Transcript of a Press Briefing on the International Monetary Fund’s Fiscal MonitorBy Carlo Cottarelli, Director, Fiscal Affairs Department, and Senior Advisors Philip Gerson and Gerd Schwartz
Friday, May 14, 2010
ALISTAIR THOMSON: Good morning and welcome to the IMF and welcome to those journalists participating online on our Online Media Briefing Center.
I’m Alistair Thomson of the IMF External Relations Department. With me on my right I have Carlo Cottarelli, Director of the Fiscal Affairs Department; Philip Gerson, Senior Advisor in the Department; and Gerd Schwartz, who is also a Senior Advisor in the Fiscal Affairs Department.
We will be talking to you today about the Fiscal Monitor, which was released overnight on the Online Media Briefing Center. The document and the contents of this briefing are all embargoed until 11 a.m. Washington, D.C. time. We also will be discussing the policy paper “From Stimulus to Consolidation.”
At this point I will introduce Carlo who has a presentation.
MR. COTTARELLI: Alistair, thank you very much. I thank you for coming here. As Alistair said we are here to present our new Fiscal Monitor. This is the third issue of the Fiscal Monitor. But in a way it’s also the first issue, because it’s the first one that comes out in the same series of the World Economic Outlook (WEO) and the Global Financial Stability Report (GFSR).
Previous issues came out as part of the Staff Position Note Series, as the Managing Director noted of course in the Foreword for this Monitor. This upgrading raises the profile of fiscal issues, how much attention we pay here at the Fund to fiscal developments.
We also are here to discuss and present a Board paper, a background paper focusing on spending and revenue measures in support of fiscal consolidation.
What I would like to do today is to give you a presentation, a sort of summary of these two papers; in particular of the Monitor, and then we will be open to questions.
Obviously, our membership includes 186 countries, so we may not be able to answer specifically all the questions that you may have. Some of them we will have to get back to you bilaterally.
So let me start with my few highlights in our Fiscal Monitor. This is the cover: “Navigating the Fiscal Challenges Ahead”. And the key message of the Monitor is that fiscal risks have risen for three reasons. First of all, there is some –- with respect to our earlier estimate six months ago -- there is some weakening in fiscal trends. It’s not a major weakening, but the numbers are a bit weaker than they were six months ago.
Second, and I don’t need to elaborate much on this: clearly markets are paying more attention to fiscal developments.
And third point, more needs to be done in defining fiscal exit strategies, although there has been some progress in some countries, even in the last few weeks.
I would like, first of all, to say something about the numbers, the underlying fiscal trends. And this is a picture that some of you may have already seen. It focuses on advanced countries. This was the deficit before the crisis in 2007 in the average of the advanced countries: minus 1.1 percent. This is what happens in 2008, 2009, and 2010. There was a very strong increase in the average deficit.
This decline, this weakening in the balance of the advanced economies, of the fiscal accounts of the advanced economies is due to a weakening in the primary balance. Some of this was cyclical, that was a strong underlying component. But even after you adjust for cyclical factors, the fiscal balance in the G-20 economies weakens significantly between 2007 and 2010, by almost 5 percentage points of GDP.
This weakening goes well beyond the fiscal stimulus measures and by and large it reflects the loss in our projections of potential output. I will come back to this is a moment. In our projections, potential output never goes back, in the medium-term at least, to the original baseline, and this involves a permanent loss of revenue. There are also other factors, such as underlying increase in spending in some countries.
Because of this weakness in the cyclically adjusted position, even in the medium-term when you project things a few years ahead and the output gap closes, at the end of forecasting period the primary balance in particular remains in deficit.
And as a result of the accumulation of primary deficits, average public debt increases for the advanced countries, the increase is about 37.5 percent of GDP between 2007 and 2015, and a bit larger than this for the larger countries. For example, if one looks at the G-20 advanced countries the increase will be closer to 39 percentage points, I believe.
Now this is the outlook for advanced economies. I would like to say a couple of words about the risks surrounding these projections, and they are on both sides. On the one hand, this projection is based on the assumption that interest rates in the future will increase in line with the recovery of real GDP. Of course, because of the accumulation of debt over the next few years there is some risk that interest rates may go up a bit more than assumed in this baseline.
