Public Information Notice: IMF Concludes 2002 Article IV Consultation with the United Kingdom

March 3, 2003

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2002 Article IV consultation with the United Kingdom is also available.

On February 26, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United Kingdom.1


Over the past decade, the U.K. economy has enjoyed a sustained expansion of output and employment, coupled with low and stable inflation. Real GDP increased at an average rate of some 2.8 percent, and the unemployment rate halved to below 5 percent by April 2001. Inflation, which has been low since the mid-1990s, was—on a harmonized basis—about 1.5 percent, below the EU average. The current account deficit has averaged 1.8 percent of GDP in 2000-02.

Real output growth decelerated in 2002, but remained above that of other large European countries. Notwithstanding the global slowdown, the U.K. economy grew by 1.7 percent owing mainly to buoyant private consumption—which was supported by a robust labor market, low interest rates, and rising housing wealth—as well as increased public spending. By contrast, private investment continued to decline and net exports made a negative contribution to growth, with export volumes also declining. Unemployment edged down to 5.1 percent by end-year.

Consumer spending, however, has been fuelled partly by a rapid increase in household debt and a housing market boom. Secured and unsecured household debt stands at levels in relation to income that are comparable to previous peaks. However, debt service ratios are much lower than in the late 1980s and early 1990s, reflecting the substantial decline in nominal and real interest rates. Following years of robust growth, house prices surged by about 25 percent in 2002, rising above trend as a ratio to household earnings.

Notwithstanding its strong growth performance over the past decade, the United Kingdom ranked only 19th in 2001 among OECD countries in terms of per capita income. Labor productivity per hour worked also remains lower than in other advanced countries, reflecting both a low capital-labor ratio and low efficiency in the use of capital and labor inputs (total factor productivity). Following a continuous decline in U.K. public investment since the mid-1970s, public capital is low compared with major economies, especially in continental Europe.

Raising income and labor productivity to the levels of partner countries has been a key focus of structural reform efforts. Public investment is being increased rapidly and private investment is expected to continue to benefit from a stable macroeconomic and financial sector environment. The authorities have also adopted a multipronged approach to boost total factor productivity. Recent reforms have focused on three areas—competition policy, skills, and research and development—that have been identified as key elements in explaining the productivity differential vis-à-vis other countries. In addition, the government has in recent years pursued welfare reforms and active labor market policies to increase employment and reduce poverty.

The fiscal position has recently weakened, reflecting both cyclical and noncyclical factors. The November 2002 pre-budget report (PBR) envisaged the overall fiscal deficit to increase by nearly 2 percentage points of GDP in FY2002/03 from a broad balance in the previous fiscal year. In cyclically-adjusted terms, the overall fiscal deficit is projected to increase to 1.2 percent of GDP in FY2002/03 from 0.2 percent of GDP in FY2001/02, due to an increase in spending (mostly on education, health, and public infrastructure) and an unexpectedly large loss of profit taxes paid by financial corporations. The authorities expect this revenue shortfall to be temporary and the PBR projects an overall deficit of 1.5 percent GDP in the medium term.

The Bank of England has operated in recent years within an inflation-targeting framework, which has emphasized transparency and the pursuit of a clear objective—a symmetric inflation target of 2.5 percent. This framework has allowed the Bank to respond swiftly to cyclical fluctuations and to anchor inflation expectations. On February 6, 2003, the Bank lowered its policy rate by 25 basis points to 3.75 percent—the first rate change since November 2001—noting weaker-than-anticipated prospects for global and domestic demand.

Executive Board Assessment

Directors commended the U.K. authorities for the pursuit of prudent and credible economic policies in the context of a sound medium-term policy framework. This has resulted in a strong performance of the U.K. economy, as evidenced by a decade of sustained output and employment growth and low inflation. While growth decelerated in 2002, the economy has so far weathered the global slowdown relatively well, in part because of the timely easing of monetary and fiscal policies in the context of a well-functioning inflation-targeting framework and a low public debt to GDP ratio.

