Transcript

International Monetary Fund
Washington, DC, September 29, 2004

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MR. HACCHE: Good morning. Welcome to this press briefing on the IMF's latest report on the World Economic Outlook. There is simultaneous interpretation through the headsets provided with Spanish on Channel 2, French on Channel 3, and English on Channel 4.

I am Graham Hacche, Deputy Director of the External Relations Department at the IMF. To my right is Raghuram Rajan, the IMF's Economic Counselor and Director of the Research Department. To Mr. Rajan's right is David Robinson, Deputy Director of the Research Department. And to David's right is James Morsink, who is chief of the World Economic Studies Division.

Before turning to Mr. Rajan for his opening remarks, I should remind you, including viewers on our media website, that the report and the content of this briefing are under embargo until 11 o'clock this morning, Washington time. I would also remind you that tomorrow morning at this time, the Managing Director, Rodrigo de Rato, will hold a press conference here previewing this weekend's ministerial meetings.

Raghu?

MR. RAJAN: Good morning, and thank you for being here today. The budding recovery we saw in the spring has matured over the summer and become more widespread. Because of the tremendous growth in the early part of the year, we have raised global growth forecasts from the one we made in April to 5 percent for 2004. This is the fastest in nearly 30 years. For 2005, however, we have lowered our forecast slightly to 4.3 percent, largely reflecting the effects of higher oil prices.

These are still very healthy numbers, though given the continuing volatility in the oil markets, the risks to the forecast are on the downside. Let me now turn to specific countries and regions.

The United States, which led the way out of the recession, recently hit a soft patch. With failing fiscal stimulus and higher oil prices weighing on consumption, much will depend on continued employment growth. Nevertheless, this is a soft patch, not a sinkhole. The measured pace of withdrawal of monetary accommodation should continue. On the fiscal side, however, despite recent revenue buoyancy, we see red ink stretching into the future. Consolidation continues to be a priority, with the added benefit it will help reduce the large current account deficit.

Despite the recent softness, we have upgraded our forecast for Japan's growth. It is not enough, however, for Japan to simply emerge from its over a decade long period of stagnation. The rapid aging of its population has raised the bar. Japan has to recover some of its past vitality, in particular by subjecting its domestic and financial sectors to the same competitive forces that have made its export sector thrive.

In the euro area, the recovery has gained momentum, though growth is still the lowest amongst developed regions, and especially in Germany it remains overly dependent on external demand. European leaders have enacted key reforms, but there are signs that people are experiencing reform fatigue. Far too many in Europe seem to have concluded that the good life and economic dynamism are contradictory terms, even though examples from Europe itself suggest this conclusion is incorrect. They might do well to remember the words of the Italian author, di Lampedusa, "The more things have to remain the same, the more things will have to change."

Growth has been particularly strong in emerging Asia, with China picking up speed again. The question increasingly is not hard or soft landing, but whether China will land at all. In its own long-run interest, we strongly believe it must land. India's growth will soften a bit because of the vagaries of the monsoon. India has to improve its infrastructure even while bringing overstretched government budgets back into balance.

Latin American growth has rebounded with Brazil's reforms finally paying dividends. Domestic demand has picked up across the region on the strength of improving confidence. But Latin America's problem has never been achieving growth. It has been to achieve sustained growth. Reform efforts have to continue so that adverse debt dynamics do not play the spoiler, as they have done so often in the past.

Higher oil prices are benefiting the Middle East as well as countries in the Commonwealth of Independent States. The critical task for all these countries will be to use the budgetary windfalls wisely while diversifying sources of growth so that they don't fall prey to the curse of oil.

Emerging Europe has continued to thrive with most economies experiencing rising domestic demand and strong export growth. Many of these countries have high fiscal and current account deficits which need attention, especially given rising oil prices.

A particularly encouraging development is the strong growth expected in Sub-Saharan Africa as a result of improving macro fundamentals, higher commodity prices, including oil windfalls, somewhat better access to industrial country markets, and reduced external debt burdens, some of it through the HIPC Initiative. It is important for these countries to build on these gains by creating the institutions that they need for continued growth.

Turning to risks, we are reminded in some ways that long-term trends will eventually, and most unexpectedly, become short-term policy concerns. For instance, the phenomenal growth of China could have run a few more years without weighing on global energy resources. But because it accompanies the global recovery, the loss of oil production in certain quarters, and the targeting of oil supply by terrorists, oil prices have risen sharply. While it would be alarmist to call this the first resource crisis of the 21st century, it is certainly a wake-up call.

