Transcript of the Euro Crisis Seminar, April, 20, 2012
April 21, 2012Friday, April 20, 2012
REZA MOGHADAM, Moderator
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MR. MOGHADAM: (in progress)—have been doing on these three crisis countries and how we see the situation in these programs.
I will begin initially by giving you some broad common themes, very, very short, and then we will have each of the three mission chiefs, essentially, giving you their perspective, hopefully for about 10 minutes or so each, and then we will have opportunity for questions and answers.
Let me begin–this is the presentation. I think the first issue here is that the three countries that we are talking about are obviously part of the monetary union, but I wanted to step back a little bit. This illustration here you see gives you the 10-year bond yield in the individual euro area countries, and against a net international investment position. And that is basically a measure of the position of the public and the private sector vis-à-vis the external world. Now, you look at that, here is pre-monetary union in 1995, and what you see there is that the bond yields obviously have quite a wide spread across the countries and the net investment positions are essentially spread around zero, around balance.
So what happened with the union? What you would expect to happen. Basically, convergence takes place, monetary union leads to convergence on interest rates. You see this massive decline in some of the countries’ interest rates, and they are basically aligned 2005, a few years after the union. So, monetary convergence took place, including for the three countries that we are talking about today.
As the international crisis hit, 2008 here, you see interest rates shifted, but, again, you see they are broadly aligned. Now, what happens as the European crisis hits? This is 2010. You see that the spreads widen quite substantially. I think you know the flags; you can spot the three countries we are talking about today and their location. But what you see here is that the differentials increase, the interest rate increases, the bond spread increases for the countries which have a negative asset position most.
So that’s the first point. So we had convergence in Europe but the stress has brought out some of the underlying tensions based on essentially indebtedness of the country. And as I said here, this measure of indebtedness here—when it is negative it’s both for the public sector and the private sector. So, it’s a measure of indebtedness of the whole economy.
Let me look at one other issue, which I think has received a lot of attention: Debt. Again, this is a common theme of these countries. Now when you look at debt in the euro area, people will say, well, it’s not actually that different to the U.S. and UK so overall, what’s the issue? And the issue is that this red area gives you the dispersion of the debt. You have very low debt countries and you have very high debt countries in Europe, in the euro zone.
But let me show you where the three countries that we are talking about today are. So, that’s the euro area and these are the three countries. So you see they are at the upper end of the range, one of them at the top end of the range, of course. So another theme that we will be discussing, you will see through the presentations today is the indebtedness situation.
And one final point: Competitiveness. You have heard us talk about competitiveness issues and how to restore competitiveness, but let me just again take a step back across the Euro zone and illustrate to you what the issue is. Now on this, what I have here on this chart is on the vertical axis you have a measure of competitiveness defined by real effective exchange rate based on unit labor cost, and on the horizontal axis I have export growth. So, we start from the beginning of the monetary union. If you are in the top right-hand corner, that means relatively you have depreciated relative to the others and you have more exports. Bottom left-hand corner, the opposite.
So if we began at the beginning of the monetary union in ‘99, 2000 and then we trace the countries for the next 10 years, how have their relative positions changed? And this is what happens. Again, you can spot the three countries that we are talking about today and see what is the relative position with respect to the others.
So, I think these are three themes. The issues of monetary union and what convergence has meant: the fact that for these three countries we are operating within a monetary union and these are advanced economies, so you will see throughout the themes of the presentations, this issue of the special circumstances of monetary union, the convergence which has or has not been achieved that affects that. The issue of debt that these are three high-debt countries that have—therefore that affects the strategy and the issues that we deal with, and finally the issues of competitiveness.
Now, I’ve talked about common themes but also as you will see from the presentations there are very different individual circumstances and they have meant that the economic adjustment programs deal with those specific circumstances of the countries.
So without further ado, let us go in more detail through each of them. I’m going to start with Mark Flanagan, who leads our team on Greece and he will give you a short presentation. We will then move to Abebe Selassie, who is our mission chief on Portugal. He will do the same on Portugal. And finally, Ajai Chopra, who started as the mission chief to Ireland, he will conclude. And then, Poul, as you know, has led both the teams of Greece and Portugal. Poul will try to draw some of these common themes, and then we will have Q&A and then hopefully we can have an exchange of views on some of the issues. Thank you. Mark?
MR. FLANAGAN: Thanks, Reza. As you’ve seen in Reza’s introduction, after Euro succession, borrowing costs fell dramatically in Greece, among other countries. This led to a very sharp buildup of debt. Now, the demand this created drove up relative wages and prices, badly undermining Greek competitiveness, creating a very large current account deficit. By the eve of the crisis, we estimated overvaluation in the range of 20 to 30 percent.
Now, the origins of this crisis lie in the government sector. As you can see in the chart on the right, once in the euro Greece’s revenue effort dropped precipitously. Let me just get that up for everybody. Greece’s revenue effort dropped precipitously and spending rose sharply, particularly social transfers and pensions. By the eve of the crisis, with Greece’s debt north of 120 percent of GDP and a primary deficit over 10 percent of GDP, Greece was deeply insolvent and faced an enormous challenge to overcome these fiscal problems while also addressing its competitiveness gap.
Now the SBA aimed to address these problems while keeping the country in the euro and minimizing contagion risks, which were then assessed to be very high. This ruled out two key policy levers, devaluation and debt restructuring, that have typically been applied in financial crises. The program, thus, had to carefully balance the use of two other levers, structural reforms and fiscal policy, to address these challenges Greece faced.
Now, fiscal policy. To help restore sustainability, the aim was to raise the primary balance from a deficit of 10 percent to a surplus of 6 percent by 2014. And of course, to allow time for reforms to take hold and for spreads to come down the program removed Greece from the bond market for 18 months, programming a gradual return thereafter, as you can see in the right-hand chart.
Now in terms of structural reforms, the intention was to use these to counter the sharp negative impact on domestic demand that fiscal adjustment would have. The focus was on liberalizing Greece’s rigid product, service, and labor markets, and in this way to improve competitiveness and stoke net exports. You can see in the chart on the left how this was designed to help offset the domestic demand contraction. However, I have to emphasize that from the beginning it was recognized that this combination of fiscal and structural adjustment represented a major challenge for the Greek authorities.
