Transcript of a IMF Conference Call on the Release of the Staff Report on the 2012 Article IV Consultations on Euro Area PoliciesSpeakers:
Mahmood Pradhan, Deputy Director, European Department
Petya Koeva-Brooks, Advisor, European Department
Helge Berger, Advisor, European Department
Moderated by Simonetta Nardin, External Relations Department
July 18, 2012
MS. NARDIN: Welcome to this conference call on the publication of the staff report on the 2012 Article IV Consultation on Euro Area Policies.
MR. PRADHAN: Thank you, Simonetta. Good morning or good afternoon, wherever you are. I would like to take a few minutes, maybe five minutes, just to give you a flavor of the report that you have and what our consultation has focused on this year. Let me start by saying that this year the Article IV consultation has focused very much on what is needed to complete the union -- to sustain the economic and monetary union. We have characterized the current situation as being at a critical stage, where national efforts of adjustment -- those countries that are facing debt burdens, fiscal deficits, market pressures, and the high spreads -- they need support from the center. That is really what this report is about this year. Let me take you through some of the key elements of where we see the need for more measures to complete the union, more initiatives. In addition, I will touch a little bit on the recent measures at the summit.
First, we think that it is vital that they make more progress towards the banking union. And I want to elaborate a little bit on the three elements we see that are necessary to complete this banking union. Firstly, common supervision. Secondly, a common deposit insurance system or framework. And thirdly, a common resolution framework.
I just want to elaborate why it is very appropriate and relevant that the recent summit [of June 28 and 19, 2012] started with the first element of that banking union, which is common supervision. What is happening in Europe right now is that the common monetary policy for the Euro area is not quite working. It’s not effective across the union, and the reason for that is that there is fragmentation in European financial markets across national borders. Very simply, what’s happening is that national regulators, national supervisors, are safeguarding their domestic banking systems by persuading, encouraging domestic banks to maintain liquidity at home. As a result, what you are seeing is that while the European Central Bank has pursued a very accommodative monetary policy, that liquidity is very, very unevenly spread across the Euro area.
That’s why supervision is important to focus on a common framework that allows banks to pay attention to all -- or be guided by European or Euro area considerations. Now let me say that this is one of the links of this -- the ties between sovereigns and banks that everyone, not just ourselves but also Euro area leaders and Euro area policy institutions, are very keen to see loosen or to break these links, or to reduce the strength of these links.
That’s why a banking union is important. We hope they will follow up with a deposit insurance framework so that depositors across the Euro area are not primarily concerned about the strength of their sovereign when they think about the safety of their deposits or the security, and so on, that the sovereigns who are currently facing debt burdens and going through adjustments don’t have the added burden of maintaining confidence among depositors in their banking system.
I want to touch very briefly on the resolution framework. There are very widespread discussions, which we have supported, about allowing common resources in the Euro area to support direct capitalization of banking systems. That is a part of this common resolution so that where banking systems are stressed and require official help, they are not solely reliant on their sovereign and do not therefore add to debt burden that may already be high. These are the three elements of the banking union.
I started by saying that national efforts should be supported by the center. Let me talk a little bit about shorter-term measures that need to support what is going on, especially in the periphery. Fiscal adjustment, structural adjustment that is necessary to restore competitiveness of the economies -- that needs to be supported by two things.
We would like to see demand support maintained. Two elements of that. One is an accommodative monetary policy from the European Central Bank. And that we think should and will likely need to include unconventional measures. More as we approach the zero bound in interest rates. There is some further room to reduce interest rates, but it is likely that they will need more measures and this could include some traditional measures such as quantitative easing or selective measures such as the ECB’s SMP program. That may need to be scaled up.
Secondly, in terms of demand support, we would like to see fiscal consolidation proceed at an appropriate pace, given the country-specific circumstances. So there we would like to see fiscal consolidation, possibly at a slightly slower pace in countries that have fiscal space and are not under severe market pressure.
It is inevitable the countries that are under severe market pressure will need to continue consolidation and will need to adjust in line with that pressure and need to pay attention to, or are definitely constrained by, market access. –In addition to demand support, we’re encouraged by the European efforts to increase their firewall, so that official assistance can be provided when necessary at a reasonable cost, because that is essential for fiscal adjustment to be successful and for these countries to be able to sustain this adjustment.