We have to realize that in the long run, and without dramatic technological change, it will simply be unsustainable for every Chinese or Indian household to consume as much energy and as inefficiently as the average American suburban household. Clearly, all countries have to increase incentives for both conservation and energy efficiency, while removing unnecessary impediments to exploration and production.

Turning to the short run, our models indicate that for developed countries, the direct effects on growth and inflation of oil prices at current levels are likely to be moderate. But monetary authorities have to be vigilant. The Federal Reserve can implement a measured increase in interest rates without fearing runaway inflation, while central bankers in Latin America, with a recent history of high inflation, do not have as much leeway because they have yet to build up the same level of credibility.

Of course, if central bankers are forced to raise interest rates in a hurry, overstretched housing markets in some developed countries could be affected, while some emerging markets with significant public and external debt levels could face difficulty.

Let me turn to another once distant concern. The retirement of the baby-boom generation is now less than one business cycle away! The WEO makes two important points about the challenges posed by aging populations in developed countries.

First, reform, especially pension reform, will become increasingly difficult to implement as populations age because it will hit retirees who are becoming more numerous daily and, thus, more politically powerful.

Second, the problems are large enough that no single-point solution can resolve it. For instance, if the fraction of the population consisting of workers was sought to be kept constant by bringing more working-age people into the workforce--this is called increasing the participation rate--we would require an average increase of 11 percent across the group of industrial countries. In Japan, participation rates would have to be above 100 percent. Presumably, the unborn and phantoms would have to be enlisted in the workforce.

But when greater participation is used in a package along with extending work lives and increasing the level of immigration, the required numbers fall dramatically and seem eminently feasible both politically and economically.

In conclusion, while downside risks have increased, global growth is still robustly above trend. Countries should use the relatively benign environment to re-create the room for policy maneuver that was given up while ensuring the recovery. There is also no better time for reform than the present, when recent adversity reminds citizens of the cost of standing still, while better times help ease the pain of reform. Domestic reforms in many cases can also contribute to reducing global imbalances.

However, people will need to be convinced that the benefits of reforms are worth the costs. That will require real leadership which I'm hopeful will continue to emerge in the years to come.

Thank you.

MR. HACCHE: Thank you.

Turning to questions, would you please wait for the microphone to come to you and then state your name and affiliation in the usual way.

First question in the front row here? QUESTIONER: You were saying that Latin American growth was not evolving in a sustained manner. But the countries have been following the IMF recommendations. So my question is, where was the mistake? What has to be done? And besides that, the World Bank said yesterday that poverty has not been reduced at all in Latin American countries in the last 20 years, while other countries like China, India, and Uganda have achieved record numbers. So what has been done wrong? What can Latin American countries do better?

MR. RAJAN: The comment that I made was not so much that they have done things wrong, but they need to continue doing what they are doing right. Latin America is doing a lot that is right, and it has a period of growth, and it should use the period of growth to strengthen some of those reforms.

Now, as you well know, in Mexico itself there has been tremendous progress over the last few years, but much remains to be done. For example, pension reforms still need to be undertaken, and there are a variety of other infrastructural issues which have to be addressed. The point was really, more needs to be done, but what has been done is good.

In terms of the poverty numbers, there is a lot of debate about whether, in fact, poverty is reduced or not in various parts of the world. I think that is an ongoing debate. But I think it is hard to imagine that without growth you will get poverty reduction, so the emphasis has to be to create that growth, but also at the same time to expand the infrastructure, to expand access to other people so that poverty also gets reduced.

QUESTIONER: Two questions if I may.

First, how concerned are you now about the U.S. current account deficit and the dollar? Some people are arguing that really it shouldn't be measured against the U.S. GDP, it should be measured against world trade, the growth of world trade as long as world trade is primarily denominated in dollars. Do you accept that argument, there really is no real need for concern over the current account deficit?

Secondly, on Asia, can you tell me what your inflation projections are? The Asian Development Bank last week, I think, projects a 4.4 percent inflation rate for overall Asia, excluding Japan, in 2005. Could you tell me what your calculations are, please?

