Transcript of a Conference Call on the World Economic Outlook with Kenneth Rogoff, Economic Counsellor and Director, Research Department, IMF
September 11, 2003Transcript of a Conference Call on the World Economic Outlook (Analytical Chapters II and III) with Kenneth Rogoff
Economic Counsellor and Director, Research Department
International Monetary Fund
Thursday, September 11, 2003
MS. STANKOVA: Good morning, everyone. Thank you for joining us today. I'm Olga Stankova of the External Relations Department at the IMF, and this is a briefing to review the Analytical Chapters II and III of the latest World Economic Outlook. The briefing will be conducted by Kenneth Rogoff, IMF's Economic Counsellor and Director of Research, together with David Robinson, Deputy Director of Research, and Jonathan Ostry, Assistant Director and Chief of the World Economic Studies Division in Research. The authors of various WEO essays are also with us, and their names and titles are on the press summaries we made available to you in advance of the briefing.
The briefing is on the record and embargoed until 2:00 p.m. Washington time, which is 1800 GMT. A transcript of the briefing and video presentations on the analytical chapters will be posted on the IMF's web site at 2:00 p.m.
Before I turn the floor over to Ken for introductory remarks, let me ask you to limit your questions to the Analytical Chapters II and III. We will not take Chapter I-type questions today.
Let me now turn the floor over to Ken. Ken, please.
MR. ROGOFF: Thank you, Olga, and greetings, ladies and gentlemen, and welcome. As Olga said, I'm here with David Robinson and Jonathan Ostry, together with other members of the World Economic Outlook team. And before we turn to your questions, I hope it's okay if you'll permit me a few opening remarks, trying to set the stage for what we see as important in these chapters, which I realize many of you as journalists find rather forbidding because they contain quite a bit of analytical material.
First, we have three shorter essays: one's on the massive buildup in Asian reserves, emerging Asia; another is on how G-3 exchange rate volatility impacts developing countries, exchange rate volatility between the euro, dollar, and the yen; and the third on growth in the Middle East.
The other chapter is a longer essay that is based on relatively new data on emerging market government debt that suggests that if history is a guide to the future, there ought to be serious concerns about problems ahead, at least for countries that do not take advantage of the current relatively benign financing environment to broaden their tax base, strengthen tax administration, reduce unproductive expenditures, and improve debt management. This study should be viewed at the very least as a yellow warning light.
Let me first talk about the buildup in Asian reserves. Many economies, especially in Asia but also elsewhere, including Mexico and Russia, have been building massive claims on industrial economy governments in the form of foreign exchange reserves. Now, overall, after the Asian crisis of the 1990s, this has to be seen, of course, on the whole as a welcome development. A comfortable level of reserves gives emerging market economies a measure of padding to deal with shocks and other financial problems that, unfortunately, inevitably occur.
But a question that is increasingly coming up is whether this accumulation of reserves is starting to go too far, especially given the gaping imbalances in global and current accounts that we've been warning about for quite some time now.
So what we've decided to do in this chapter is try to look at the issue statistically to try to see if one can quantitatively rationalize the rise in reserves in terms of standard insurance type explanations. Yes, it's been big, but how big is it relative to import needs? How big is it relative to short-term debt that they might be trying to cover? How much of this buildup can be explained by insurance explanations? How much of the buildup in Asian reserves is really about saving for a rainy day as opposed to other policy objectives, such as limiting fluctuations in Asian currencies against the dollar?
The short answer we get is that the accumulation until the end of 2001 could be regarded as explainable or in line with fundamentals. The further run-up in reserves over the past 18 months, however, is much harder to rationalize. It's one thing to save for a rainy day, but a trillion dollars in reserves accumulation looks more like building Noah's Ark.
Most of the reserves are held in the form of very low-interest-bearing loans to industrialized country governments, making this an awfully expensive insurance policy when these governments typically have much higher interest-paying loans of their own sitting out there.
From a global perspective, we see two major concerns:
First, there is a strong case for broadly sharing the burden of adjustment to the inevitable closing of the U.S. current account, and somewhat more flexible exchange rates in Asia have to be considered as part of any long-run solution.
Second, someday Asian central banks may wake up to their massive, relatively unproductive reserve assets and begin to diversify more, out of dollars and possibly out of cash altogether. The larger these reserves grow, the greater the impact of this eventual diversification is going to have.
If the diversification comes too suddenly, there is the danger that Asian central bank funds, built up partly to ensure against hot money private capital flows, will themselves become the hot money of the future. These multilateral risks, of course, have to be weighed against domestic considerations, but it's our job to voice them.