Let me end by –coming back to my earlier point about completing the union. On a more medium term perspective we would see a need for more fiscal integration, more fiscal union, providing, of course, it goes with stronger governance, stronger fiscal discipline. That would help allay some concerns -- which are possibly quite widespread in a number of countries -- about moral hazard. This is something that is very relevant for the discussions about common debt or debt mutualization or, in brief, Eurobonds. We are very supportive of debt mutualization but recognize that it will take time and recognize that it will need to go with stronger fiscal governance.
Let me finish by saying in this context we are encouraged by the developments of the last two years -- the initiatives at the policy level -- to strengthen fiscal governance by the fiscal compact and within the stability and growth pact.
Very finally, coming back to my first point -- we are at a critical stage -- I want to emphasize that we see the Euro area as a whole as having internal issues. We do not see vis-à-vis the rest of the world the Euro area is having any significant imbalances, which need to be addressed. They are within the region and can be resolved by Euro area policymakers with a better and a stronger architecture.
I will stop there and happy to take your questions together with my colleagues Petya and Helge. Thank you.
QUESTION: I have two things, if I could. The premise of the EMU was that over time all of these economies would converge (the Germans have spoken very deeply on this), that you’d end up with common levels of debt, productivity, spending. They’d all sort of look alike. This was formed 30 years ago before China came online, before Asia became a competitor, before the economies in Poland and the Czech Republic emerged. Do you think the premise still holds that these economies can ultimately sort of look alike, and how much harder has that gotten in the current kind of globally connected competitive environment than it was, say, 20 years ago?
The other question was, I was struck by two things and one comment. One, the implications of disinflation, if it occurs -- you highlight that risk. And second, the comment about the supervisors encouraging banks to bring money home. I’m just wondering what examples you have of that and how explicit the message is to, you know, protect yourself behind national borders.
MR. MAHMOOD: Let me take your first question about the aspirations for convergence. I think that you make the right point, and for many countries -- not just for Euro area countries and the point is that what we are seeing around the world a lot – for ten, twenty years -- is the rise of a number of lower income countries rising to middle-income levels.
For example, the rise of the Asian economies, is a phenomenon that one should take as a very big positive, and in the follow sense–The rise in these income levels in Asia, which we expect to continue, has been remarkable. It is also a very, very big opportunity for most countries in the world -- and I would say pretty much all the exporting countries of the world -- to benefit from that. We do not see this as a competition between, say, Asia or the BRIC countries or the larger emerging market countries, as undermining growth prospects or export opportunities for the advanced countries.
To answer your question, convergence hasn’t quite happened in the way many would have envisaged, okay? There have been some issues about skewed development. We have not seen some countries within the Euro area maintain competiveness levels. To give you an example, we saw during the good years, if you will, convergence took place in the form of large capital flows, similar cost of credit across the Euro area, and some of this credit went into financing what we now look at as excesses. Perhaps we could think about the property sector in Ireland, or the property sector in Spain.
Now we are looking at some of these economies -- they didn’t quite adjust in the right way in terms of your earlier point about convergence. This is a wider question, which is looking back at this and the lessons we’ve learned from the global financial crisis and credit excesses in a very large number of countries. There may have needed to be some supplementary policy framework, such as macro prudential controls and controls on lending, in an environment when you are faced with very large capital in-flows at very cheap costs.
I take the broader issues about the rise of other countries as a positive. I don’t see this as a negative. I think it’s a question of taking advantage of it. The U.K., for example, which is faced with the challenge of rebalancing away from domestic demand towards external demand is faced with a very similar challenge. That will require a change, not just in competitiveness as measured in very simple macro terms that we normally look at, but also changing a kind of business model.
Now, your question on disinflation. In the report, I did not touch on this in my opening remarks in detail, we do recognize that the ECB has a mandate for price stability for a Euro area average. We would encourage policymakers to allow inflation to be at somewhat higher levels in the stronger countries, so that the countries that are faced with strong adjustment efforts are not in a prolonged inflation environment.
