All you ever wanted to know

about European austerity plans…

(…but were afraid to ask)

October 2010

Daniel Fermon Phone: +33 (1) 42 13 58 81

Written by a non-U.S. research analyst not registered/qualified under FINRA rules

THIS RESEARCH REPORT IS THE PRODUCT OF SOCIETE GENERALE (AUTHORIZED IN FRANCE
BY THE AMF).
PLEASE SEE IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION IN APPENDIX
 1

Austerity Plans - Kill or Cure?

Public debt/GDP – 1900/2015e

300% 300%
Public finances
impacted by WW2
250% 250%
Start of Japan’s
lost decade
200% 200%

150% 150%

100% 100%

50% 50%

0% 0%
1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010e 2015e

US UK Japan

Source: SG Cross Asset Research, IMF

Question 1
Why is it necessary for European
countries to deliver austerity plans?

“In the middle of every difficulty lies opportunity”.

Albert Einstein
 3

European government debt is held by non residents (%)

90

80

70

60

50

40

30

20

10

0
Japan UK Spain US Germany Italy Ireland France Greece Portugal

Source: OECD, IMF, SG Cross Asset Research

 4

Fears of higher cost of debt fully justified

Senior 5-year CDS (bp) and austerity plan annoucements: a limited impact

Doubts on future of
eurozone after S&P
downgraded Greek
debt to junk

Source: SG Cross Asset Research, Datastream

 5

Debt remain a major threat for developed economies

Question 1
Why is it necessary for European
countries to deliver austerity plans?

Answer 1
Because, if governments do not
rapidly address their debt
problems, the cost of debt could
explode, as in Greece. Thus, fears
of escalating interest rates and the
resulting dire consequences for
their economies are seen to justify
the need for austerity measures.
Question 2
What do we really know about the
different austerity measures?
“Waiting is painful. Forgetting is painful. But not
knowing which to do is the worst kind of suffering”
Paulo Coelho.
 7

Recap of austerity measures

Overview of European austerity measures
y
Country Debt to Budget Austerity plan details
GDP Balance
2011e 2011e Size Size, % Years Spending cuts Pension reform Tax increases
€bn of GDP
Greece 129.4 -7.0 35 17 3 State salary freeze until 2014 Pensions freeze until 2012 VAT raised from 21 to 23%
Holiday bonuses partly abolished Retirement age extended to 65 One-off tax on companies

Italy 119.2 -3.9 24 2 3 State salary freeze for 3 years Retirement pushed back by 3 to 6 New taxes on stock options and bonuses
€13bn of spending cuts 2011-12 months Possible expansion of toll roads
Belgium 97.9 -4.0 22 15 5 Elections and regional divisions are delaying a clear deficit reduction strategy

Portugal 86.1 -4.6 11 7 4 5% pay cuts for public sector - VAT increased from 20% to 21% and
Sell €6bn of state assets (e) then to 23%
Crisis tax created
France 87.7 -6.0 45 3 3 3-year freeze on public spending Retirement age raised from 60 to Top rate income tax to 41%
State subsidies cut by 10% 62 by 2018 Taxes raised on capital gains + life insur.
Ireland 92.8 -11.1 4 2 2 3 austerity budgets over a year. - VAT up from 21% to 21.5% 2008
Public sector salaries cut by up to +2% on top income tax rate
15%

Germany 69.3 -3.8 80 4 4 Welfare spending cut by €30bn - Taxes on nuclear power plants
Cut in public sector payrolls Financial transaction tax

UK 73.4 -7.5 110 9 5 25% cut in government spending Retirement age raised from 65 to VAT up from 17.5 to 20%
66 Total of £40bn in tax increases
Spain 68.7 -6.5 15* 1 2 Civil service payrolls cut 5% in Pensions freeze VAT up from 16% to 18%, and 8% from
2010 7%
€6bn cut in public sector
investment
Source: SG Cross Asset Research
*Agreed €15bn cost-saving plan in May on top of an €50bn package in January. So €65bn overall
 8

Fears of 1937 rerun in the US at the end of economic stimulus

End of economic stimulus: consequences on equity markets

400

350

300
End of
economic
250
stimulus

200

150

100

50
Dow Jones Industrial
Average
0
1928

1929

1930

1931

1932

1933

1934

1935

1936

1937

1938

1939

1940

1941

1942
Source: SG Cross Asset Research, Datastream
 9

End of Bush tax cuts for the US in 2011

Many European countries on the road to austerity

End of Bush Tax cuts in

January 2011 ?