Another reason to adopt a somewhat more flexible exchange rate is to be able to better absorb fluctuations in the exchange rates of the G-3 currencies. Another of our essays, entitled "How Concerned Should Developing Countries Be About G-3 Volatility," looks at the impact of G-3 exchange rate volatility on emerging markets and finds that, on the whole, it is less dramatic than one might have expected. Frankly, it's less dramatic than we expected when we undertook this.
It is true that for countries with relatively fixed exchange rate systems, especially if fixed to a single currency, then G-3 exchange rate volatility can be quite problematic, and even a relatively small amount of flexibility can potentially be quite helpful.
That said, we would strongly disagree with those who say that further tariff reductions, such as are being discussed in Cancun, are of no use if exchange rate volatility is not eliminated. Reducing exchange rate volatility might add a few percentage points to developing country trade, but eliminating all developing country tariff barriers would raise North-South trade by 20 percent and South-South trade by 50 percent. Compared to reducing tariffs, exchange rate volatility is a sideshow.
Let me turn now to the emerging market debt. Although relatively good data on external debt for emerging markets has been around for a long time, having consistent data across countries on domestic debt was harder to get. There are different accounting conventions, different meanings of what's public and private in different countries; and although there are numbers for different countries, it's difficult to compare them. And we need to be able to compare them in order to get an idea of whether a debt that's large for the United States might also be large, for example, for a country like Russia.
Until 15 to 20 years ago, this data deficiency really wasn't much of an issue, not having domestically issued debt, since very few emerging markets were able to issue domestic debt in any significant amount, anyway. However, the wave of financial liberalizations of the last 15 years has led to a sea change in this situation, as the chapter illustrates. Emerging market country governments having relaxed financial repression, are now issue domestic debt at market interest rates in record quantities. Indeed, as the chapter documents, average public debt levels in emerging markets are equal to or exceeding those of many industrialized countries as a percentage of GDP.
Is this a concern? Well, given that the revenue base of the average emerging market country government is much smaller than that of the average industrialized country government, and given that most of the debt crises of the past years have involved domestic debt, albeit dollar-denominated, we think this issue certainly merits attention.
The basic finding of the chapter is that, despite current near-record-low risk spreads on emerging market debt, the present environment, of course, is very benign in part to still low industrialized country interest rates. Many countries need to be alert to the possibility that financing problems may arise over the medium term.
The chapter looks at sustainability from a number of perspectives, not just one, and I want to emphasize that there is no magic cutoff number above which debt becomes unsustainable. Nevertheless, the historical evidence strongly suggests that there will be widespread problems if over time emerging market countries do not take measures to rein in expenditures and increase taxes, especially if debt levels continue to rise.
Simply put, the current benign financing environment provides a window of opportunity in which countries with particularly acute debt problems need to begin steering debt ratios to safer ground, ideally taking quality measures such as strengthening the tax base and reducing unproductive expenditures.
Dealing with long-term pension sustainability, a problem that, of course, is hardly unique to developing countries, is also critical. And, by the way, in case you ask, the World Economic Outlook has looked extensively at industrialized country debt issues in the past, and we're surely going to revisit this issue again. I would note, however, that whereas public debt in emerging markets has risen sharply in recent years and on average across the set of countries we looked at is at about 70 percent of GDP, this contrasts with industrial country debt as a percent of GDP, which now averages around 65 percent and down from 75 percent in 1995.
Finally, with the Bank-Fund Annual Meetings scheduled to be held in Dubai, it was natural for us to include one essay specifically on the Middle East. The first essay in Chapter 2 is entitled "How Can Economic Growth in the Middle East and North Africa Be Accelerated?" The essay, which built on work on growth in institutions from the last World Economic Outlook, explored different reasons why per capita income growth in the Middle East and North Africa Region has been so weak over the past 20 years.
The most interesting finding of the chapter, perhaps, is the differences across the region. In those economies that derive a large share of their income from oil, large governments have been the overriding problem, stifling private sector growth and making it hard to diversify production. In countries where oil revenue is significant but not dominant, poor institutions and corruption are the biggest single hindrance to growth. In many of the remaining countries, both issues—overly large governments and poor institutions—are problematic.
Before I turn to your questions, I just want to see if Jonathan or David wanted to add anything.
MR. ROGOFF: I guess not, and so we're happy to take your questions.
QUESTION: Yes, Dr. Rogoff, I was interested in the essay on the central bank reserves. The conclusion is that the accumulation is out of line with the fundamentals as laid out in the essay. But there was no positive conclusion as to what the reason was that the reserves are being accumulated. Obviously, one potential is, as you indicated, holding down the exchange rate volatility or holding down, presumably, the real effective value of that exchange rate.