So, turning to implementation. Well, in terms of structural reforms to improve growth we had some initial successes. The authorities got off to a strong start. They undertook reforms to liberalize aspects of the transportation sector, they undertook reforms to deal with aspects of the labor market, like job entry and exit costs. But, the reforms stalled amid problems with political commitment. The second wave of key reforms, which involved liberalization of service markets, which involved eliminating some rigidities in the labor market that prevented downward movement of wages, these were delayed by almost a year.
As a result, gains in competitiveness lagged program projections. If you look in the chart on the left, you can see the initial program projection for the GDP deflator against the outcome. That is the broadest measure of prices and it’s actually kind of remarkable that after five years of sharp recession, even depression, the Greek economy has not yet seen any deflation at all.
Now two other developments also made their effects felt in 2011, actually first in late 2010. The issue of debt restructuring was put on the table in the context of the ESM discussions in Europe. Now this placed a big barrier in front of return of investor confidence. Now secondly, by late 2011 a nascent recession in Europe, which in no small part was due to delays in addressing the crisis, began to take a toll on Greek exports.
So in sum, by late 2011 with the external environment deteriorating, with competitiveness gains lagging, and with confidence slow to return due to problems with political commitment and getting measures done, we did not see the growth inflection that we had originally expected to see in the program, and the recession turned out to be deeper than projected.
Now against this difficult backdrop, fiscal policy still managed to deliver quite a bit. In fact, the Greek authorities managed to improve the primary fiscal balance by some 8 percent of GDP in 2010/2011, but this has not been an easy achievement of the authorities. As you know, reviews have been delayed as we have had to address implementation problems. The adjustment has proved to be difficult for the Greeks in terms of their political and administrative capacity.
But even with this very impressive fiscal adjustment in this context of deep recessionary headwinds, even with this we have not seen an improvement in the debt trajectory for two reasons. One being the fact that after the program started we learned that actually the starting point was worse. The level of general government debt was revised up by over 10 percent of GDP. A second reason being, of course, the recession.
The sum of this was that as the trajectory shifted up, as you can see at the top right, the Fund no longer found itself in a position to say that debt was sustainable. It’s in this context that discussions on PSI commenced, private sector involvement, the debt restructuring—once that began, market spreads soared upwards.
That brings me to the new program. Now, the new program had to place Greek debt sustainability on a much firmer basis. This meant first and foremost, providing a stronger underpinning to growth. Now based on the difficult experience with structural reforms under the standby arrangement, the new program has taken a conservative review about the time needed to implement the complicated labor product and service market liberalization reforms, and the time needed to realize productivity gains. So a more direct approach has been taken to improve competitiveness, and this involves deep reforms in the labor market, which are meant to eliminate wage rigidities and allow Greek firms to rapidly align their wage levels with their productivity levels. These reforms include, as many of you are aware, reductions in Greece’s comparatively high minimum wage and liberalization of collective bargaining.
The overall aim of this is to facilitate an improvement of unit labor costs of about 15 percent by 2015, which we deemed to be the amount that should close Greece’s competitiveness gap. A few more years after that will be needed to deal with price competitiveness issues, as it takes a little longer for wage changes to pass through to price changes. But I want to emphasize that these reforms are designed to bring forward the recovery and preserve jobs in Greece.
The new program, of course, had to address Greece’s unsustainable debt dynamics, and it had to provide for higher financing needs. Now after discussions lasting through late 2011 and into 2012, Greece and its European partners settled on a combination of private sector involvement—that is, the debt restructuring—debt relief directly from Greece’s European partners, and substantial new program support. The IMF, we offered our support through a 28 billion euros, 4-year EFF arrangement, the largest fund program ever.
The PSI and debt relief will help to reduce Greece’s debt stock. Beyond the immediate 53-1/2 percent nominal reduction in the value of bonded debt a big benefit will come from a reduction of the interest rate on official debt, which will help Greece run a lower overall balance, overall deficit over time, which will help bring down the debt. You can see that on the charts on the right.
The PSI and new program will also dramatically reduce Greece’s gross financing requirements, as you can see in the chart on the left, basically by extending amortization of the debt beyond 2020. Still, new program finance is necessary from both the euro area member states and the IMF because deficits still have to be financed until Greece completes its adjustment, but also due to bank recapitalization needs and amortization to official creditors. Importantly, Greece’s official creditors have committed to provide additional support to Greece as necessary, both within and beyond the program period provided Greece continues to implement its adjustment program.
Now to further enhance Greece’s prospects, the new program also recalibrated fiscal targets. The pace of adjustment was slowed in 2012 to account for the up-front impact of the structural reforms, which will tend to depress the economy a little bit before they revive it. The endpoint target was adjusted down to 4-1/2 percent of GDP from 6, 4-1/2 being the level that Greece maintained on average in the 5 years leading up to euro accession.
With the revised targets and the revised macro framework and given the debt relief, the debt trajectory for Greece has markedly improved and we now anticipate that by 2020, debt could fall to in the range of 116 to 117 percent of GDP. But there’s no doubt the road ahead for Greece will be difficult. The project debt trajectory is very high. If the economy takes longer to respond to the structural reforms I he program, if the external environment is worse, if fiscal adjustment takes longer, debt would track a higher and likely unsustainable trajectory. Indeed, if all these shocks were divest, if you look you can see our alternative scenario which many of you would be familiar with from our DSA. You end up with debt much higher in 2020.
But the program baseline—I want to emphasize—the program baseline is our best assessment of potential returns from full program implementation and the priority is to work with the Greeks to make sure that they can implement their program in a timely manner and realize that baseline outcome.
In that context, of course, what lies ahead is our first program review. That will take place after elections scheduled for early May, and the focus there will be on identifying the fiscal measures necessary to compete in Greece’s fiscal adjustment. Thank you.
MR. SELASSIE: Very good morning. So, the program with Portugal was agreed about 11 months ago today, and I will, in my presentation, focus on the key issues that we identified as problems, or policy on these problems, and how the program goes to tackle those. Then lastly a couple of slides on where things stand at this juncture.
