT POLICY

GLOBAL RISK PERSPECTIVES

2010 in Perspective and Global Macro Risk Scenarios 2011-2012: Curbing Contagion
Executive Summary
2 8 10 15

Table of Contents: 2010 IN PERSPECTIVE OUR FORECASTS FOR 2011-2012: CENTRAL SCENARIO STILL SLUGGISH RECOVERY DOWNSIDE RISK SCENARIOS MOODYS RELATED RESEARCH Analyst Contacts:
NEW YORK 1.212.553.1653

Moodys continues to believe that a sluggish recovery remains the most likely global macroeconomic scenario, where the world economy will continue to recover from the 2009 recession only at a moderate pace, eventually returning to trend growth rates but with persistent unemployment and budget deficits. The global economy rebounded in 2010. Despite increased uncertainty during the year, growth in advanced countries remained steady, while many emerging markets grew especially strongly. Nevertheless, many challenges to the recovery remain going into 2011. Ongoing deleveraging efforts, persistent unemployment, and lingering real estate market problems will continue to constrain growth in a number of high-income economies. Moreover, market discipline has forced a shift of policy priorities towards fiscal consolidation which will continue not only this year but also in the coming years. At the same time, the vitality of the rest of the world will limit the risk of a double-dip recession. A sustained rebound will continue in economies that have not suffered banking or credit dislocation. The solid economic pace is expected to continue in emerging markets, although growth in most countries will moderate towards trend growth rates. Downside risks to the outlook have persisted and the macroeconomic outlook remains dependent on the sovereign outlook: Curbing contagion in the Eurozone is a central issue as risks in sovereign bond markets and banking systems have built upon one another via complex financial linkages and deterioration of fragile confidence. Finding the right balance between existing economic and financial support measures and implementing fiscal austerity measures, without damaging the economic recovery, has become even more important. At the same time, the risk of a material increase in interest rates complicating further fiscal adjustment in advanced economies has come closer. Finally, concerns about increased capital inflows, inflation, and asset price appreciation in emerging economies have heightened.

Elena Duggar 1.212.553.1911 Group Credit Officer-Sovereign Risk Elena.Duggar@moodys.com Richard Cantor 1.212.553.3628 Chief Risk Officer Richard.Cantor@moodys.com Bart Oosterveld 1.212.553.7914 Managing Director-Sovereign Risk Group Bart.Oosterveld@moodys.com

In this report, we review key developments that shaped 2010, present our baseline forecasts for 2011-2012, and discuss the downside risks as they have coalesced in the Eurozone.

GLOBAL CREDIT POLICY

2010 in Perspective
Global Recovery After the unprecedented world output contraction of -0.6% in 2009, global growth was approximately 5.0% for 2010. The global economy started to rebound over the last year and 2010s world growth is going to well surpass the weak 2008s performance of 2.8%, as well as the average growth rate of the pre-crisis decade and a half (1993-2007) of 3.8%. The economy has been catching up starting from a very low base, however, and world growth is projected to slow down slightly to around 4.4% in 2011 and to rise only slowly thereafter. As such, global growth will remain well below the 5.2-5.3% growth of the boom years of 2006-2007 for the medium term.

One of the major contributors to the global recession was the collapse in world trade flows. Correspondingly, a resumption of export and import flows has spearheaded the recovery: trade flows rebounded strongly in 2010, expected to have risen about 12%, after the -11% slump in 2009 (Exhibit 1). Inflation, at 3.7% globally in 2010, has risen slightly over the 2.5% level of the previous year, but remains at historically low levels (Exhibit 2). Commodity prices have also rebounded from the 2009 slump. On average, they remain at below pre-crisis levels, as illustrated in Exhibit 2, but have been on a rising trend since 2002.
EXHIBIT 1

World GDP and Trade Volume (% change)

Real world GDP (ppp GDP weighted) Trade volume (goods and services) 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 -12.0

Inflation and Commodity Prices

Crude oil price index (2005=100, left axis) Food and beverage price index (2005=100, left axis) Metals price index (2005=100, left axis) Inflation (global CPI, year avg, GDP weighted, right axis) 200.0 150.0 100.0 50.0 0.0 40.0 30.0 20.0 10.0 0.0

EXHIBIT 2

2000

Source: IMF WEO.

Source: IMF WEO.

But the Recovery Has Been Uneven Across Countries There has been a growing divergence in the recovery among advanced economies and also among emerging market countries. Despite increased uncertainty during the year, growth in advanced countries as a group remained steady; however performance differed greatly within the group. Among advanced economies, Germany, Japan and the US reported stronger growth in 2010, with rates returning to pre-crisis levels (Exhibit 3). The Eurozone (ex-Germany), on the other hand, grew relatively slower, with 2010 growth remaining below pre-crisis levels. Finally, the European periphery countries, save Portugal, continued to experience negative 2010 growth rates (and we expect Portugal to experience a double-dip recession in 2011).

