Transcript of a Press Conference on Updates of the International Monetary Fund’s World Economic Outlook, Global Financial Stability Report and Fiscal Monetary
July 16, 2012Washington, D.C.
Monday, July 16, 2012
with Olivier Blanchard, Economic Counsellor and Director, Research Department
José Viñals, Financial Counsellor and Director, Monetary and Capital Markets Department
Carlo Cottarelli, Director, Fiscal Affairs Department
Phillip Gerson, Deputy Director, Fiscal Affairs Department
Robert Sheehy, Deputy Director, Monetary and Capital Markets Department
Thomas Helbling, Advisor, Research Department
|Webcast of the press conference|
MS. NARDIN: Good morning everybody, and good afternoon to those following us in different time zones. My name is Simonetta Nardin from the External Relations Department of the IMF.
We welcome you to this press conference for the launch of the World Economic Outlook, the GFSR, and the Fiscal Monitor.
We have a number of speakers here on the podium today and the order is, starting from my right, we have Thomas Helbling, who is a Division Chief in the Research Department; Olivier Blanchard, Economic Counselor and Director of the Research Department of the IMF; Carlo Cottarelli, who is the Director of our Fiscal Affairs Department; José Viñals, who is the Financial Counselor and Director of the Monetary and Capital Markets Department; Mr. Robert Sheehy, Deputy Director also of the Monetary and Capital Markets Department; and last but not least, Phil Gerson, Deputy Director of the Fiscal Affairs Department of the IMF.
You have seen the documents that have been now posted and are available to all. We will start with introductory remarks from our speakers, and then we will open it up for questions. I will invite those following us online to send questions at this time.
Olivier, if you would like to start please.
MR. BLANCHARD: Thank you, Simonetta. Good morning. The global recovery continues, but it is a weak recovery, indeed, than we forecast last April.
If you look around the world in the Euro zone, growth is close to zero, reflecting positive but low growth in the core countries and negative growth in the periphery countries.
In the United States, growth is positive, but too low to make a serious dent to unemployment. And growth has also slowed in major emerging economies, from China to India to Brazil. And maybe most importantly, downside risks coming primarily from Europe have increased.
That is going to be the theme that I’m going to develop in the next few minutes, so let me start with Europe. So in Europe we are observing an increasing divergence between core and periphery countries. Periphery Euro countries face difficult adjustment. Fiscal consolidation is needed, but it’s weighing heavily on growth. Structural reforms will bear fruit, but only in the future.
Banks have to deal not only with bad legacy loans but also with increasing non-performing loans, which themselves reflect the depressed state of the economy. High debt burdens are making borrowing expensive for the sovereigns. The result is negative growth, not only for this year but also for next -- both for Italy and for Spain.
Turning to core Euro countries, France and Germany: to some extent they face similar problems but on a more limited scale. The required fiscal consolidation is smaller. Banks in general are in better shape. Still their growth is forecast to be low. We have one percent for Germany and three percent for France for this year, a bit higher for both in 2013.
Continuing the tour of the world, in the United States the recovery continues, with some good news early in the year offset by some bad news since then. Fiscal consolidation is taking its toll, so are lower exports. The good news is that housing appears to be stabilizing. Still, the recovery is not strong enough to substantially decrease unemployment. Our forecasts are of two percent growth for 2012; 2.3 percent for 2013. That’s a revision of minus .1 percent for each of the two years.
Finally, turning to emerging markets. Growth in emerging markets has slowed down a bit more than we expected in April. For example, we’ve revised our forecast for China down from 8.2 percent down to eight percent for 2012. Our forecast for India from 6.9 percent to 6.1 percent. Our forecast for Brazil from three percent to 2.5 percent.
The proximate causes vary across countries, with low exports and low investment playing the dominant role. In general, we expect these countries to be able to achieve soft landings, but to lower growth rates than ones which have been observed in the past decade.
Now, putting everything together, our forecast for world growth is for 3.5 percent in 2012; 3.9 percent in 2013. That’s down 0.1 percent for this year and .2 percent for next year. Here you might be surprised by how small these downward revisions turned out to be, given the general feeling that things are worse.
And I think there are two reasons. The first is that we were not very optimistic to start. And the second is that in many countries, while the second quarter of this year was worse than forecast, the first quarter was actually better than forecast, so that the implications for 2012 of that revision are relatively small.
More worrisome than these revisions to the baseline forecast is the increase in downside risks. The main risk is obvious. It is that vicious cycles in Spain and Italy become stronger -- that output falls even more than it does, that one of these countries loses financial access to markets. And the implications of such an event could easily derail the world recovery.
