Transcript of a Press Conference on the International Monetary Fund’s Regional Economic Outlook for Europe
with Ajai Chopra, Acting Director, European Department
Bas Bakker, Division Chief, European Department
Helge Berger, Deputy Division Chief, European Department
Olga Stankova, Senior Press Officer, External Relations Department
Wednesday, October 20, 2010
Ms. Stankova: Good morning, everybody, and welcome to the press conference on the IMF’s Regional Economic Outlook for Europe. The report was prepared by the European Department of the IMF, and Acting Director of the department, Ajai Chopra, will present and discuss with you today its main conclusions. Also present at the press conference are Bas Bakker, Division Chief in the European Department and Helge Berger, Deputy Division Chief of the European Department.
I would like also to welcome journalists who will participate in the press conference via IMF’s Online Media Briefing Center. We will take questions from them as well as questions from the audience when we move to the question-and-answer session. With that I would like to pass the microphone to Ajai.
Mr. Chopra: Thank you very much, Olga, and welcome to all of you to this launch of the Regional Economic Outlook for Europe. I’m going to start with a brief presentation. As you know, there’s just about eight slides so I’m not going to take very long doing this.
Let me start first by saying a few words about Europe’s growth prospects. The good news is that the recovery in Europe has continued despite problems flaring up in sovereign debt markets six months ago. Indeed, Europe’s GDP is now projected to expand somewhat faster than we expected in the previous REO in May 2010. And here I would highlight far-reaching policy interventions that were crucial. These interventions included financial assistance for Greece from the EU and the IMF, securities purchases by the ECB, and the establishment of the European Stability Mechanism. Now that said, the recovery is sluggish and uneven and projected growth rates are low by the standards of previous recoveries from recession. And we see three main reasons for this, which brings me to the second slide. First is that the healing of the financial sector is proving to be a drawn-out process, and as you see from the first chart, credit growth is still very weak. We, of course, don’t expect it to go back anywhere close to the levels that were there before the crisis. In fact, we’d be worried if they did, but they’re still weak.
Second, as the middle chart shows, unemployment remains high and, indeed, a number of structural factors inhibit growth. And finally, as you can see from the last chart, it’s inevitable that fiscal policy will become less supportive to the recovery as governments scale back deficits. So we have a slide which gives you the numbers in aggregate, and here I’m just going to highlight the emerging European economies. And the point I want to make is that in emerging Europe, an export-led recovery is underway, and we expect that all emerging European countries will post positive growth in 2011. But domestic demand remains weak, particularly in countries where the unwinding of previous credit booms led to a deep recession. Within this region, we expect growth to be the strongest in the CIS countries and also Turkey.
This brings me to how we view the risks. On the downside, I think the primary risk that we see is the risk of renewed financial market volatility, and this could come from two sources: One is if there’s a rise and spread of strains in sovereign debt markets, and second if there’s a loss of confidence in financial institutions where capital and liquidity buffers are not seen as being sufficient. But I think it’s essential to also note that there is upside potential and most importantly, it’s quite possible that Germany will continue to surprise on the upside with higher-than-expected activity. And if that happens, this typically has very important knock-on effects for the rest of the region.
But what is essential for our central scenario to pan out is very strong policy implementation and getting the policies right. And here I’m going to highlight three aspects, starting with fiscal policy. So how should policymakers address the fiscal challenges that they face? Now this is a delicate task. No doubt fiscal consolidation is necessary virtually everywhere following the sharp deterioration of public finances in the wake of the great recession. But it will be important for governments to optimize the composition, the credibility, and the phasing of adjustment so as to minimize the economic fallout. And here I would point you to Box 1 in the REO, which looks at various aspects of how the fallout from fiscal consolidation can be mitigated. Essentially, it will require that consolidation should focus on selected expenditure items and be embedded in medium-term plans and phased according to country-specific circumstances. Countries that are under market pressure are, of course, already consolidating. Those with remaining fiscal space can proceed at a more measured pace starting in 2011.