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010e

2004

2008

2006

2002

2010e

1990

1980

1988

1984

1986

1998

1994

1996

1982

1992

GLOBAL CREDIT POLICY

A solid economic growth pace, on the other hand, continued in countries that did not suffer banking or credit dislocation. Many emerging market economies grew especially strongly last year. A number of Asian economies, including China and India, which experienced only a moderate slow-down in growth, have continued to perform strongly. In addition, a number of Latin American economies, like Brazil, have grown at above pre-crisis (and above potential) growth rates in 2010. However, a third group of countries, including for example Russia, South Africa and a number of East European economies, were severely affected by the crisis and have not recovered to pre-crisis growth rates (Exhibit 3). We must point out here that Exhibits 1 and 3 show developments in terms of growth rates the countries that were affected by the global financial crisis suffered large loses in terms of output levels and, for some, it will be years before pre-crisis output levels are regained (see Exhibit 4).
EXHIBIT 3

Real GDP Growth in Selected Countries, 2005-2010 (in %)

Germany Japan Spain 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 2005 2006 2007 2008 2009 2010e United States Euro Area

Brazil India 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 2005 2006 2007

China South Africa

Russia

2008

2009

2010e

Source: IMF WEO.

EXHIBIT 4

Real GDP in Selected Countries, 2005-2010 (index, 2004=100)

Germany Japan Spain 115 United States Euro Area
200 180 Brazil India China South Africa Russia

110
160

105
140

100

120 100

95 2005 2006 2007 2008 2009 2010e

2005

2006

2007

2008

2009

2010e

Source: IMF WEO.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Key Developments that Shaped 2010 Some of the key developments that shaped 2010 from a macroeconomic and financial perspective and that will continue to shape the economic outlook over the medium term include:

economic activity in advanced economies. Nevertheless, withdrawal of crisis-related fiscal measures began to be implemented in some European countries, mainly prompted by market pressures (Greece, Portugal, Spain, Ireland). Fiscal tightening was also initiated in countries where economic activity has been picking up (Korea), or there has been a sharp rebound (Brazil, India), or where sustainability concerns have emerged (Lithuania, Romania, Ukraine). However, a number of large economies continued their fiscal stimulus measures, including the US, Germany, France, Japan, China, and Russia. The crisis-related discretionary fiscal stimulus for the G-20 countries represented 2.1% of GDP in 2010, the same amount as in 2009 (Exhibit 5). The size of advanced countries fiscal stimulus in 2010, also at 2.1% of GDP, compares to 1.9% in 2009. Emerging markets 2.0% of GDP fiscal stimulus in 2010 was below the 2.4% of 2009. In addition, late in the year, the US announced a further two-year stimulus package which is expected to add about half a percentage point to growth over the next two years but at a significant fiscal cost.
EXHIBIT 5

Extensive government fiscal stimulus measures. Fiscal policy on average remained supportive of

Fiscal Stimulus Measures (% of GDP)

2.5 2.0 1.5 1.0 0.5 2009 2010

Central Bank Securities Holdings (% of GDP)

14.0 12.0 10.0 8.0 6.0 4.0 2.0 2008 2009 Q3 2010

EXHIBIT 6

0.0 G-20 Average Advanced economies Emerging economies

0.0 Federal Reserve Bank of England ECB

Source: IMF, Fiscal Monitor, November 2010.

Source: IMF, Fiscal Monitor, November 2010. Note: Exhibit refers to US Federal Reserve Treasury securities, ECB Securities Market Program, and Bank of England Gilt Purchase under Asset Purchase Facility. Agency debt and MBS purchases in the US and purchases under the ECB Covered Bonds Program not included.

Further monetary stimulus in advanced economies. Interest rates remain at historically low levels
in advanced economies. In addition, 2010 saw further expansion of monetary policy stimulus measures by major central banks: o

In May 2010, the ECB announced its Securities Market Program, which included interventions in the Eurozone public and private debt securities markets, in order to address the severe tensions in financial markets. The Bank of Japan continued quantitative easing operations to fight deflation.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

In November 2010, the US Federal Reserve announced a second round of Quantitative Easing (QE2).1 The plan includes the purchase of further US$600bn of longer-term US Treasury securities by the end of Q2 2011. The Bank of England, on the other hand, placed its quantitative easing program on hold in February 2010, holding the stock of asset purchases at 200bn on signs that the economy was emerging from recession.