Our baseline forecasts are based on the assumption that policies will be taken to slowly decrease the spreads on Spanish and Italian bonds from their current high to a still-high but lower level in 2013. This, however, requires that the right policies be adopted and implemented.
Now this takes me to policies for the Euro crisis to be contained and eventually resolved. Two conditions must be satisfied. First, the countries under pressure must follow through with fiscal consolidation, wage and price adjustments, structural reforms, and bank recapitalization if and when needed. Spanish and Italian governments have taken important steps in this direction, but they can only succeed if they can finance themselves at reasonable rates.
And here is the second condition. So long as these governments are committed to reforms, other Euro members have to be willing to help so as to make the adjustment feasible. And this implies not only designing Euro-level architecture, but also being willing in the short run to stabilize funding conditions for these countries. Progress was made in recent weeks, but more remains to be done.
Moving away from Europe, for the U.S. the issue remains primarily a fiscal issue. Avoiding the fiscal cliff is clearly the short run priority, but the lack of a medium term fiscal plan continues to be worrisome and a source if not of immediate risks, at least of risks in the not too distant future.
Emerging economies differ in too many ways to allow for a simple, common advice. The best advice may be: be ready. Be ready to use both macroeconomic and macroprudential tools to respond to what is a complex external environment. Capital flows are likely to remain highly volatile. Exports to advanced countries are likely to remain subdued.
Taking a step back, in concluding, the world recovery can continue and can strengthen. The right pace of fiscal consolidation, continuing expansionary monetary policy, getting the financial sector back to health so as to decrease borrowing costs, and solidarity, especially within the Euro zone, are all of the essence.
With this, let me pass on the mic to first José and then Carlo, who will focus on the all-important financial and fiscal aspects of this crisis. Thank you.
MS. NARDIN: Thank you, Olivier.
MR. VIÑALS: Good morning to all of you. And let me begin with the three key messages in our Global Financial Security Update.
The first is that financial stability risks have increased because of escalating funding and market pressures in a weak growth outlook.
The second is that the measures agreed in the most recent European leader summit provide significant steps to address the immediate crisis, but more is needed -- not only the timely implementation of the measures that have been agreed, but also further progress on banking and fiscal unions, and these must be a priority.
And third, time is running out. Now is the moment for strong political leadership, because tough decisions will need to be made to restore confidence, which is fundamental, and to ensure lasting financial stability both in advanced and emerging economies. So it is really time for action.
So let me first describe the reasons why financial stability risks have increased and then I will turn to the policy priorities.
A first reason why risks to financial stability have increased is that government bond yields in southern Europe have sharply risen, while funding conditions for many European banks have deteriorated. The beneficial effects of the European Central Bank’s extraordinary long-term refinancing operations have decreased in recent months, amid renewed policy uncertainty and growing concerns about the health of banks. And this has led to a substantial flight to save assets.
Second, financial fragmentation has exacerbated the adverse feedback loop between weak banks and sovereigns and threatens to undermine the currency union. Private capital outflows have continued to erode the foreign investor base for government debt in countries such as Italy and Spain, and the governments have increased their reliance on domestic banks to finance the public debt. At the same time, these banks have increasingly turned to the European Central Bank to meet their liquidity needs as wholesale funding markets remain closed to them.
Third, sovereign and bank funding pressures have spilled over to the corporate sector in the periphery of the euro area. Companies there have seen rising wholesale funding costs and a drop in bank lending. And they’re also facing a large amount of maturing bonds in the near term, which will likely exacerbate their funding squeeze.
And finally, as Olivier has just explained, growth prospects in other advanced economies and emerging markets are a bit weaker. This has left them somewhat more vulnerable to spillovers from the euro area, while reducing their ability to address homegrown fiscal and financial vulnerabilities. In this regard, uncertainties about the fiscal outlook in the United States present a particular, latent risk to global financial stability.
Let me know turn to the key policy priorities. Now, given the risks that I have just mentioned, it is clear that increased efforts are needed, and are needed now, to prevent financial conditions from further deteriorating and adversely affecting growth. In the euro area, the measures agreed at the recent European leaders’ summit are significant steps to address the immediate crisis. And while their timely implementation is essential, further efforts are necessary to break, once and for all, the adverse feedback loop between weak banks and weak sovereigns. In particular, measures are needed to help the euro area stabilize, integrate, and grow.
Stabilization requires bold policy actions right now. Policymakers should do a number of things. Strengthen the balance sheets of viable banks, where needed, through recapitalizations and restructurings. And in some cases this may involve direct equity injections from the European Stability Mechanism. There is also a need to strengthen sovereign balance sheets by implementing well-timed fiscal consolidation strategies and by enacting sweeping, growth-enhancing structural reforms. It is also essential to maintain supportive monetary and liquidity policies. And consideration should also be given to actions at the euro area level to stabilize funding conditions in sovereign debt markets, such as the reactivation of the Securities Markets Program by the European Central bank.
