Transcript of a Conference Call on the 2008 Article IV Consultation with the United Kingdom
August 6, 2008Washington, D.C., August 6, 2008
MS. GAVIRIA: Hello everyone. I'm Angela Gaviria, Press Officer in the IMF's External Relations Department. This is the conference call on the 2008 Article IV Consultation with the United Kingdom. Let me start by introducing the speakers, Ajai Chopra, Deputy Director in the European Department and Mission Chief for the United Kingdom; and Peter Doyle, Division Chief also in the European Department. Ajai Chopra will be reading some remarks to start with, and then they both will be happy to take your questions.
MR. CHOPRA: Thank you, Angela. Good morning, or good afternoon to those of you in Europe. My name is Ajai Chopra. I headed the team of IMF economists that conducted the Article IV Consultation discussions with the United Kingdom. With me is Peter Doyle, who is in charge of the day-to-day work in the U.K.
The IMF Executive Board concluded its discussion of this year's Consultation on July 30th, a week ago. You have all the documents, but I'd like to draw your attention to three main points. After that, Peter and I will take your questions.
First, let me start with the economic outlook. It is clear that the outlook has deteriorated markedly in recent months. But it's important to keep matters in perspective. Specifically, for over a decade the United Kingdom has had a remarkable run with stable economic growth and low inflation. However, strains were emerging even before the economy was hit by major global shocks. Notably, inflation and inflation expectations were on the rise, the housing market was overheated, and headroom under the two fiscal rules was eroded. Moreover, the U.K.'s current account deficit, which has been in the 1.5 to 2.5 percent of GDP range in 2004 and 2005, rose to the 4 to 5 percent of GDP range in 2006 and 2007.
The current challenging economic environment is the result of both these earlier strains and the recent shocks to the global financial system and global food and energy prices.
With tight credit conditions, rapidly falling house prices, depressed equity prices, and weak income growth, private consumption and investment are projected to slow sharply. We expect that activity will continue to decelerate for the next couple of quarters or so. On an annual basis, economic growth is expected to slow to 1.4 percent in 2008 and fall further to 1.1 percent in 2009.
Given the substantial sterling depreciation in the past year, external demand would likely provide some relief. Net exports are projected to pick up some of the slack from the slowdown in domestic demand, especially in 2009 when the external markets are expected to improve.
On inflation, we expect the headline CPI inflation to rise to about 5 percent at the end of this year as the surge in global commodity prices and the recent depreciation of sterling continues to work through. But so long as wage restraint continues, the disinflationary impetus from the slowdown in activity is likely to keep inflation on track to return to target by 2010.
The second issue that I would like to highlight concerns the appropriate macroeconomic policy response to these more difficult economic circumstances. Two key elements of the U.K.'s policy framework, namely, maintaining public net debt below 40 percent of GDP, and an inflation target of 2 percent, are likely to be breached for extended periods.
Despite the challenges, our view is that these are not the right circumstances in which to loosen the targets on either the budget or inflation sides. Such steps would unnecessarily complicate the management of the immediate threats to stability and growth.
That said, a balance does have to be struck between the need to respect the framework objectives by avoiding an excessively sharp policy adjustment to achieve that aim.
Accordingly, for fiscal policy, our recommendation is that concrete adjustment plans should be devised to bring debt back under the 40 percent ceiling in a reasonable time frame. In that regard, we welcome the already announced fiscal adjustment of 0.5 percent of GDP in each 2009 and 2010. But this adjustment should be regarded as a starting point and as a minimum. More should be done on that front over the next few years. Frontloading the adjustment and elevating the status of nominal expenditure ceilings would send a strong signal of the government's commitment.
For monetary policy, the priority is to ensure that the recent spike in headline inflation does not lead to a wage-price spiral. Therefore, continued moderation in wage growth will be essential. On this, I would point out that the government's role in promoting wage discipline in the public sector has been exemplary. The challenge for the Bank of England will be to balance the upside risks to inflation and inflation expectations against the risks of an excessive disinflationary effect from the economic slowdown. With the flexibility allowed in the inflation targeting framework, the bank is appropriately setting its monetary stance to return inflation to its target level in about two years.
I would also like to emphasize that the mix between fiscal and monetary policy matters. Stronger fiscal adjustment would reduce the burden on monetary policy consistent with the inflation target. This better balanced policy mix would lessen reliance on domestic demand and facilitate stronger external support for activity, contributing to a reduction in external imbalances.
Third and finally, a few key points on financial markets. Market conditions remain difficult, not least because of skepticism about banks' robustness. As we note in the report, even where losses have been announced and capital raised, there are concerns that these adjustments focus on banks' trading books with prospective losses from credit impairment yet to be addressed. Further initiatives to strengthen bank capital, together with information disclosure, therefore, remain critical to boost confidence in banks' resilience.