So, Portugal was one of the countries in Reza’s presentation where we saw the net international investment position going from broad balance in 1995 to a deficit of a hundred percent of GDP by 2010 or so. So, Portugal got shut out of markets, so we’re in a very difficult position starting around late 2010. And there were three problems that staff identified when we started discussion with the Portuguese authorities on the program.
The first of these problems was very loose fiscal policy as exemplified here on the left panel, with very large primary spending over the years and blowing up in 2008 and ’09. So, a very sharp increase in government spending, leading to very large deficits. A consequence of this, of course, was very large government debt of the order of a hundred percent of GDP around 2010. So, unsustainable fiscal policy was one of the major problems.
The second issue in Portugal was this very high corporate and household debt levels. In a sense, companies following the decline in borrowing costs, companies went out and borrowed both domestically, but abroad, and increased leverage very substantially starting in the late 1990s. So, by 2010, Portugal had one of the most leveraged non-financial corporate sector debt level was of the order of 150 percent of GDP.
Household debt was also very high. Certainly, you know, not overleveraged but about a hundred percent, but it’s very high relative to other periphery countries included. So, very substantial levels of leverage both by households and the corporate sector.
The third issue in Portugal was the loss of competitiveness starting around 1999, 2000. This loss of competitiveness translated into low growth and very large current account deficits by 2010.
But I think I want to paint a nuanced picture here with respect to competitiveness. It wasn’t that, you know, overall economy-wide there was a lot of competitiveness, but there were particular sectors that could continue to do well. So, here I’m showing the evolution of unit labor costs in the manufacturing sector and for the total economy, and productivity growth in the manufacturing sector, as shown in the slide panel, was high. Unit labor cost growth still exceeded the productivity gains, but still productivity growth was high and there was—the tradable sector in Portugal was doing relatively well. The problem more was in the non-tradable sector where competitiveness was very low, productivity was very low, and basically economy-wide unit labor costs remained high and made the country uncompetitive and entail very large current account deficits.
Around late 2010, early 2011, we had a situation in Portugal where you had the balance sheet of the public sector extremely leveraged, as well as the balance sheet of the corporate and the private sector in token aggregate. So, you had a very high indebtedness situation and being shut out of markets, which is when discussions on financial support by the Fund and EC started.
The program that was agreed with the government last May essentially has three pillars to address these three problems. On the fiscal side, you know, there has been a lot of talk in the context of these meetings about what is the optimal path of adjustment for countries in the euro area? I in the case of Portugal, the program is apt to be very ambitious in the fiscal domain largely because they were shut out of markets. There’s a limit to how much financing is available, and the fiscal situation was really out of hand. Although the adjustment path is smoother than they would otherwise have had to take, it’s still an ambitious frontloaded program.
By design, following the measures that were taken in the 2012 budget, the government is only 1-1/2 percentage points of GDP short of the terminal primary balance they need to reach next year. So, the idea with the program is by next year, they will have arrived at the primary balance that’s needed to stabilize debt going forward. So, a very ambitious adjustment program, but one that hopefully will pay dividends when they get there next year.
In comparison to the other countries which still have market access, this chart here on the right shows where Portugal, Ireland, and Greece is, and again the programs have had to be frontloaded, reflecting the lack of market access.
In the area of central reforms and improving the economy’s competitiveness, in the original program design one of the proposals that was entertained was fiscal devaluation to try and shift taxes to overall consumption and reduce for them on labor. In the event that was impossible for a variety of reasons, so the program has instead has focused more so far on trying to improve the labor markets and product markets. The labor markets fear there were particular issues with respect to employment protection, which was making companies reluctant to hire and explaining the very low employment growth that we saw in Portugal in the 2000s. But also there were other elements of the bargaining framework, which was virtually automatic in terms of its extensions through companies not involved. So, on the labor market side, there’s been quite a range of reforms to try and improve functioning of the labor market and to avoid companies that just think by laying off people and still try and get some rich flexibility going.
On the right I’m showing here a chart on the evolution of labor costs, and we are seeing economy-wide labor costs beginning to basically come down significantly and are broadly flat right now. And, more interestingly, I think within this picture we are seeing, in the non-tradable sector in particular, some declines in wages. So, again, moving in the direction of improving the economy’s competitiveness.
With respect to the leverage issue that I spoke earlier, the private sector leverage, a big chunk of their borrowing came through the financial sector, the domestic financial sector. So, financial sector strengthening has been a major component of the program. One of the program targets that we have is to try and reduce, you know, the leverage ratio of the banks in particular, which tended to rely excessively on borrowing abroad to finance domestic lending. We have a program to try and reduce that in a very gradual manner. At the moment, the loan-to-deposits ratio stands at about 150 percent, and under the program that’s going to come down to 120 percent by 2014.
Importantly, in trying to calibrate the deleveraging I think we’ve been very cognizant of the need to not starve this strong-performing tradable sector. So the path of credit growth basically mirrors the path of GDP growth we have in the program these two red lines basically show. The red and the blue line on the right chart show the path under the program of credit and real GDP growth.
A couple more slides on where things stand at the moment. About a year into the program, I would characterize the situation as being very encouraging. The program has delivered, you know, program targets have all have been met. Implementaion has been very strong. I think in large part this has to do with the broad political consensus in the program. We have with the trade union, the opposition polity, and the government having an agreement, a tripartite agreement, which supports the basic tenets and the policies under the program. So, I think that has allowed policies to be advanced as envisaged. Importantly, outcomes have also been more or less as we envisaged. In some dimension, the improvement has actually been better than we programmed.
On the left I am showing a chart on improvement in the current account balance, and the horizontal axis you see an improvement just in the first year of the program of 3-1/2 percentage points of GDP. The minister of finance, a very keen economist, argues that this actually has come at lower output costs, and basically the idea—what happened last year—over the last year is that export growth has been very strong in Portugal of the order of 12 percent, and the improvement in the current account has come not from contraction in domestic demand but, rather, stronger export performance. So, at least on this dimension, the program outcome has actually exceeded our expectations, so very encouraging signs.