Further integration requires progress towards a full-fledged banking union and deeper fiscal integration. The planned, unified supervisory framework is the first building block of a future banking union, but more building blocks are needed, including a pan-European deposit insurance guarantee scheme and bank resolution mechanism, both of them with common backstops. These measures should be part of a very clear roadmap to reinforce the confidence in the future of the euro area.
Turning now to the United States, the U.S. economy is also facing an important fiscal turning point, and Carlo will describe that in detail later on. By early next year, the U.S. is expected to reach the current debt ceiling. Market consensus suggests that the ceiling will be raised in time to avert a default. But a significant adverse market reaction cannot be excluded, especially if there is political gridlock over raising the ceiling. Credible medium-term, fiscal consolidation in the U.S. is needed to avoid further sovereign rating downgrades and to preserve an important global public good -- the stability of the U.S. Treasury market.
As regards policy priorities for emerging economies, they need to be understood in the context of the challenges facing these economies: on the one hand, dealing with the spillovers from advanced economies and, on the other hand, confronting increasing home-grown vulnerabilities. Slowing global growth and spillovers from the euro area crisis have clearly had an impact on many emerging markets, as seen in the response of equity markets and capital flows. Homegrown vulnerabilities include rapid bank asset and credit growth in recent years, which may eventually trigger a significant increase in non-performing loads. Moreover, slowing domestic growth could erode bank profitability and pose risks to financial stability in countries such as Brazil, China, and India. In view of these challenges, emerging economies need to remain on their guard and pay special attention to the health of their domestic financial systems. At the same time, they need to preserve and -- even better -- increase the room for policy maneuver to respond to potentially large domestic and external shocks.
Let me conclude. While monetary policies, including unconventional measures such as the long- term refinancing operations by the European Central Bank, provided essential liquidity support to financial systems, they need to be complimented by bold political actions to address the underlying balance sheet problems. Monetary policy has bought valuable time, but time needs to be used well by political leaders to make progress now. Concerns over the solvency of banks and governments, for example, cannot be addressed through liquidity measures alone. So now is the time for bold and concrete actions in advanced economies to achieve sustained balance sheet repair and institutional reform. Tough decisions will need to be made to restore confidence and ensure lasting financial stability in both advanced and emerging economies.
Let me stop here and pass the mic to Carlo.
MS. NARDIN: Carlo, please.
MR. COTTARELLI: Simonetta, thank you. Good morning to all of you. The Fiscal Monitor as usual provides an update of fiscal development and outlook for advanced and emerging economies. And there are three points that are worth highlighting in this issue of the fiscal monitor update. First of all, there is continued fiscal adjustment in advanced economies at the pace that we regard more or less as appropriate, although we have some areas of concern that we’ll highlight later. Second, there is a persistent difference for some advanced economies in Europe between the state of the fiscal accounts as described by fiscal fundamentals and the perception of risk as reflected in spreads: in some cases markets are more negative than fundamentals suggest.
And the third point I want to make is that there has been a pause in the process of fiscal adjustment in emerging economies, which is fine because these economies are in a stronger fiscal position and their growth is decelerating. But we think that in some cases a more ambitious fiscal adjustment strategy should be followed for some emerging economies. So let me elaborate on these three points.
As I said, fiscal adjustment is proceeding in advanced economies at the pace that we regard more or less as appropriate, at least under the baseline scenario of the WEO update. Fiscal adjustment, the average decline in the fiscal deficit this year for advanced economies, will be about three-quarters of a percentage point of GDP. We project for next year a decline of about 1 percentage point of GDP. This year about three-quarters of advanced countries will see a decline in the deficit. And next year the percentage of countries with a decline in the deficit will rise to about 90 percent, so almost all advanced economies next year will have a decline in the deficit.
There is also progress in halting the growth of the public debt-to-GDP ratio. This year about one-third of advanced economies will see a decline in the debt-to-GDP ratio. And this percentage will rise to about 50 percent next year. So next year about half of the advanced economies will have a decline in the debt-to-GDP ratio.
If we focus on Europe, we see that countries like Germany and Italy are closer to obtaining the so-called medium-term objectives, the MTOs, agreed with European institutions, which means essentially they are very close to a balanced budget in structural terms. So a lot has already been done in 2011 and 2012. And this is important because it means that in the future the fiscal tightening will imply a smaller drag on growth than in the past.