Overall, central bank net purchases of government securities in 2010 were much lower compared to 2009 in the US and the UK. The ECB only started purchasing Eurozone bonds in May 2010. According to IMF data, as of Q3 2010 central bank holdings of government securities represented only 0.7% of GDP in the Eurozone, compared to 5.4% of GDP in the US and 13.7% of GDP in the UK (Exhibit 6).

Commenced monetary exit in a number of emerging markets. Central banks in a number of emerging markets began to tighten monetary policy in the face of a sharp rebound of economic activity and/or in an effort to fight inflationary pressures. Policy responses have ranged from rate hikes (China, India, Indonesia, Chile), to intervention in foreign exchange markets and accumulation of additional reserves (Brazil, Peru), to imposing taxes on foreign purchases of bonds or equity (Brazil, Thailand, Korea).2
Great Recession, the average public debt level in the G-20 advanced economies in 2010 was 26% higher than in 2007. As Exhibit 7 illustrates, despite a 0.8% of GDP improvement in the average primary balance, the average G-20 advanced economys cyclically-adjusted primary balance actually deteriorated by 0.6% of GDP.

Rising fiscal deficits and sovereign debt burdens in advanced economies. In the aftermath of the

Primary Budget Balances and Debt-to-GDP Levels in the G-20 (%)

Advanced G-20 PB (left axis) Emerging G-20 PB (left axis) Advanced G-20 cyclically-adjusted PB (left axis) Emerging G-20 cyclically-adjusted PB (left axis) Advanced G-20 debt-to-GDP (right axis) Emerging G-20 debt-to-GDP (right axis) 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 2006 2007 2008 2009 2010e 110.0 90.0 70.0 50.0 30.0

EXHIBIT 7

Net Cost of Financial Sector Support (% of GDP)

Pledged direct suport Recovery 12.0 10.0 8.0 6.0 4.0 2.0 0.0 UK US Germany Utilized direct support Net direct cost

EXHIBIT 8

Source: IMF, Fiscal Monitor, November 2010.

Source: IMF, Fiscal Monitor, November 2010. Note: Direct support includes capital injections and purchases of assets.

1 2

The first round of quantitative easing (QE1) in the US was initiated in October 2008, after the collapse of Lehman Brothers. For more details, please see Moodys Special Comment Currency Appreciation Pressures Create Challenges for EM Sovereign Credits, October 2010.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Fiscal stimulus programs and financial sector support measures accounted for only a fraction of the deterioration in public finances during the crisis the majority of the deterioration was due to the fall in economic activity and the resulting decline in tax revenues and increases in social safety net spending (automatic stabilizers). As Exhibit 8 shows, the net cost of financial sector support measures in the three countries that accounted for of the worldwide financial sector support was 4-6% of GDP as of end-June 2010. Most direct financial support measures remain in place, but the provision of additional support has generally been limited, with the exception of Ireland. Nevertheless, possible contingent liabilities arising from banking system losses remain in several European economies.

Brothers collapse, and 2009 became the year of the Great Recession, 2010 is likely to be remembered as the year of the European sovereign debt crisis. Concerns about rising government deficits and debt levels in advanced economies in general, and the revelation of much worse than previously reported financial balances in Greece in particular, combined with market uneasiness about the health of the financial sector and triggered a crisis of confidence and widening of bond yield spreads on European periphery countries. Initially the crisis centered on Greece, but subsequently contagion spread to the other periphery countries. As Moodys macroeconomic and sovereign outlooks anticipated in 2009,3 the combination of lower levels of economic activity and diminished potential growth in a number of countries, along with the interdependence of the sovereign and financial sectors, had an important impact on credit. The crisis of government finances is the last phase of the global crisis, after the financial and subsequent economic crises, and we continue to believe that the macroeconomic outlook is closely intertwined with the sovereign risk outlook.

Heightened financial markets turbulence. Just like 2008 became the year of the Lehman

the creation of European support facilities for troubled countries. The 110bn rescue package for Greece was announced in May 2010. A week later, the 440bn European Financial Stability Facility (EFSF) was created. An 85bn support package for Ireland and, indirectly, its banks was announced in November. Further discussions on a permanent European support mechanism have continued; however, to date market confidence remains challenged.4

The creation of European support funds. Another unprecedented development during 2010 was

Further bank stress tests and the introduction of new bank regulations in Basel III. In an effort to reassure markets in the aftermath of the global banking crisis, EU-wide bank stress tests were conducted in July 2010 (following a similar test conducted in the US in May 2009). Further, in September 2010, the Basel Accord introduced new bank regulations, which include stricter capital requirements, the introduction of a leverage ratio and liquidity ratios, a framework for countercyclical capital buffers, and measures to limit counterparty credit risk. The regulations are to be phased in gradually by 2019, in order to allow banks time to adjust. Finally, at the end of 2010, the EU announced plans to perform another round of bank stress tests, following renewed concerns about the solvency of European banks.