Size of austerity
measures in % of
USA 2009 country GDP

Distribution still unknown

Greece 17%
UK 9% Tax Increase
European Union = Portugal 7%
Public lay -of f s
21% of global Germany 4%
Rest of the world GDP France 3%
Ireland 2%
Italy 2% Spending cut
Pension ref orm
Spain 1%

Source: SG Cross Asset Research

 10

Still plenty of fog

Question 2
What do we really know about the
different austerity measures?

Answer 2
At present all we know is that the
austerity plans in Europe will
represent more than €350bn or 3%
of European GDP for the next four
years.
Question 3
Do past examples fully justify
these austerity measures?
“Keep your eyes on the stars, and your feet on the
ground”.
Theodore Roosevelt
.
 12

Fiscal adjustements take an average 8 years to succeed

Examples of successful large fiscal adjustments

Country & period of consolidation Duration of General government debt Structural primary balance Real GDP Inflation Interest Unemployment
the plan growth Rate rates rate
Start Peak End Swing Start End Average over the period
In years As a percentage of GDP In per cent
Short duration
Denmark (1983-86) 3 65 77 72 13.4 -6.4 7.0 3.9 5.4 11.8 6.8
Sweden (1981-87) 6 47 71 62 8.6 -5.7 2.9 2.2 7.6 9.0 3.7
United Kingdom (1994-2000) 6 49 53 45 7.7 -4.4 3.3 3.5 1.8 7.0 7.3
Sweden (1994-2000) 6 78 84 64 11.8 -7.1 4.7 3.7 1.0 6.1 10.1
Long duration
Western Germany (1980-89) 9 29 41 40 5.2 -3.7 1.5 1.9 2.9 7.8 5.2
Ireland (1980-89) 9 68 114 100 11.8 -7.0 4.8 3.1 9.3 10.5 14.5
Japan (1979-90) 11 41 77 64 7.0 -4.9 2.1 4.6 2.7 6.6 2.4
Italy (1986-97) 11 89 130 130 10.2 -3.4 6.7 2.1 5.0 10.6 10.2
Canada (1986-99) 13 67 102 91 11.1 -5.4 5.7 2.8 2.8 11.1 9.2
Belgium (1984-98) 14 107 141 123 10.3 -3.6 6.7 2.3 2.6 8.3 8.9

Source: European Commission AMECO database; OECD; BIS; Datastream; national data; SG Cross Asset Research
 13

First difference: interest rates already very low

Long-term interest rates: same pattern observed in Canada and Sweden

10

7
austerity measures
Announcement &
establishment of

5
11
4
Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99
9
Canada Benchmark bond 10yr US Benchmark bond 10yr

& establishment
Announcement

of austerity
measures
5

3
Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99
Sw edish Benchmark bond 10yr Germany Benchmark bond 10yr
UK Benchmark bond 10yr US Benchmark bond 10yr

Source: SG Cross Asset Research, Datastream

 14

Second difference: austerity measures much larger with 21% of global

GDP
Previous economic cycle Current economic cycle

Interest
rates rising 1 2007- 2009
1 2001-2003 4 2012-2013e
Crisis in developed
US Economic Economies slow
economies
Slowdown
4 2006-2007
Growth stabilising Yuan
revaluation?

High LBO and Market Emerging Market

consumer M&A Stress Markets IPOs stress
Interest
spending Inflation/
rate drop
and rising Interest rate Interest rate
inflation hikes cuts
Corporate Government
Capex
Capex debt debt
M&A
reduction increasing

2 2003-
…….2004 3 2011-2012e
3 2004-2006 2 2009- 2010e
Start of recovery Rise in consumption
Recovery and Recovery in emerging
Low interest rates: and investment
Growth markets and rise in
consumer borrows
Improving commodity prices
consumer
confidence

Source: SG Cross Asset Research

 15

Third difference: further depreciation of western currencies takes

time to materialize

Source: SG Cross Asset Research, Datastream

 16

All countries cannot win at the same time

Question 3
Do past examples fully justify these
austerity measures?