Let me now turn to the financial sector. So how should policymakers address financial sector challenges? The key here is to strengthen bank balance sheets and enhance confidence. For advanced Europe, the EU-wide stress tests were a very important step that was taken, and they announced the results and the conclusions in July. It will be important for countries to build on the results of these EU-wide stress tests to develop a roadmap to identify vulnerable institutions and then to recapitalize, restructure, or resolve them without delay. In emerging Europe, it will be important for banks to recognize loan losses and also recapitalize banks as soon as possible. Europe has a very integrated financial market, and what this means is that it will require a strong supervisory framework with enhanced cross-border cooperation which we see as another essential element for building confidence, and I’ll return to this in a minute.
The final policy challenge that we’re highlighting in this REO concerns structural policies. So how should policymakers address the structural challenges that they face? The IMF has been advocating steps to liberalize product, service, and labor markets in advanced Europe for quite some time now. This is not a new emphasis for us. We see these structural reforms in these areas as holding the key to unlock dormant growth potential in Europe. But the point I’d like to highlight is that what is often overlooked is that the structural reform is important not only for countries themselves, it is also important for reducing large intra-euro area external imbalances. In Chapter 1 of the REO, we present evidence that such reforms could help ameliorate the large current account surpluses of, say, Germany, vis-à-vis the large current account deficits of, say, Greece or Spain. Now reenergizing the push for structural reform, for example in the context of Europe’s 2020 strategy, is therefore more important than ever.
In emerging Europe, structural reform is important for similar reasons. The boom years have inflated the non-tradable sector when capital inflows financed excessive credit expansion. With the abrupt end of the boom, many countries now need to find new engines of growth and rebalance towards the tradable sector. Structural reforms should facilitate this process, along with wage policies and investment in retraining, education, and critical infrastructure.
The other aspect that we highlight in this REO is that there are significant holes in the governance framework for the monetary union and, hence, it becomes critical to improve the institutional framework, and we see this as essential for building confidence. And we highlight three areas: The first is on the financial sector and although I said that there were very large holes in these frameworks, the encouraging thing is that work is underway to fill these holes as I’m sure you’re all aware. On the financial side, there have already been agreements to set up a European Supervisory Authority and also the European Systemic Risk Board. The challenge now is to ensure the effective operation of these bodies and to develop and integrate a crisis management and resolution framework.
When it comes to the Stability and Growth Pact and the Excessive Deficit Procedures, here our point is that fiscal governance needs to be made more effective primarily by strengthening procedures to ensure compliance with the excessive deficit procedure and also the requirements under the preventive arm of the SGP. And we have emphasized that such a reform of the fiscal framework will require a shift of policy authority to the center.
Finally, on the structural side, I think there’s less progress on this front, but there is an important development in that there’s now discussion of an Excessive Imbalance Procedure as well that will look at the structural policies in both deficit and surplus countries. So we see that as an important development as well.
Now before I conclude, I just want to come back to a point about emerging Europe and draw your attention to Chapter 3 of the Regional Economic Outlook. And that chapter focuses on the lessons from the boom and bust for emerging Europe. As you can see in the slide, the contraction and output in emerging Europe was much deeper than the contraction in advanced Europe, but it’s also bounced back a little bit faster. So we thought that it’s important that, two years after the collapse of Lehman Brothers, for this REO to take stock of the aftermath for emerging Europe. So what that chapter does is that it looks at the country experiences and points out that country experiences were very diverse. Some countries, like the Baltic countries, experienced double-digit output declines while others, such as Poland, escaped the recession altogether. We find that the primary reason for this divergence was the size of the credit boom in the run-up to the crisis. Countries that had the biggest booms during good years suffered the most severe downturn during the recession. One of the main lessons is that it’s better not to let credit booms get out of hand. And, of course, we would grant that credit booms are hard to control especially if they’re financed by large capital inflows, but we think that this is not an impossible task. It would require prudential measures. It would require close cooperation with supervisors of parent banks that intermediate these inflows, and it would require counter-cyclical fiscal policy. In particular, buoyant revenues during boom years should be saved to build up buffers for bad times instead of being used to finance an increase in expenditures.
So I think that gives you quite a comprehensive overview of the key points that we’re making in this Regional Economic Outlook. We’d be happy to take your questions now.
Ms. Stankova: Thank you, Ajai. Please identify yourself and your affiliation when asking questions. If we have any questions from the audience, yes, please?
Questioner: This is a point about credit (inaudible) slight interest exists in the U.S. there was a credit boom there from markets. How could policy -- which policy could be used to decrease -- lower the risk -- because what the policymakers have found is the interest rates too low (inaudible).