Looking ahead, Directors noted the prospects for continued economic recovery, but they saw appreciable risks to this outlook stemming from both external and domestic uncertainties. In particular, domestic demand is being sustained by high and increasing levels of household debt, fuelled by house price inflation and low interest rates, which increases vulnerability to potential adverse shocks. Directors therefore called for heightened vigilance to these risks by the authorities, especially regarding the possible existence of a housing price bubble with its potential deflationary consequences.

Directors agreed that EMU membership remains a key decision for the United Kingdom with substantial long-term ramifications. They observed that the five economic tests announced in 1997 remain appropriate for evaluating the economic considerations relevant to this decision. Directors welcomed the authorities' intention to publish their assessment, as well as the associated background studies, by June 2003. They also supported the authorities' approach of continuing to make preparations for entry, should a decision to join be made.

Directors commended the impressive performance of monetary policy, as attested by low long-term interest rates and inflation expectations that have been firmly anchored around the inflation target over the past five years. They agreed that monetary policy has the difficult task of striking an appropriate balance between supporting demand during the current slowdown and minimizing the risks associated with the continued rise in house prices and household credit. In this context, most Directors supported the central bank's recent interest rate cut, given the weakening of the global growth outlook and indications of weakening domestic activity. It was agreed that, going forward, the authorities should stand ready to respond swiftly to the changing balance of risks.

Directors noted the underlying strength of the public finances, as evidenced by the low levels of net public debt and of future public pension liabilities. In this light, and given the cyclical position of the economy, most Directors considered that the current widening of the fiscal deficit does not give cause for concern. Directors had a wide-ranging discussion on the revision of the authorities' medium-term fiscal projections from a deficit of 1 percent of GDP to 1½ percent of GDP. Noting the staff's projection of a cyclically adjusted medium-term fiscal deficit of 2-2¼ percent of GDP, most Directors agreed that risks on the revenue side make an overshooting of the authorities' projected fiscal deficits likely, since growth assumptions appear optimistic in light of recent developments and there are uncertainties about future tax revenue from the financial sector. They encouraged the authorities to take action over the medium term to boost revenue and slow expenditure in order to move the cyclically-adjusted medium-term fiscal deficit gradually back toward one percent of GDP, with automatic stabilizers allowed to operate freely around this path; and a few of these Directors urged an even more ambitious consolidation. Such a lowering of the medium-term cyclically-adjusted deficit would increase room for future countercyclical fiscal policy; build a buffer against long-term public liabilities related to population aging; reduce crowding out of private sector activity; and prevent any weakening of fiscal credibility. Some Directors, however, did not believe that the widening medium-term fiscal deficits would damage fiscal credibility, since the fiscal rules will continue to be applied and the fiscal position will remain sustainable.

With regard to taxes, Directors felt that it would be more efficient to raise revenue by broadening the base of existing taxes than by raising tax or social security contribution rates. In this regard, Directors welcomed the authorities' intention to streamline corporate taxation and suggested that other areas of the tax system could also benefit from a simplification of special tax treatments introduced in recent years.

On public spending policies, Directors recognized the need to respond to the demand for better public services. However, they expressed concern about the size of the increases in spending, and considered that more moderate increases would help contain medium-term fiscal deficits. Directors stressed that the speed at which expenditure is being increased also raises the risk of spending inefficiencies. They welcomed the ongoing reforms to the public expenditure management framework, which will help minimize these risks, but some cautioned that the effectiveness of these reforms in increasing efficiency is not yet known. Some Directors considered that scope exists for greater private, or user-fee financed, provision of public services, although it was noted that this should not be promoted at the expense of equity or efficiency, particularly where there are market failures.

Directors observed that the strength of the United Kingdom's underlying fiscal position depends importantly on containing future public pension obligations, which in turn depends on adequate individual retirement saving. They agreed that the recent proposals to simplify the tax treatment of retirement saving would facilitate such saving, and encouraged the authorities to consider further measures to enhance the transparency of various pension and saving instruments.