On the other hand, things could go better than that, primarily for one important reason that I referred to earlier: our projections assume a permanent loss in potential output for advanced countries of the order of 7 or 8 percentage points of GDP.
Now this is what’s happened sometimes in past financial crises. But this has a major impact on our fiscal projections. If eventually output went back to the original baseline, the recovery in revenues would be of the order of 3 percentage points of GDP. This, by the way, underscores the importance of growth, of boosting potential growth as a way of strengthening the fiscal accounts over the medium-term.
Let’s have a quick look at the emerging markets. In this picture, the blue line refers to the fiscal balance in the emerging economies. As a reference I also put here the advanced countries’ average. Clearly, the deterioration was much less than in advanced countries. The situation of emerging economies looks better, clearly, from this chart.
And again, in the medium-term, the deficit doesn’t go back to where it was, but taking into account the faster growth rate of these countries the dynamics of the debt-to-GDP ratio are much more benign for emerging economies. Again, there are risks around this baseline. This projection is premised on the fact that these countries will continue to grow. These countries will continue to run, on average, a primary deficit which exposes them to shocks from interest rates and growth including from possible spillover from advanced countries.
Turning back to the advanced economies, for many of the G-7 it’s clear that public debt-to-GDP ratio has now reached levels that are higher than those prevailing at the end of the Second World War.
Now of course this is true for some countries, because at the end of the Second World War their debt levels were low, but this is true also for countries like the United States here, where again we see the public debt-to-GDP ratio going up above the level prevailing in 1950.
So with this, this is the outlook in terms of data. Before I go to this, in terms of the second point that I mentioned, markets are paying more attention to fiscal developments. I don’t have a chart on this, because I don’t think I need to highlight –- I mean this is self-evident, with what’s happened in the last few weeks. The European stabilization measures I think were very helpful in calming down markets. They have succeeded in doing so. You know, of course, we know there is some more volatility, but all together I think it was a very important step.
The underlying fiscal weakness, of course, have to be tackled, but the availability of financing provides a way of doing so in a more orderly fashion, a more orderly way. Which brings us to my third point, which is the adjustment strategy, and the size of the required adjustment.
Those of you who are familiar with the previous Monitors may remember that we had indicated that for the average of the advanced countries, an adjustment in the primary balance, net of the cycle, of about 8 percentage points of GDP was needed to bring down the public debt-to-GDP ratio below 60 percent on average by 2030, within the next two decades.
We have updated these projections, the number now is higher. It’s 8.75 percent of GDP because of the slightly weaker initial position. The starting point in 2010 is a bit weaker. And this is the new path of the cyclically adjusted primary balance, which, under this scenario, is expected to improve by 8.75 percent GDP over the next 10 years and then to stabilize at the higher level. But the headline primary balance would improve by even a bit more because of the cyclical recovery, and the overall balance will move into surplus for the advanced countries by the end, by 2018, 2019. The debt ratio will stabilize and start declining and hit the 60 percent mark in 2030.
Very quickly, for emerging markets, the picture is better. For emerging markets the target is 40 percentage points of GDP. Even with this more cautious -- or more ambitious -- target, the adjustment for emerging markets is only 2.5 percentage points of GDP. So the situation is better in emerging economies than in advanced countries.
As I said, for advanced countries the number needed to achieve this target of 60 percent, this is a scenario, it’s an illustrative scenario, but I think it’s a useful starting point to look at the order of magnitude of the adjustment. The adjustment is clearly large, 8.75 percent of GDP to be implemented within 10 years in this scenario. But it’s not unprecedented. There are 13 countries, advanced countries, that have implemented, in the last decades, adjustments of this order of magnitude or even larger. There are 22 or 23 emerging economies that have implemented adjustments of this order of magnitude.
So, the adjustment is not impossible. This, of course, does not take into account the possibility of facilitating the adjustment through measures that will increase potential growth. These measures are very important. Just to give you one number. If a country increases potential output growth by one percentage point and maintains this for 10 years, revenue increases, and if this country does not increase spending the debt-to-GDP ratio at the end of 10 years will be lower by 30 percentage points. So potential growth has a huge impact on the debt-to-GDP ratio.