Mr. Chopra: I’m going to ask to Mr. Bakker who is one of the lead authors of this chapter to answer the question more from the perspective of the European emerging markets, and I think that’s where we should keep the emphasis. But I would point out that from a broader perspective, a number of -- as I said earlier, in the European Union they are setting up the European Systemic Risk Board. And one of the key tasks of the ESRB will be to look at developments such as very rapid credit growth and asset price booms in different parts of the Union and to devise policies to address these. Now this is also the approach being taken in the U.K. where they are now setting up a Financial Policy Committee to complement their Monetary Policy Committee. Now, of course, these two committees will need to work closely together, but there’s a great deal of emphasis that we’re now putting on macro-prudential regulation, which really relies on micro-prudential tools, but then calibrates it based on specific developments. But Mr. Bakker can give you some more information on emerging Europe in this context.
Mr. Bakker: You are quite right that what we have seen in emerging Europe is not unique. We have seen in other countries rapid credit goes as well, but the scale at which this happened in Eastern Europe was unprecedented. There were large capital inflows, very rapid credit growth, a domestic demand boom, and in some countries unprecedented current account deficits. In Latvia and Bulgaria, the current account deficit peaked at 25 percent of GDP. This credit growth was financed by large capital inflows and when after Lehman Brothers defaulted, there was turmoil in international markets and these capital inflows dried up. The credit flows suddenly stopped and domestic demand had to adjust. And if you have a current account of 25 percent of GDP, it means that it’s going to be very painful. So emerging Europe was hit very hard because at the same time when the capital inflows stopped and domestic demand had to adjust, at the same time its export markets dried up. So the result was a very deep contraction. Countries that had less of a credit boom during the boom years had less imbalances and less to adjust when the capital inflows stopped. It Rapid credit growth is hard to stop, but it’s not impossible, and one measure that also could have been used more is fiscal policy. Many countries during the boom years had what looked good headline deficits, but the domestic demand boom also led to a very rapid growth in fiscal revenues which led to rapid public expenditure. If you have already a fiscal surplus, but revenue is growing by 25 percent, it’s not sufficient just to keep the surplus. What is better is to keep expenditure restraint and to have a build-up of fiscal surpluses. That’s, of course, difficult during boom times, but it gives you much more of a buffer when the boom eventually ends.
Questioner: Was credit growth in emerging Europe boosted by low interest rates in western Europe?
Mr. Bakker: Interest rates in emerging Europe, and particularly in countries with fixed exchange rates, are, of course, influenced by what happens in Western Europe. So if interest rates in Western Europe are very low, this will, of course, boost credit growth in emerging Europe. But it means that other policies need to compensate for that. It means you need to have very prudential policies. It means that fiscal policy will need to counteract.
Questioner: If you can see that the recent budget law passed by the Italian Parliament is sufficient, is on a good path, and also if it’s enough to stabilize the national debt?
Mr.. Berger: Yes, so while I’m not an expert on the Italian budget law, I think that we see a move to strengthen national fiscal institutions in Europe overall. And I think this is certainly an important element in the reaction to the crisis. And I would like to link this to what Mr. Chopra said about fiscal governance and the need to improve what we see as problems in the fiscal governance framework, and it goes a little bit beyond the national reforms that we are seeing. I think it is time to realize that within the currency union, prudent fiscal policies and fiscal policies adjusted to the needs of the union overall are pursued and beneath that stronger center there in addition to strengthening of the national fiscal institutions.
Mr. Chopra: I can add a couple of words on that. To be more specific, in Italy we do see that the expenditure-based consolidation package goes in the right direction. But we see considerable reliance on sub-national spending cuts and also on revenue from fighting tax evasion. So we see scope for enhancing the credibility of the entire fiscal adjustment package. But as I said, the expenditure-based consolidation package goes very much in the right direction.
Questioner: I had a question about some of the risks ahead. I was wondering if you could give us an assessment of how you see Greece now and the risks exposed to the European scenario and perhaps if it needs to restructure its debt?
