Governor of the Fund for Italy
International Monetary and Financial Committee
April 16 2000
|The International Monetary and Financial Committee member for the constituency consisting of Albania, Greece, Italy, Malta, Portugal, and San Marino.|
Prospects for the World Economy
During the last six months global economic and financial conditions have turned out better than expected. For this year world growth is projected at above 4.0 percent-more than ½ of 1 percent higher than was anticipated in October-and a similar pace is expected for the next year. The greater dynamism of the global economy is also evident in trade flows, which will grow by more than 7 percent in real terms, a rate which is relatively high by historical standards.
The better-than-expected performance of the world economy hinges mostly on two factors. First, the recessions in crisis-hit emerging market economies are proving shorter in duration, a result which owes much to the Fund's active role. Second, the US economy continues to be buoyant, which more than compensates for the slower-than-hoped recovery in Japan.
There are nonetheless considerable downward risks. Indeed, some imbalances that were already present six months ago have become more pronounced. In the US, in particular, the risk of overheating and an abrupt correction in asset prices is still very much present. Moreover, current account imbalances between the major economic areas remain large and unlikely to be sustainable in the medium term. The substantial increase in oil prices is adding uncertainty to this picture.
While a scenario in which an abrupt loss of confidence in the US dollar and equity market takes place is probably not very likely, it would be unwise to dismiss it completely, as suggested by the recent turbulence in major equity markets. Such a turnout could have disastrous worldwide consequences. It is therefore essential to achieve a smooth transition to a more sustainable pattern of growth.
The US economic expansion, now the longest in US history, is driven by technological advance, more open markets, and investment in human and physical capital. This expansion also results from a permanent increase in the economy's long-term growth rate, though at this time it is difficult to assess how large. In the short term, securing a soft landing of the economy is the main task for the authorities. The burden falls primarily on monetary policy, which should remain geared around traditional indicators of inflation while not ignoring the behavior of asset prices. Fiscal policy should remain on course: this is not the time to provide a fiscal stimulus to the economy.
The recoveries in Japan and Europe are instrumental to sustaining global economic growth while the US cycle dampens. But they are also needed to reduce the external current account imbalances and achieve a configuration of exchange rates between the three major currencies that would be more consistent with fundamentals. In Japan the data for the last two quarters of 1999 were quite disappointing, but several indicators now point to a bouncing back of growth. Monetary and fiscal policies must remain accommodative in the current circumstances. Yet, it is clear that they have reached a limit and that structural reforms are indispensable for laying the foundation for sustained growth of the Japanese economy. In the euro area the pace of recovery is now quite strong and poised to exceed 3.0 percent. To achieve rapid economic growth and low unemployment on a permanent basis, however, European governments must press ahead in their efforts to reform the European economy and increase the resilience of labor and goods markets.
In emerging market economies the outlook is quite favorable, a condition that owes much to the policy responses to the recent crises. Growth is on the rise and the downward trend in inflation should continue markedly. In virtually all cases the greatest challenges are in the area of structural reforms. Here is also where the major risk lies and, by symmetry, where the Fund's role is greatest. The risk is that authorities, led by the improved conditions in their economies, assume a complacent attitude toward their reform agendas.
Reforming the IMF's Role in the Global Economy
We believe that the basic goals of the IMF, as clearly stated in the Articles of Agreement, continue to be valid and flexible enough to encompass new priorities. However, the environment in which these goals have to be achieved has changed considerably in recent years. Increasing capital mobility has become a source of both enlarged opportunities and greater risk. The Fund must strive to help its members to fully exploit the former while at the same time minimising the latter. But to be effective, it has to be focused and have clear priorities.
Since the Mexican crisis of the mid-90s we have gone a long way in adapting the Fund to the new global environment. But the process is not completed yet. More efforts are necessary in order to strengthen surveillance, the Fund's primary function. In doing this, we should be guided by three principles. The first is partnership with other relevant institutions in both core areas, where the Fund should take the lead, and non-core areas. The second is selectivity: non-core areas should be addressed by the Fund only when they have demonstrably macroeconomic implications. The third is transparency: the results of surveillance should, as a rule, be made public.