If that is what China and others are doing, aren't they in violation of Article IV of the IMF Articles of Agreement, which says that members must avoid manipulating exchange rates in order to prevent effective balance-of-payments adjustment? And if that's true, what is the IMF going to do about it?
MR. ROGOFF: Let me plead to not being a lawyer and interpreting Article IV, but countries are allowed to choose their own exchange rate policy as long as they adopt policy measures that are consistent with it.
Now, that doesn't mean that we can't encourage countries to consider broader global issues in deciding the monetary policy and their exchange rate policy. Of course, while many of the emerging Asian economies are small individually, together they're large. They've really become a fourth locomotive in the global economy—indeed, one of only two, you know, that's really working at times.
And so certainly part of the point of the chapter is we're investigating what are domestic considerations for building up these large reserves, and people point fundamentally to insurance, saving for a rainy day. And as I said, we find it hard to rationalize the recent acceleration over the past 18 months in those terms.
Now, that is not to say that there aren't other factors which have been significant. The low interest rates in the industrialized countries have sent money all over the developing world in emerging markets in search of higher returns, and that is one of the reasons, a major reason for the benign financing environment in emerging markets at the moment that we talk about in the debt chapter. It's also one of the reasons there have been more flows to emerging Asia and elsewhere. And, of course, the decline in the dollar has played a role.
David, did you want to add anything?
MR. ROBINSON: I'd just like to add one point, which is simply to stress that we are suggesting more flexibility in the exchange rate management in many of these countries, not just or perhaps not even primarily for multilateral reasons, but these are actually recommendations that we believe are desirable for these countries for domestic reasons as well.
China is a very good example of that, where we supported the stability of the Chinese renminbi during the Asian crisis, we always argued that they would eventually need to move to greater flexibility to facilitate all the structural reforms going on in their own economy. So it's very important to recognize that we see this as something desirable for domestic reasons, but also for international reasons, as Ken said.
QUESTION: If I could just follow up, Dr. Rogoff, can you make a positive conclusion that the massive acceleration in reserve buildup is a sign that China and others are manipulating their currencies, or maintaining unfairly low valuations for their currencies?
MR. ROGOFF: No, I certainly wouldn't agree with that. What is true is that the massive reserve buildup reflects a lack of flexibility in exchange rates, and we think there are lots of good reasons for countries in emerging Asia, particularly as they become wealthier, particularly as their institutions improve, to have more flexible exchange rates.
You know, China is a very complex case. It's managing an economy which is growing at a very rapid clip. There are still very large differences in incomes across coastal China and agricultural China. It's almost like two different economies, 450 million people who live in coastal China and the remaining 700-plus million who live in the interior. And these are very difficult problems.
It's also true, as we pointed to in past World Economic Outlook, that there are potential problems in the banking system that may require government financing down the road.
So there are a broad range of domestic problems to suggest that this is a complex problem, and they have to weigh domestic considerations against these multilateral considerations. And as David said, the IMF has been saying for a very long time that China in its own interest would be well advised to move towards a more flexible exchange rate system. But I think at the same time, we can agree that the pace and timing of this is a very difficult call.
QUESTION: Yes, good morning. Regarding the Chapter III about debt, I'd like to have your opinion about the agreement reached with Argentina yesterday that has just announced the default in debt with IMF two days ago.
MR. ROGOFF: We're not going to comment on that kind of issue today, and we'll take country-specific issues next week.
I will say that Chapter III looks at the history of restructuring and the history of defaults in international markets, and also some of the related work that's been done in the Research Department. And certainly defaults on international debt is something we've been seeing for hundreds of years, and it's not something unique to emerging markets. The industrialized countries earlier in their past have done this. If you go into the 1800s, Spain defaulted on debt seven times, Germany and Austria five times, et cetera. There have been many, many incidents over the past, and one of the factors that we try to weigh in doing the chapter is what the likelihood is of having these problems come in the future, given what we've seen in the past.
MR. OSTRY: I would just say on the issue of defaults and distressed restructurings, I think one of the points the chapter makes in looking at how countries have actually brought down their debts is that restructurings are not necessarily a panacea. In some cases, restructurings have been followed, as Ken mentioned, by restructurings a second and third time.
Other countries have actually been successful in sustainably reducing their debt by fiscal consolidation and growing their way out of the problem.
So restructurings are not a panacea, and there are other ways of getting down your debt.