Mr. Chopra: Let me emphasize that the program with Greece has made a very strong start, but, of course, risks remain. The first point I would highlight is that the fiscal consolidation is on track. Of course, much of this fiscal consolidation is based on consolidation by the central government. I think there’s still more work that needs to be done to make sure that this consolidation gets broadened to other levels of government, and the IMF is providing -- and other agencies are providing -- technical assistance on this front. The second point is that there’s been very ambitious pension and labor market reforms, and these reforms have been front loaded.
And, thirdly, the Financial Stability Fund is ready to backstop capital needs in the banking system.
The challenge will be to put fiscal adjustment on a sustainable footing, and also to overcome resistence to structural reforms, which we see as being -- we see these reforms as being essential to elicit an early supply response.
Now, we get this question about Greece’s debt quite often. And here, what I can do is just reiterate that we agree with the Greek authorities, and with the European partners, that the cost of debt restructuring far outweighs any benefits of such restructuring. In particular, debt restructuring would not address the very large primary deficits of this country. By “primary deficits,” I mean the difference between spending excluding interest payments and revenue -- and this gap is still very large, and that needs to be addressed. Also, it does not deal with the cost of aging. And it does not generate growth, because that requires structural reforms, as we’ve just said.
And as I said right at the beginning, the program with Greece and their policy implementation is very much on track. And debt spreads have started to come down. So, you know, this has been quite sizeable in the last few weeks. And our expectation continues to be that Greece will return to the markets over the next 12 to 18 months, as was built into the program.
Questioner: I have two questions. The first one is you said that some countries who have still fiscal space should maybe postpone their consolidation in the vent of stalling recovery. Could you please say which countries are these in Europe? And where would you put Austria in this kind of growth?
And the second question is about completing the financial sector repair. You said there’s still regulatory reforms needed, regional and global. Could you maybe specify this a little bit? And what already happened, from the point of view, which was good? And what should still be done? What still must be done?
Mr. Berge: Well, I think there’s a whole set of countries who have, relatively speaking, more fiscal space than others. Germany is definitely one of these countries, where fiscal consolidation is moving a little bit faster than we’d expected, on the heels of growth that is a bit faster than we’d expected. Austria would be sort broadly in that group.
The question is, how far should that go if downside risks were to materialize? And I think the general advice we would be giving is that consolidation paths that are built in in the medium-term framework should be followed. But automatic stabilizers would be an example for an adjustment that would be permissible in the case of downside risks realizing.
Clearly, however, there are countries in the Euro area where there is no fiscal space, and where these things would have to be considered very closely. Do we have a rigid rule that applies to all countries? Probably not That really depends on the size of the shock of that negative scenario, and where countries exactly are.
Mr. Chopra: On the financial sector, as I said, Europe has made a good deal of progress in setting up some key institutions. The European Supervisory Authority, and also the Systemic Risk Board. The challenge now is to get these institutions to be operational, and to develop a crisis-management and resolution framework.
But I think, there are some other areas where work needs to be done. There’s been, under Basel III there’s now a time path to increase capital and liquidity buffers. So banks will need to adhere to these new requirements -- and the supervisory authorities in the countries will need to ensure that banks are in a position to do so.
There’s another element where the discussion is still ongoing, and that is how to deal what are called the SIFIs -- Systemically Important Financial Institutions. What has been agreed is that those institutions will need to have a greater loss-absorbing capacity, through different types of instruments. So countries will need to figure out the instruments that they would wish to use to increase the loss-absorbency of these institutions.
And coming back to the European situation, I think, you know, here, just to highlight on the point that I made earlier about a more integrated crisis-management and resolution framework, I would point you to a speech that our Managing Director Dominique Strauss-Kahn gave in Brussels in March -- I think, March 19th -- where he laid out proposals for establishing a European Resolution Authority. Now, this is a very ambitious goal, but we do think that it is one that ought to be pursued, because that gives the best chance of getting this cross-border framework for such resolution.
I would also point out that there’s been a recent agreement -- this was on one of the slides that we had, the Nordic-Baltic Cooperation Agreement -- and we see that as moving forward the framework for a small group of countries. But it will be good to broaden that in other groups, as well.
Questioner: I have a question about the ECB’s unconventional measures. You mentioned in the report that the European Central Bank should remain ready to extend those measures if it becomes necessary. Now there is some talk and a discussion within the ECB whether to stop them now. Several Governing Council members have said that should be done. Do you think that talk is premature? And is the moment already there where the ECB should phase out these measures?