But these projections do not take this into account. I have been conservative in that respect and assume the adjustment takes place primarily through additional measures. And there are three pillars of a fiscal consolidation strategy that I want to mention.
The first one is the need to stabilize age-related spending relative to GDP. Age-related spending is spending for health care and pensions, and that is projected to increase, in the absence of adjustments over the next 40 years, by 4 to 5 percentage points of GDP for advanced countries.
There is a part of this that comes from pension expenditure. About 1 percent comes from pension spending. But most of it comes from health care spending. The main challenge for the next 20 years is not so much pensions, but health care spending.
In the pension area, we compute the increase in spending is about 1 percent of GDP. We compute that it will be sufficient to increase the retirement age over the next 20 years by 2 years in advanced countries to prevent this increase. So it’s relatively simple.
For health care the increase is larger, 3 to 4 percentage points of GDP. And the recipe is not as simple here. You have received the printout of the PowerPoint presentation, and I don’t have time to go through these measures one by one. There is a list of measures that could help in improving the outlook for health care spending. They act both on the supply side and on the spending side.
But clearly I believe we all need to do more work in this area to understand, to have a recipe to address health care spending challenges.
Now let me now go to the second pillar. The first pillar stabilizes age-related spending, and it is going to be difficult to stabilize it because of the increased pressure from aging and other trends. It’s going to be difficult to reduce spending in this area in relation to GDP. Where we think it’s possible to reduce spending relative to GDP is in non-age-related area. And here, the Fiscal Monitor and the background paper highlight four or five critical areas.
The first one is public wages. Public sector wages have been a key element in previous strategies of fiscal consolidation. In successful consolidation about one-fourth of the adjustment has been through cuts in the wage-to-GDP, public sector wage-to-GDP ratio.
This, of course, is a particular focus in countries where there has been increase in the last few years in the wage-to-GDP ratio.
The second area is social spending. Social spending in some countries -- here we have as an example the European Union countries -- is still high and in addition to this a lot of this is not means tested. Only a small part of this is means tested, so this is spending that goes to everybody. There is room for some savings in this area.
The third area is not so much for advanced countries, but also emerging economies need to adjust. An important area here is fuel subsidies, which are still very large in a number of countries. This does not include the tax component of the subsidies. In some countries fuel is under taxed with respect to principles of appropriate taxation. So this does not include this -- otherwise it would be even larger and it would be significant also in advanced countries.
Next is budgetary subsidies, sometimes through tax subsidies. These are significant. A lot of this is agricultural subsidies, but subsidies go beyond the agricultural sector. Very often this happens through what we call tax expenditure, taxation below the standard rate.
And last, but not least, it’s worth noting that military spending went up over the last 10 years by about 1 percent of GDP. If it were possible to bring it back to where it was 10 years ago, the savings would be 1 percent of GDP. If it were possible to bring it back to where it was 5 years ago, the savings would still be about 0.5 percent of GDP.
And finally, the third and final element of an adjustment strategy is on the revenue side. We think that for the countries that need to adjust, most of the effort has to come on the spending side because advanced countries have spending levels that are already high. Given the magnitude of the adjustment, though, it may be necessary to take measures also on the revenue side.
Nobody likes paying taxes, and taxes are also distortionary. We made an effort to identify tax measures that were relatively better in terms of economic efficiency. Some of them actually reduce distortions with respect to the current situation. We start from a tax system that in many countries was already quite distortionary. By eliminating some of these distortions it should be possible to improve revenues also.
And here are some numbers that talk about package for the average of the advanced countries, on the order of 3 percentage points to GDP. Many countries apply VAT rates on some sectors at the lower-than-standard level. By eliminating half of this gap between the standard level and the below-standard level, it would be possible to save more than 1 percentage point of GDP. Here we reduce the VAT policy gap. As I said, this refers to eliminating at least half of the below-standard VAT rates.
Second, excises for tobacco and alcohol are still fairly low in some countries. If they were raised to the 2006 average it would be possible to save 0.3 percent of GDP, to increase revenue by 0.3 percent of GDP on average.
A third: in some countries, gasoline and diesel taxes, fuel taxes are still low. By raising them a bit it would be possible to save something like 0.4 percent of GDP, 10 cents more per liter in each case. Of course, in the U.S. where they are lower, perhaps, a large increase would be possible.
