International

The total costs of the credit crisis that has afflicted the market over the past six months are estimated to be somewhere between $100 and $250 billion. The financial sector as a whole should be able to absorb the costs fully even if they are at the high end of this range considering that the total amount of Tier-1 capital of the combined European and U.S. banks is estimated at approximately $2,000 billion. The risks, however, are primarily concentrated with individual participants in the market. Potential downgrades of the ratings of financial instruments that are based on mortgages and other forms of debt, and the possible ensuing price pressure, will not, after all, affect all parties with equal severity. While more information is gradually becoming available, the lack of transparency vis-à-vis individual market participants’ exposure to the sub-prime market has proven to be more tenacious than originally anticipated. This is why confidence has not yet been restored within the sector. This is reflected principally in relatively high interbank money market rates and a bigger restraint on the part of banks in providing credit. There is consequently no doubt that the financial sector will be faced with a difficult year ahead. It is, however, also important to note that increased volatility of the markets and higher risk premiums could also actually offer attractive opportunities for investors, providing that they follow a selective approach.

The credit crisis constitutes a major financial jolt that will certainly have repercussions on the world’s economies. The adjustment process in the housing market will severely impede economic growth in the U.S. in the years ahead. Even a recession cannot be ruled out, although this is not our baseline scenario. Higher risk premiums translate into higher finance charges for companies and households. Financial institutions are also likely to tighten the terms for loans. This will create difficulties for borrowers with lower credit ratings in particular, also in the Eurozone. A number of surveys reveal that banks in the U.S. and Eurozone have already considerably tightened their credit standards in the past year. In addition, trade and investment are particularly being affected. Although trade with Asia and Eastern Europe is growing rapidly, 25% of all goods exported from the Eurozone still go to the U.S. Moreover, while we currently see a shift towards emerging countries, European companies and households still have a relatively large stake in direct investments in the U.S. as well as substantial holdings of securities. Both regions furthermore have strong cultural ties and their financial markets are extremely interconnected. It can consequently be assumed that the European economy will also be negatively affected by the crisis in 2008.

However, with respect to the outlook for the world economy, we do not believe there is cause for pessimism. The rise in the risk premiums in the markets has so far been partially compensated by a fall in risk-free interest rates (such as official central bank rates and the yield on government bonds). This means that finance charges have increased on only a limited basis, primarily for those firms and people who have a lower credit rating. For example, the Federal Reserve System (Fed) lowered its policy rate by 0.75%-points in September and October. What’s more, record profits and balance sheet restructuring in recent years suggest that companies in both the U.S. and Eurozone can withstand a blow. The expansion of the world economy, which is chiefly driven by technological progress and a gradual transition from centrally managed to market economies, especially in China, is likely to continue unabated for the time being. Financial markets in emerging countries have been less affected by the crisis and are in considerably better shape to absorb blows than they were at the time of the Asian (1997) and LTCM (1998) crises. The Chinese and Indian economies contributed no less than 2.2% to the total worldwide GDP growth of 5% in 2007 (in comparison: the U.S. contributed only 0.4%). We are forecasting real growth in the world economy to be approximately 4.5% for 2008, which is still a healthy growth rate, albeit lower than in 2006 and 2007.