Financial Stability 2/2001

Print

2 International developments and securities markets

2.1 The international environment
2.2 Securities markets in Norway
Boxes:
Terrorist attacks in the US – immediate effects on the financial sector
Indicators of price levels in the stock market

2.1 The international environment

Growth forecasts for the global economy have been further revised downwards after the terrorist attacks in the US on 11 September. Easing of monetary policy in a number of countries has reduced borrowing costs for households and companies. However, slower income growth, which is a result of the downturn, weakens debt servicing capacity. Although banks in many countries have strengthened credit rating procedures and increased their capital adequacy in recent years, the vulnerability of the financial sector has increased due to developments in the last few months. There are signs of an increasing number of bankruptcies and non-performing loans in a number of countries. The situation in Japanese banks has worsened as a result of the decline in share prices, rising loan losses and continued deflation.

Uncertainty surrounding some emerging economies is high, especially in Argentina, where the authorities have now asked to renegotiate interest terms on their foreign currency debt.

Wide fluctuations in stock markets

The US stock market has been characterised by periods of sharp decline in prices and a high degree of uncertainty since September 2000 (see Chart 2.1). Share prices continued to fall through the summer following a temporary rise in April and May. The decline was aggravated by the terrorist attacks on 11 September. From the end of May to the last week of September, the S&P 500 index fell by more than 26%. Since prices hit bottom on 21 September, they have climbed again. The S&P 500 index is now almost 5% higher than just prior to the terrorist attacks, due in particular to developments in technology shares. The prolonged decline in the US stock market must be seen in the light of expectations about weaker growth and reduced earnings in listed companies.

Chart 2.1

Information from the options market indicates that the uncertainty is greater now than half a year ago (see Chart 2.2). In connection with the terrorist attacks, implied volatility rose sharply, but the level is now approximately at the historical average for the last three years. Market participants' estimates for listed companies' future earnings indicate nevertheless that they believe that the recession will be brief and that earnings will rise again quickly (see Chart 2.3).

Chart 2.2     Chart 2.3

Developments in the European stock markets have largely shadowed developments in the US the last year. Since May of this year, however, the European markets have fallen more sharply than the US market, despite a more positive growth outlook for Europe, compared with the US. The correlation with the US stock market may be explained in part by the fact that large European companies are vulnerable to changes in demand in the US economy, especially through their US subsidiaries. The spread of confidence effects from the US to Europe probably plays a significant role as well.¹

In the US and Europe, the decline has at times been driven by strong price corrections in the ICT sector. From March 2000 to March 2001, US ICT shares fell by more than 50%. At its peak, the market value of the ICT sector accounted for as much as 45% of the US stock market, although value added in the sector only accounted for 9% of value added for the entire enterprise sector in 1997. At the end of October this year, the sector accounted for approximately 25% of total market capitalisation in the US stock market. Developments are also reflected in the P/E ratio in the ICT sector compared with the rest of the stock market (see Chart 2.4 and separate box).

Chart 2.4

Lower interest rates and a reduction in lending growth

The deterioration in the economic situation has led to slower credit growth in many countries. In the US, total credit to the private sector rose by 7¼% in the first half of 2001, down from 8½% in 2000. Continued high demand for dwellings and other consumer durables have contributed to sustaining the demand for loans in the household sector. In the euro area, the 12-month growth in lending to the private sector was 6.9% in September, down from a growth rate of more than 10% in 1999 and 2000. In Japan, on the other hand, banks' loans to the private sector continue to fall at an annual rate of more than 2%, despite an expansionary monetary policy.

The interest rate cuts in the US and Europe have reduced the costs of short-term fixed-interest loans. Long-term interest rates have fallen less. In addition, the yield spread on bonds has widened (see Chart 2.5).

Chart 2.5

So far, the cyclical downturn has not resulted in extensive defaults. A survey conducted by the supervisory authorities in the US show, however, that the share of syndicated loans considered to be doubtful rose to 9.4% of all syndicated loans in the second quarter of 2001.² This was an increase from 5.1% a year ago, but is still far below the peak level of 16% from the previous downturn.

Developments in emerging economies

Emerging economies are affected by slower growth in industrialised countries and an increased risk aversion among investors. Hardest hit are countries with large foreign debt, such as Argentina, Brazil and Turkey. The risk premium on dollar loans to the Argentinian government has been more than 30 percentage points recently (see Chart 2.6). Combined with weak deflation, this leads to very high real interest rates. The country's banks are highly capitalised, but fear of problems in the banking sector induced customers to withdraw deposits this summer. At the beginning of November, the Argentinian authorities announced that they wished to renegotiate parts of the foreign currency debt amounting to USD 132 billion. The goal is to reduce the budget deficit by reducing the central government's interest expenses by USD 4 billion.