Fourth, real estate. Real estate is, from a tax point of view, something that should be taxed because it is always better to tax immovable property.
Some countries already have a fairly high taxation of real estate, like the United States and the UK, but other countries have a low tax rate for real estate.
If it were possible for a country where property taxation is relatively low to bring it to the average level in the U.S., Canada, and the UK, the saving would be 0.4 percent of GDP. Now, of course, at the moment, the real estate market is still weak, so this is not something that could be implemented now, but here, remember, we have a measure that could be implemented over a number of years.
And finally, carbon taxation, carbon pricing, this goes beyond the taxation of fuel. Putting a tax on carbon emissions, or the auctioning of emission rights, it would be possible to save 0.6 percent of GDP. Altogether, this yields 2.8 percent of GDP and this does not include a few other things that may be important for specific countries.
For example, introducing VAT in the United States at the rate of 10 percent, a fairly modest rate, would yield 4.5 percentage points of U.S. GDP. Japan has a very low VAT rate, 5 percent. If it were possible to double it to 10 percent the saving would be 2.6 percent of GDP.
And, last but not least, tax evasion. Tax evasion is significant. The Monitor and the background board paper present calculations of country-by-country of tax evasion for VAT and that is sizable. It’s 0.7 percent of GDP for the average advanced economy, but for some countries, of course, it’s much more than this. Fighting tax evasion is something that remains a priority in many countries.
This brings me to the end of my presentation. The last point I want to make really is on the timing of the implementation of these measures, and here we have to distinguish across countries and across types of actions.
Let me start from actions that go directly into the reduction of the deficit. As you know, some countries are already implementing fiscal tightening this year. There are two groups of such countries: on the one hand, you have countries where fiscal accounts are weaker and where countries are already in a way under the pressure of markets; on the other hand, some countries are also tightening, like in the case of Korea, because economic recovery is stronger than expected. The same applies for various emerging market countries-- These countries should tighten fiscal policy already in 2010. Other countries can wait until 2011. This, however, does not mean inaction for any of these countries. For all countries there is a need to clarify the fiscal exit strategy and there is also a need to take steps under these strategies that do not risk jeopardizing the economic recovery.
There is the broad area of entitlement reform. All countries that are facing fiscal pressures, and particularly those that are aging faster, should implement entitlement reform as soon as possible. Increasing the retirement age is a very important step and does not risk weakening aggregate demand. There is no need to delay this to the future.
Strengthening fiscal institutions is also something that could be implemented now and we know that it is being implemented now by a number of countries including in Europe.
So, with this I will close. As I said, some action should take place in 2010, some action could be delayed to 2011. What is most important in any case is a clarification of the fiscal strategies to reduce deficit and public debt.
So, thank you very much for your attention. Sorry if I took a bit longer than I expected, but now we are ready to take any questions that you may have. Thank you.
MR. THOMSON: Thank you, Carlo. And if I can reiterate, the journalists participating online can submit questions via the Online Media Briefing Center. Journalists in the room, if you could identify yourselves and your affiliation and use the microphones please.
QUESTIONER: Hi. One, I have a basic math question I’m trying to understand and then a sort of broader question.
So, you’re saying overall for the advanced G-20 countries, by 2030 the debt increases by 40 percentage points or thereabouts. And so to get it to a safe level they have to reduce the deficit by 8.5 percentage points over 10 years -- 8.75, sorry. How does that math work? Why does 8-3/4 get you 40 percentage points?
And then secondly, a sort of broader philosophical question, so you have a variety of tax increases and spending cuts, why don’t you have built in there, since you’re saying growth is so important, growth measures that you would score in the same way you’re scoring this?
MR. COTTARELLI: Let me start from the second one. Of course, there is a recovering growth in the projections, but there is no major increase in potential growth. The reason why we have not done this is to be, in a way, on the cautious side because these reforms in this area are extremely important but it’s difficult to calculate when they will yield benefits.
So, I think that while all countries facing fiscal adjustment should implement the measures to boost potential growth, I think it would be a bit risky to assume from the beginning that potential growth would pick up more strongly than expected, than before the crisis.