But, of course, we are not declaring victory. There remain very formidable challenges ahead. The debt trajectory in particular is very sensitive to what happens with growth, what happens with interest rates in the next couple of years. Any shocks as a result of the external department being poorer or domestic reform effort being weaker can lead to a debt trajectory, which is going to be very uncomfortable.
This said, again, a year into the program, even the debt trajectory has been almost exactly as had been envisaged at the time of the program request, which is the panel on the right. So, all told, I think very strong program implementation and very encouraging progress so far in the Portuguese case. Thank you.
MR. MOGHADAM: Thank you, Abebe. Ajai?
MR. CHOPRA: Good afternoon. I should first start off by saying that the Mission Chief for Ireland is my colleague, Craig Beaumont. He is currently in Dublin on a Review Mission with the team. So apologies; you get a poor substitute instead.
There are three basic points that I want to make in this presentation. The first point is that Ireland’s crisis is first and foremost a banking crisis. It was a classic boom and bust that was caused by very rapid credit growth and a lack of oversight of the financial sector. The credit growth was financed by wholesale funds. So that’s the first point.
The second point is that this banking boom and bust had profound implications for the rest of the economy. The vicious feedback loops between the various sectors, so the design of the program needed to take into account these feedback loops. But at the same time the design of the program was hindered by the lack of instruments to break some of the most vicious feedback loops, in particular the one between banks and the sovereign. So in other words what happened is that virtually all the bank debt became sovereign debt. That’s the second point.
The third point is that program implementation has progressed well so far in terms of policy implementation, in terms of political cohesion, in terms of the broad outcomes. On the outcomes, there has been modest growth that has been driven by exports.
So there are positive signs, but there are also negative and worrying signs: Unemployment remains very high and a large part of it is becoming structural and more importantly the doubts about medium-term growth.
Now in the case of Ireland, the headwinds to growth are not just from domestic factors, but also to a very large extent from external factors. It’s a small open economy so what happens elsewhere in the eurozone, what happens elsewhere in the U.K., has a major impact on what’s happening in Ireland. And because of these concerns about growth, debt sustainability remains fragile. So those are the three basic points. Let me elaborate a little bit on each one.
So the boom came to a halt around 2007 as property prices began to fall. What happened is that between the peak of the economy in 2007 and 2010, real GDP fell by 10 percent and employment also fell by 13 percent, and this is all before the program started. The program was approved in December 2010. So the government began to take a number of measures before the program started. There were fiscal measures that added up to over 6 percent of GDP between 2008 and 2010. There was a controversial bank guarantee that was extended in September 2008 that created an asset recovery vehicle to handle the large property loans.
So what happened is that public debt—this is the right-hand panel—public debt started out quite low, under 30 percent, indeed lower than it was in Germany, and all of the SGP criteria were met. Now, of course, this amassed a huge contingent liability for the public sector coming from the banks, and there’s no doubt that fiscal before the crisis could have leaned more against the wind so that there’d be higher fiscal buffers. But fiscal was not the origin of the problem.
So what began to happen is that it became evident that bank support costs were going to be much higher and there were uncertainties about what these bank support costs were. These uncertainties led to questions about sovereign debt sustainability. So as the concerns about bank insolvency grow, starting in September 2010—and this is the left-hand panel-you basically have a run on maturing bank debt which was not rolled over and ECB liquidity support had to shoot up as these deposits in wholesale funding fled. You had the sudden stop on that side and this had to be replaced by a whole lot of ECB liquidity. So that’s again my first point. This is fundamentally a banking crisis.
Now on the second point about all these adverse feedback loops, I’m not going to go through all the arrows in this. In fact, we’ve kept this slide very simple. It could easily be a real spider web with the arrows going all over the place between all these different things. So on my second point the program design had to deal with very vicious feedback loops. Basically what you have is very high private debts. For example, household debt was over 200 percent of disposable income, so the household savings rate remained high as they deleveraged and this means that you don’t have any domestic demand even as exports pick up. Then also you have rising unemployment and declining incomes that come from the financial stress, and so you have mortgage arrears that start to go up. At the same time you’ve got to act on the fiscal side, but when acting on the fiscal side lowers growth and it reduces disposable income, that increases debt ratios and households will need to now save more. This increases arrears so banks now lend less and this feeds back into the property market and so on and so forth. So the program had to take into account all these pernicious feedback loops, and this means you need to tread a very narrow path to get to growth and debt sustainability.
So what does this mean? This meant that the program had to focus first and foremost from getting the financial sector in shape so that it’s less a source of risk and it can support the economy. But also you need to phase in the fiscal adjustment because the public’s finances after the crisis were completely out of whack as the revenues just collapsed and there was a huge addition to debt to support the banking sector. So that’s my second point on the adverse feedback loops.
So the focus has to be on the financial sector, and there were a number of steps that had been taking place even before the program started. One of the key elements at the start of the program was to try to sort of get clarity on what was the size of the hole in the banking sector. So together with the Irish authorities, we designed a set of very rigorous stress tests to determine what the recapitalization needs were going to be. These stress tests relied on an outside party, BlackRock, in order to come up with a loan-loss forecast which gave it a lot more credibility. The Central Bank also did a terrific job in terms of transparency. They put out this massive document that gave a lot of detail about the stress tests and the assumptions and so on. That’s on the Web site so other analysts could go and assess this. Also the capital thresholds that were a part of the stress tests were tighter than the capital thresholds under the European Banking Authority’s stress tests. So they had higher standards.
Just a couple of things to point out: On the extreme right bar, there’s a small blue bit that shows the work that they did manage to attract private investment. The total hole was $24 billion, so that hole needed to be filled. So some of it came from private investment, some of it came from what we call LMEs on sub-debt. LME is a polite term for haircutting subordinated bank debt holders. It stands for liability management exercises that were conducted that saved the Exchequer quite a sizable sum. But I should mention that these liability management exercises focused on what I call the pillar banks. There was also another disaster bank that was not covered in this exercise and that is Anglo Irish--primarily Anglo Irish, but there’s another one as well—that have now been consolidated into a new resolution company, but the senior unguaranteed debt of these failed banks were paid in full.
