Concluding Statement of the IMF Mission on Euro-Area Policies
June 20, 2011
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
June 20, 2011
1. A broadly sound recovery continues, but the sovereign crisis in the periphery threatens to overwhelm this favorable outlook, and much remains to be done to secure a dynamic and resilient monetary union. A strong core is pulling ahead of a periphery facing daunting challenges, with very high debt levels, severe competitiveness problems, and fragile banking systems. Strong policy action by national authorities is a prerequisite, but should be backed by a truly cohesive approach from all euro area stakeholders. While courageous attempts have been made to address the crisis, policymakers are yet again facing uncomfortable dilemmas, raising uncertainty about the final outcome. With deeply intertwined fiscal and financial problems, failure to undertake decisive action could rapidly spread the tensions to the core of the euro area and result in large global spillovers. These risks currently dominate the policy debate, but moving ahead with a broader policy agenda to secure stronger potential growth and establish a more resilient Economic and Monetary Union (EMU) is equally pressing.
2. A more cohesive and cooperative approach is needed to manage the crisis in the periphery. Crucial is a determined commitment to adjustment in the program countries, including immediate and far-reaching structural reforms and an ambitious drive to open up the economy to foreign competition and foreign ownership along program commitments. Privatization will contribute to these objectives beyond helping to establish debt sustainability. But continued financial support from other euro area members is also needed. Rapid implementation of the commitment to scale up the European Financial Stability Facility (EFSF) and a further extension of its potential uses (e.g., to secondary market purposes and term funding guarantees) would send a much needed signal that member countries “will do whatever it takes to safeguard the stability of the euro area.” In this context, it will be essential to bring the unproductive debate about debt re-profiling or restructuring to closure quickly, and avoid any impression that under the European Stability Mechanism, financial support will be conditional on debt restructuring. Policies to stop contagion from sovereign debt adjustment or re-profiling are at a premium.
3. Even if the periphery crisis can be contained, a broad policy agenda lies ahead to boost growth and make EMU more resilient. In many ways, the current recovery is healthy, with growth better balanced in the core economies, and becoming less dependent on public support. Still, potential growth needs to be boosted significantly: among other things we would emphasize the need for a stronger banking system; a faster development of capital markets; more economic and financial integration; and a strengthening of economic governance, building further on recent, welcome initiatives. In non-core economies, up-front structural reforms are even more important to rebuild competitiveness, rekindle growth, and combat unemployment.
4. Against this background, continuing fiscal consolidation broadly as planned will support confidence. Consolidation is proceeding, but it will be important that announced plans are implemented to ensure that the targets agreed under the Excessive Deficit Procedure (EDP) are met. Faster growing economies should let automatic stabilizers work and reach their EDP targets earlier than planned. Crisis countries might have to extend their plans in line with program requirements, but consolidation will have to continue. Given market pressures, the positive confidence effects from fiscal adjustment—both for the euro area itself as well as global spillovers—could be sizable.
5. Given the expected path of the recovery, the normalization of interest rates should proceed gradually. This will help keep inflation expectations well-anchored in the face of high headline inflation and a slowly closing output gap. Moving cautiously will help limit stress from higher interest rates that could be felt in the periphery. At the same time, unconventional monetary measures should remain in place until financial market tensions have been addressed, including through completing the stress test follow-up and solving problems related to the funding of private illiquid assets.
6. Strengthening the banking sector is a top priority. The European banking model is traditionally one of high leverage, and capital positions have to be strengthened fundamentally. The stress tests provide an opportunity to do so in a timely manner, which is especially relevant in the context of the current crisis as a disorderly outcome cannot be excluded. To create confidence, the terms of the follow-up need to be announced well before results are published. Preference should be given to market-based solutions, including private capital raising and cross-border mergers and acquisitions. Public support may nonetheless be necessary and should be made available in a manner coordinated across the European Union (EU).