In 2011 and 2012, the fiscal tightening, the aggregate fiscal tightening in the euro area amounted to about 2-1/2 percentage points of GDP. If we look ahead in 2013 and ’14, the projected fiscal tightening is only about three-quarters of a percent of GDP. Again, this is good news in terms of future growth in the euro area.
Also, on Europe, the recent decision to slow down the pace of fiscal adjustment in Spain, will still occur at a relatively important pace but it has been slowed down with respect to the previous targets, is a good decision in light of the weakness of the Spanish economy.
So in general, we are happy about the pace of fiscal consolidation in Europe. This said, we remain a bit concerned about continued focus on headline, unadjusted deficit targets, targets that are not adjusted for the economic cycle. We think that there should be more reliance on structural cyclically adjusted targets.
What we are really concerned about in Europe is the fact that in spite of progress in adjusting the fiscal accounts, spreads, as you know, remain very high for some European countries. And they remain higher than what could be explained by what economists the “fundamentals”: the underlying factors that over the medium term affect interest rates, like the deficit, the public debt, growth, inflation.
According to our estimates, Italy and Spain are currently paying spreads at least 200 basis points higher than what could be explained by underlying fundamentals. So a key question is why are spreads higher than justified by the underlying fiscal fundamentals? And there are, of course, various reasons for this. But an important one is what my colleagues already referred to: that high spreads reflect the challenges that the Euro project as a whole is facing. Hence the need not only to continue fiscal and structural adjustment in the countries that are under pressure, but also a need to reassure markets that the Euro Project remains viable.
And again, as it has already been mentioned by my colleagues, this requires increased banking and financial integration. It also requires actions at the euro area level to stabilize funding conditions in the sovereign debt markets such as the activation of the SMP.
There is progress, also, in strengthening the fiscal accounts in the United States. This year we projected the deficit for the general government -- that is the federal government, the states, and local governments, municipalities -- to decline by about 1-1/2 percentage points of GDP, which is a sizeable adjustment, although the level of the deficit remains high, of course, about 8 percent. If we look ahead, if we look at 2013, there is a need to avoid what people now are calling the “fiscal cliff,” namely the very strong decline in the deficit that would take place in 2013 in the absence of additional action. We estimate that in the absence of supportive action the deficit in the United States will decline by more than 4 percentage points of GDP in 2013, which would be the largest adjustment on record since 1947 and which would not be a good idea for the U.S. economy, where growth is still not high enough. We think it is important to avoid, therefore, the fiscal cliff, this very strong tightening, and more moderate adjustment perhaps on the order of 1 percentage point of GDP would be appropriate in the context of a medium-term adjustment plan that is still missing in the United States.
As to emerging economies, with respect to the April projections there is some weakening in our deficit projection for both 2012 and 2013, which is fine -- we don’t consider this as a major problem at the moment because this reflects primarily a deceleration in economic activity in these countries in the context of generally stronger fiscal positions than in any advanced economies. In other words, these countries have more fiscal space and some of them are using it.
This said, for some emerging economies a somewhat more ambitious fiscal consolidation strategy would be appropriate, in some cases reflecting macroeconomic considerations, still high inflation, or large external current account imbalances or deficits; in other cases, reflecting persistent fiscal risks.
So I will stop at this point and thank you for your attention.
MS. NARDIN: Thank you very much, Olivier, José, Carlo, for your remarks. We are now taking your questions here in the room and online.
QUESTION: For Mr. Blanchard, I just want to see if you would elaborate a little bit on some of the constraints that appear to be facing the emerging markets as they now are drawn into the slowdown. It seems that the fundamental message here is that all of the stimulus, all of the efforts since 2008 have really exhausted themselves. The emerging markets have been a bright spot. Now if I’m reading these reports sort of as a group it looks like, you know, there’s worry about credit issues in China, there’s worry about fiscal issues in India, there’s worry about, you know, the currency collapsing in Brazil and credit issues there. So is it fair to say that none of these economies are really positioned to make the same sort of effort they made in 2008 if there is another shock?
MR. BLANCHARD: So I think the slowdown in emerging market countries varies from country to country, but it’s clear that they’re all affected to some degree by low activity in advanced economies and by low exports. And the influence of trade is actually quite striking. In 2009, we saw a collapse of trade much larger than the collapse of output. We’re not seeing this on the same scale, but there is a very strong trade effect. So if these countries are facing this, this decreases their demand.
In many countries you also had credit booms or investment booms, and these are coming to an end. And they were, you know, partly unhealthy and so coming to an end is good.
Now, the question is will these countries be able to handle this slowdown in demand? And here we think that in most cases they really have the policy space to do it. I mean, if you take China, I think China has made clear that they are ready to push demand in some ways. They have indicated that they are going to do more public investment, in particular investment in social housing. They have started relaxing monetary policy. So this is going to help.