Answer 3
No. Three major differences with
the situations observed in Canada
and Sweden in the 1990s suggest
that not all the austerity plans will
be successful and point to a major
risk on economic growth if
governments implement austerity
plans in an uncoordinated manner.
Question 4
Which variable should you look at to
analyze the success of these austerity
plans?
“In matters of style, swim with the current; in
matters of principle, stand like a rock”.
Thomas Jefferson

.
 18

Unemployment rate jumped in many countries during the 2009

recession

Unemployment rate in major countries

2008 2010e Increase over the recession
Germany 7.40% 8.01% 8.24%
France 7.90% 9.50% 20.25%
Italy 6.80% 8.30% 22.06%
Portugal 7.60% 9.45% 24.34%
Greece 7.60% 9.50% 25.00%
UK 5.20% 7.80% 50.00%
USA 5.80% 9.30% 60.34%
Spain 11.30% 18.20% 61.06%
Ireland 6.10% 12.00% 96.72%

Source: SG Cross Asset Research

 19

Property bubble reveals the risk associated to austerity plans

Nominal residential home price

1996 2001 2006 2011 2016 2021 2026

450 450
OECD official
data w ith
2009 and
350 2010 350
estimates

250 250 1996 2001 2006 2011 2016 2021 2026

OECD official
350 data w ith 350
150 150 2009 and
2010
estimates
250 250
50 50
1980 1985 1990 1995 2000 2005 2010
Japan lost decade UK Ireland Spain
150 150

50 50
1980 1985 1990 1995 2000 2005 2010
Japan lost decade Italy
France Germany

Source: SG Cross Asset Research, Datastream, OECD

 20

Unemployment rise and saving rates major variables to analyze

the success of austerity plans
Austerity plans and social risk

Source: SG Cross Asset Research, Datastream

 21

Confidence in the future is essential

Question 4
Which variable should you look at
to analyze the success of these
austerity plans?

Answer 4
Unemployment trends, saving
rates, social movements and
property markets are the key
variables that can be analysed to
forecast the chances of success
of the austerity plans. Depending
on the country, the austerity
plans could be devastating.
Question 5
How to invest under an austerity
plan scenario
“You only have to do a very few things right in your
life so long as you don’t do too many things wrong”.
Warren Buffett

.
 23

What is discounted by these plan so far

Successes (bp)

Failures (bp)

Source: SG Cross Asset Research, Datastream

 24

Worried about inflation? Austerity plans suggest deflation more

of a risk for 2011
Comparing 1929-1950 period with today’s US 10YR
bond yields

2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023
7 7
US Government Bond Yields from 1929
6 Prime bankers' acceptances, 90 days from 1929 6 Comparing the S&P today and the S&P in the 30s
US Government Bond Yields from 2004
5 US FED FUNDS MIDDLE RATE from 2004 5
2000 2002 2004 2006 2008 2010 2012 2014 2016
4 4
End of fiscal
stimulus 100 100
3 3

2 2
70 70
1 1

0 0
1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 40 40

10 10
1930 1932 1934 1936 1938 1940 1942 1944 1946
S&P Composite Real (Inflation-adjusted) Price - 1929 peak through 1945
S&P Composite Real (Inflation-adjusted) Price - 2000 peak to the present

Source: SG Cross Asset Research, Datastream

 25

Key recommendations summary

Recommendations from a European austerity standpoint

Asset class Impact
- = +
Fixed income – overall positive Spain USA Portugal
UK France Greece
Ireland Germany Italy

Equities – overall negative

Spain UK Portugal
Ireland France Italy
Germany
Greece
USA
Currencies – overall neutral Expect emerging market currencies to continue to
revaluate
Source: SG Cross Asset Research
 26

UK and Spain: risk not priced in

Question 5
How to invest under an austerity
plan scenario

Answer 5
Risk-reward is positive for the
Greek, Italian and Portuguese
bond markets. The execution
risks inherent in austerity plans
make us more cautious on bond
markets in Ireland, Spain and the
UK. The UK could benefit from
renewed currency depreciation if
its austerity measures have an
overall negative impact on the
economy.
 27

APPENDIX -- DISCLAIMER
ANALYST CERTIFICATION: Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and
all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this
report: Daniel Fermon
This research report was written by a non-US research analyst who is not an associated person of a FINRA member, who is not registered/qualified as a research analyst under FINRA Rules
and who may not be subject to the FINRA restrictions on communications with a subject company, public appearances and trading securities held in the research analyst (s) ’ account (s).

