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RBC Capital Markets survey: global executives concerned about rising sovereign debt as competition for capital gets more acute

LONDON, NEW YORK, TORONTO, June 28, 2010—  Rising sovereign debt in the developed world is one of the main concerns for the world's business leaders and financial executives, according to 440 senior executives who participated in a survey commissioned by RBC Capital Markets, the corporate and investment banking arm of Royal Bank of Canada (RY on TSX and NYSE).

Among the key findings of the survey, conducted by the Economist Intelligence Unit:

Sovereign default:

The debt problems facing eurozone nations have raised questions about the monetary union's future in its current form. Almost half of those surveyed agree that there is a greater than 50 per cent chance of one or more countries leaving the eurozone in the next three years. More than one-third (36 per cent) see at least a 25 per cent chance of a complete breakup of the eurozone over the same period.

Out of those who see a significant chance of the eurozone losing a member in the next three years, Greece is considered the country most likely to leave the eurozone, followed by Portugal, Spain and Ireland. Germany is perceived as the fifth-most likely country to leave the eurozone, possibly reflecting the respondents' concern that the German government may lose confidence in the monetary union if the current crisis continues1 .

While the prospects of a G20 economy defaulting on its debt remain relatively low, almost one-third of the respondents place the odds of this occurring at 50 per cent or more, indicating a rising concern that the debt problems facing the global economy may spill outside the eurozone.

Among those who foresee a significant chance of a G20 default, Italy received the most votes, followed by Argentina, Turkey, Mexico and Russia. The United Kingdom is perceived to be the Western European country, after Italy, most likely to default on its debt, both within the G8 and the G20.2

Outlook for currencies:

Two-thirds of executives (67 per cent) believe the value of the euro will continue to slide over the next 12 months. Concerns about the euro's weakness have reinforced the position of the dollar as the reserve currency of the near future, although its power is perceived to be in decline. Eighty per cent of the respondents believe the dollar will remain the dominant reserve currency in three years' time, with the consensus dropping to 57 per cent over a five-year period. This picture likely says more about the lack of real alternatives, rather than confidence in the dollar, and is further illustrated by the fact that more respondents (15 per cent) see the Chinese renminbi as the reserve currency of choice within five years rather than the euro (12 per cent), despite the low likelihood of this occurring.

Although the dollar is expected to remain the world's reserve currency for the near future, 40 per cent of respondents believe that over the next three years the currencies of exporting countries, such as the Persian Gulf States, Taiwan and Hong Kong, will stop being pegged or managed closely against the dollar. The recent action by the Chinese government which led to the removal of renminbi's unofficial peg to the dollar further strengthens this expectation.

Emerging and developed economies:

Survey respondents see an increased divergence between emerging and developed economies. Eighty-seven per cent of the respondents expect growth in the developed nations to be positive, albeit modest and remaining below historic norms. Respondents have a positive outlook for industrialized Asia, followed by North America, while there is a strong consensus that Europe's prospects are negative.

The respondents predict an increasing growth imbalance between Europe and the rest of the world, even as U.S. economic influence is seen to be waning, with over two-thirds of the respondents (66 per cent) in agreement. There is also a growing consensus (56 per cent) that emerging markets such as China, Brazil and India will replace the U.S. as a source of demand driving global growth.

Fifty-nine per cent of corporate and financial executives believe that the governments of developed countries will not have the firepower to raise the credit needed to jump start their economies in the event of another financial crisis. A similar number agree that the credit capacity of developed economies will diminish compared with today (58 per cent).

Nearly two-thirds of the executives surveyed (64 per cent) agreed that developed countries will not stop increasing their levels of indebtedness until investors force them to do so by scaling back on debt purchases. Thirty-nine per cent of executives say that corporate bonds from the most creditworthy companies will come to yield less than their sovereign benchmarks. In spite of these concerns, just 41 per cent have adjusted their portfolio strategy in response to changes in sovereign risk.3

Inflation vs. Deflation:

Asked what they fear more, inflation or deflation, the majority of the survey respondents expect inflation to pose a greater threat than deflation to their financing and budgeting decisions. This finding reveals a shift in perception from a previous RBC Capital Markets survey conducted in the third quarter of 2009, in which executives from the same demographic were evenly split between inflation and deflation when asked a similar question.

Competition for Capital:

Demand for funding is low today, with just 38 per cent of corporate respondents expecting to raise fresh capital in the next two years. However, the competition for capital may well grow more acute as heavily-indebted governments seek to raise unprecedented amounts of capital for structural outlays related to aging populations, deteriorating infrastructure and possible energy and climate crises.