Please refer to Moodys Global Financial Risk Perspectives report On the Hook Update on Moodys Global Macroeconomic Risk Scenarios 2009-2010, May 2009 and Moodys Special Comment Sovereign Risk: Review 2009 & Outlook 2010, Fasten Your Seat Belts: Tumultuous Times Ahead, December 2009. For more details, please see the following Moodys Special Comments: EMU Act II: EU Support Package Alleviates Liquidity Concerns, May 2010; Key Elements of EFSF's (P)Aaa Rating, September 2010; Ireland's EU/IMF Bailout Is Major Step Addressing Crisis, But Greater Weaknesses Are Exposed, November 2010; Late Sunday Agreement Confirms EU Support of Ireland and Ireland Support of Banks, November 2010; Sovereign Credit Risk in Eurozone Countries Under Stress, December 2010.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Continued deleveraging. The deleveraging process continued to weigh in on short-term growth prospects. In the US, there is evidence that household sector deleveraging has progressed. The latest Federal Reserve report on household debt burdens shows that US consumers have been borrowing less and actively reducing their debt over the past two years. Further, the household debt service ratio (the ratio of mortgage and consumer debt payments to disposable personal income), supported by low interest rates, has fallen to pre-2000 levels. As Exhibit 9 shows, the debt service ratio fell sharply from its 14% peak in 2008 to less than 12% in September 2010. In addition, consumer spending has started to move up in the US.
As a number of European countries, including Ireland and the UK, have levels of household indebtedness higher than those in the US, the process of deleveraging is equally important in shaping their recoveries. According to the latest OECD data, household balance sheet adjustment is well underway as saving rates have risen in all major OECD economies. Deleveraging in the banking sector continues to constrain credit growth. Bank lending surveys for the third quarter are showing slight relaxation of lending standards in the US, but a small net tightening in the Eurozone. Putting things into perspective, lending conditions have eased significantly compared to 2009. Further, declining benchmark long-term interest rates have helped ease bank lending rates for mortgages and consumer credit. Bank loan volumes, however, remain depressed. Signs of a small pick-up in lending volumes to the private sector have emerged in the Eurozone (primarily driven by loans for house purchases), but not yet in the US. Loans to non-financial corporations remain at negative growth rates in the US, the Eurozone, and Japan.

Overall, 2010 has seen an unprecedented amount of policy intervention around the world. Going forward, government policy will remain key to the medium term outlook and the economic outlook remains intertwined with the sovereign outlook.
EXHIBIT 9

US Households Debt Service Ratio, 1980-Q3 2010 (%)

14.0 13.5 13.0 12.5 12.0 11.5 11.0 10.5 10.0 15.0 14.0 18.0 17.0 16.0 Household debt service ratio (right axis) Household financial obligations ratio (left axis) 20.0 19.0

Source: The Federal Reserve Board.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Our Forecasts for 2011-2012: Central Scenario Still Sluggish Recovery

Our central macroeconomic and financial scenario remains that of a sluggish rebound in advanced economies, which continue to face the headwinds of deleveraging and the hypersensitivity of financial markets to real or perceived policy mistakes, with policy priorities shifting towards fiscal consolidation. In contrast, we expect a continuation of the solid economic pace in emerging market economies.5 Growth in advanced economies will be subdued as they continue to face high unemployment rates, the need to repair household, bank and sovereign balance sheets, weaknesses in real estate markets in a number of countries, and market pressure towards fiscal consolidation. The intensity of the recovery will continue to vary from region to region, with large emerging market economies leading the way. Growth in a number of emerging markets is expected to remain strong but to moderate slightly moving towards potential growth going forward. The diagram in Exhibit 10 illustrates how we see the balance of risks evolving for 2011 and how decoupled we expect regional prospects to be.
EXHIBIT 10

Global Economic and Credit Conditions

We expect further decoupling of monetary conditions in advanced and emerging economies. In advanced economies, we continue to see deflation and inflation risk as being successive rather than mutually exclusive threats. In emerging markets, inflation has emerged as a more prominent risk. Further, we expect financial conditions to continue to ease across most of the world, but to remain challenging in the Eurozone where substantial market uncertainties persist. There have been a number of positive developments over the last year. Overall, asset prices and bank regulatory capital ratios have improved, global writedowns and loan provisions have declined, and corporate bond markets have