Now, from our point of view, it would be better if they actually relied more on an increasing consumption than an increasing investment. But in terms of achieving and sustaining high growth, I think they can do it.
In the case of Brazil, the slowdown is very much due to an earlier credit tightening and they are relaxing it and we think that they’ll be able to sustain high growth next year if you look at our forecasts.
In the case of India, it’s a bit more complex. We think that some of the slowdown in investment is due to political problems, uncertainty about policy, some freezing of permits for infrastructure and other investment. And there is, I think, more of a political problem and India may not be able to react as well the other two.
So I think it’s really a case-by-case answer. But in general we think that they’ll be able to increase demand if needed. Although they’re not going to go at the 10 percent of the past, they’re going to go at fairly high rates.
MS. NARDIN: Thank you very much for all your questions.
QUESTION: I have a question on the U.S. and the general type question. In the U.S. even this morning we are reading about continued brinkmanship on that fiscal (inaudible) issue. In the report you say that it is fraught with very serious spillover effects for the outside world. If you could elaborate on that I would appreciate it, especially for countries that you have just talked about and Russia.
And the more general question -- I wanted to ask about the scandal around Libor and whether it has any real significance for the world economy, but then I thought that the more interesting question here is how this is a part of a general picture. We see the political squabbles in the U.S.; we see the political squabbles in Europe; we see scandals such as the Libor scandals in the private sector. Doesn’t it all undermine trust, the essential element of everything you do, of everything you call for? Trust in the ability to perform, in the ability to reform the economies? And how significant is that? Thank you.
MS. NARDIN: Thank you very much, I think we have a few questions here maybe on the U.S. Carlo?
MR. COTTARELLI: On the fiscal cliff, it’s clear that given the size of the U.S. economy what happens in the U.S. has large spillovers for other economies. We highlighted in our presentation three points that are critical. One, the magnitude of the fiscal cliff, more than 4 percentage points of GDP, will clearly have implications for growth in the U.S. and in the rest of the world. So there is a need for avoiding such a large adjustment. We think as it is mentioned in the Fiscal Monitor that a pace of adjustment of about 1 percent will still provide a strong signal that there is progress in fiscal adjustment in the U.S. and yet will be not as inconsistent with the continuation of growth as a tightening of 4 percentage points. At the same time as it has been mentioned by my colleagues, there other forms of spillover that are important. One relates, as I mentioned, to the debt ceiling. There is a need to raise the debt ceiling well in advance of the January deadline.
And finally, the third point is more of a medium-term nature. The fact that the U.S. does not yet have a clear medium-term fiscal adjustment plan that would take care of the short-term level of the deficit but also of the long term challenges for fiscal policy in the U.S. including demographics. So these are the three key areas where action is needed in terms of fiscal policy in the United States.
MR. VIÑALS: I would like to comment on the LIBOR issue. I think that the most serious consequence of this scandal, which is under investigation, is that it undermines the certainty and the trust that markets have in benchmarks that are used to price many contracts. But it also underscores the importance of regulatory reform. It underscores the need to complete the current regulatory reforms regarding financial institutions. These regulations need to be implemented without delay. Moreover, good supervision is needed to ensure that financial institutions have internal procedures and governance that prevent these things from happening in the future -- in the area of LIBOR or in any other area. So, this is why it is very important to continue with the reform process that was launched by the G-20. It needs to be completed; it needs to be implemented in terms of regulation and supervision.
MR. BLANCHARD: I want to go back to the fiscal cliff and give you some arithmetic results which I think will be useful. So, we at this stage, forecast -- our forecasts are based on the consolidation of 1.5 percent. So we’re at 4 percent which is what will happen if we fell down the whole fiscal cliff. It would be 2.5 percent more, right? I think it’s reasonable at this point to assume that multipliers of the order of 1.5, which means that other things equal this would take 4 percent off growth next year for the U.S. and then, as a back of the envelope number, assume that the effect on advanced economies would be one-third of that. And so this would be a decrease in growth relative to our baseline of 1.5 percent by advanced economies as a whole.
We’re talking about potentially an enormous shock, and therefore, yes, if it were to happen this would be a major, major event.
MS. NARDIN: Thank you very much. I’m going here and then we’ll take a couple more questions online and then come back to the room.
QUESTION: You mentioned in the report that bond buying of sovereign debt, particularly for Italy and Spain may be required but then I think you said, Carlo, that it is required which is a little stronger statement given the spread differential that’s then higher than you say is justified. So, are you saying that the EU authorities whether it’s ESM, EFSF, or the ECB must start buying bonds, sovereign debt bonds, now?