MR. RAJAN: Let me first take the question on the current account deficit. It is a problem. We do not anticipate a sharp reduction over time. We don't anticipate an explosion, either, but we think that levels will not fall to levels that we feel comfortable with. It is an ongoing risk, that it might unwind in a disorderly fashion. When and how it will happen is unclear, and that's why it's a risk.

I think the big issue in financing the current account deficit is really the incentives of private investors outside the United States. Thus far they have been fairly cooperative, and again, there is no reason to believe they will turn tomorrow. But it is possible they could turn at some point, and that is the big risk there.

To the extent some of the incentives are motivated by trade, there might be a connection, but I am not sure I'd hang my hat on a very strong connection.

On the issue of inflation, let me turn to David.

MR. ROBINSON: Well, just to say if you look at Table 1.6 on page 33, you will find inflation projections for emerging Asia, for the group you mentioned: we project 4.3 percent for 2004, so very close to the projection of the ADB. I think if you look across the region, obviously inflationary risks differ quite markedly, being greater in places that are more advanced in the cycle like China, probably less so in places like Korea.

QUESTIONER: When you said the Government of India has to bring its overstretched budget into balance, do you mean just the government budget or also the losses of the state-owned companies?

Secondly, you also mentioned infrastructure. The government itself has said that it needs $115 billion to improve the infrastructure over 10 years. Do you see any IMF role in that? And, also, at what point will the rise in oil prices begin to hit India very hard?

MR. RAJAN: First, whenever we talk about budgets, we're talking about a consolidated budget, including potential losses of public sector enterprises, state governments and so on, as well as guarantees offered to various entities.

Second, I think, yes, there is a tremendous need for funding the infrastructure, while the government budgets are stretched. And so one has to think of innovative ways of making this happen. I don't think the IMF is the source here because the Indian Government is not in any form of crisis. But I think the issue is one of trying to find clever ways of funding infrastructure, some of which might include public-private partnerships, but also an adequate role for private investment and perhaps even foreign investment. I think one has to think of all these ways in order to get the infrastructure up and running.

On the issue of oil, I think in general developing countries are a little more susceptible to oil price increases, partly because they have a higher sensitivity to energy prices--their GDP is more energy-sensitive than in developed countries--but also the central banks have lower inflation credibility in general. That means that they have to be very vigilant to the effects of inflation, not just the first-round effects, but as it spirals into wages and further into inflation.

So that is an important concern that all developing countries should have, and they should be very vigilant and monetary policy has to be appropriately proactive.

QUESTIONER: We always hear that Germany is overly dependent on external demand. What is the IMF's magic bullet to fire domestic demand in the face of the aging populations and the concerns of the people who are nearing retirement?

MR. RAJAN: Well, magic bullets are rare. What you really need is a range of proposals, and I think Germany is undertaking some of them under Agenda 2010.

The problem is, there are a number of factors which are coming and hitting at the same time. For example, you have house prices falling, you have high unemployment, you have the aging populations, all of which weigh heavily on consumption but also to some extent on investment. For example, in the construction sector, you have had a decline for quite some time, and that is again weighing on domestic demand.

So I think that on the one hand, there is a need to continue some of these reforms, to increase labor market flexibility, but also to increase product market flexibility, and some of the reforms will impinge in the short run on consumption. For example, one thing we suspect is some of the pension reforms might have increased the desire to save and therefore reduced consumption. Now, in the longer run, however, some of these adverse effects will wane and I think Germany will resume growth. But, again, as in many situations, it is important to stay the course.

QUESTIONER: Would you please explain to us how you see the downside risk of the global economy linked to the oil prices, and especially because last year you told us here that at the price sustained--or increased sustained of $10 coming from 26.5, if I remember, the global economy will be downsized 0.5 percent. So why the economy this year is increasing to 5 while the oil price is coming up more than 10 dollars in your outlook?

MR. RAJAN: Very good question. Why have our projections increased for this year despite higher oil prices? The first thing is I think growth has been unexpectedly strong in the recovery; especially in the first quarter of this year, it was very, very strong. And that has set the stage for much of the growth projections for this year.

Now, as I said, going into 2005, the effect of higher oil prices will weigh somewhat, but also the withdrawal of some of the stimulus that supported the recovery will also weigh on growth. So you will have a moderation of growth in 2005.