Now the fact that the senior unguaranteed debt of these failed banks was paid in full has caused considerable resentment in Ireland because the view is that the Irish taxpayer has had to bear a disproportionate burden in maintaining pan-European financial stability. So that’s the recap element and that has progressed well.
The other thing in the financial sector was this was a bloated financial sector. It was huge relative to GDP so it needed to rightsize or downsize so that it could really support the economy. So deleveraging of the banks was needed, but this is not easy. The way this was done was to phase it over three years, bring down the loan-to-deposit ratios. The idea was to focus more on the non-core assets and less so on the core assets. One reason is that these non-core assets were primarily offshore; they were in the U.K. or the U.S. The idea was that doing it that way would reduce the impact on the domestic economy. We also built in safeguards on fire sales. There has actually been good progress in getting rid of these non-core assets, especially U.S. portfolios have been sold with some success. But the way with incentives so banks work, unfortunately they also—regardless of how you design this—there’s also a tendency to focus on the domestic side as well on the core assets, so this feeds back.
Now fiscal: Even though this is a banking crisis, when your debt blows up because of the banking crisis, you do have to address the fiscal side. There’s no question about that so fiscal consolidation has been the other element of the program. As I said, some of this started before the program, but when you start with a deficit of 11.5 percent, excluding bank financing costs in 2010 and you want to get to 3 percent in 2015, there’s a good bit of adjustment that needs to be done. I would focus more on the blue bars that just give you the quantum of consolidation measures that Ireland has had to implement. But what I would emphasize over here is that the consolidation, each year’s consolidation, had been underpinned in a very solid and credible medium-term consolidation plan. And the fiscal plan is on track, and I would ascribe a lot of this to a high degree of ownership. The authorities took the lead in designing the fiscal measures, and we’ve also allowed some flexibility in the design of these measures. When the government changed, they put in a jobs initiative package which changed the mix of measures.
The other element in the Ireland program, which is a bit distinct from the other programs, is that at least from the IMF side we do allow automatic stabilizers to operate on the revenue side so growth is a lot less and that hits you on revenues. We at the IMF would not ask for additional adjustment to offset that growth. So that’s the fiscal side.
Now finally my last slide. This comes back to my final point that I made right at the beginning that we have a number of positive elements, but we also have some areas of concern. On the positive side, as I said, program targets are being met, policy implementation on all fronts has been very good, and reviews have been completed on time. This has been shown and you see this in the spreads that Ireland has relative to the spreads that many of the other program countries have. Ireland can now borrow. The spread for two-year lending is under 500 basis points, so that is a marked improvement.
I haven’t talked about competitiveness, but competitiveness has improved. It’s contributed to export growth, which is the main source of overall growth. But as I said, there’s no domestic demand so there are downside risks to consumption from household debt burdens, and house prices continue to decline. And as I said, bank deleveraging becomes more difficult, the underlying profitability of the banking sector is still weak, and this hinders the pickup of lending which hinders the revival of the economy. So we did have a scenario where domestic demand did not recover and there were external shocks that constrained export growth. And let’s say growth got stuck at—the dashed bars—of around .5 percent. You would then not have debt stabilizing. It would continue to go up. So the basic point like in all the other cases that I’ve just mentioned is that risks are high. It all comes back to growth. We have been making the case for additional European support that goes beyond the current setup. Here I’m sure you’ve seen reports on the press conferences in the last couple of days and the WEO and GFSR. One of the things that has been emphasized is that if European facilities had the flexibility to take direct stakes in banks without going through the sovereign—direct equity, direct stakes, bank debt—this would help break that sovereign banking loop and could make a world of difference. Thank you.
MR. MOGHADAM: Thank you very much. Let me now turn to Poul, who will say a few words. As you know, Poul was closely associated with both the Greek and Portuguese programs. If you hear Poul coughing during his talk, it’s not just because of the subject matter, he’s also suffering from a cold. Poul?
MR. THOMSEN: Thanks, Reza. I shall try to be brief and just identify some themes and then we can follow up any questions. As you can see, this is very far from one size fits all. Each of the three programs are very, very different reflecting that the underlying problems are fundamentally different. As my colleagues explained, we have Greece that in many ways is close to a classical problem of excessive fiscal relaxation, with also a deep structural problem.
On the other extreme, Ireland is a classic case of private sector boom and bust with the credit channels and housing markets, and we have Portugal somewhere in the middle. Now, while these programs are indeed very different, they, of course, also have some common features. Above all, that we are working inside a currency union with the advantages and constraints that this entailed.
So let me very briefly identify a few issues from that angle. Let me start with process and talk a little bit about financing and then a program design as far as policies are concerned.
As far as process is concerned, there’s no doubt, you know, we are working in the so-called troika with our colleagues from the Commission and from the European Central Bank. There’s no doubt when three institutions like that get together in a room, procedures get sometimes cumbersome, and from a procedural point of view that has certainly sometimes indeed been cumbersome. But it’ll also mean that we draw on three sets of experts. We have three institutions with three different perspectives, three different mandates, and that has been an advantage.
The Fund obviously has program expertise and an expertise of dealing with crises, an expertise in seeing how those things add up and fit together. While our European counterparts have a very deep local knowledge about what’s going on in these economies reflecting the fact that they, on a daily basis for a long time, have been working with the authorities in these countries. So I think that has worked out to a big advantage for all of us.
There are certainly also more checks and balances. When we work -- when we do a debt sustainability analysis, three different teams with three different models and we compare the results, all of this is good. I do think the program design overall has benefited significantly from us working as a troika, and I know this is a view also shared by our two partners.
Financing. In part, financing needs were exceptionally large. That’s in part because membership of a currency union allowed these countries to borrow unusually large amounts, so when we had a sudden stop in funding, that revealed very, very large deficits and funding needs. The financing needs have also been large because we do not have the benefit of being able to make exchange rate changes inside a currency union. In particular, for Greece and Portugal that face a significant competitiveness problem, they have to deal with, in part through a prolonged and painful process of internal devaluation that will take time, and that’s adding to the financial need over time. By pooling the resources, the troika partners were able to commit very large financial support and this has clearly—the scale of that financing is, of course—means that we could cushion the adjustment. The adjustment would have been significantly more painful, significantly deeper without this large-scale support.