Directors considered the fiscal framework to be transparent, comprehensive, and forward-looking. A number of Directors observed that past budgetary over-performance has resulted in the sustainable investment rule not being as helpful as in the past in guiding future fiscal policies. These Directors, while noting that the sustainable investment rule is intended to apply at all times, saw merit in the authorities reviewing the fiscal rules, with a view to clarifying their interpretation and tightening their role in anchoring fiscal policy. In this context, a few Directors noted the relevance of the Stability and Growth Pact in determining and assessing fiscal policy. Other Directors noted that stability in the rules framework promotes clarity and predictability and enhances the credibility of fiscal policy, and saw the benefits of retaining a framework that is well understood by market participants as the guiding principles for fiscal policy.

Directors supported the authorities' strategy to foster medium-term productivity growth. In this connection, Directors endorsed the authorities' focus on promoting competition, labor force skills, and research and development activity. They commended the recent strengthening of the competition framework—particularly boosting the powers of the competition authorities—and encouraged liberalization of land use and planning restrictions. Regarding skills, Directors noted that the United Kingdom's education spending levels are similar to those of comparable economies, and that the emphasis should therefore be on improving delivery.

Directors noted that the United Kingdom's employment rates are among the highest in industrialized economies. They commended the authorities for the success of active labor market programs in reducing joblessness among the young and encouraged tightening job-seeking incentives in similar programs aimed at other socio-economic groups.

Directors welcomed the findings of the Financial Sector Assessment Program (FSAP) conducted last year. They agreed with the FSAP conclusions that, overall, U.K. banks are sufficiently profitable and well capitalized to absorb the effects of likely macroeconomic shocks without systemic distress. Directors noted the significant difficulties of the insurance industry, and agreed that these do not appear to constitute a systemic vulnerability for the financial system. Nevertheless, they emphasized the need for close monitoring and supervision, and welcomed the authorities' prompt actions to strengthen the insurance regulatory framework. Directors supported the FSAP conclusion that the U.K. financial markets and infrastructure function well, and noted the need to continue intensifying surveillance of interinstitutional exposures, such as in the unsecured inter-bank segment of the money market. On supervision, they commended the authorities' high degree of observance of international standards and codes and the authorities' continual improvements to the framework. Directors welcomed the strengthening in recent years of the regime to counter money laundering, the financing of terrorism, and bribery.

Directors welcomed the United Kingdom's strong stance within the European Union in promoting trade liberalization, including with regard to removing barriers to imports from developing countries. Directors welcomed the authorities' support for the HIPC program and their commitment to increasing the budgetary allocation for official Development Assistance (ODA). They encouraged the establishment of a time path to accelerate progress towards the U.N. target for ODA of 0.7 percent of GNP.

United Kingdom: Selected Economic Indicators







2002 1/












Real Economy (change in percent)

Real GDP









Domestic demand









CPI (excluding mortgage interest; RPIX)









Unemployment rate (in percent) 2/









Gross national saving (percent of GDP)









Gross domestic investment (percent of GDP)










Public Finance (fiscal years) 3/


General government balance









Public sector balance









Public sector cyclically-adjusted balance









Public sector net debt










Money and Credit (end-year, percent change)



















Consumer Credit










Interest rates (year average)


Three-month interbank rate









Ten-year Government bond yield










Balance of Payments


Trade balance (in percent of GDP)









Current account balance (in percent of GDP)









Reserves (national valuation of gold,









end of period, in billions of SDRs)


Fund Position (As of December 31, 2002)

Holdings of currency (in percent of quota)




Holdings of SDRs (in percent of allocation)




Quota (in millions of SDRs)




Exchange Rate


Exchange rate regime




Present rate (February 3, 2003)


US$ = £0.6101


Nominal effective rate (1995=100) 5/









Real effective rate (1995=100) 5/ 6/









Sources: National Statistics; HM Treasury; Bank of England; International Financial Statistics; INS; and IMF staff estimates.

1/ IMF staff estimates, except otherwise indicated.

2/ ILO unemployment; based on Labor Force Survey data.

3/ For example, fiscal balance data for 2002 refers to FY2002/03. The fiscal year begins in April. Debt stock data refers to the end of the fiscal year.

4/ Includes 2.4 percentage points of GDP in 2000/01 corresponding to the auction proceeds of spectrum licenses.

5/ An increase denotes an appreciation.

6/ Based on relative normalized unit labot costs in manufacturing.

7/ Data as of November 2002.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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