I think our feeling is that at these levels of oil prices, even despite touching the highs of yesterday, the effects on developed economies are going to be moderate--moderate--but the question, of course, is to be vigilant. The issue is to be vigilant because there are, perhaps, aspects of oil price increases that are feeding through other channels than the direct channels. For example, consumer confidence, if it impacts consumer confidence, if all the talk about higher oil prices somehow does impinge there, there could be larger effects than we anticipate.

But, all in all, I think at these prices we don't think the effect will be huge. After all, we have 4-plus percent growth, and the effects will be relatively small compared to that. I think the big issue, as I said before, is for developing countries. They have to be much more vigilant, partly because they have great energy sensitivity and partly because inflation is less well anchored there.

QUESTIONER: I've got a couple of questions, if I may. The first is on China. In your box on China, you seem to some extent to be downplaying worries about whether a serious slowdown could cause serious effects in the wider world economy. I'm talking about a third of a percentage point of GDP. I just wonder whether that takes into account the effect it's going to have on demand for oil and oil prices and so on, so whether that's combined with the effects of higher oil prices.

And, secondly, I have a question about house prices, particularly in the U.K. There have been signs in the last week or couple of weeks that there has been a quite significant slowdown in mortgage approvals and lending. I just wondered whether that's the first sign of a natural correction to house prices in the U.K.

MR. RAJAN: Let me turn the first question to David and the second to Jim.

MR. ROBINSON: Okay. On China, our assessment when we look at the trade linkages, primarily--and that's the calculation that's used in this box as you said--is that the impact of a 10 percentage point decline in the growth of China's nonprocessing imports, technically speaking, would reduce growth in Asia by 0.4 percentage point, which is significant. It's a little bit more for the newly industrialized countries than it is for the other parts of Asia, but obviously in a region that is growing at 6 percent, a little bit more than that, it is not huge.

In terms of the effect on oil demand, I would have thought actually that would be modestly helpful, and it's not taken into account in our projections, in the sense that if China's import growth slowed, presumably its growth would be slowing as well and presumably its demand for oil would be coming down. And so the pressures on oil prices would tend to decline. And that would tend to be good for global growth, there would be some offset there.

MR. MORSINK: On house prices in the U.K., I would just point out that we see an adjustment of house prices as the most significant risk to the outlook. Analysis that we present in Chapter 2 suggests that house prices in the U.K. are about 15 to 20 percent more than what can be explained by underlying fundamentals.

Now, as you point out, there has been a recent slowdown in house price appreciation, and I think that's very much consistent with our view. In other words, we see the central scenario as a slowdown in house prices.

I would just finally note, though, that earlier analysis that we did in a previous WEO suggested that about 40 percent of house price booms, which is what has happened in the U.K., are followed by busts. So while it is not at all the central scenario, I would say there is a risk of an abrupt adjustment in house prices.

QUESTIONER: Mr. Rajan, on oil, how much of the current spike in oil prices is due to the surge or increasing demand in China and other Asian countries? Also, what price do you think oil has to reach to trigger a slowdown? And in that context, one hears that $40 from the '70s is really $70 today. What is the figure that you use? And, finally, on oil, since these forecasts are so good, typically, how did you fail to see this rise in oil prices, given the fact that we had not unexpected continuing fast growth in China and India?

MR. RAJAN: First, how much of the demand is from Asia? Our sense is that these numbers are all a little fuzzy, part of the reason why forecasts are hard in the oil industry. But 30 percent of the increased demand this year is from China and approximately 8 to 10 percent from India, and then other countries. The U.S. recovery has also taken up some of the increased demand. So the increase in demand has been unexpected. I think the IEA has been revising its forecasts up for demand quite a bit.

The issue of how serious is this--what price do we start getting worried at--my sense is that it's linear up to some point, that every additional dollar will weigh a little bit on growth. Our estimate, our rule of thumb, is that a $5 per barrel increase for a year affects global growth by about negative 0.3 percent and, of course, it varies across regions.

At what point does it start getting nonlinear and weigh much more? That is a hard question. And on your question about comparing it with the '70s, all we can say is that the oil price right now is in real terms way below what it was in the late 1970s.

There are a few other factors that are important to remember at this time to put the oil situation in perspective. First, oil intensity in developed economies was far higher in the 1970s. Second, the amount by which oil prices increased during that time was in relative terms much higher, at least over certain periods.