Now, even by pooling the resources, each of these institutions, and I speak to the size of the gaps, had by any metric to go well, well beyond what we have normally done with other member countries. And that is, of course, from Fund’s point of view, an important justification for that is, of course, the potentially very large spillover risk to the global financial system, to the rest of the membership. That’s a key concern in justifying this kind of large-scale support.
While being on financing, a key question that I’m sure all of you have is, will they go back to market on these timetables that are built into these programs? There’s, you know, obviously uncertainty. We know that the assumption about Greece, as Mark explained, did not hold and we have to have a follow-up program. The key here is, of course, that Europe has underscored, European leaders have emphasized that Europe stands ready to support these countries for as long as it will take to bring them back to market, provided, of course, that there’s steady progress under these programs. That is clearly unprecedented.
One dimension for membership of a currency union is to provide exceptional benefit. It’s true that membership means it’ll take a longer time, but membership can mean, also, that there is a solidarity that allow you to take a longer time.
Now, what about policies? I think that the troika has surprisingly quickly, in all three cases, zeroed in on a common diagnostic and on what should be the appropriate policy mix. So I think that from that perspective, the troika has also functioned quite well. We should keep in mind, though, that, again, the troika institutions have different responsibilities. The Commission is responsible for ensuring vis-à-vis the euro group that the fiscal government mechanism of the Union is adhered to. The ECB is rightly concerned about ensuring that it’s exceptional policies vis-à-vis program countries are normalized as soon as possible.
The Fund is, of course, concerned that these varies objectives are reconciled and consistent with the macroeconomic assumptions and a reasonable pass of adjustment. I think overall we have come up with a policy mix in the three countries that has avoided excessively procyclical policies and excessive deleveraging.
Now, this will remain a challenge, to be sure, that the programs are properly balanced going forward. I mean, there should be no doubt that if these programs, particularly in Greece and Portugal, where we have a deep structural problem, if these programs only become about fiscal consolidation and financial deleveraging, they will obviously fail. They will only succeed with a significant amount of structural reforms to deal with the competiveness problem, and that is the key issue facing these countries going forward.
So let me just end by saying that clearly, as my colleagues have mentioned, there are significant risks going forward, there are many challenges and, you know, we stand ready to continue to work with these countries and adopt these programs as circumstances evolve.
MS. LOTZE: Yes, maybe we can take two or three questions at once, and then go from there.
QUESTIONER: Question for Mark or Poul. How do you interpret the fact that the new Greek Government bonds, after the debt exchange, trade way below par? In fact, they are still the widest credit spread in the Euro area.
Specifically, do you think this is a market mis-pricing? Or is it the outcome of near-term risk relating to elections, and longer-term risks that Mark outlined, relating to the debt burden? Thank you.
QUESTIONER: Mr. Chopra, you seem significantly gloomier in your assessment of the Irish position. I wonder what you would put that down to—bearing in mind you've just returned from Dublin?
QUESTIONER: Reza, I was interested in the description of the different situation that after 10 years various countries were with reference to exports. And especially last year, starting with last year, Italy ended up being in a very difficult position because of the spread. It was very hard to get good credit from the banks for companies.
So I'd like to bring it down to competition of companies. Many Italian companies, about a thousand, with about another 3,000 or 4,000, that are part of the so-called backbone of Italy in the districts have been extremely competitive in the very high-tech export sector. So very high value added.
When the spread becomes about 25 to 30 percent over a five-year project, it becomes impossible to compete. And they have been losing important market quotas vis-a-vis Germany, especially, which we have seen that happen anyway over 10 years. But this is becoming dramatically dangerous. And, of course, it doesn't help, it doesn't produce a virtuous cycle in trying to get the country back.
So, question number one: Do you think that some of these market quotas will be lost forever? And don't you think that something should be addressed urgently
QUESTIONER: Thank you very much. Actually, I have two. One is, having heard quite promising presentations about the situations in the three program countries, what's your assessment about the ability of those countries to regain growth by themselves?
And, second, there is regulation being discussed that relates to the further banking re-capitalization needs that government bonds should no longer be treated as risk-free assets. How would that affect the banking situation, in those countries especially?
QUESTIONER: For Mr. Chopra: you mentioned two measures that you're pushing for. One is a change in the way bailouts are structured, so that they can engage directly with financial institutions, thus breaking that sovereign banking loop you mentioned. Also, you said you were making the case for additional European support that goes beyond the current arrangement.
What's been the response to those requests? And is there division on how to proceed, between yourselves and the other members of the troika?
QUESTIONER: I have a question for Mr. Flanagan and Mr. Thomsen. Recently, the Greek police arrested the former Defense Minister of Greece, Mr. Tsochatzopoulos. They accused him of corruption. I wanted to know your comment. Since Mr. Thomsen and Mr. Flanagan many times, you have asked for end of corruption in Greece. So I want to know if you are satisfied with this positive development? Thank you.
MR. MOGHANDAM: Thank you for your questions. Let me say a few general words. Of course, this is not a press conference, it's about the presentations we gave. So forgive us if we do not go through some of the general issues that you have raised. I'm sure you'll have many opportunities in the next two days to raise some of the general questions with people who are here.
So I think I would try and focus on some of the questions which were relevant to the presentations. Then I will ask Poul and Ajai to answer some of the specific questions that you raised on Greece and Ireland—and, again, the relations to the presentations.
I think the question of the availability of credit and its relations with growth is very, very key. I hope you have seen that the focus of the programs has been very much on how to put the conditions in place for growth in the long run.
Now it is obvious, given the imbalances that I indicated to you at the beginning of our presentations, to correct those imbalances, it is clear that some degree of de-leveraging would have to take place. The key here has been to try and protect, as much as possible, to ensure that the de-leveraging is done in a manner which is, in the long run, good for the economies.