7. It will be important to get deleveraging right. Re-developing the market for securitization, appropriately regulated and based on high quality standards, should safeguard credit supply as bank deleveraging proceeds. More generally, European regulators should welcome and actively support the development of market-based alternatives for corporate finance to reduce the dependency of the euro area economy on the banking system. Many banks still rely heavily on European Central Bank (ECB) financing, and market access might not be immediate even after a recapitalization. A conditional term funding facility for private illiquid assets, possibly operated by the ECB but with the explicit backing of euro area sovereigns (e.g., via the EFSF), would smooth the transition, while protecting the ECB’s independence and flexibility and reinforcing the incentives to tackle the banking problems at their root.
8. More economic and financial integration is essential for a dynamic and stable EMU. Policymakers have focused on national priorities, but the key to success is the strength of the economic union. This calls for the completion of the single market to boost both growth and stability. The integration of labor, goods, and services markets must continue, but progress is particularly important in the area of capital. A fully integrated economy has no need for “national champions,” and the relevant Directives for Cross-Border Acquisitions and Takeovers should be applied, and reviewed where necessary, to overcome the formal and informal national obstacles the free flow of equity capital.
9. Strong and common rules are a prerequisite for the single financial market. We strongly support the single rulebook and rapid progress toward common supervisory practices focused on the riskiness of activities rather than the location of financial institutions. To ensure financial stability and minimize the scope for regulatory arbitrage, Capital Requirements Directive 4 (“CRD4”) should implement Basel III swiftly and without exceptions. Capital requirements should be set at an ambitiously high level, with significantly topped-up capital demands on systemically important financial institutions, reflecting the prevailing balance sheet uncertainties. Consideration should be given to exceeding Basel III minima, especially as the European financial stability framework remains incomplete. At the same time, there must be sufficient flexibility for the introduction of macro-prudential tools to fend off future asset price bubbles. The European Systemic Risk Board should play a prominent role in the coordination and calibration of such measures, including home-host coordination and reciprocity. Given the market perceptions of sovereign risk, the zero risk weight for sovereign bonds in bank balance sheets will need to be reconsidered.
10. All this points to the benefits of making faster progress toward a unified European financial supervisory and stability framework. The more rapidly the European Banking Authority will become effective, the sooner it can guarantee a high standard of supervision for banks operating across borders, including through the building of a prudential database and data sharing with and among national authorities. Progress toward an integrated framework for crisis prevention, management, depositor insurance, and resolution needs to be accelerated. And the ultimate goal should be a European Resolution Authority backed by a deposit guarantee and resolution fund that would address the issue of burden sharing and provide a euro area-centered backstop for both liquidity and solvency support.
11. Without political union and ex ante fiscal risk sharing, stronger governance of the euro area is indispensable. To improve fiscal discipline, the efforts under way to strengthen the SGP’s preventive and corrective arms and upgrade national budget processes are welcome. The Excessive Imbalances Procedure (EIP) has the potential to detect and help correct macroeconomic imbalances, and the European Semester and Euro Plus pact should improve policy coordination and shore up the political will to implement structural reforms. However, to make a difference, all these governance tools will need to be made more binding and relevant for national decision making—for example, through the consistent application of Reverse Qualified Majority Voting. The in-depth investigation to start the EIP should be activated automatically based on a small set of scoreboard indicators, and the ensuing process based on tighter deadlines. The European Parliament plays a crucial role in the reform of the governance framework, but its application should remain the domain of the Commission and Council.
12. Executing the structural reform agenda with more emphasis on ensuring contestability and competition will greatly bolster growth prospects. The path to higher, balanced, and sustainable growth is through deeper market integration and improved market flexibility. Many of the underlying issues are well known. The new governance tools are an opportunity to re-energize the reform agenda which includes: adjusting tax and benefits systems, collective bargaining systems, and employment protection to increase labor market participation and create and sustain jobs; opening up services and goods markets to lift competitiveness; and lower opening and closing costs for firms will improve the business environment and help foster entrepreneurship, innovation, and productivity.
13. Given the euro area’s role in the global economy, success in addressing the sovereign crisis and raising growth has a significant impact elsewhere. A cohesive and cooperative approach containing the crisis in the periphery will limit global spillovers. However, an intensification of the crisis, especially if stress were to spread to the core of the euro area, would have major global repercussions. At the same time, the rest of the world will profit from policies that lift the euro area’s growth potential, and would have positive, though modest, external spillovers.
14. The EU’s continued support for a successful completion of the Doha round of trade liberalization remains essential.