This is a continuation of the sluggish hooked-shaped recovery central scenario which Moodys introduced in May 2009 in the Moodys Global Financial Risk Perspectives report On the Hook Update on Moodys Global Macroeconomic Risk Scenarios 2009-2010.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

remained resilient: global bond issuance by non-financial corporates remains below the 2009 record level but above long-term averages, especially in the Eurozone. However, confidence in the financial sector has not been fully restored. Equity markets have experienced significant volatility in recent months. There has been less progress in dealing with bank funding pressures and the wave of bank debt that needs to be rolled over in the next two years.6 There is also uncertainty about the impact of new regulatory requirements on banks balance sheets and consequently on lending and economic growth. The turmoil in sovereign debt markets in the Eurozone highlighted the increased vulnerabilities of bank and sovereign balance sheets coming out of the crisis, as well as the interlinkages between the two sectors. Budget deficits will decline only slowly over the medium-term and government debt-to-GDP ratios in a number of countries will take several years to stabilize. Moreover, sovereign balance sheets remain highly vulnerable to growth shocks, further raising concerns about the ability of governments to deliver their fiscal consolidation plans in full. The financial systems exposure to sovereigns is creating an additional source of uncertainty in both sectors. The stress test of the EU banking sector and the announcements of the EU support packages helped alleviate immediate market concerns, but have not succeeded in fully restoring confidence, and the interdependence between Eurozone governments and banks has the potential to trigger a vicious circle. Low money market rates and government bond yields provide support to financial conditions at present, except in the Eurozone periphery where spreads have widened significantly. Interest rates and government funding costs are likely to rise more generally going forward, however, and the horizon has likely shortened as the global economy is recovering. Overall, emerging market economies have proven resilient to sovereign and banking strains in advanced economies, and most have continued to enjoy ample access to international capital markets. Many Central and East European and CIS countries, however, continued to see cross-border bank outflows as Western European banks decreased their exposures to the region. We present our central scenario in Exhibit 11 as follows: We provide a range (of 1%) to avoid spurious precision in such agitated times. Note that our rating decisions across asset classes are influenced by meaningful economic shifts rather than decimal changes. Our central assumptions are based on a sample of forecasts, including of course Moodys own economic forecasts. We indicate whether the bias [1] is positive or negative, i.e. whether we are more likely to be positively or negatively surprised. Lastly, we indicate the level of uncertainty surrounding the central forecast. We present the range of forecasts that we survey and compare them to the historical standard deviation of the countries real growth.

See Moodys Global Banking Special Comment Banks Wholesale Debt Maturity Profiles Shorten, Exposing Many Banks to Refinancing Risks, November 2009.

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

EXHIBIT 11

Forecasts for 2011-2012

Countries
Growth central range

2011
Bias [1] Unemplo yment central range Growth central range

2012

Forecast uncertainty measures

Argentina Australia Brazil Canada China Eurozone France Germany India Indonesia Italy Japan Mexico Russia South Africa South Korea Turkey UK USA

Bias [1] Unemplo 2011 2012 GDP yment growth growth volatility central forecast forecast [3] range range range [2] [2]

4.0/5.0 3.0/4.0 4.5/5.5 2.5/3.5 8.5/9.5 1.0/2.0 1.0/2.0 2.0/3.0 8.0/9.0 5.5/6.5 0.5/1.5 1.0/2.0 3.5/4.5 4.0/5.0 3.0/4.0 4.0/5.0 4.0/5.0 1.5/2.5 2.5/3.5

positive neutral positive neutral neutral neutral neutral neutral neutral neutral neutral neutral neutral neutral neutral positive neutral

-4.5/5.5 -7.0/8.0 --6.5/7.5 --8.0/9.0 4.5/5.5 -----7.5/8.5

3.5/4.5 3.0/4.0 4.5/5.5 2.5/3.5 8.0/9.0 1.0/2.0 1.5/2.5 8.0/9.0 6.0/7.0 1.0/2.0 3.0/4.0 4.0/5.0 3.5/4.5 4.0/5.0 4.0/5.0 1.5/2.5

neutral neutral neutral neutral positive neutral neutral neutral neutral neutral neutral neutral neutral neutral neutral positive neutral neutral