Regarding the financial stability framework in the aftermath of the failure of Northern Rock, we are encouraged by the proposed reforms in this area, including steps to fortify the tripartite structure by enhancing the Bank of England's role in the financial stability framework, and to boost the supervisory capacity of the FSA. Meanwhile, particular care should be given to securing the legal basis for actions under the proposed special resolution regime to ensure its effectiveness. Moreover, pre-funding for deposit insurance, to commence as soon as conditions allow, would help improve the clarity of the tripartite authorities' role and the speed of bank resolution under the regime.
To conclude, by recent standards the U.K. is going through a difficult period. But the implementation of appropriate policies within the parameters of its well established macroeconomic policy framework, which has served it well over the last decade, will set it back on a stable growth path in coming years. We'd now be happy to answer your questions.
QUESTIONER: I know in your forecast there is no negative growth. But I'm wondering what odds you would give the chance of a recession.
MR. CHOPRA: You're quite right to point out that in our quarterly forecast, we do not have a negative number. But the forecast for the next few quarters, for quarter-on-quarter growth, is only about 0.1 or 0.2 percent.
When you've got growth that low, it doesn't take very much of a shock to push that into negative territory. So, it really depends whether there are shocks, including the way the external environment will turn out, and also on how the economy reacts to the headwinds it is already facing.
But the basic point is that when growth is getting so close to zero, essentially flat growth, it doesn't take very much to push that into negative territory.
QUESTIONER: You've given, you know, quite a strong indication that tighter fiscal policy is key in the next two years; I mean what sort of mix do you think is best in terms of tax increases and reduction in spending growth?
MR. CHOPRA: First, I should mention that we are looking at fiscal policy in terms of the aggregate. The specifics of the tax and spending side, we have not looked into that in detail on this mission. As you know, our mandate is primarily on domestic and external stability, and that implies that the focus is on the aggregate fiscal stance. How that is achieved is indeed a difficult question that we leave up to the authorities.
But I think the broader point that I would like to make in this regard is that, you know... when you look at our fiscal policy recommendations, one needs to keep that in perspective. The main point that we are making is that we do think it's important to maintain the debt rule. This has been an important part of the credibility of the fiscal framework. And using the analogy of an inflation targeting framework, it's not necessary to change this target, in our view, but rather, one needs to look at the time frame over which debt needs to be reduced to bring it back under the ceiling if it is breached. And I want to be very clear that we are not saying that fiscal policy should be tightened in order to meet the debt rule in a very short horizon, because that would certainly be overkill. But at the same time, reforming the fiscal rules to allow a loosening of fiscal policy in the short term would not be a sensible approach either.
QUESTIONER: But just to be clear, I mean the report is quite specific that over the coming two fiscal years a tightening is advisable, both for, you know, the fiscal position in itself and the support that would give to monetary policy?
MR. CHOPRA: Again, to be very specific here, what we say is that in the 2008 budget, the authorities outline a medium-term adjustment path. This medium-term adjustment path implies structural fiscal adjustment, that is on a cyclically adjusted basis, of a 0.5 percentage point of GDP in each 2009 and 2010. That is in the authorities' plan. Our view is that, despite the concerns on the output side, with the concerns about inflation and long run inflation expectations, we believe that a commitment on this front should not waiver and that it should be regarded as a minimum.
QUESTIONER: In July, the World Economic Outlook was updated and the growth forecast was much stronger. This may be just a technical issue. But how is it that we have a prediction of much stronger growth in July, and now all of a sudden we're seeing a much weaker growth prediction? I'm just trying to understand that.
MR. CHOPRA: That's a very fair point. I think it's important to give you a little bit of background here. When the mission team was in London in May, you'll recall that we came out with the forecast at the end of that mission, which was for growth in both 2008 and 2009 to be about 1¾ percent. To be more precise, it was 1.8 percent in 2008. And 1.7 percent in 2009. Now, we maintained that forecast in the first report that we issued to our Executive Board, and it was right around then that a lot of the news, the economic data that started coming out, were much more grim than what we had expected.
Now, we knew that we would have to revise our forecast because of the data releases. But at the same time, we knew that the second quarter GDP numbers were going to come out on July 25th, and our Executive Board meeting was on July 30th.
So we faced the decision, should we revise our forecasts for the update of the World Economic Outlook, which was going to be released before the second quarter numbers come out, or should we wait for the second quarter numbers to come out? And we made the decision that we would wait for the second quarter numbers to come out on July 25 because that would give us the more complete picture rather than the partial bits of data that were coming out, and we felt more comfortable revising after the July 25 second quarter numbers, and that's why we ended up with this sequence of revisions. But even at the time that the World Economic Outlook update came out, we knew we would have to revise downward, but we just wanted to wait for the numbers to come out.
MS. GAVIRIA: If there are no more questions, we end the conference call here. Thank you very much, everyone, for participating.