U.K. Should Restore Growth, Rebalance Economy
May 22, 2013
- Some signs of an uptick in growth, but still far from strong, sustainable recovery
- Financial policies should ensure monetary easing reaches broader economy
- Fiscal, structural policies to boost expectations of incomes and investment returns
The United Kingdom could boost growth by bringing forward measures already included in its fiscal plan, such as spending on infrastructure and job skills, the International Monetary Fund said as it wrapped up its annual check of Europe’s third largest economy.
Despite recent improvements in some indicators of economic growth, the economy is still a long way from a strong and sustainable recovery. The economy also needs to rebalance, the IMF said, and make the transition to a high-investment and more export-oriented economy.
After five years of relatively weak growth, investment is low and youth unemployment is high, and the IMF is concerned about the risk of permanent damage to long-term growth.
“Recent data suggest some improvement in economic and financial conditions, which is encouraging. But the United Kingdom has a long way to go. Investment has been persistently weak and unemployment, especially among young people, is high,” said David Lipton, the IMF’s Deputy Managing Director during a press conference at the conclusion of the IMF’s work in London.
A multipronged approach needed
The complexity of the issues means policymaking has become particularly difficult. Conventional distinctions between demand and supply problems don’t work so neatly—firms might give up on demanding credit lines if they think the terms supplied to them will be particularly onerous, for example.
This makes it all the more important to pursue a package of policies that support each other, the IMF said. Financial policies are needed to restore the health of the banking system, to ensure that monetary policy is fully effective, and fiscal and structural policies are needed to raise expectations of incomes and returns on investment.
The government has shown flexibility in its fiscal program to mitigate damage to growth, but planned fiscal tightening this year will be a drag on the economy, the IMF said.
With unemployment high and interest rates low, the government should take the opportunity to bring forward “high value” spending that has big long-term payoffs. The government could do this within its current fiscal plan, such as
• Bring forward planned capital investment. This would help catalyze private investment.
• Further modify the composition of plans to reduce government debt and deficits. This could include growth friendly measures, such as reducing the marginal effective corporate tax rates to bring investment forward, and introducing tax allowances for raising equity.
The government’s commitment to a medium-term plan has earned it credibility, and it has the advantage of good institutions and astute debt management practices. Raising growth expectations will do more to reassure financial markets about debt sustainability, the IMF said.
Making monetary policy more effective
The Bank of England has lowered short term interest rates, bought government bonds and used other tools in its arsenal to help increase the flow of credit to help the economy. With the economy’s output running below capacity and inflation pressures easing, the central bank can afford to keep in place policies that support the economy, according to the IMF.
But credit flows have continued to fall. The problem is the monetary stimulus is not fully getting through to the real economy. Restoring the health of the banks is crucial for restoring credit flow, according to the IMF.
Banks have improved the health of their balance sheets by raising capital, but the share of non-performing assets across some major banks remains at high levels.
Banks will need to focus on building capital while not compromising the availability of credit, by some combination of new equity issuance, dividend reductions, remuneration constraints, and balance sheet restructuring.
Because they account for nearly two fifths of total lending, a strategy to deal with Royal Bank of Scotland and Lloyds Banking Group, the two troubled banks the government took large stakes in at the height of the financial crisis in 2008 and 2009, is particularly important.
The IMF said any strategy should return the banks to private hands in a way that maximizes the value for taxpayers, strengthens confidence and competition in the financial sector and minimizes spillovers.
The recent transition to a new more intrusive and intensive financial regulatory and supervisory structure was well managed, with the creation of the Financial Policy Committee, housed in the central bank, and the Prudential Regulation Authority to replace the former Financial Services Authority.
The IMF said greater coordination between the two agencies is needed, along with operational independence and adequate resources for the Prudential Regulation Authority given the important role of the United Kingdom’s globally-systemic financial sector.
To help ensure that future asset price bubbles do not threaten financial stability, the government should consider granting the Financial Policy Committee powers to set limits on loan-to-value and loan-to-income ratios.
The effectiveness of the planned reforms to impose limits on the scope of banks’ businesses will depend on progress at an international level toward robust cross-border supervisory and bank resolution frameworks. In addition, the government should address concerns about regulatory arbitrage, including the risk of significant activity migration to more lightly regulated shadow banks and non-banks.
The IMF’s full report on the United Kingdom’s economy is expected to be discussed by the Executive Board in July.