-4.0/5.0 -6.5/7.5 --8.5/9.5 6.5/7.5 --8.0/9.0 -----7.0/8.0 8.5/9.5

2.1 0.4 1.1 0.6 1.3 1.5 0.7 1.4 0.6 1.0 0.9 1.0 0.8 1.1 0.6 0.5 1.9 0.8 0.8

1.4 0.9 1.6 0.8 1.3 0.4 0.7 0.4 1.2 0.8 0.6 0.9 1.1 0.9 0.4 0.6 1.7 0.7 1.9

6.5 0.9 2.1 1.9 1.6 1.3 1.4 1.9 1.8 4.9 2.0 2.0 3.9 6.8 1.9 4.3 5.4 2.1 1.8

neutral 9.0/10.0 1.5/2.5

1.5/2.5 negative 4.0/5.0

neutral 9.0/10.0 2.5/3.5

Notes: [1] Positive bias denotes higher risks to the upside, i.e. growth could be higher than the central range. [2] The difference between the highest and lowest forecasts of sources such as the IMF, WB, OECD, Eurostat, JPMorgan, Barclays and Moodys. [3] The standard deviation of real GDP growth over the past 15 years including 2009. [4] Green denotes improvement from last update, orange denotes deterioration.

Downside Risk Scenarios

The key downside risks globally remain as follows: The risk of a material increase in real interest rates complicating further fiscal adjustment in advanced economies. Limited credit availability for productive investment due to banking systems deleveraging, vulnerability to deterioration in governments perceived creditworthiness and regulation-induced rebuilding of capital buffers. Concerns about the ability of emerging market economies to manage overheating economies and resulting increased capital inflows and currency and asset price appreciation.

10

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Downside Risks Have Especially Coalesced in the Eurozone The Eurozone is where many of the downside risks have coalesced. Moreover, the Eurozone as a whole represents the second largest economy in the world and a macroeconomic or financial downturn in the Eurozone will have global repercussions as shocks transmit through both trade and financial channels. Therefore, we focus here on the Eurozones challenges.

The stress scenarios below are selected not so much because of their likelihood they are respectively unlikely and very unlikely but because of their potential impact. Central scenario: Continued sluggish recovery. The recovery in Europe has so far been characterized by growth at below-trend rates, which is slow relative to the usual pace of expansion following a recession. Indeed, for 2011 and 2012, we expect the Eurozones real growth to be moderate, about 1.5% and 1.6% respectively. This masks discrepancies between Germany, which is experiencing quite a sharp recovery, and slower growth in other Eurozone economies including those that have needed to retrench fiscally. In our baseline scenario, we expect that the policy response at both the European and national levels will ultimately succeed to improve market confidence. Governments will make the required fiscal adjustment and public finances will, over time, be repaired in an orderly fashion. The banking system will become more strongly capitalized and indeed stronger overall, with its weakest parts restructured. The adjustment process is likely to be rocky and painful as market pressure will speed up the fiscal adjustment, but the Eurozone will eventually muddle through. This scenario is predicated on several important developments: i) decisive actions taken by the EU, including additional and more flexible financial backstop mechanisms if needed, and by the ECB and national central banks in the non-Eurozone EU to support financial stability; ii) fiscal consolidation efforts by member states; and iii) increased transparency concerning financial institutions asset exposures and speedy recapitalization of weak but viable institutions where required. Risk Scenario 1: Double-dip recession. In this stress scenario, fiscal tightening fails to restore confidence sufficiently to spur a robust expansion of private sector investment and consumption. The negative impact of fiscal tightening could also be exacerbated by continued uncertainties about the health of the banking system (perhaps due to a less-than-convincing banking sector strategy) and weaker growth among Europes main trading partners, particularly the US. In this scenario, the risk of a sharp slowdown in growth would be significant (0.5% growth in 2011) and an outright double-dip recession would be a distinct possibility. Also, in this scenario governments would have to compensate for the provision of budgetary support to banks with even tougher fiscal measures, and more private sector debt restructuring would likely be necessary. Deflationary forces would prevail, at least for several more quarters, thus further complicating fiscal consolidation plans and increasing real debt burdens. This is an unstable equilibrium. Risk Scenario 2: Severe dislocation. In this severe stress scenario, persistently negative economic developments, such as weak economic growth and stubbornly high unemployment, combined with an unconvincing policy response to the worsening public debt situation and banks vulnerabilities, spiral out of control to threaten the

11

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Eurozone. This severe, quasi-existential crisis for the 50-year-old European project could lead to one of two radical and very different outcomes: 2A: Further European integration (e.g. a Euro debt agency, some sort of EU federal budget institution that controls and transfers funds between states, etc.). Such developments would be in line with past instances when senior leaders have used crises to drive EU integration. Assuming a smooth execution, major policy developments on this scale would be likely to restore confidence over time and ultimately lead to a benign outcome (back to the central scenario). 2B: Abrupt dislocation, such as government defaults or a break-up of the Eurozone.