Mr. Chopra: Let me just start by making an initial comment, and then Mr. Berger can sort of add some more specifics around this. The basic point that we have on monetary policy for the Euro area is that as fiscal policy is being tightened, monetary policy can afford to remain accommodative. And the reasons for this are the following. The output gap is still large. Inflation is low. And inflation expectations are well anchored. So with this, we see the scope for monetary policy to remain accommodative. On the specific aspects, Mr. Berger can add a little bit more.
Mr. Berger: Now, I think on the ECB, there are two main policy lines or issues that we see. One is the one that Mr. Chopra just mentioned. I think we clearly see a need, and also the ability, of monetary policy to remain accommodative and supportive. This is a moderate recovery. We still have major risks.
And so, as a general policy stance, a supportive policy is the right thing to do.
That said, there is also a need to think about gradual exit from what you already mentioned as “extraordinary and crisis-oriented measures” -- of which there are many, in many different central banks around the region. For the ECB it would be mostly the extraordinary liquidity support, full allotment procedures, the lengthened monetary offerings of liquidity, and the security markets program.
Now, I think there is a clear line on both of these measures, as far as we are concerned. On the liquidity measures, it is correct to continue this gradual exit that has restarted -- mostly because these policies have costs. There is no free lunch, and that includes liquidity policy.
We have to realize that these measures distort markets, and they bring a certain degree of moral hazard on the banking side. Still, these policies also have a benefit, and these costs and benefits needed to be weighted.
So our advice would be -- and I think that is mostly in line with what we hear from the ECB -- to continue this exit, conditional on systemic risks in the money markets and in the banking sector dissipating -- but also to be ready to withdraw from the exit if you wish to delay it, as they have done before, if necessary.
Questioner: Is it already at the moment where you can continue this exit? Or are we at the juncture where the, you know -- these measures should be extended?
Mr. Berger: I think there have started, sort of picked up where they left earlier this year in their move to exit these measures. And I think they do this conditional on the systemic risk that is in the market.
So the ECB will have to monitor these risks, just like they will have to monitor the general outlook risk that we have been talking about for monetary policy overall. This is a continuous process, rather than a zero-one, binary decision.
And I think that’s exactly what’s happening. I think this is on the right track.
Ms. Stankova: We received a question from the Media Briefing Center. What impact will the recent strengths of the Euro have on your outlook?
Mr. Chopra: Firstly, let me just emphasize that when the IMF looks at exchange rates, when we assess exchange rates, we focus on the consistency of currency values with medium-run fundamentals. And we don’t focus on short-term currency movements.
Now, the Euro’s depreciation earlier this year moved it to a level that we saw as broadly consistent with medium-term fundamentals. But its appreciation in recent weeks has brought it closer to the territory of overvaluation.
Now on your specific question, a strengthening of the euro will impart some headwinds to the recovery.
Questioner: My question is sort of a follow-up to his question. I wanted to know whether the currency mismatches and the sort of global devaluation race could pose any downside risks, and if you see any policy risks stemming from sort of a currency war.
Mr. Chopra: I think my answer on this is essentially the answer that was given at the time that the Economic Counselor of the IMF, Olivier Blanchard, did his press conference on the World Economic Outlook. Because this goes beyond Europe. And what he emphasized is that a strong global recovery rests on two re-balancing acts. The first re-balancing act is internal re-balancing, from public to private demand. And the second aspect is external re-balancing of net exports from surplus to deficit countries.
So, from a global perspective, it is crucial that policies -- including exchange-rate policies -- support this re-balancing. And that is the position of the IMF on this issue.
Questioner: So is this a re-balancing of exchange rates threatened, in a way, by interventions?
Mr. Chopra: On the specific point about intervention, our view is that it’s appropriate in some circumstances to use all available tools in the short run to react to potentially destabilizing movements -- whether this is by intervention or by a mix of prudential measures. But large-scale and repeated exchange market intervention should not hinder the re-balancing that I just emphasized as being needed for a sustainable and healthy global recovery.
Questioner: The Spanish government hopes to get a growth in 2011 of 1.3, that’s doubling your perspective of 0.7. Do you think that the recent measures taken by the Spanish government have been enough -- labor market reform, spending cuts? What is the opinion of anybody on the panel who might by the best for this issue?