The two percent price stability objective in headline inflation, we’d say if inflation is somewhat higher in the stronger countries, the ECB should tolerate that so that we make sure that inflation in some of the adjustment countries, in the adjusting countries in the periphery, is not negative.
Very finally, there are no formal frameworks where supervisors, say, introduce new rules, to say you will bring liquidity back home. What I meant was that there are informal networks of things like liquidity requirements on banks, capital buffer requirements, which naturally tend to favor exposures that banks have at home. And that’s the fragmentation I was talking about. I do not mean, by the way, that in the current crisis new rules have been introduced. Here I’m talking about things like risk weight and so on and how liquidity is treated -- how different assets which comprise liquidity, how they’re treated.
QUESTION: In the negotiations and debate about the direct recapitalization of euro area banks, there’s a question about whether there should be guarantees by the sovereign. And generally and specifically, I’m wondering whether you would suggest that to be a good or a bad thing in general; and specifically in Spain, wouldn’t this weigh on the debt, the deficit too much? I noticed in your WEO, or the GFSR, you did not include it in the deficit.
Secondly, how well insulated is the eurozone from a Greek default until deposit insurance is in place? And finally, the part of the euro area sovereign bond markets -- in the [Fiscal Monitor] I think it said that yields were 200 basis points off fundamentals and that the euro area authorities needed to support those bond markets. When I asked about that[at the WEO-FM-GFSR press conference on July 16] I was given an answer something about bonds, euro area bonds as well as bond buying. But that’s a long-term project, which suggests it’s not an urgent or a near-term suggestion at all. Is it a near-term suggestion? Is it urgent in that sense?
MR. PRADHAN: On your question about guarantees by the sovereign, our preference would be direct recapitalization where the liability of an entity that receives that capital -- in this case let’s say that’s Spanish banks that receive some form of financial assistance to strengthen their capital -- their liability is to a common entity in the euro area away from the sovereign. This is going to take a little while. The current discussion is going on with the ESM, and the ESM has the possibility of taking that direct stake, meaning not going by the Spanish sovereign. Those discussions are still going on, but as I say, you asked me a question about our preference. Our preference would be for a direct recap.
On deposit insurance, let me elaborate a little bit on my earlier point, which is that I do not want to be misread as saying national banking systems do not have deposit insurance. All euro area countries have deposit insurance, reasonably standardized. The European Union -- and here I digress for a little bit -- has a strong initiative within the single market context to promote a harmonized framework of deposit insurance. So deposit insurance, wherever you live in the euro area, you will be offered the same similar deposit insurance. We think that within the euro area where people are moving deposits around when they are concerned about pressures on their sovereign, a euro area-wide deposit insurance framework would help. A of us would strongly urge that this is consistent with the initiatives going on in the euro area.
Thirdly, I think the point that my colleagues are making is that some yield levels we see in the euro area are difficult to explain by the fundamentals. The 200 basis points difference is uncertainty about future prospects and stresses currently going on. Some of these stresses, let me emphasize, are when we say fundamentals, we mean the economic fundamentals -- debt burdens, fiscal adjustment, and so on. What is very difficult to model is when your banking system is going through some stresses. That’s very difficult to model, and that’s where some of the difference comes from, some of the difference that we cannot explain, some of the yield levels. If you’re thinking about Spain, for example, you know that Spanish banks have had recourse and have had to use recourse to liquidity facilities provided by the ECB. It’s those kinds of stresses that are difficult to explain in yields. This is not an issue, as I emphasized earlier, about euro bonds in the near term. This is an issue about what I said earlier in my remarks was how national adjustment efforts need to be supported by the center. What I meant in detail, to be specific, is that we think what the ECB will need to do is maintain an accommodative stance and unconventional measures that may mean a further expansion of the liquidity provision, the LTRO, and that may also mean scaling up some asset purchases.
QUESTION: Two questions. On page 14 of your selected issues report, you have a couple of paragraphs about European deposit insurance guarantee scheme and also a centralized bank resolution agency. You say to be effective immediately, you should have access to additional funding such as a credit line from the euro system -- and then you seem to suggest that could be from the ECB. So that’s one question. The second question is you were talking broadly about the pressures that national regulators face to avoid undermining the credibility of their banking systems as they try and deal with this stuff.