The availability of conditional financing from the IMF can usefully complement surveillance by providing increased leverage to convince countries to follow sound policies and introduce the necessary reforms. A comprehensive review of the Fund facilities is, however, in order. In the past facilities have often been created in response to short-term contingent needs without taking due account of the need to design a coherent structure. The aim is to streamline the existing structure, making it more attune to a better-focused mission of the institution.
The main objectives of the Fund lending facilities are:
- to help countries with balance of payments problems choose an appropriate mix of adjustment and financing, while minimising moral hazard problems;
- to strengthen the incentives for preventive actions and the ex-ante adoption of sound policies;
- to accompany members' reform efforts while discouraging addiction to, and the prolonged use of, IMF resources.
To achieve these basic objectives, existing facilities should be redesigned according to the following principles:
1. Two short-term balance of payment facilities: i) the Stand-By Arrangement (SBA), designed to meet the short-run balance of payments needs of members. This facility has been at times used repeatedly and in a prolonged way. To prevent repeated and excessive use, its cost should be made an increasing function of the maturity of repayment; ii) the Supplementary Reserve Facility (SRF), designed to cope with potentially systemic crises when they occur. It has so far served its objectives well;
2. A precautionary facility: the Contingent Credit Line (CCL), designed to encourage the ex-ante adoption of sound policies, with a view to preventing crises. The CCL has not yet been used. It should be made more attractive, including through a reduction in its rate of charge, a slashing of the commitment fee, and an easing of the activation review;
3. A structural reform facility: the Extended Financing Facility (EFF). This is a potentially valuable tool, that can play a crucial role in allowing countries to undertake an ambitious reform program and eventually graduate from Fund financial support. It needs however to be reformed. The maturity of EFF purchases (currently 10 years) should be reduced. The use of this facility should also be targeted to the adoption of specific reforms enabling countries to rely on private financing for their balance of payments needs. Countries requesting EFF should commit, at the end of its use, to submitting themselves to enhanced surveillance on codes and standards.
There should be a general presumption that any financing provided by the Fund be accompanied by private sector financing. The degree of private sector involvement must be inspired by the principle of comparability of treatment between private and official creditors and the fair treatment of the various categories of private creditors. In assessing the effective involvement of the private sector by the debtor country, the IMF should be satisfied that these basic principles have been fulfilled. Debtor countries should know in advance that failing to involve private creditors as expected could result in a stronger required adjustment. Countries should also be encouraged to adopt ex ante instruments that facilitate the involvement of the private sector in times of crises, such as contingent credit lines or collective action clauses.
The Fund's resources must always be utilised for their intended purposes and, therefore, the Fund has the right to adopt measures to safeguard the use of its resources. In doing this, it should mostly rely on preventive measures. We thus welcome the multi-faceted approach adopted by the Executive Board that is now being put in place, which is consistent with that philosophy. It is crucial, in particular, that members accurately report their true foreign reserves, which are key to assess a country's external position and policies. Thus, for all program countries central bank financial statements should be subject to an independent audit.
The IMF reform cannot-and should not-be limited to enhancing the Fund's tools of actions. It ought to be completed with a modernisation of its governance structure, in line with the institution's evolving role in the global economy. The recent transformation of the Interim Committee into the present body, though important, is not sufficient. Critical issues remain, such as the co-ordination with other relevant institutions and fora involved in promoting the stability of the international monetary and financial system. The interaction with groups like the FSF should be strengthened to widen the debate on different issues. As for implementation, the IMF should take the lead in the field of surveillance, co-ordinating the activities of other organisations involved in financial matters.