What countries, in our view, should do is to base fiscal adjustment on relatively conservative projections on output growth and then hope, to have the strong expectation, that through reforms it would be possible to improve potential growth and there would be upside surprises.
But in terms of measuring risk, I think it would be better not to base fiscal adjustment plans on the expectation that potential growth will be higher than before the crisis. Actually, it is better to be cautious.
On your specific question, the difference is between flows and stock. The improvement in the primary balance is an improvement in the flow and that of course is not from the first tier. It’s a gradual improvement, but it’s an improvement in the flow, in the primary position every year. As a result of this, at the end, you get a decline in the debt ratio by about -- with respect to the baseline and to the starting point, by about 35, 40 percentage points. We can perhaps go through separately to do the math later on at the end.
MR. THOMSON: Thank you, Carlo, we’ll take a question online and then come back to the room. We have a question: “What’s your opinion about the fiscal consolidation plans announced by Spanish and Portuguese governments? Could they delay recovery?”
MR. COTTARELLI: Clearly, the steps that have been taken by these countries, as well as by other countries, to strengthen the fiscal accounts, go definitely in the right direction and are important steps. The question also related to the effects that this would have on growth, and I want to give a broader answer here. There is a fear that fiscal tightening could slow down the growth process over the next few years. Now, this -- the extent to which this may happen depends on two factors, one is the credibility of the adjustment. There is some work on this in the last few pages, as you will see, of the Fiscal Monitor. There is a discussion and there is evidence of the difference, with respect to growth, between credible and non-credible adjustment.
This comes from work that has been done by our colleagues of the Research Department which we just reproduced. The basic result is that if the fiscal adjustment is credible, there could even be a boost to economic activity because people start expecting lower interest rates in the future, and they expect less volatility in the future.
This may not happen, so there may be some costs, in terms of output, but in general, the more credible the fiscal adjustment is, the lower the effect on growth, and this underscores not only a need to prepare clear and transparent plan, but also the role that the strength of fiscal institutions can play.
The second point relates to the timing of the adjustment. There is nothing wrong in expanding fiscal policy -- actually, it’s appropriate to expand fiscal policy when economic activity is weak and then to tighten it when there is a recovery in economic activity. This is part of how fiscal policy should be managed from a countercyclical point of view. So, in other words, in the next few years we should expect a recovery of private sector demand. It’s perfectly normal that public sector demand steps back.
One last point, sorry, if you allow me, this -- if fiscal tightening takes place, indeed we should expect over the next few years a lower increase in interest rates than we would normally see during the exit from an economic recession.
QUESTIONER: On the tax measures, the less distortionary tax measures, you know, these are the bad excise taxes. Could you talk, though, about the role of other taxes potentially -- income taxes, payroll taxes -- to help countries return to balance, and what are the challenges of that and what are the benefits of that?
MR. COTTARELLI: I don’t know whether my colleagues want to add something, but our work and the work of the OECD indicate that indirect taxation is in general better with respect to growth, with respect to direct taxation. That’s why we have focused primarily on indirect taxes and real estate taxes.
This said, I think, there may be a need in some countries, depending on countries’ circumstances, of favoring also some increase in direct taxation. But as a general policy we believe that indirect taxes, without being dogmatic at the same time, are better than direct taxation.
MR. GERSON: The only thing I would add is that even with direct taxation, there may be cases where base broadening can help remove some distortions and so it could be that in fact by broadening bases you can both increase efficiency and increase revenues at the same time.
QUESTIONER: My reading of your report, which is very long and very complete, is that, bottom line, governments in advanced economies are spending too much and cannot continue on this path which is unsustainable because they are borrowing too much. You are touching very politically sensitive issues there. We can take a few examples like in the U.S., the housing sector is highly subsidized. In France, the age of retirement is too low. In Japan, VAT is too low, but consumption has been seen as very depressed for the last decades. So, how politically realistic do you think it is to touch with very sensitive issues which are the biggest sources of potential revenues?
MR. COTTARELLI: It’s clear that the adjustment is not going to be easy. Nobody can deny this. At the same time we have seen a number of countries, and I gave you some examples before of countries that did manage to implement a very large fiscal adjustment and they did manage to do this without actually killing growth.