Chart 2.6

After the Russian government defaulted on its loans in the autumn of 1998, the risk premium on foreign currency loans was more than 70 percentage points. Russia has still not renegotiated all of its loans. The agreements that have been made have substantially reduced debt. Strong economic growth, strengthening of government finances and lower inflation have renewed confidence in Russia's debt-servicing capacity. The risk premium is currently lower than for the average of emerging economies.

The countries in Asia are particularly affected by declining demand for computer equipment. Although economic developments are very weak, there is no sign of financial unrest so far.

2.2 Securities markets in Norway

The stock market

Since prices peaked on 25 May 2001, the all share index on the Oslo Stock Exchange has fallen 24% as of 20 November. The Norwegian market fared better than the markets in Europe and Japan through the summer. After the terrorist attacks in the US on 11 September, the Norwegian market performed less favourably; the decline after the attacks was sharper and the subsequent rebound somewhat weaker than in most other countries (see Chart 2.1). Developments are only partially explained by the fall in the oil price since the energy index, which includes Statoil and other oil-related companies, performed better than the all share index to the middle of November. A sharp drop in prices for Storebrand and DnB contributed to the marked decline in the financial index in September (see Chart 2.7).

Chart 2.1     Chart 2.7

Turnover in the stock market has gone down so far this year compared with last year (see Chart 2.8), in part due to a lower price level. Periods of lower share prices also affect the volume of new share issues. If we disregard the new share issues in connection with the partial privatisation of Telenor last year and Statoil this year, the volume of new share issues on the Oslo Stock Exchange has fallen from a good NOK 25 billion in 2000 to about NOK 10 billion so far this year. Since this summer, activity in the new issue market has been limited.

Chart 2.8

 
We have compared the Oslo Stock Exchange with other stock exchanges during the periods autumn 1987, summer-autumn 1992, summer-autumn 1998 and September 2001 (see Chart 2.9). The first and last periods may be characterised as periods of market shock, with a sharp fall in prices over a short period, while the other two periods were marked by a strong decline in prices over a prolonged period. Compared with stock markets in other small, open economies, the Oslo Stock Exchange has recorded the most substantial decline in prices in three out of four periods. One reason may be that the Oslo Stock Exchange has a large number of commodities-based companies with volatile earnings, such as the smelting industry, and relatively few companies with more stable earnings, such as energy and pharmaceutical companies.

Chart 2.9

Reduced investments in securities funds this year

Due to falling share prices and increased uncertainty, net subscriptions in securities funds in the first three quarters of 2001 have dropped by 75% compared with the same period last year (see Chart 2.10). Total net subscriptions in the period were less than NOK 4.1 billion. There were net redemptions in both unit trusts and bond funds.

Chart 2.10

Combined total assets in the securities funds have declined by 10% so far this year, and as of 30 September amounted to NOK 128 billion. As of 30 June 2001, the household sector's share of total assets was 52%. Institutions' share has increased in recent years due to an increase in net subscriptions by institutional investors and to the fact that households have a considerable share in unit trusts that have declined substantially in value.

Market risk in Norwegian financial institutions

Norwegian banks' shareholdings are very small, while holdings of bonds and short-term paper are somewhat larger (see Table 2.1). Estimated interest sensitivity for the bond portfolio indicates that interest-rate risk in banks' trading portfolios is low. Use of hedging instruments further reduces the risk. Thus, banks' market risk is relatively small. The market risk may also be measured by using Value at Risk (VaR) models. VaR models take into account recent price fluctuations in bond and stock markets and assume that they are representative of market fluctuations in the immediate future. Based on a simple VaR model, there is less than 1% probability that the value of the banking sector's securities holdings will fall more than 2.5% during a two-week period.

Insurance companies have considerable holdings of shares and interest-bearing securities (see Table 2.1). The equity share in life insurance companies has declined by 11.2 percentage points since the beginning of the year, while the bond share has risen by 8.3 percentage points. Total assets amounted to NOK 383 billion at the end of the third quarter. Buffer capital³ fell through the year to 3.8% of total assets at the end of August. Due to the decline in share prices in September, buffer capital declined further. Extensive share sales in order to satisfy capital adequacy requirements could have reduced customers possibilities to achieve satisfactory returns in the long run and intensified the decline in the Norwegian stock market. To avoid this, the authorities adjusted the rules at the end of September. At the end of the third quarter, life insurance companies' buffer capital came to about NOK 10 billion. After the decline in the securities market, several life insurance companies have strengthened their capital. The rise in prices in the stock market in October and so far in November has also contributed to strengthening buffer capital.

Table 2.1

© 2001 Norges Bank webmaster@norges-bank.no