WHERE IS EMU AND SWEDEN HEADING?

1
WHERE IS EMU AND SWEDEN HEADING?

• Klas Eklund
• SEB
• March 1999

2
INTERNATIONAL SCENARIO
The Asian deflationary process rolls on. Brazil
in dire straits, but global effects less than
feared much was priced in. Different regions
pull in different directions.
1. Emerging markets Recession in Latin America.
Russia has not bottomed yet. But Asia is
turning. 2. Negative growth in Japan. Strategic
monetary choice 3. US is strong but will slow
down a soft landing 4. Europe is braking, but
will recover

• Global growth 1999 around 2
• Very low inflation. Low rates - but they are
  bottoming
• Shaky stock markets, volatile currencies
• But no global depression

3
RISKS
1. Hard landing in the US. Wall Street crash and
ripple effects 2. Failed monetisation in Japan.
Yen causes new currency turmoil

• More severe Brazilian effects
• What if China and Hong Kong devalue?
• Regional troubles in Mid East and South Asia
• Y2K
• Krugman The world is a very scary place

4
USA DEFIES GRAVITY
5
IMBALANCES IN THE USA
6
EMU A GOOD START

• Convergence process worked well A large number
  of countries, on time, credibility
• Technically smooth transition to euro
• Great potential for structural changes and reform
• Price transparency
• Economies of scale
• Less currency volatility
• Pressure on taxes
• But great tests remain
• Monetary and fiscal policies
• Conflicts between ECB and national politicians
• Federalism?
• Will the SDP governments change the EMUs role?

7
WHAT WILL THE ECB DO?

• Many technical problems in getting started How
  to measure monetary growth and inflation?
• How to interpret the targets?
• Core inflation rate is very low
• Rates may be lowered if economy slows further
• But euro has weakened
• Political pressures question ECBs independence
• German wage settlements are too high
• American rates have climbed
• Conclusion On hold for a while

8
DIFFERING VIEWS OF THE FUTURE
9
THE SWEDISH MODEL IN CRISIS

• The middle way Big government, big business
  and big unions
• 1970s through 1990s a gradual crack-up of the old
  model
• The water-shed 1989-92 Over-heating, tax
  reform, real interest rate shock, banking crisis,
  currency crisis and then budget crisis
• Out of the crisis
• Resolution of banking crisis
• Floating currency
• EU membership
• Independent central bank
• Stricter budget process
• Now low inflation, strong budget, but still
  growth and structural problems

10
GROWTH AND INFLATION
11
INFLATION AND UNEMPLOYMENT
12
THE SWEDISH ECONOMY TODAY

• Currency, banking and budget crises have made the
  90s volatile, while Sweden has adapted to Europe
• After several weak years consumption is finally
  moving
• But exports are slowing due to international
  slowdown
• In total Some slackening of GDP, but not severe
• Slow improvement of labour market
• but structural reforms are badly needed
• Extremely low inflation, which gradually will
  pick up
• Riksbank can stay close to ECB levels. Will it go
  lower?

13
SWEDISH GDP GROWTH
14
PURCHASING MANAGERS INDEX
15
CONSUMER CONFIDENCE
16
SWEDEN KEY FORECASTS
1997 1998 1999 2000 GDP 1,8 3,0 2,4 2,9 Ex
port 12,8 6,9 5,5 5,4 Private
consumption 2,0 2,7 2,9 2,4 Savings
ratio 0,8 1,5 1,3 1,3 Unemployment
8,0 6,5 6,2 5,9 Wage costs 4,5 3,5 4,0 4,3 Cur
rent account 2,7 2,3 2,2 1,9 Inflation
(CPI) 0,9 0,4 0,5 1,5
17
SWEDEN M0 and CPI
17.5
17.5
15.0
15.0
12.5
12.5
10.0
10.0
7.5
7.5
5.0
5.0
2.5
2.5
0.0
0.0
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
-2.5
-2.5
M0
Inflation
18
SWEDISH AND GERMAN REPO RATES
19
RIKSBANK AND ECB INFLATION TARGETS
3
Riksbank inflation target
2
ECB inflation target
1
20
THE POLITICAL SCENE

• The 90s have been turbulent and difficult for
  governments - and especially for SD Party. The
  Swedish model has been forced to adapt to Europe
• 1998 A polarizing election - and a huge loss for
  SDP
• A lot of soul-searching in several parties. The
  all-powerful Prime Minister is openly criticized
• The parliamentary base of the Government is more
  fragile now. SDP needs support from two parties
  or more.
• SDP co-operates with Left and Greens. Moves left
  in rhetoric - but is gradually forced to the
  right by markets and globalization. An untenable
  situation.