MR. COTTARELLI: I think what we said is that what is needed to take care of the medium term project for Europe is stronger integration of banking and stronger fiscal integration. There is also a need for some form of support but we have not really provided anything of a specific way of providing -- we’re not talking about a specific way of providing support. We said as it was mentioned in the concluding statements of the Article IV consultation with the Euro area institutions, that consideration could be given to restarting the program of purchases of government paper. But there are other solutions that are possible.
So what we think is clear is that there is a need for intervening at two levels. One is the level of the long term project for the Euro area; another one is to increase the liquidity in the banking and the securities market.
QUESTION: But what other type of support specifically do you think would be effective?
MR. COTTARELLI: We mentioned in the past, for example, that consideration needs to be given to Euro bonds issues. And, again, this is something that is mentioned both in the Fiscal Monitor and in other documents like the concluding statement of the Article IV consultation for the Euro area. So there are various solutions.
MS. NARDIN: Thank you very much, we have a few questions online. One on Spain. Do you have any estimate about the effect or implication about the new austerity measures in your growth projections? I would ask Thomas.
MR. HELBLING: The new fiscal measures that were just announced mid-last week are indeed not yet incorporated in our forecast. Our Spain team is looking at these new measures and for the discussion of the Spanish Article IV consultation at the end of the month these effects will be assessed. Preliminary estimates suggest that this additional fiscal adjustment will lead to a greater contractions in real GDP this year and 2013 relative to our baseline. While it is too early to be definitive, back of the envelope calculations suggest the revisions would be of magnitudes that would materially change our forecasts both for the Euro Area as a whole and the global economy. That’s not true necessarily for Spain.
MS. NARDIN: Thank you very much. We have a couple of questions on Italy, the first one is from (inaudible), “Considering the negative growth of Italy, how do you consider the spending review program? Is that enough to lower the public debt and restart growth?” And another one that we have somehow already addressed, “The Fiscal Monitor says regarding Italy, the 200 basis point spread is not justified by country’s fundamentals. Do you believe Italy would get significant relief asking for ESM to buy Italian bond (inaudible) the secondary and/or on the primary markets?”
So, maybe the first one, if José will take it or to Phil. Okay.
MR. GERSON: Thanks very much. And the first thing I’ll say at the outset is I would direct you to the Article IV report for Italy, which was published last week, which is obviously going to give a much more comprehensive answer to that question than I can do here.
Having said that, the authorities have implemented plans for adjustment over 2012 to ’14 equal to 5 percent of GDP, which is sufficient to give Italy the largest primary surplus, that’s the surplus excluding interest payments, the largest primary surplus in the Euro Area in 2012, the largest primary surplus in the Euro Area in 2013, a structural surplus, that is the fiscal position excluding the effects of slow growth, a structural surplus in 2013, and a debt ratio that begins to decline after 2013.
So, the challenge for the authorities going forward is twofold, first of all, to make sure that that significant fiscal adjustment is as growth friendly as possible, and secondly, to make sure that over the medium-and longer-term, that progress has been locked in.
In terms of making the fiscal consolidation as growth friendly as possible, it is true that much of the consolidation so far has been on the revenue side and one of the challenges for the authorities going forward will be to shift some of that adjustment from revenue to expenditure.
The authorities have already announced and begun implementing expenditure reviews that will allow them to cut spending and replace some of those revenue measures with spending measures in order to make sure that more of the adjustment comes on the spending side. Given the very high tax ratios and high spending levels in Italy already, it’s clear that an adjustment that is based more on spending measures than on revenue measures is something that would be growth friendly. So, that’s the first part of the process.
The second part of the process for locking in measures over the medium-term is, we think, first of all, to set a target under the authority’s new structural fiscal rule of a structural surplus of 1 percent of GDP rather than just structural balance. We think the 1 percent target would give them greater room to respond to shocks that might happen in the future to help build fiscal space and also to begin bringing the debt ratio down more quickly than would otherwise be the case.
The second thing that we think they need to do is to make sure that the fiscal council that’s being set up is implemented in a way that makes it as independent as possible, because there’s a lot of evidence that the more independent a fiscal council is, the more effective it is in ensuring that it plays its role in creating confidence about the course of fiscal policy.
So, in terms of what Italy needs to do, specifically, I think that’s the answer, to make sure that adjustment occurs in as growth friendly a manner as possible, and to make sure that over the medium-term those achievements that they’ve already made are locked in. And I think the second question, with respect to interest rates in Italy and how they come down, has already been addressed by Carlo and by José, and so I won’t go into that.
MS. NARDIN: Okay, we’re coming back to the room. There is a question there.
QUESTION: I’d like to ask about your relative optimism about Greece -- sorry, Spain and Italy, because you’re projecting that the economic decline in 2013 will be only half of the decline in 2012.