The second, extreme risk scenario is therefore bifurcated, characterized more by an intense uncertainty rather than by a clear directional outcome. Where Does the Risk of a Sovereign Default Fit Within the Macroeconomic Risk Scenarios? As the economic data flow has turned more positive, policy issues have become the dominant theme. Concerns have shifted from the ability of the private sector to rebound (as manufacturing activity and consumer confidence indicators have improved more steadily recently) to the ability of the public sector to contain the recent expansion of public balance sheets and to mitigate the crystallization of banking sector contingent liabilities. A debate about the risk of a default by one or more stressed sovereigns continues, in spite of the European rescues of Greece and Ireland last year. In the current environment of fragile market confidence, strong interconnections between the sovereign and banking sectors and lingering concerns about the strength of the banking system after the global financial crisis, a sovereign default in the Eurozone would likely trigger an adverse scenario, with contagion for Eurozone financial institutions and possibly other sovereigns.7 Hence, we expect the European authorities as well as national governments to respond with sufficient policy measures to prevent such a development. This scenario is, therefore, very unlikely. Going forward, however, one could argue that a strengthening of the financial system and improvement in market confidence could limit contagion effects from a sovereign default. The likelihood that such a scenario of an orderly sovereign restructuring would result in minimal contagion depends more on country-specific developments, including the political will for prolonged fiscal adjustment and the speed of the economic recovery. At present, we believe that such a scenario of an orderly default is also unlikely, although the risks differ by country as reflected in Moodys sovereign ratings. 8 Finally, debt restructuring for a country is not synonymous with leaving the Eurozone. In fact, we believe that the exit of one or more of the Eurozones members is an even more remote possibility than a sovereign debt restructuring. In conclusion, whether Eurozone risk scenarios materialize will ultimately depend on: (i) the credibility of the governments medium-term fiscal consolidation plans and growth-focused economic
7

A hypothetical scenario of disorderly sovereign restructuring, which imposes drastic loses on the financial system and triggers a strong rise in risk aversion, could include sharp rises in funding rates for both the sovereign and banking sectors, a freeze in short-term money markets, severe dislocation, and in turn a negative impact on growth in the Eurozone and globally. In Moodys view, such a scenario is very unlikely. For more details, please refer to Moodys Special Comment Sovereign Credit Risk in Eurozone Countries Under Stress, December 2010.

12

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

strategies; (ii) the ECBs willingness to continue to provide financial support to governments and banks; and (iii) the ability of governments to limit taking on its balance sheet private debts.
Downside Risks in Other Regions While we believe that a slow-down in economic growth in the Eurozone represents probably the main downside risk to the global outlook currently, risks emanate from other regions as well.

The monetary and fiscal stimulus measures announced in the US towards the end of 2010 have improved the outlook for the US economy over the next two years. In particular, the recent package of tax and benefit measures is estimated to raise economic growth by about half a percentage point over the next two years. The recovery in the US is still fragile, however, as the unemployment level remains elevated, household and financial deleveraging continues, and as real estate market weaknesses persist going forward. Risks to the outlook include a further substantial fall in house prices or a sharp rise in mortgage defaults and foreclosures, which could impose further losses on the financial sector. In addition, a rise in interest rates could complicate household deleveraging efforts. Moreover, although the announced stimulus measures are beneficial to economic growth in the shortterm, they put additional burden on public finances. Official projections for the federal budget deficit indicate a continuation of the primary deficit over the next decade. In addition, recent political developments have thrown into question the likelihood of action that would address the federal deficit and debt trajectory, at least in the coming two years.9 The willingness of investors to finance the deficits appears to have continued, although very recently Treasury bond yields have risen from their lows. It is unclear whether this has been due to an increased perception of risk or, more likely, the upward revisions in the growth outlook resulting from the tax package. In addition, US municipal spreads widening in the last months of 2010 have highlighted investor concerns with state and local government finances in the context of diminishing federal aid to local governments and the expiration of the Build America Bonds Program. The risk of a material increase in interest rates complicating further fiscal adjustment in government finances, therefore, is relevant to the US as well as to the Eurozone. A number of risks have also become more prominent in some emerging market economies which grew strongly in 2010. In particular, concerns about increased capital inflows, inflation and asset price appreciation have heightened. The growth differential between advanced countries and emerging markets and the maintenance of expansionary monetary policies in high income economies have led to excessive capital flows into emerging markets. While these inflows have provided support to economic growth, they have also caused currency and asset price appreciations. Surging capital inflows carry intrinsic risks as they can overshoot and lead to the formation of asset price bubbles. Also, high portfolio investment flows, which finance growing current account deficits, could make countries complacent about addressing external vulnerabilities exposing them to capital reversals if global or local fundamentals change.10 Further risks to emerging markets include unexpected shocks to currently rising commodity prices, which have contributed to the strong pace of economic growth. A sharp slow-down of the growth dynamic in China, for example, can represent such a shock as Chinas strong growth and subsequent strong demand have contributed to the rise in commodity prices. As China has spearheaded the global
9