MR. PRADHAN: On the first question, to have a deposit guarantee scheme: If you were to set it up now, to make it credible, you may need a liquidity backstop; meaning if you think about deposit insurance within the national system, it is often under-funded. But it relies on the credibility of a central bank; that if it needs to be used, then there’s no question mark asked, is there a pool of funds set aside to pay depositors who are exercising their insurance? Within the euro area when you set it up, what we’re suggesting is you may need a liquidity backstop until it is adequately funded. I’m glad you asked the question. By adequately funding, we mean until there is a system in place where most of it is funded by levies on the industry itself, levies on banks, which is how deposit insurance is normally funded. It is just a point that putting all of that in place may take a little time. So that’s what we mean by some backstop from the center, and that could be the ECB. But this is the next leg, as I emphasized earlier, this is the next leg of this banking union. There is specific proposal that everyone has accepted -- but you could, for example, design a deposit insurance system by pooling current national resources that are earmarked for deposit insurance within each member state. Your second question is -- I’m going to have a go at it -- it’s still a little vague to me. Responsibility for banking systems rests entirely on member states. In the EU, there are single market initiatives, harmonization, there are lots of collective agreements including Basel and so on about rules, but the responsibility of maintaining a sound banking system is with national regulators. Now, some of these national regulators are also faced with pressures from their fiscal authorities which are faced with debt burdens, they need to raise capital, et cetera, and the banks are traditionally a relatively large holder of sovereign asset.
QUESTION: But do they have an incentive to make their banking systems look better than they are because of the risks they would face if the banks really --
MR. PRADHAN: Oh, that’s a separate issue. Sorry, that is a separate issue. Here I’m just thinking about maintaining liquidity at home. That’s really all I’m talking about.
QUESTION: If you look at your economic projection, you have a negative growth rate of 0.3 and a positive growth rate of 0.7 next year. But on the other hand, you have the output gap in both years at -2.3 percentage points. And I’m just wondering, you have a swing in the growth rate of 1 percentage point from 2012 to 2013, and the output gap is going to stay the same. I would just like you to explain how that could work.
And my second question is it seemed that there is a lot of resistance in the eurozone about going on with the banking union, but going on with the fiscal union. If these proposals you mentioned in your report do not take place, what is your outlook for the eurozone? How is this going to evolve if we don’t see a fiscal union, if we don’t see further steps for a banking union or a fiscal union?
MS. KOEVA-BROOKS: Thank you, yes, indeed. This year we are projecting overall growth to be negative at -0.3, and then we’re also expecting a fairly sluggish, very modest, recovery in 2013 where the growth rate would be 0.7.
In terms of why the output gap is not changing very much, the answer to that is that at the same time, the trend level of growth, the underlying growth rate, is also changing which is why we have a gap remaining.
MR. BERGER: We are pretty clear in this report that in order to anchor the short-term crisis effort that we’re seeing, we need a very decisive effort to allow more integration along two dimensions. One is the financial sector I mentioned, the banking union as Mahmood discussed in some detail. And then linked to this, but somewhat more following the former, is an effort to improve fiscal integration. And that is important, too. It is important to support what we call the banking union because the banking union needs an element of risk sharing -- these are these common backstops that have been discussed and are discussed in some detail in the papers you have in front of you. One of you already pointed to the background work that we have, there’s background work on the banking union and another one on fiscal integration.
Now, how important is it that all of this be implemented, in particular the fiscal part, right now? I think what is important is that we get a clear sense of the roadmap towards this integration. It is one thing to define where this is going and to create a sense of momentum towards a more viable economic union, another thing is to be very specific up front what is happening and when. I think we need that roadmap, and I think once we have the roadmap, the roadmap will sort of assure the viability.
QUESTION: So do you say if we don’t get a roadmap, if you don’t get a sense that the eurozone is going into this direction, would that mean that the eurozone can survive? My question is what’s happening if the Europeans are not going into this direction?