It seems counterintuitive given all the austerity that has yet come into place and this, we’re already halfway through 2012.
MR. HELBLING: Well, as I said before, turning to Spain, I think if we look at the new fiscal package, at the measures, it seems fairly sure that the impact will be largest in 2013. Now, in Italy, a lot of the measures that were announced by the Monte government in November and December of 2011 were known and incorporated in the forecast in 2012 and ’13. The measures at the time were frontloaded, so that’s the reason why the impact is strongest in 2012.
MR. BLANCHARD: Can I add something? This is more Carlo’s territory, but I think an important point is to realize that fiscal consolidation is very strong in some countries this year, and then looking forward in many countries it is going to be weaker, which means that the drag on demand is going to be smaller. So, this is some reason for optimism.
You know, you’ve asked about Spain and Italy, but for example, the UK would be another example. So, I think it’s important when you’re in the middle of the worst part to realize that the drag will be less later.
Now, what has to be avoided is that this drag today leads banks to be weaker and then transfers to problems next year. It’s important to just limit the damage, but I think that the reason we are somewhat optimistic looking forward, beyond just 2013, is that the fiscal consolidation is really happening now in its major form and will be weaker later.
MR. COTTARELLI: Actually, if I can, again, the numbers -- the key numbers for the Euro Area are that in 2011 and 2012, the fiscal adjustment cumulative is 2.5 percent of GPD. For 2013 and ’14, it will be 0.75 of a percent of GDP, so there will be much less fiscal tightening in 2013 and ’14 than in 2011 and ’12, and that’s very important for growth.
MS. NARDIN: I have a question right here.
QUESTION: Thank you. The question is about China. China’s growth rate this year has reversed down from 8.2 percent to 8 percent, so my question is, what this downward revision mainly reflect? And the Central Bank of China has already adopted the monetary easing policy. And what else should China do to get better prepared for the global slowing down? And another question is for the U.S. And some people say that the policy measures the U.S. needs right now is more on the fiscal side rather than on the monetary side, and what would your view on this? Thank you.
MS. NARDIN: Thank you very much. Maybe on China we stay on the (inaudible) if Carlo wants to add something later.
MR. HELBLING: On China, the revision relative to April is relatively small as a whole, 0.2 percent. The main reason for that is the weak external demand from Europe, other advanced economies. But if you look at investment, to slow down investment, I think has started to bottom out. If you look at the latest number in June, this started rising again and our forecast incorporates or based on the view that the easing of policy that has started to set in in 2012 will gain traction in the second half of the year.
MR. COTTARELLI: Sorry, I didn’t catch the question on the U.S. Can you please –
MS. NARDIN: The need for fiscal action more than monetary action.
MR. COTTARELLI: No, I mean, as I said, what is critical in the U.S. is to find the right balance. Deficits are large, public debt is increasing. So, there is a need for fiscal consolidation in the U.S., but the pace of fiscal consolidation that will happen in the absence of action is just too large. So, there is a need of identifying supportive measures for 2013 that would avoid such a large tightening of fiscal policy. And among these measures, one should consider measures that are of largest impact on economic activity and aggregate demand, such as infrastructure spending, a measure to support housing, unemployment benefits.
MR. VIÑALS: On China, I think it’s very important that the authorities remain very vigilant about the health of banks and that they continue to ensure that the banking system is as well capitalized as possible. This is particularly important in an economy that has seen rapid credit growth in the past.
So, in addition to other macroeconomic policies, I think that prudential policies are extremely important in China and other emerging markets, where the growth of credit has been quite significant in the past.
MS. NARDIN: We have a question online. He asks, “In a petition 172 German economists have dismissed the idea of a banking union in the Euro Zone. What is your stance on this issue?” Maybe, José, would you like to –
MR. VIÑALS: Well, let me reiterate what I have said. It is essential that the monetary union is put on firm ground. The monetary union really needs to be accompanied by a certain degree of financial integration. And for this, it is essential that banks, which are the main segment of the financial system in Europe, are supervised in a unified manner, that there is a single rule book, single regulation --this is something that is already happening. Single regulation, centralized supervision, centralized deposit insurance schemes or a European dimension of deposit-guarantee schemes, and a European bank resolution process are all essential.
If you don’t have that, it is very difficult to continue having an integrated financial market. What we have seen in the recent past is that there has been an increasing financial fragmentation, and that is fundamentally inconsistent with a single currency area like the euro area. So, I am absolutely for a banking union. And I understand that some elements of the banking union, like the deposit-guarantee scheme and the bank resolution mechanism, may require some elements of fiscal risk-sharing. If you want the euro area to continue and to be on solid ground, the inescapable consequence is that you need a banking union and further fiscal integration.