MR. ROBINSON: I might just make one subsidiary point, which is that perhaps Argentina is a good example of one of the key messages of this chapter, which is to use the good times to address debt sustainability problems and prevent them becoming a problem in the sense that, as I think we now all know, in the late 1990s Argentina probably did not do enough to bring down its public debt at a time when the economy was doing relatively well. And that was a major contributor to the crisis later on.
And right now we are at a time when conditions for emerging market financing are relatively good, and it is another opportunity for other countries to take the steps that they may need to bring down debt over the medium term, and there are lots of suggestions to that end in this chapter.
QUESTION: This question of foreign exchange reserves, one thing I'm interested in. You've looked at them, looked at kind of the optimal level in terms of historical relationships over some time. Is it at all conceivable that the extreme volatility during the Asian financial crisis actually justifies a higher level of reserves, even though, of course, you don't have enough data, I guess, to look at that scientifically with econometrics?
MR. ROGOFF: Yes, certainly it's notable that the countries which have had the sharpest reserve buildups are largely ones that experienced crises. Naturally, outside of Asia, Mexico and Russia have had substantial reserve buildups. And we certainly applaud countries building up their reserves to self-insure.
That said, the reserve accumulation has been growing at a very rapid clip the past 18 months, and while there's no magic formula to suggest what the right size is, I do think that the analysis in the chapter gives one reason to be concerned if this buildup continues at this pace in the future.
You're right, there's no magic number, but this is an attempt to try to say something more concrete. But it certainly leaves open the question that more insurance funds could be welcome.
But there is a big cost to this. These are loans being made to industrialized countries at very low interest rates. And as I mentioned earlier, from a multilateral perspective there's a concern that as these get larger and larger and the yields are low, someday the Asian central banks and other central banks that have built up large reserves may feel compelled to diversify. And if this happens too rapidly, the results could be somewhat chaotic.
MR. ROBINSON: Just to add one thought to what Ken has said, there is a box in this essay, Box 2.3, which looks at this issue in a little bit more detail. Certainly, as you said, you know, the volatility and the Asia crisis and the desire for much greater self-insurance by these countries is a very understandable reason for building up reserves. But the work that is cited there tends to suggest that while these things obviously vary from country to country, once your reserves start to get above the level of short-term debt, unless you have a large current account deficit or unless you have a significantly overvalued exchange rate, the sort of extra bang for your buck in terms of reducing the risk of crisis starts to decline quite a lot.
Now, it varies, of course, across countries, but as you'll see from the chapter, the ratio of reserves to short-term debt in Asia is now five and a half, so it's well above one, and there are current account surpluses in just about every country. And I don't think we would say that exchange rates are presently overvalued. So I think that box gives you a little bit more evidence on that issue.
QUESTION: Yes, you said the restructuring isn't a panacea. And I would like to know how can emerging market countries begin to lower the exposure on debt. And at what level of (?) will be (?) Argentina to make sustainable debt?
MR. ROGOFF: The kind of measures that can be taken for countries that aim to avoid restructuring—and many countries are striving hard to not have to face restructuring—include trying to reduce unproductive government expenditures; they include trying to broaden the tax base, make tax collection, administration better so that of the posted tax rates more gets collected; and other such measures to strengthen their systems.
There isn't a magic number, but it is true that if you look at the debt/GNP ratios in emerging Asia and Latin America, they are around 60 percent.
Now, it's true that these are roughly within the Maastricht criteria limits that European countries apply to themselves. On the other hand, these countries on the whole have much lower tax bases than the European countries. So something has to give in that equation, that either taxes have to go up, expenditures have to go down, or there has to be restructuring at some point. And the choice of policies, you know, clearly lies with each individual country and its circumstances.
I think what the chapter says is that given the current levels of emerging market debt and looking at past government spending and tax behavior, significant adjustment is still needed across a broad range of countries in order to ensure medium-term sustainability. And I'd further say if history is any guide, many countries will make these adjustments and many countries will avoid these problems, and we're certainly seeing that. On the other hand, there will probably be a few that don't.
MR. OSTRY: Yes, I'd just add a couple of things. I think the way the chapter kind of presents the issue—how can they bring down their debt. I think what you have to look at, as Ken mentioned, is the weaknesses in the fiscal systems that have been responsible for debt being, on average, substantially above levels that these countries can sustainably run. And there are weaknesses in their fiscal systems that Ken mentioned, including the fact that effective tax rates—I think it's quite staggering if you look at one of the tables in the chapter. Effective tax rates in emerging markets outside Eastern Europe are on the order of 10 percent, which is barely a third, I think, of corresponding levels in industrial countries.
So there is the tax issue. There is the fact that expenditures tend to be procyclical in emerging markets, very much in contrast to industrial countries.