It is not just a question of the programs themselves, as, again, I indicated at the beginning of my presentation. These programs operate in the broader monetary union, in the broader European context. We have not talked much—although there was a question, we have not talked much about the broader European measures to assist these programs indirectly that have come at the Euro-wide level.
I think two points there: one on the specific issue of the availability of credit. The measures that have been taken by the ECB have been extremely helpful in ensuring the bank funding needs are met across the Euro area, including in the three program countries. Therefore, indirectly, they have helped the program countries. I think there is no moving away from the fact that—as, for example, Ajai explained in the Irish case very clearly—that the degree of de-leveraging is unavailable in these countries.
In terms of, again, the European-wide measures, and some of the issues that have been talked about over the last couple of days, if one goes through the events of the last 18 months, I think our European partners have repeatedly shown that they are prepared to take the measures that are needed.
Now, they have not gone as far as we would have liked. Sometimes they have not been as speedy as we would have liked. But the track record has gone in the right direction. The changes in the ESM and ESFF, which directly affect these countries, are important.
Let me pick up one example from the presentation that Mark gave. If you look at the borrowing costs of Greece at the outset of the program, and if you look at them in the revised program, there is a massive difference. Mark brought that out quite clearly. So, again, that has been done due to European-measures.
And you asked do we advocate further measures? I think you heard the Managing Director advocate further measures yesterday. Of course, those could be helpful, but they need broad political support across Europe for them to be implemented. Let me turn to Poul, perhaps, and then Ajai.
MR. THOMSEN: Yes, thanks. The question from Miranda on the bonds, and why they are trading, new bonds, at a high discount –clearly, the uncertainty is exceptionally high, both in the short run and I would say certainly well beyond the elections.
For this thing to work, there will have to be a significant reinvigoration of structural reforms compared to what we have seen. The pace of structural reforms that we have seen, you know, certainly during 2011, is not consistent with success. It will lead to failure. So there is need for a significant reinvigoration of structural reform.
There is obviously some concern among investors whether Greece can deliver that. The social constraints have been becoming more and more evident during 2011. So, no, I think this is, quite frankly, rather obvious. But what perhaps is not so obvious is that we have also seen in the last, you know, since the end of last year, there has been a realignment in Greek politics in the sense that the two main parties have come together in support of the program. That is a major change compared to where we have been before.
There's no doubt that the elections will test the support for the program. But this is a very important change, and it's with that we hope that Greece will undertake this, will get to this inflection point where we will have a significant reinvigoration of structural reform.
But, obviously, investors still need to see that, be convinced. I think if we have a couple of years with steady progress on the reform side, you know, I'm very sure that you will see these prices you refer to recover.
On the question of corruption, obviously that is a concern of us. You know, all politicians I have talked to in Greece have mentioned that as an overarching concern. Now, you're not surprised that I have no comment on any particular cases, so I shall not comment on that. But let me just, on one issue that we feel very strongly about that is sort of related to this, is that we think, again, one of the overarching issues is tax administration, and improvement in tax administration. This is one of the issues where I would go as far, again, saying that I'm not sure this program will succeed unless there is a significant improvement in tax administration.
I cannot see how Greece can deliver on its commitment, on its fiscal targets over the medium term—deliver on this fiscal targets—while maintaining an adequate standard for social transfers and social services, without dealing with the tax administration. If it doesn't deal with the tax administration problem, I think it would be forced into cuts in social transfers over the medium term that are simply, you know, far, far too harsh, and that's not consistent with what we would expect from a modern state in terms of providing adequate social service.
So I think this is the key issue, and this is clearly an issue where we have failed so far. So this is yet another one of these issues where we need to do much better.
MR. CHOPRA: Firstly, I disagree very much with the premise of the question that I'm gloomier. I'm not any more gloomy than what we've said in all our reports. If you look at our staff reports, we have a litany of risks that we outline in those reports, and there's nothing that I've said that goes beyond what we have already said.
We do need to keep in mind, of course, the broader picture in the euro zone. Ireland and the other countries, all these countries, are seriously affected by the heightened level of risks in the euro zone, as we have seen. A lot has been done to address these risks, but the risks remain.
What Ireland and the other countries all need to focus on is fulfilling their commitment to strong policy implementation. That's what's crucial, that's what they can control, and that's what they need to do.
On the other questions about European support and changes in bailouts, I think Reza has already mentioned and talked about the broader perspective over here. I don’t have much to add. You know, we don’t want to be too prescriptive on this. I mean Europe has its own decision-making process.
I think they’re aware of the issues. It’s not for us to be prescriptive in the precise type of support. I think we’ve given general indications of these things. Again, what I would mention is that we’ve had longstanding suggestions on how to strengthen the common financial stability architecture in Europe, and that remains very much on the agenda.
QUESTIONER: I wonder if I might ask a question about Spain, which, as you know, is very much in focus these days. Could you give some some context on how you assess Spain’s problems at the moment in terms of borrowing costs and access to markets vis-à-vis where these crisis countries where when they required bailouts? Thank you.
QUESTIONER: With regards to the most important and maybe the most difficult part of the whole thing in the euro zone, I think it is growth. I agree with you very much. But I’m a little bit skeptical towards the programs and also initiatives introduced by the IMF. My question is, could you please provide the very solid, or a little bit could be dubious, evidence that all the initiatives, all the programs have delivered some signs of the growth or a little bit impetus for the growth. That is my first question. I’m sorry it’s a little bit hard for you.
And the second one is that as the time goes on, it seems to me that because the costs of the exit from the euro zone by some countries is declining and the benefit seems to be rising, do you see any sign or do you see the possibility of the exit from the euro zone becomes a little bit higher?
QUESTIONER: There’s increasing talk in Portugal about a financing gap in the program. There’s a number that’s being talking about, which is circa 16 billion Euros. I wanted to know if you are aware of such a gap, how this gap could be fueled by FMI funds going to the market? What do you think about that?
Also, you didn’t mention the fact that the recession is actually quite higher than was envisaged in the program; it’s almost one percentage point. How much of a risk is this?
And about risks, one final question. Spain, is it a very big concern for you at this point? Thank you.
QUESTIONER: For Mr. Flanagan, what’s the best-case scenario as to when Greece would no longer be insolvent and might regain competitiveness?