MS. NARDIN: We have one question online about the forecast and maybe it’s good for all in the room and listening to clarify this. “How is this possible that the global GDP forecast was 0.1 percentage points lower than April’s, but the forecast remains at 3.5 percent?” So, maybe if you could explain very briefly?
MR. HELBLING: It’s a rounding issue, essentially. We calculate global growth bottom up. In the table, we then calculate the differences between the forecasts, and then round the forecasts and the differences to one decimal. So, in April, we had something like 3.54 and now we have something closer to 3.46.
MS. NARDIN: Just a rounding issue. One question online: “Given the sharp downgrade to UK growth forecasts, is it time to consider fiscal easing as per the last Article IV report? What policy changes might be appropriate at this stage?”
MR. COTTARELLI: There was already reported in the Fiscal Monitor, a slowing down of the pace of fiscal adjustment this year in the United Kingdom. I think it’s also important to keep in mind the important operation, the funding for lending operation that the Bank of England has announced it would be implementing. That also will be important to support economic activity. So, one would have to see how things develop before revising the fiscal plans.
MS. NARDIN: Thank you very much. There is a question right there now.
QUESTION: Are you too optimistic about the emerging market’s growth prospects next year? I mean, you project 8 for China in their market stock and about 5 -- about 7, and for Brazil, you are expecting more than 4 next year, and there is some talk in Brazil about the slowdown of the economy because of the end of the credit cycle.
So, I’d like to know, why are you projecting higher growth for emerging markets than remarked?
MR. HELBLING: Overall for emerging economies, I think there are a number of common factors at hand. On the one hand you have a drag from the advanced economies. If you look at our forecasts, I think the drag from the advanced economies is probably going to stabilize in the sense that it will not worsen further in the forecast. U.S. growth is assumed to pick up. Euro Area growth as a whole is expected to pick up.
Second, if you look at emerging economies, I think part of the slowing has been deliberate. It has been deliberate in China, it has been deliberate in Brazil and other emerging economies.
Now, that policy response, an attempt at slowing was a response to signs of overheating, also to signs of too rapid credit growth. In this respect, the slowing was welcome. But the deliberate slowing, I think, has now come to an end, broadly since the end of last year, and emerging markets have started easing again.
So, in our forecast we assume think that this easing will gain traction. If you look, for example, at Brazil, there were issues with the effectiveness and the transmission of the monetary easing last year, a starting problem of sort, with credit and rising non-performing loans. But the expectation is that these problems are more under control, that banks have adjusted, and that the policy easing over the past year or so should gain traction.
So, our baseline remains for stabilization and slight pickup in emerging market growth.
MS. NARDIN: We have one question here.
QUESTION: Two questions for José. Do you have a view of how senior bondholders in Spanish banks should be treated in a rescue? As you know, there’s some debate about that point. And, secondly, do you have any concerns about how European officials are discussing the Spanish bank rescue, particularly the issue of whether the sovereign or the ESM will be responsible ultimately for any losses in a bank recapitalization?
MR. VIÑALS: Rather than commenting on a specific country, where negotiations are taking place, let me just make a general point: the treatment of bondholders during a restructuring or resolution depends on the specific circumstances, while global regulations need to be taken into account. For example, the attributes of effective resolution regimes are very clear on this: if a bank is resolved or liquidated in any country in the world, then the first losses need to be absorbed by shareholders, followed by junior bondholders and then unsecured senior debt holders.
In the European Union, the European Commission has put forward a number of proposals on bank resolution regimes, which also contemplate bail-ins for debt under certain circumstances. But I don’t think that you can say anything specific about a specific country at any given time without knowing exactly the circumstances. Which country are we talking about? Which bank are we talking about? Has the bank been restructured with public money? Is it being restructured, or is it being resolved? So there are many things you have to clarify before you can answer your question on a specific country. And I’m providing a general response rather than a specific response.
MS. NARDIN: We have one very quick last question over there.
QUESTION: Last week the fact-finding mission returned from Greece. As we know, they find delays at the Greek program. How do these delays affect the implementation of the Greek program and the disbursement from the next installment of the loan money? And how these difficulties affect Euro Zone?
MS. NARDIN: Sorry, can you repeat the question?
MR. VIÑALS: I think I understood it. Let me just mention one thing. As you know, we had an IMF mission team in Greece, which has just returned to headquarters. This was a fact-finding mission to assess recent developments. And there will be another mission towards the end of the month to continue looking at things. The main priority for the Fund right now is to make sure that the program goes back on track.
MS. NARDIN: Thank you very much. This concludes our press conference today. Thank you.