10

While the National Commission on Fiscal Responsibility and Reform came up with a list of possible measures to address the long-term budget deficit, these measures will not be addressed as a package. It is unclear whether some of the individual measures will be eventually considered by the Congress and passed into law. For further analysis, see Moodys Special Comment Evolution of Moodys Perspective on the US Aaa Rating, January 2010. See Moodys Special Comment Currency Appreciation Pressures Create Challenges for EM Sovereign Credits, October 2010.

13

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

recovery, an unexpected fall in its growth dynamic could affect adversely not only intra-regional trade in Asia, but other regions as well e.g. Latin American exports to China have grown significantly in recent years impacting the global economy (this risk scenario was discussed in more detail in our Global Financial Risk Perspectives report of January 2010 11). Thus, the ability of China to maintain relatively strong sustained growth will be a key factor for the global economic outlook.

11

Moodys Global Financial Risk Perspectives, Global Macro-Risk scenarios 2010-2011: On the Hook for Some Time Yet, January 2010.

14

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Moodys Related Research

Global Financial Risk Perspectives:

Global Macro-Risk Scenarios 2010-2011: Diminished Expectations, July 2010 (126284) Global Macro-Risk Scenarios 2010-2011: On the Hook for Some Time Yet, January 2010 (122431) On the Hook, Update on Moody's Global Macroeconomic Risk Scenarios 2009-2010, May 2009 (117203) Global Macro-Risk Scenarios 2009-2010 - From Global Integration to Global Dis-integration?, December 2008 (113063) Navigating the Fog: Update on Moodys Macro Stress Scenarios for 2008-09, July 2008 (109919) Mapping the Near Future: Macro Stress Scenarios for 2008-2009, January 2008 (107173) The Archaeology of the Crisis, January 2008 (106824) Stress-Testing the Modern Financial System, September 2007 (104759) The Asian Crisis Ten Years Later: What We Know, What We Think We Know and What We Do Not Know, May 2007 (103254) Global Imbalances: A Positive-Sum Game from a Global Credit Perspective, April 2007 (102686) The European Union at 50: Are Its Best Years Behind It?, March 2007 (102530) Asia-Pacific Sovereign Outlook 2011, January 2011 (130923) Latin America and Caribbean Sovereign Outlook, January 2011 (130753) European Sovereign Outlook, August 2010 (127080) Middle East Sovereign Outlook: 2010 Mid-Year Update, August 2010 (126469) Sovereign Risk: Review 2009 & Outlook 2010 Fasten Your Seatbelts: Tumultuous Times Ahead, December 2009 (121695)

Sovereign Outlook Reports:

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

15

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION

GLOBAL CREDIT POLICY

Report Number: 130911

Author Elena Duggar

Production Associate Amanda Ealla

2011 Moodys Investors Service, Inc. and/or its licensors and affiliates (collectively, MOODYS). All rights reserved. CREDIT RATINGS ARE MOODY'S INVESTORS SERVICE, INC.'S (MIS) CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MIS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. CREDIT RATINGS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MIS ISSUES ITS CREDIT RATINGS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODYS PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODYS from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODYS is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODYS have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODYS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODYS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODYS IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moodys Corporation (MCO), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MISs ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. Any publication into Australia of this document is by MOODYS affiliate, Moodys Investors Service Pty Limited ABN 61 003 399 657, which holds Australian Financial Services License no. 336969. This document is intended to be provided only to wholesale clients within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODYS that you are, or are accessing the document as a representative of, a wholesale client and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to retail clients within the meaning of section 761G of the Corporations Act 2001. Notwithstanding the foregoing, credit ratings assigned on and after October 1, 2010 by Moodys Japan K.K. (MJKK) are MJKKs current opinions of the relative future credit risk of entities, credit commitments, or debt or debt-like securities. In such a case, MIS in the foregoing statements shall be deemed to be replaced with MJKK. MJKK is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly owned by Moodys Overseas Holdings Inc., a wholly-owned subsidiary of MCO. This credit rating is an opinion as to the creditworthiness or a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be dangerous for retail investors to make any investment decision based on this credit rating. If in doubt you should contact your financial or other professional adviser.

16

FEBRUARY 4, 2011

GLOBAL RISK PERSPECTIVES: 2010 IN PERSPECTIVE AND GLOBAL MACRO RISK SCENARIOS 2011-2012: CURBING CONTAGION