MR. MOGHADAM: Again, I say a few general words and then maybe I can pass to Mark, Abebe, and to Ajai. On the issue of comparison of Spain to these three programs, as I said, we need to focus on the subject of the seminar, but let me just say generally, as I think I hope the presentations have illustrated, each of these cases are very different in terms of the problems. There are some common themes, but there are very specific circumstances. So it’s very difficult to compare one of the other countries to these three and draw conclusions, so I would caution against that.
In terms of euro zone commitment to staying within the euro zone or possibilities of exit, I think what certainly I have seen in dealing with the European partners over the last two years, the commitment to maintain the Union is extremely strong and you can see that by the steps that have been taken to strengthen it and you can also see that in each of these programs.
I mean, look at the magnitude of financing that has been provided to, for example, Greece. As Mark mentioned in his presentation, our contribution to the Greece program is the biggest the Fund has done. But it is minuscule compared to the total financing that has been provided by the euro zone. So just to put it in perspective.
There was a very good question about what signs of success or growth you see in each of these economies and maybe I ask the other three to point to one thing that they see in each of the programs they are dealing with. Mark.
MR. FLANAGAN: Thanks, Reza. First, on the best-case scenario for when Greece is no longer insolvent and when it will regain competitiveness, well first of all, the program is a framework which delivers Greece to a sustainable debt trajectory. So in that sense we would consider the country solvent under the program already. Of course, there’s work to be done. It’ll take some time to bring the debt ratio down. It’ll take a lot of work to bring it down, but we would certainly consider it to be solvent within the framework of the program.
Competitiveness, you know, internal devaluations take some time to be realized. If you look at international experience, very flexible economies can realize internal devaluations very quickly, you know, the case of Hong Kong has done it. You’re from Hong Kong. You know Hong Kong is very liberal, very flexible, it delivers changes in competitiveness very quickly in response to external shocks. Latvia managed it as well.
For an economy with the kind of structural rigidities that Greece has, it will take more time. Our present goal is to deliver competitiveness as measured by unit labor costs by the end of the program, 2015. It will take a couple more years for that to translate into price competitiveness measured by, for instance, the real GDP deflator, based real exchange rate, simply because some of the product market reforms are fairly complex, and, of course, you’re covering a lot of markets in that instance and it can take some time.
Now, on the price competitiveness you’re looking towards the end of the decade. Wage unit labor costs competitiveness, mid-decade.
In terms of signs of growth, well, we absolutely have seen a version of what we hoped for in the original program, which is a recovery to some degree of net exports to offset the domestic demand contraction. Unfortunately, the slowdown in the euro zone has hurt exports of late. But that is where we would point that, to an extent, that adjustment has been happening. We have seen a shift in the composition of growth away from domestic demand to net exports.
MR. SELASSIE: On the first question about the financing gap, I think that was a very erroneous report that came out today. The program remains fully funded through, you know, the program period as originally cast. I think it was a misreading off the tables that we had in the late—last staff report and my colleagues in Lisbon have been correcting that story. So there’s no financing gap of the 16 billion that you noted.
Second, on the question about the recession, at the start of the program it was, you know, it was always envisaged that in the short term there would be a contraction of the order of 5, 6 percentage points. What in the event turned out is like last year actually, we had less of a contraction that we had originally envisaged. But I think original program requests had group contraction of 2-1/4 percent. It came out that’s closer to 1-1/2 percent, and this year we are having a little bit more of a contraction.
So if you look in totality between 2011 and ’12, we have broadly the same order of contraction in the program. So, you know, so I think that remains as projected. This, I think, nicely brings me to a question on growth.
You know, or more broadly where we see output this year. So the recession this year is going to be we’re projecting around 3-1/4 percent. So you know, this adjustment effort, this program is a very tough thing and I don’t want to in any way kind of underplay how difficult conditions are. But so far, all of the indicators that we watch on a monthly basis—revenue performance, growth performance, some revenue performance, export growth—really have been pointing in a direction in which this growth trajectory that we have in the program is set to be observed.
In contrast, there’s also some other indicators, like unemployment, which are running a bit higher than we had projected. So a mixed picture, but one overall showing very strong, vibrant manufacturing sector, exports performing well, and the program projections coming out where we expect them to be so far.
Just to say kind of I see the problem more in the broader European context for Portugal. The better conditions are in the broader European euro zone area, the better. And on export performance, actually what’s encouraging is we’ve seen a lot of exports through the looser formed regions. So those regions have been providing some support for exports.
MR. CHOPRA: Okay, on the issue of growth, firstly, I’ll talk just a bit about the Irish context and then talk also about the broader European context following on what Abebe just said.
On Ireland, after two years of a very wrenching adjustment and a deep contraction in 2009, 2010, Ireland did register positive growth in 2011. I mean, it was growth to 0.7 percent, which was very close to what we built into the program. The program had been based on 0.9 percent. It came in at 0.7, and I would say the difference over here came about because of the external environment, not because of any new domestic news. Again, the story here is that it’s export-driven.
For 2012, we are still projecting growth of a half percent. It’s been marked down, but it’s been marked down global in euro zone forecasts, relative to last September. I mean we’ve gone up relative to January, but relative to last September.
As I said earlier, the issue in Ireland is that we still don’t have domestic demand. I think on that front, to the extent that uncertainty within Ireland and within Europe can be reduced, that would make a very big difference.
Again, since all of these countries that are affected by the environment elsewhere, a major theme of these meetings, and of our world economic outlook and other documents over the last few days that you would have seen, is that you know, there is a need for growth in Europe. That’s going to be very important. There’s a demand side component to this, which can be addressed through a monetary policy and the calibration of fiscal policies.
But there’s also a supply side component of this, of raising potential growth. That is going to need—you know, and the specifics will vary by country, but it’s going to need a combination of product market reform, service market reforms, labor market reforms so that more people are working. These things have been on the agenda for a number of years, but now it really needs to be found to move this forward.
MR. MOGHADAM: Thank you very much. We have run quite a bit over time, but thanks for your participation and questions. (Applause)