More generally we have seen, in the last 10 or 20 years, very important reforms undertaken, for example, in the pension area. Those are not easy reforms and yet they’ve been implemented. I think that there will have to be sufficient political consensus, of course, to implement these difficult measures, but as I said, this is already happening, it’s happened in the past.
QUESTIONER: Two questions: You talked about fiscal adjustment in some way potentially encouraging growth. You are also including in that fiscal adjustment the increase in taxes that you were referring to, correct?
And secondly you talked about that growth coming, if the fiscal adjustments are credible, and I think the question was relating to Spain and Portugal, do you think their fiscal reform measures are credible?
MR. COTTARELLI: Well, as I said, I mean, the announcements have been important for these countries. I don’t want to discuss too much about these specific countries because, as you know, there is an Article IV consultation that is ongoing on Spain, so these things are being discussed with the authorities.
So, what I was making was a general point about the importance of credibility of the fiscal adjustment. I don’t want also to be seen as too optimistic. I would not bet on the fact that fiscal tightening is going to boost growth. What I’m saying is that there is a possibility that fiscal tightening, if appropriately implemented, will actually help growth, and if the adjustment is credible and it comes at the right time, the loss in terms of output can be quite modest as our evidence in the Monitor shows.
QUESTIONER: Actually, in the light of that question I have a question on Spain and one on a broader issue.
I mean, the issue, I think, in Spain people fear is that the economy is really weak right now. I mean, the economy is not recovering fast at all and there is this fear that these new measures are just going to stall recovery and I wonder if you could comment on that.
And the broader question is, if you can comment on the recovery -- on the world recovery. I mean, you know, like three months ago I think people had a different idea of how things were going to play out. I mean, there was an expectation there would be an increase in interest rates and all that, and sort of the European crisis has changed a little bit that. It seems that countries are going to have to have a fiscal adjustment earlier than expected and I wonder if you had -- you know, if you can comment on how the world recovery is going to change a little bit because of this?
MR. COTTARELLI: I think that one should not exaggerate developments, the implications of developments. It’s clear that there are some countries that are implementing fiscal tightening earlier than perhaps had been expected, but we need to keep in mind that the largest European countries are still in a position to wait until 2011 and what matters for world growth is the behavior of the largest countries. So that needs to be taken into account in terms of the effects of these recent developments on world growth.
On the specific case of Spain, again, there is an Article IV consultation in progress, so I would take away the job of my colleagues if I said too much at this juncture. But as I said, the measures that have been taken are important. They go in the right direction and improve the credibility of fiscal adjustment in that country.
QUESTIONER: If I just may politely push a little bit more. There is no Article IV mission in Portugal, so perhaps you could comment on that credibility.
MR. COTTARELLI: Yes, I mean, as I said, I don’t have the alibi on the Article IV consultation in Portugal, but again, the point I want to make again, it goes in the right direction in increasing the credibility of the adjustment. Of course, all the European countries have more general challenges and those are particularly important in the area of health spending and pension spending. This, of course, does not apply particularly to Portugal, but is a point that I wanted to reiterate. I think the Europeans, as a group, are underestimating the challenges coming from health care spending. It’s a point that we make clearly in our report. We have a sort of differences of views with respect to the European Commission’s in the projections over the next 20 years of health care spending. You could find the details in the Fiscal Monitor.
QUESTIONER: Can I ask about another European country? If you look at it a different way, what’s the lesson from Greece on the message that you’re trying to enunciate today?
MR. COTTARELLI: Yeah. I mean, the lesson is that there are some countries where the fiscal accounts are weaker and that are potentially more exposed to a loss of confidence, including because they have, for example--and I’m not referring specifically to Greece, but as a general point --for example, because they have weaker fiscal accounts, because they have weaker fiscal institutions. And the message is that those countries -- some of these countries cannot afford waiting until 2011, they will have to tighten earlier. This is already happening.
So, that’s basically the lesson that I would draw from the recent developments.
MR. THOMSON: If that’s all the questions we have, then we’ll wrap up this briefing. Thanks very much for taking part, both journalists in the room and those who participated online.
Just to reiterate, the contents of this briefing and all the documents that we posted are under embargo until 11:00 a.m. D.C. time. That’s 1500 GMT today.
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