The third thing to remember, also, is that there was much less inflation-fighting credibility amongst the central banks. And one of the most important ways that the oil price affects growth is by leading to an inflationary spiral which then has to be counteracted by very, very tight monetary policy, which then creates the downturn. Our sense is that with greater inflation-fighting credibility amongst the central banks, lower oil intensity, and in a sense a relatively lower real price for oil, we are in a much better situation now than we were in the 1970s. So it is possible to exaggerate the current situation.

Of course, it's hard to tell where oil prices will go, and you talked about forecasting. We have done a study on forecasting oil prices, and our sense is that the best way to forecast future oil prices is to use today's oil price. It is as good as we get.

QUESTIONER: You mentioned that developing economies will be the most affected by the spike in oil price, especially with regard to inflationary pressures. I would like to know how far do you think interest rates would have to be raised in developing countries fighting inflation, and if you predict that there's a risk of a new debt crisis due to that?

MR. RAJAN: Well, there are two factors to think about. The first one is: do world interest rates go up, and--this is more a developed country factor--are developed countries going to raise interest rates? And that depends on how fast oil feeds into inflation. There I think there is more reason to be, not complacent, but at least to watch and wait, because as I said before, they have more inflation credibility.

So, to that extent, how much that feeds into external debt interest rates may be more limited. There is a measured pace of increase of interest rates the world over, but hopefully central banks will not have to raise rates too fast and too quickly because they have a little more time to wait and watch.

For developing countries' central banks, however, I think they have to be more vigilant, and it really depends on case to case, how quickly inflationary pressures might feed into wage increases and thereby into more generalized inflation. In some countries it may not, in some countries it may. So they have to be vigilant. And then if interest rates increase, of course, how much it feeds into their own domestic interest rates and the cost of their domestic debt.

At this point, the calculations that we have done do not suggest a reason for alarm.

QUESTIONER: In the case of Mexico, the report says that--or again emphasizes--the necessity for Mexico to go deep into the structural reforms. The question that I have is: Do you feel that there has to be some kind of wake-up call so political actors in Mexico will see the necessity of moving forward because this is a process that it has been following, at least for the three years in the Mexican congress. And in a broader sense, I wonder also, the report emphasized the necessity to have this process of structural reforms across Latin America. Last week, there were several Latin American Presidents here in Washington who talked about the necessity to put a human face on globalization. So I wonder if--do you see that this slow process toward reforms in Latin America is due to increasing political pressures, taking into consideration that we saw some political tumult last year in countries like Ecuador and Bolivia?

MR. RAJAN: Let me address the broader question first. I think it's mistaken to think that reforms necessarily hurt the poor. In my view, exposure to crisis and the downturns that arise are much more harmful to the poor. They're much less insulated, and they have much fewer reserves of assets to withstand them. Obviously, there are some reforms which are harder to bear than other reforms. And I think the issue is to work on a broad set of reforms, which also have the benefit of strengthening the situation of the poor, including issues like working out a better social security system which protects them.

On the issue of whether there is the possibility of moving forward in Mexico, I think we have seen some movement forward, for example with the social security institute pensions. But, yes, it would be good if the pace was accelerated. Obviously, this has to work with the domestic political configuration, and again, if there was a way that the consensus could be reached between the various parties, it would be a good thing.

David, do you want to add anything?

MR. ROBINSON: Well, just to say on the issue of pension reforms, which I think is one of the challenges facing Mexico, I think that in a way one wake-up call is just looking at the problems that have emerged in advanced countries from not having addressed that problem early enough and quick enough. I think in many developing countries, not just Mexico, perhaps this is an opportunity to move forward just so you can avoid the sort of problems we have seen elsewhere.

QUESTIONER: Do you support the European Commission's idea of opening up the Stability and Growth Pact, and how would you modify it?

MR. RAJAN: Well, there is a chapter in the World Economic Outlook this time which focuses on some of the experiences with the Stability and Growth Pact. I think we support some of the ideas that have been proposed, and let me come at the end to some of the difficulties in making this work.

But, first, we think it certainly makes much more sense to focus on making greater adjustments in good times. Those give you the reserves to have countercyclical policies in bad times. Also, placing much more emphasis on medium-term sustainability, on structural balances, on lowering the debt levels to help maintain sustainability, those are very good and sensible ideas. And I think that having a more credible enforcement mechanism, so reserving the sanctions for absolutely flagrant breaches of the target levels, while showing flexibility for temporary breaches, especially if they're for reasons beyond a country's control, and finally having an independent panel which might assess fiscal sustainability and fiscal plans, would also be a good thing. I think these are all very sensible proposals.