The IMF has to be made more accountable. In this connection, we welcome the recent decision by the Board to establish an Independent Evaluation Office that would report to the Board and, in our view, also to the IMFC on the work of staff and management. Other measures can be envisaged, such as establishing a panel of outside consultants to advise the Board both on major programs and on major policy issues, a procedure that is followed by the Federal Reserve Board with its panel of academic consultants. The Board itself should be made more accountable. We could consider publishing the Board minutes with an adequate delay, and creating an Audit Committee that would report annually to the IMFC on how the Board and management have discharged their mandate.
Progress on the HIPC Initiative and Poverty Reduction and Growth Strategies
By looking at the last half century, we must recognise that progress in raising real incomes and alleviating poverty has been very slow and that in some countries the gap between the rich and the poor has widened. In Africa real per-capita income is today lower than 30 years ago. The share of the world population living in poverty is still unacceptably high.
The HIPC initiative launched a few years ago, which is now integrated to a new strategy geared towards poverty reduction and growth, is an important contribution to the alleviation of this problem, though it is by no means a solution. We must strive to ensure that the initiative delivers, both fully and timely, on its stated objectives. Flexibility is called for in the application stage, but we should be mindful that faster debt relief in not an end per se. Instead, we must make certain that the exit from the debt overhang is permanent and carries with it lasting progress in poverty reduction.
The Fund is committed to the HIPC initiative through its Poverty Reduction and Growth Facility, with a role focused on its core areas of activity. Growth is essential to eradicate poverty. However, without macroeconomic stability growth is hardly sustainable. Moreover, inflation would result in an unfair distribution of income that goes to the detriment of the poorest. But the reverse is also often true: without poverty reduction, adjustment and growth become unsustainable, for social and political reasons. Thus, a greater attention on the part of the Fund is called for in assessing the impact of its adjustment programs on the social sector.
We are convinced that strong ownership, involving a broad consultative process with civil society, can greatly improve the implementation and degree of success of poverty reduction strategies. The Fund, however, should not be involved in the determination of which groups and organisations are representative of the civil society.
Recent progress in Italy and challenges for the future
Italian GDP growth in 1999 reached 1.4 percent, with output expansion accelerating during the course of the year. The turn-around in exports was the most significant factor underpinning the recovery in the second half of the year. Domestic demand also provided a sizeable contribution to GDP growth by 2 percent. Investment was particularly lively, especially in the second part of the year, due to the improving level of business confidence.
Despite relatively modest growth performance, the Italian economy maintained its momentum in terms of job creation; employment increased by 1 percent in 1999, adding more than 200,000 new net jobs. The unemployment rate started declining, reversing its negative trend. On the fiscal front, there was a further strengthening in the budgetary position, notwithstanding the weak cyclical position of the economy.
The recent increase in headline inflation is not, we believe, a major source of concern. It is indeed mostly a temporary phenomenon, fuelled by the rise in oil prices. Nominal wage growth remains very moderate (around 2-2.5 percent). Italian wage agreements are forward looking (and in line with a target inflation rate). We see no reason therefore why the new contracts should be confronted with a significant upward revision of the target inflation.
We remain fairly optimistic about the prospect for the year 2000. Taking into account the positive carry-over effect from the second half of 1999, we have revised our GDP growth forecast up to 2.5 percent. Looking further ahead, we expect a gradual strengthening of output growth that will allow Italy to converge to the average EU economic performance.
Much of the reform effort, undertaken within the framework of the European Union, is starting to bear fruit. Macroeconomic imbalances have been largely addressed. The emphasis at the Italian and European level has shifted to an acceleration of the process of structural reform. We have made significant progress in this area as well. Some of the effects can already be seen. Growth contributes more than in the past to employment generation; sectors affected by privatization and regulatory reforms are now enjoying a higher degree of competition and contribute to price stability.
We are aware that the improved economic outlook should not lead to complacency. We must step up the efforts in a number of key areas. The liberalization of the energy sector has to be completed. This is a major priority for the Italian government. Also, more progress should be achieved in the financial sector in order to make it fully competitive.