MR. BERGER: In a way it’s a hypothetical question because they’re moving in this direction. We have the summit decision in favor of a banking union. They already had elements of a roadmap in it. There is a process in place to discuss what will happen on the fiscal side with -- I believe the report by Van Rumpus and others in the autumn -- and I think this is indeed the discussion we need to see so we’re reassured that things are moving in the right direction.
QUESTION: Yeah, but you still have some questions with the German Constitutional Court. You still have the rate and several EU countries, which are not too eager to go that direction. So put it on the theoretical level. I mean from a theoretical level, if you don’t see a fiscal union and a banking union, would you say that the eurozone can survive?
MR. BERGER: Absolutely.
QUESTION: For the eurozone to survive or put it differently, if you don’t see these outcomes, what could be other outcomes to save the eurozone?
MS. NARDIN: I think we answered the question in saying that we believe that this is the road that the European Union is taking, so we’re working under these assumptions.
QUESTION: But there was no alternative to these policies.
MS. NARDIN: Do we have anything to add?
MR. BERGER: No, but I think we can discuss this at a later point. I would also look at the work in the papers that you have seen will give you an idea of what is important and what the priorities are.
QUESTION: First of all, just to follow up on a question that was asked earlier , on Greece. I don’t think we got an answer on that. Do you think that the euro zone is now braced for a Greek euro exit? And what is your take on that possibility, on that scenario?
And two brief further questions. The one is given that you’re also recommending that the EFSF or the ESM fund the resolution fund for some period of time until it goes on to the industry, as well as other roles for those two, for the rescue funds, and given that they are not particularly large, do you consider them to be adequate in size as they’re capped at 700 billion euro and with an actual lending capacity of 500 billion? Do you think that it might be advisable to consider making them bigger at some point in the future? And generally, what’s your take on their adequacy? And if I may, you do have a box in your report that discusses some risks to implementing the decisions of the Euro Zone Summit, which you say are in the right direction. Could you please elaborate on those risks, especially with regard to lack of clarity, detail, and uncertainty on a timetable? And could you tell us if you think those risks are significant with regards to implementing the Euro Zone Summit decisions of June 28/29? Thanks.
MR. PRADHAN: I’m going to start with your questions in reverse order. On the risks that we have highlighted in the box, I think what we’re calling for is implementation to be followed up with decisions, which we think are very positive and important. We would like to see European leaders implement them in the time scale provided. So the time scale is, on the banking union, for example, they will have something by September for the ECB to have a framework that starts in December. I think that is -- if you were to step back a little bit, if you think about the euro area embarking on a new initiative or setting up a banking union, common supervision, I think that is a very, very short time period. To be able to start this process with the beginnings of it in six months or so, I would say is very commendable the decision is the important bit, they’re going in that direction.
Secondly, again, while staying on the summit, the important decision of ESM being able to take direct stakes in banking systems, as you know, the ESM has to go through national jurisdictions, parliaments to get ratified. It’s been ratified by 10 out of 17 so far, I think we’re progressing at the right pace. This is how these things are done in the euro area. Implementation should proceed kind of as fast as possible. But right now I would just emphasize to you that things are proceeding on a reasonable timetable.
Secondly, you say EFSF and ESM is not particularly large. I would emphasize that in the report there’s a lot of initiatives where we think common resources will be required. –In my previous answer on deposit insurance, I said you could provide an ECB liquidity backstop or you could provide it through the ESM, in an initial period. We do not see the ESM in a steady state as funding a common deposit insurance framework or a common resolution framework. I just want to emphasize that we are not calling for the ESM to be the finance mechanism for all these initiatives that we’re talking about.
As I said earlier, in a steady state we could see deposit insurance being funded completely out of -- fully from a levy on the industry or pooling national resources currently already earmarked for deposit insurance. It is s not that the ESM should fund that. The ESM is large enough for current contingencies. On your first question, our mission team on Greece will be going back soon and is working with European partners to discuss how to, you know, move forward with the program.
QUESTION: Good morning. I wanted to come back to the quantitative easing. I just wondered if you could elaborate on how you would envision ECB quantitative easing in the euro zone context. And what’s the distinction between quantitative easing and ramped-up SMP?