I have to say there is this tension between creating enough rules so as to have commitment and creating enough flexibility so that it doesn't become overly rigid and violated at every corner. I think that is really the struggle going on, and I think the proposals are a worthwhile attempt to improve the pact.

QUESTIONER: I was wondering if you could give us a little bit more insight on how you did the projections on Argentina, because as I understood, you think that the slowdown is going to be due mainly to the delay in the reforms. But there were many economists expecting the slowdown because after the bounce of the crisis, there is always a slowdown. So I was wondering if you could tell us a little bit more about that.

And second is your evaluation of the restructuring process. In fact, the government is saying that they are aiming to finish it at the end of the year. If you in your evaluation for 2005, you take account of that.

MR. ROBINSON: Well, on the forecast, I'm going to be fairly brief, which is just to say that clearly Argentina had a very sharp decline in GDP in 2001, 2002, and what we're seeing is in part a bounce-back from that. Yes, that will slow over time and that is what we're showing in our forecasts. And we're seeing some signs of it slowing indeed right now.

In terms of the debt restructuring, I think you know that in our view this is one of the key priorities for the Argentine Government. They're going to be proceeding with that over the next few months. We believe that is the critical thing, to get a credible medium-term framework for debt restructuring and a credible fiscal balance underlying that. And we hope that they will be able to achieve that with a fairly substantial creditor participation--a high level of creditor participation--over the next few months.

QUESTIONER: Despite all the good things the IMF has been saying about Brazil, Brazil has a forecast compared to the world, compared to Africa, compared to Latin America in the Western Hemisphere, very low. I'd like to have your assessments on that. Also, the report says that it was a good measure to put interest rates up in Brazil last month. I'd like to have your assessment on that as well.

MR. RAJAN: Well, first, our forecast is 4 percent this year, and I think that's a very healthy growth rate. Would more be better? Of course, more would be better, and we are hopeful that the reforms underway will create the platform for which--from which growth will be higher.

But I think, again, I want to emphasize the issue is sustained growth. It is possible to have 6, 7 percent for a few years and then plunge to minus 10 percent. What is more useful is to have a sustained growth path which is steady and maintains itself, and that, I think, is what Brazil is trying to achieve.

On the interest rate increases, clearly, this is somewhat precautionary in nature because of the precise issues that we talked about earlier, the potential effect of oil prices feeding into higher inflation. Inflation numbers have been reasonably high in Brazil. So I think that is a good thing to do, in anticipation. Hopefully, if the pressures wane, one might be able to maintain or even reduce those rates.

QUESTIONER: How urgent do you see reform of the pension system in Europe? And what's your assessment of the experience in France, Italy, and Germany?

MR. RAJAN: Well, "urgent" is, I think, a good word because I think there is not that much time before it starts weighing, before the retirees start increasing in number and this starts weighing. Also, as we emphasize in the Outlook, it becomes politically harder because you have to spread some of the pain on people who have been assured a pretty good pension, so they will have the incentive to oppose it.

We see pension reform as part of a whole package. It can't just be done in isolation. If you, for example, want to extend working lives, you also have to give the elderly more opportunity to work by increasing flexibility in the labor markets and by creating more opportunities there. So I would see pension reform as part of a whole package of reforms, which include product market and labor reforms.

We also, I think, have some suggestions in the World Economic Outlook. For example, we think that extending work lives, especially given that people are growing older, their life expectancy is increasing, that certainly seems a better way to do it than cutting benefits, if you had the choice between those two, and it also has better short-term effects. It doesn't force a much higher level of saving, which might then impinge on economic growth. So extending work lives may be a better way to do pension reform than cutting benefits.

But, in general, I think a number of measures have to be taken in concert, and I think when you look at it that way, it becomes a whole lot more feasible and less painful.

QUESTIONER: I have another question on the Stability and Growth Pact. You were elaborating on a few points that have been suggested by the EU Commission. But two other points are that under certain economic conditions, it should be allowed to get more time to get your budget deficit under control and secondly, countries that have a low debt relatively to others would also be allowed to have more time to get their deficit under control.