21
THE ELECTION 1998

• 1998 Per cent and seats
• Left 12.0 43
• SDP 36.6 131
• Greens 4.4 16
• Centre 5.2 18
• Liberals 4.7 17
• Moderates 22.7 82
• Christ Dem 11.8 42

• 1994 Per cent and seats
• Left 6.2 22
• SDP 45.3 161
• Greens 5.0 18
• Centre 7.5 27
• Liberals 7.2 26
• Moderates 22.2 80
• Christ Dem 4.1 14

22
STRAINS BETWEEN SDP - LEFT

• Globalisation will put pressure on taxes. Tax
  bases are becoming more mobile. Hot topic Exodus
  of companies
• The EMU issue is becoming more important by the
  day
• Rigid labour market will make lower unemployment
  difficult to achieve
• Slippages in the budget? Expenditure ceilings in
  danger
• Internal strains inside the SDP and the Left
• Conclusion It will be difficult to make the
  alliance stick - but Mr Persson has still not
  decided when and how to change horses

23
ECONOMIC POLICY UNCERTAINTY

• Expenditure ceilings questioned
• But the budget numbers are OK
• Privatization will come
• MoF under siege. Conflicting power centers are
  built up. Negotiations on all fronts Taxes,
  defense, pensions, nuclear power, labour market
  wages
• Long-term political uncertainty What is
  Perssons strategy?
• How long will the alliance SDP-left last? When -
  and how- will SDP switch alliances?
• Markets are normally nervous in such an uncertain
  situation. But the EMU process gives strength

24
THE TAX PROBLEM

• Globalization threatens tax revenue
• Flight of financial capital
• Increasing brain drain
• Even consumption is more mobile
• Corporate tax is OK, but taxes on mid-managers
  and experts are becoming an acute problem
• But slashing taxes on mobile bases is at odds
  with SDP ideology, redistribution aims and
  co-operation with left
• Compromise in the pipe-line? Exceptions for
  ex-pats, promises of future cuts?
• Too little too late?

25
DIRECT INVESTMENTSBn SEK
Inflows
Net
Outflows
26
SWEDISH AND GERMAN BOND YIELDS
27
EUR/SEK
28
WHEN WILL SWEDEN JOIN THE EMU?

• No decision would mean breaking Maastricht
  treaty. But in reality, it is a political
  decision, depends on public opinion - which is
  turning
• EMU has started
• SDP governments in Europe
• Turn-around of opinion in Denmark
• Blair moves
• EU chair in 2001
• Persson wants to move ahead
• Extra SDP congress March 2000
• Referendum or snap election autumn 2000,
• ERM-entry late 2000
• membership 1/1 2002?

29
THE SWEDISH ROAD TO EMU
1999
June 13 EU Parliament election. Riksbank
analyses fair value of SEK Late autumn SDP
party leadership states its view
2000
March SDP party congress September
Referendum or snap election After that SEK
enters ERM2
2001
Jan 1 Sweden chairs EU Preparations for euro
Jan 1, 2002 Sweden enters EMU?
30
THE FORMAL ERM2 DECISION

• The government decides Swedish entry
• Formally, Riksbank decides Swedish position on
  SEK level and band width
• But in practice the Swedish position must be
  joint
• Final decision taken by joint decision by
• Ministers of finance in Euro zone
• ECB council
• ERM2 participants (Denmark Greece)
• Decision taken after consultation with EU
  Commission and Economic Financial Committee
• The Riksbank needs one year before EMU entry

31
WHICH ENTRY LEVEL?

• The Riksbank wants a firm SEK, the Government
  wants competitiveness
• The ECB - and the Fins - want a strong SEK
• EUR/SEK 8.60 a possible level gives TCW 115
• Note that when the SEK is tied to the euro, SEK
  will follow EUR vs US
• Weak USD would mean much stronger SEK, tough
  structural demands. Puts pressure on government
  to want a weaker SEK
• The ECB will say EUR/SEK decisive, not USD
• Negotiations 8.50-9.00. Forecast 8.60
• ERM central parity becomes conversion rate

32
SEK vs TCWCentral parity 8.60
EUR/USD 1,04
EUR/USD 1,44
33
SEK vs TCWCentral parity 9.00
EUR/USD 1,04
EUR/USD1,44
34
SEK PROs AND CONs
-

• EMU-ERM2-discussion
• Commercial flows
• Global diversification of bond portfolios

• Budget negotiation worries
• Structural policy deficiencies
• Global financial turbulence
• No more support from short rates
• Swedish portfolio diversification
• Rapprochement to euro makes SEK less interesting
• What if EMU opinion turns?

35
SEK CONCLUSIONS

• EMU dominates
• Riksbank wants SEK to enter ERM
• Stronger SEK dependent on EMU process
• U-turn on EMU would give volatility and SEK
  weakening because of foreign debt, economic
  policy and capital flows
• Forecast SEK TCW interval 124-128 during spring,
  strengthening towards 119 if EMU-process on track
  

36
KEY FINANCIAL FORECASTS
990217 jun-99 sep-99 mar-00 dec-00 Repo
rate 3,15 2,90 2,90 2,90 3,25 10-year
yield 4,26 4,25 4,45 4,75 4,85 TCW 123,4 125,2 1
21,7 118,1 115,4