A related question is a lot of people, particularly in Germany, would see quantitative easing as a violation of the ECB mandate. Do you disagree with that, or do you think that the crisis has reached the point where the ECB has to simply stretch its mandate or go beyond its mandate? And then a last question on a different topic. I see your forecasts, if I’m reading them right, are basing a euro dollar level of 1.28 for 2012. Today the euro is at 1.22. And I’m just wondering if that affects your forecasts at all? Would a weaker euro against the dollar lead to faster growth in Europe or somehow change your outlook for Europe? Thank you.
MS. KOEVA-BROOKS: Let me start with your last question on the exchange rate. Of course, a weaker euro, other things equal, would translate into better net exports, more exports for the euro area countries. However, it’s important that -- my caveat about other things equal, I think, is very important in this case. It’s important to keep in mind why the euro is weaker. And the euro has weakened partly because of the increased uncertainty and the financial stress, which we see in the market in the euro area. So that financial stress and the more difficult financial conditions would work in the opposite direction, of weakening growth, which is a factor that we emphasize in our report.
On the quantitative easing, we see it as one of the tools that the ECB has similarly to other central banks, where if there were generalized downside risks to inflation, which we see at the moment, quantitative easing is one of those things that the ECB could do. The way it could be implemented would be to purchase bonds across countries, so in terms of the difference between that and other unconventional measures it would be that, for example, that would translate into the ECB buying German bonds in addition to those from Spain or Italy or any of the other countries.
MR. BERGER: I think the mandate of the ECB is clear and the ECB is very precise in explaining how the measures they have taken so far are in line with the mandate for finance stability. Now, we have seen interest rates being reduced and I would expect the ECB to consider further measures also motivated by the same price stability goal, you know, as the interest rate becomes very low and cannot be lowered further.
You also asked about the SMP. The SMP is a program, according to the ECB, being used to ensure that this monetary easing reaches all corners of the euro zone. And I think in that sense it is an essential part of the ECB fulfilling its mandate as it is defined. So I do not see a need for a discussion here in this regard on the ECB’s mandate.
QUESTION: I wanted to go back to the idea of a banking union and given that one of the first elements, or the first element, of that that has to be brought online is that supervisory powers or a single European supervisor would be set up. I wonder if the panel could comment on what the view is on exactly what those duties might be or what they should be and how they would be divided. Would the ECB also have resolution powers, for example?
And then secondly, in that environment are there any risks that the panel sees to Central Bank independence?
MR. BERGER: The exact proposal and the details of it will come later, s -- those are currently under discussion -- so let me address some issues of principle.
One, just as background information which I think is relevant, 14 of the 17 members of the Governing Council at the ECB are currently national supervisors. If you think that these individuals are already charged with a supervisory role, a supervision role, in their national jurisdictions, it’s natural for the ECB to be in a euro-wide supervision framework, to be the entity that gets this responsibility. I think in terms of details what you will see is these national supervisors coming together in one place. Actual supervision of banks can stay at the national level because national supervisors and their staff, in the framework they already have, have the local knowledge and the local contacts and relations with their banks. What we’re talking about here is something that is supervised itself at the center and makes sure that those are common standards and common rules applied across the euro area. That’s really the idea about common supervision, and later on a common resolution framework.
You asked about the risks of Central Bank independence. I do not see this as potentially a serious conflict, I think, we have seen in many different models around the world where central banks have supervision responsibilities as well. I think the issue is the mandates. The mandates, by and large, are broadening out to, in addition to price stability, to financial stability. And that’s fairly widespread now. This is a very important part of financial stability. I think if you have a common resolution framework, then it is possible for a central bank, like the ECB, to be fully guided by, you know, price stability when it comes to setting monetary policy if that’s what you have in your mind about conflicts. In the event that there are some problems in banks in parts of the euro area, they can be addressed through both the supervisory framework and the common resolution framework. They do not have to interfere or in any way influence monetary policy settings for the entire euro area. This may be different in situations where you have got more systemic events, in which case financial stability and price stability are very closely related.