Mr. Chopra: On Spain I have several points that I can make.
Firstly, on the recovery, I think you’ll notice that we have marked up our forecast for Spain -- not by much, but by 0.1 in both 2010 and in 2011. And this improvement reflects a somewhat stronger momentum of private demand than we had initially projected -- and also an upward revision of growth in Euro area trade partners.
Our view remains that, beyond 2010, the recovery is likely to remain weak and fragile, with downside risks. And this is because our central scenario is one of a long and gradual adjustment to the various imbalances in the economy.
Over the medium term, we see growth gradually rising to 1-1/2 to 2 percent. But we have to keep in mind that in a country such as Spain, private demand is weighed down by continued uncertainty, by high unemployment, and also the need to reduce indebtedness. So that’s how we see the outlook.
Now, briefly, on the policy side. There’s been very strong reform momentum in Spain since May. The authorities have undertaken a comprehensive array of reforms -- and this includes front-loaded fiscal adjustment. It includes labor market reform. And it includes restructuring of the savings banks.
The commitments in these areas, in our view, need to be followed through and strengthened where necessary. And it will be important that there’s no relaxation on these policies.
On your specific aspects about the fiscal sector -- yes, ambitious fiscal consolidation is underway to reduce the deficit from about 11 percent to 3 percent by 2013. We have said for some time that we feel that the budget is based on macroeconomic projections that could turn out to be optimistic. Therefore, we have stressed that it is important for the government to have contingency plans to ensure that they meet their 6 percent deficit target next year, if it looks like there will be shortfalls in meeting this deficit.
I would also emphasize that implementation of consolidation and fiscal adjustment at the sub-national level in Spain is going to be very important, given that Spain is a highly decentralized economy.
Another aspect of the reforms that is -- I said earlier that labor markets, the cajas and so on, the reforms are moving. One area where the debate is still ongoing is on pension reform. And we feel that it’s going to be important to have a political consensus to get an ambitious pension reform in Spain.
On the financial sector and labor markets, as I said, they’ve undertaken a number of bold, ambitious steps. The important thing now will be strong implementation. For example, in the labor markets, the steps that have been taken -- there have been important steps taken to reduce severance pay and to have opt-out clauses from centralized wage bargaining.
But we see that there is scope for further strengthening, because severance pay still remains above the EU average levels. And it will be important to keep evaluating how these reforms are actually working on the ground, and whether firms are, indeed, taking advantage of these opt-out clauses. So it’s going to be important to keep monitoring this process to make sure that it is yielding the benefits that are hoped.
But the important point that I want to emphasize is that there’s been strong momentum on the policy front, and this has helped also distinguish Spain from some other vulnerable countries in the Euro area. And we see this in terms of the market reaction.
It’s going to be important to follow through on these commitments, and strengthen them where necessary, and avoid any relaxation.
Questioner: The Austrian government is planning to introduce an additional tax on banks. I would be interested in your opinion about this.
Mr. Berger: Well, there’s an ongoing debate about this, not just in Austria. And the position that the Fund has taken here is that it really depends on what kind of levy, what kind of tax is implemented.
There are two types of taxes. The financial transaction tax idea is one that focuses on trades and sales. There is a bit of an issue when these kinds of measures are introduced at the regional level -- I would even say introduced, for instance, at the European level -- because there could be distortions in financial trades globally. So this is something that should be discussed and will be discussed, I think, at the global level. The G20 is an ideal platform for this kind of discussion.
Another idea that is influential is that of a financial activity tax wish, which could be a complement to existing taxation of value added -- VAT -- taxation. Here the arguments we’re introducing that, at a regional basis, are slightly more convincing.
I think one of the things to keep in mind with a number of initiatives in the financial sphere at the national level now is that there is room for coordination. Or that the coordination aspect shouldn’t be forgotten.
So, as we see that financial stability framework evolving at the European level, as we see the European supervisory authorities becoming active next year, I think this is part of the discussion that there, as well as in these, we should be having at the European level.
Mr. Chopra: I would also just draw your attention to Box 6 in the Regional Economic Outlook, which is on page 39. It looks, in some detail, at the issue of financial sector levies in Europe. So I just wanted to draw your attention to that.
Ms. Stankova: There are no more questions from the audience. The press conference is concluded. Thank you for coming.