And then I think a third issue, which is related also to work that we undertook in the last World Economic Outlook, is that the growth record of these countries in terms of having a sustainable record of fast growth is not as good as it should be, and that's related to the quality of institutions in a number of emerging markets. And I think some of the work we did last time suggests that, for example, if Latin America could adopt the type of institutions that advanced countries have, it could durably raise its sustainable growth rate by 1.5 percent a year. And in Asia, the gains would be perhaps double or more that.
So there are a lot of gains from institutional improvements that can raise your growth rate, and as I mentioned earlier, I think that some countries have, in fact, the record shows, been able to bring their debt down in a sustainable way by fiscal and structural reforms that have raised their growth rates.
QUESTION: Yes, I was just wondering if you could talk a little bit about what makes you optimistic that the countries will address the debt problem given the trend line is so sharply up in increasing debt, and given that it seems—if you look at past history, the lost decade of the '80s, that a lot of countries have failed to address this issue in the past. I guess—do you see any signs of what the countries are moving to address the question? Has there been any turnaround in this growth in debt? Just what gives you reason for optimism?
MR. ROGOFF: Well, there have been countries that have graduated from having debt problems, and I think Chile would be one that I would identify. Chile in the past has defaulted three times in its past history and shared at that time a common characteristic among many of these countries, which I would describe as debt intolerant, an analogy to the medical term "lactose intolerant." That is, incidentally, the title of another IMF research paper. And that when they run into relatively low debt levels due to weak institutions, weak tax collection, they run into problems.
Some countries have graduated, and Chile is an example where it has gotten its public debt/GDP ratio way down. Its spreads are much lower. Mexico is certainly doing very well considering where it was in 1995.
And if you go further back in the past, there are countries, for example, Greece, I think, had defaulted four times in the 1800s, and Portugal six times; actually, France has defaulted eight times. And they all seem to make it after a while, and countries do emerge from this, but it takes a very long time.
Now, if you look at the key Figure 3.8 in the chapter III, where basically we look at how big are countries' debts and how big are the surpluses they're running and what would they need to stabilize their current debt/GDP ratios, and for the industrialized countries, it looks okay, although, admittedly, we don't have pension liabilities, and we'll talk about other things next week. But for the emerging markets, an awful lot are on the wrong side of the line. And there's certainly a question going forward how many of them will improve. I mean, today I think everyone applauds what's going on in Brazil, which still, of course, has many difficult problems ahead and a high debt level. But there have been many encouraging developments there, and President Lula has made many brave and difficult decisions and has put together a superb economic team. And there are certainly countries around the globe that are struggling, successfully, to address these problems.
But I think what we would guess is that, going forward, while many if not most countries will succeed in avoiding at least a traumatic restructuring, there will be some left behind. And I think it's our job in surveillance, especially in the current benign financing environment, to raise a yellow light. Figure 3.8 is screaming out that there are imbalances that need to be addressed, and we suggest some ways to do them.
David or Jonathan?
MR. ROBINSON: I would just add, you posed the question, Why are we optimistic? In terms of the chapter, I don't think the chapter is either optimistic or pessimistic. I think what the chapter is saying is that whether countries are able to reduce their debts depends on the policies that they are sustainably able to pursue and that we offer some examples of countries that have sustainably brought down their debts by adopting the kinds of—the package of policies that we recommend in the chapter. And, equally, we give examples of countries that, as Ken mentioned, are on the wrong side of that 45-degree line in the figure he mentioned and have been there before and have gotten into trouble.
So I don't think the chapter is actually optimistic or pessimistic, but I think the issue is really what kinds of policies the countries adopt.
MR. ROGOFF: We also have with us here Tim Callen, and I wanted to see if he wanted to add anything to answer this question.
MR. CALLEN: Just adding on to this, the calculation in Figure 3.8, means on average emerging market countries need to improve their primary balance by that 1.5 percent of GDP to get in a position where they could stabilize their public debt ratios.
OPERATOR: And we have no further questions in queue.
MS. STANKOVA: Thank you, everyone, for being with us today. The embargo is 2:00 p.m. Washington time. If you would like to have a copy of Ken's introductory remarks, please send me an e-mail or give a call and we will send them to you.
If you have any follow-up questions, please feel free to contact Ken directly at firstname.lastname@example.org or myself at email@example.com, and we will do our best to arrange answers for you.
Ken's remarks and responses to your follow up questions will be embargoed until 2:00 p.m. Washington time as well.
And we look forward to seeing you in Dubai at the WEO Chapter I press conference.
Thank you. Good-bye.