Aren't you worried that relatively to the current rules this will be weakening of the pact in practice?

MR. RAJAN: Well, there is always a trade-off, right? It makes sense to make the pact a little more contingent on the actual condition of a country. A country with very low debt has the fiscal room in some sense to take its time, and needs to sacrifice, if you will, less growth in order to maintain sustainability. So it seems that on one hand you should allow that country a little more flexibility. On the other hand, if you have a whole lot of contingencies of this kind, then, as I think you are hinting at, there is a sense in which there becomes a possibility for each country to claim a special exception for itself under its circumstances.

This said, I don't want to minimize the difficulty of trying to choose between these two corners. Sometimes "one rule fits all" is much easier to enforce, and therefore has more credibility. But if that becomes overly rigid, then it loses credibility for that reason because countries then say, you know, it doesn't really pay to adhere to this.

If something doesn't look sensible ex post, it is not a particularly credible rule. Therefore, you have to balance making it a little more sensible while at the same time having the credibility.

I think this is a difficult balance, and I think it's good that the debate is going on. And I am hopeful that the right mix will be achieved.

MR. ROBINSON: I was just going to add one point, which reinforces something Raghu said a little bit earlier, which is that I think one way of improving the domestic incentives for fiscal adjustments in these circumstances is to have some kind of independent assessment by a national independent board, whatever you care to call it, who put down fully and frankly how they see the medium-term situation of that country, and that, I think, would very much help the national debate in those countries. That's something we don't have in many countries at present.

QUESTIONER: This might require a bit of a stretch of the imagination, but are you sensing any kind of recovery in Iraq?

MR. RAJAN: I think the first step in Iraq is, of course, to deal with the security situation. In the same way as countries that suffer severe economic crisis rebound very quickly from that, once the immediate crisis has passed, one would be hopeful that Iraq would rebound very strongly once the security situation is dealt with. There are signs, certainly, of a rebound within Iraq itself--you know, goods in the markets, flourishing trade, and so on, but really to get the economy going, I think the security situation needs to be dealt with first. And then, of course, there is all the reconstruction possibilities that will increase once that happens.

QUESTIONER: Going back to the response of developing countries, especially countries with very little credibility or those who are building credibility in fighting inflation, the transmission mechanism, as you put it, in the '70s, in the oil prices, contractionary monetary policies, lower growth, wouldn't these developing countries face the same risk if central banks are to build this credibility, as inflation-fighting central banks, they would have to increase interest rates. And how do you see that impacting on growth in these countries?

MR. RAJAN: Yes, you are absolutely right, they would have to increase interest rates. The question is increase interest rates early and, therefore, head off the inflationary consequences, or wait to see inflation embedded, then have to increase them far more in order to wring out the inflation from the economy. And our sense is that doing it early and in a proactive way might be better than waiting, seeing the inflation take off, and then having to act very strongly and seeing even worse growth performance. So it is a choice between the lesser, if you will, of two evils.

QUESTIONER: Just to go back to the fiscal situation that looms in the U.K., you're recommending fiscal consolidation next year which is probably a year of an election in the U.K. I was wondering what prescription you had, whether it was cutting spending, raising taxes, or charging for public services? What would you recommend?

MR. RAJAN: Well, that's a good question. Let me turn it to Jim.

MR. MORSINK: I would just point out that the U.K. has a very sound fiscal framework and that it has been managed very well over the past several years. Net and gross debt in the U.K. are the lowest among the G-7 countries, and they have already enacted pension reforms, which is a challenge for many other advanced economies.

Nevertheless, there has been this increase in deficits in recent years, which has appropriately supported the recovery, but now that the recovery is in place, it is time for consolidation. We have already seen some consolidation this year, in 2004, of about 0.4 percent of GDP.

Now, looking forward, I think we broadly share the government's objective of reducing the deficit over the medium term to about 1.5 percent of GDP. I guess, we're not sure, though, that the measures are in place to achieve this objective. So I guess I'm going to sidestep your question a little and say this is the time to define those measures and reduce the risk of breaking the golden rule going forward.

MR. HACCHE: Thank you. Apologies to those of you that we didn't manage to get to this time. I remind you again of the 11 o'clock embargo and thank you very much for coming.

[Whereupon, at 9:54 a.m., the press conference was concluded.]