This new level of scrutiny will bring about a new era of competition for capital. Investment-grade borrowers, both corporate and sovereign, can choose their investors and almost name their price. Nevertheless, over the next few years there will be stiff competition for increasingly scarce capital. With banks looking to rebuild balance sheets in a more stringent regulatory environment, sovereigns seeking to restore public finances to health, and corporates looking to finance - at the very least - day-to-day needs, this competition presents a highly challenging overall environment for raising capital.

Commenting on the findings, Marc Harris, co-head, Global Research, RBC Capital Markets, said: "Competition for capital will no doubt become more acute for corporates and sovereigns and the next few years will continue to present a challenging environment. While there is an obvious consensus that not all sovereign bonds are created equal, our survey results imply that investor appetite for specific sovereign debt will be closely correlated with each country's ability to bring fiscal discipline in fighting the spectre of inflation."

Richard E. Talbot, co-head, Global Research, RBC Capital Markets, said: "Rising government debt in the developed world, and the re-balancing of power between developed and developing nations, poses questions over the outlook for currencies. The downside of growing sovereign debt and pressure on currencies such as the euro is clear. However, it is the dynamic of the relationship between the world's creditors and the world's debtors and their currencies that will ultimately determine the competition for and the cost of capital in the new era."

Richard Talbot Video - Richard Talbot, co-head, Global Research, RBC Capital Markets, RBC Capital Markets - Highlights from the survey and white paper "The New Normal": Implications of Sovereign Debt and the Competition for Capital

Harry Samuel, global co-head of Fixed Income & Currencies, RBC Capital Markets, added: "The relative volatility in the currency markets is strongly correlated with the derailing effect of sovereign risk that we are witnessing across the globe, albeit in different degrees. Investors will therefore continue to avoid investing in currencies of countries with unsustainably high levels of debt, while favouring currencies of countries with sound public finances. As the question over the long-term preeminence of the dollar remains widely open in this zero sum game, we expect a broadening of interest in a wider range of currencies, including commodity linked FX trades."

Additional findings from the survey:

  • Divergent outlooks - Corporates vs. Financials: Financial firms tend to be more optimistic than their corporate counterparts about transaction volumes in their country over the coming year. For example, 49 per cent of financial firms expect that IPO levels will be higher, compared to 38 per cent of corporate respondents. Financial services executives also expect higher levels of activity than their corporate counterparts for secondary equity offerings (53 per cent vs. 27 per cent); M&A (61 per cent vs. 52 per cent) and investment-grade debt (46 per cent vs. 31 per cent).

    Asset classes: More respondents said that risks were higher this year for every single asset class, with currencies, commercial real estate, equities and corporate debt showing the greatest relative increases in perceived risk. In fact, currencies and equities were perceived to have become even riskier than sovereign debt. Notably, a significant minority said that certain asset classes had become less risky, including such classic inflation hedges as real estate and commodities.4

  • Cash is king? While investors once frowned on companies hoarding cash, many now recognize the benefits of significant cash reserves. In evaluating investments, the criteria that financial executives most often say they value more than they did two years ago are a company's financial strength (59 per cent), its ability to maintain adequate levels of cash or other sources of liquidity (49 per cent) and its ability to mitigate the risks of extreme market conditions (49 per cent). All three criteria imply the desirability of a war chest to withstand financial crises.

About the survey
RBC Capital Markets commissioned the Economist Intelligence Unit to survey 440 senior executives from around the globe (North America (34 per cent), Europe (41 per cent), Asia Pacific (16 per cent) and Rest of the World (nine per cent), including both clients and non-clients of the firm, on their outlook for the future of capital markets. The survey was conducted between April 28-May 25, 2010. The respondents included 229 senior executives from commercial and investment banks, hedge funds and private equity firms and 211 executives from non-financial companies active in the capital markets.

About RBC Capital Markets
RBC Capital Markets is the corporate and investment banking arm of the Royal Bank of Canada and is active globally in debt and equity origination, sales and trading, foreign exchange, infrastructure finance, and structured products across a number of industry sectors. Its North American platform includes a significant U.S. investment banking franchise and leading equity and fixed income underwriting, sales, trading and research businesses.

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RBC Contacts:
Beverley Weber,
+44 (0)20 7029 7685, Beverley.Weber@rbc.com

Kevin Foster,
+1 (212) 428-6902, Kevin.Foster@rbccm.com

1Survey respondents were asked to choose the probability that one or more countries would withdraw from the eurozone over the next three years. The 76 per cent who said that probability was 20 per cent or more received a follow-up question: Which country or countries were most likely to leave, with respondents permitted to choose up to three countries.

2Survey respondents were asked: What probability would you assign to a sovereign debt default from a G20 country over the next three years? The 68 per cent that chose a probability of 20 per cent or more were asked to select the G20 countries most likely to default during this period, with respondents allowed to choose up to four countries.

3The final data point relates to a question asked of financial services executives only.

4All data in this bullet relates to a question asked of financial services executives only.


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07/12/2010 12:56:37