IMPORTANT DISCLAIMER: The information herein is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities and including any expression of opinion,
has been obtained from or is based upon sources believed to be reliable but is not guaranteed as to accuracy or completeness although Société Générale (“SG”) believe it to be clear, fair and
not misleading. SG, and their affiliated companies in the SG Group, may from time to time deal in, profit from the trading of, hold or act as market-makers or act as advisers, brokers or
bankers in relation to the securities, or derivatives thereof, of persons, firms or entities mentioned in this document or be represented on the board of such persons, firms or entities. SG is
acting as a principal trader in debt securities that may be refered to in this report and may hold debt securities positions. Employees of SG, and their affiliated companies in the SG Group, or
individuals connected to then, other than the authors of this report, may from time to time have a position in or be holding any of the investments or related investments mentioned in this
document. Each author of this report is not permitted to trade in or hold any of the investments or related investments which are the subject of this document. SG and their affiliated companies
in the SG Group are under no obligation to disclose or take account of this document when advising or dealing with or for their customers. The views of SG reflected in this document may
change without notice. To the maximum extent possible at law, SG does not accept any liability whatsoever arising from the use of the material or information contained herein. This research
document is not intended for use by or targeted at retail customers. Should a retail customer obtain a copy of this report they should not base their investment decisions solely on the basis of
this document but must seek independent financial advice.
Important notice: The circumstances in which materials provided by SG Fixed & Forex Research, SG Commodity Research, SG Convertible Research and SG Equity Derivatives Research
have been produced are such (for example because of reporting or remuneration structures or the physical location of the author of the material) that it is not appropriate to characterise it as
independent investment research as referred to in European MIF directive and that it should be treated as a marketing material even if it contains a research recommendation («
recommandation d’investissement à caractère promotionnel »). However, it must be made clear that all publications issued by SG will be clear, fair, and not misleading.
Analyst Certification: Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personal views about any and all of
the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report.
Notice to French Investors: This publication is issued in France by or through Société Générale ("SG") which is authorised by the CECEI and regulated by the AMF (Autorité des Marchés
Financiers).
Notice to UK investors: This publication is issued in the United Kingdom by or through Société Générale ("SG") London Branch which is regulated by the Financial Services Authority ("FSA")
for the conduct of its UK business.
Notice To US Investors: This report is intended only for major US institutional investors pursuant to SEC Rule 15a-6. Any US person wishing to discuss this report or effect transactions in
any security discussed herein should do so with or through SG Americas Securities, LLC (“SGAS”) 1221 Avenue of the Americas, New York, NY 10020. (212)-278-6000. THIS RESEARCH
REPORT IS PRODUCED BY SOCIETE GENERALE AND NOT SGAS.
Notice to Japanese Investors: This report is distributed in Japan by Société Générale Securities (North Pacific) Ltd., Tokyo Branch, which is regulated by the Financial Services Agency of
Japan. The products mentioned in this report may not be eligible for sale in Japan and they may not be suitable for all types of investors.
Notice to Australian Investors: Société Générale Australia Branch (ABN 71 092 516 286) (SG) takes responsibility for publishing this document. SG holds an AFSL no. 236651 issued under
the Corporations Act 2001 (Cth) ("Act"). The information contained in this newsletter is only directed to recipients who are wholesale clients as defined under the Act.
IMPORTANT DISCLOSURES: Please refer to our websites:
http://www.sgresearch.socgen.com/compliance.rha
http://www.sgcib.com. Copyright: The Société Générale Group 2010. All rights reserved.

SG leader in Global Cross Asset Research
Strategy & Cross Asset
2010
#1 Global Strategy
#1 Multi Asset Research
#1 Quantitative/Database
#1 SRI Research
Commodities
#2 Research in Emissions
#2 Research in Base Metals
#3 Research in Oil
#3 Research in Power and Gas
28
Fixed Income & Forex
2010
#1 in 6 out of 15 categories Credit & Rates
#2 Flow FX Research
#4 Quant FX Research
#4 FX Emerging Research
Equity
2010
#1 Research on French Equity
#1 Thematic Research
13 sector teams in the Top 10
Equity Derivatives Research
#3 Flow Product