After the privatization of the major banks and the regulatory effort put in place in the past years, it is now time to address forcefully the issue of developing both markets for venture capital and widespread access to pension funds. Developing markets for venture capital is a fundamental step towards the growth of the quantity and quality of high technology sectors in Europe. The growth of pension funds is a focal point for the solution of several problems that the European economies are facing. We ought to strengthen the second and third pillars of the pension system and direct household savings toward lucrative and - to the extent possible - safe forms of investment. In so doing, it will be possible for our governments to accelerate the pace of reform of our welfare systems and safeguard the first pillar from the challenges posed by ageing populations characterizing our economies during the first half of the current century.
The economic situation in the other countries of the constituency
The Greek economy has been experiencing healthy growth against a background of increased macroeconomic stability. Growth, which has been above the EU average for the past four years, is expected to reach 3.8 percent this year and to exceed 4 percent in 2001 and 2002. This performance has been underpinned by strong private and public investment. Macroeconomic stability is reflected in the lowest government deficit and inflation figures for many years. The deficit, already well within the relevant Maastricht criterion, is expected to fall to 1.2 percent of GDP this year. Inflation, as measured by the harmonized index of consumer prices used by the EU, fell to 1.3 percent in September 1999. Despite the subsequent surge in oil prices that has caused harmonized inflation to rise somewhat, Greece met the inflation criterion of the Maastricht Treaty in February of this year, implying that the country now satisfies all the criteria for accession to the euro area. On March 9, 2000, Greece formally applied for membership of the euro area and is expected to join on January 1, 2001 after receiving the approval of the European Council on June 19-20, 2000.
In Portugal economic activity is projected to maintain a robust growth path in the current year, following real GDP growth of about 3 percent in 1999. In line with developments in the last part of 1999, the composition of growth is expected to shift: domestic demand should decelerate further, as both private and public consumption are projected to slowdown, while exports should accelerate, in line with the euro area economic upturn and the broadly improved international climate. Despite slightly lower-than-expected economic growth in 1999, the general government deficit remained on target, at 2 percent of GDP. The budget deficit is targeted to decline to 1.5 percent of GDP in the current year. Inflation has continued to go down, reaching 1.6 percent in February. The subdued inflation profile since early 1999 reflects not only the unwinding of several temporary factors that had a major previous impact but also the fact that changes in oil prices are not automatically fed through energy consumer prices. As these have been recently adjusted, a moderate upward inflation path in the course of 2000 can be expected to materialize.
In Albania during 1999 the balance of payments did not deteriorate as feared in the wake of the Kosovo crisis, thanks to the prompt and extensive support of the international community and also to a firm policy stance. Over the last months the exchange rate has strengthened and foreign reserves have reached a relatively comfortable level. For the current year, GDP growth is expected to remain at 8 percent and annual inflation at a low level. The objective to finance the 1999 state budget deficit with internal sources was met. It is also expected that fiscal discipline will be strengthening during the current year. The authorities are fully committed to removing all impediments to economic development. Among their priorities are developing the private sector, boosting foreign direct investment, strengthening security, and enhancing governance.
The Maltese economy is presently going through a period of consolidation and structural reform as the country prepares itself for EU membership, for which negotiations commenced in March of this year. The Government has introduced further measures to address the large budget deficit, which is expected to contract to around 7 percent of GDP in 2000, from over 8 percent in 1999. Major policy initiatives include a comprehensive privatization program and reform of the welfare system, particularly pensions. Monetary policy continues to be geared towards maintaining price stability through a fixed exchange rate for the Maltese lira pegged to a basket of currencies. It is expected that in 2000 the Maltese economy will grow by 2.5-3.0 percent in real terms and inflation remain stable in a 2.0-2.5 percent range, although the effect of imported inflation could push the rate to the top of the range. The current deficit of the balance of payments is projected to remain almost unchanged from the previous year's level of about 3.5-4 percent of GDP.
In the Republic of San Marino indicators continue to substantially run parallel with those of the neighboring Italian regions. In this context, the positive development of the industrial sector has led, inter alia, to a steady increase in employment levels, which has indirectly benefited the surrounding Italian territories, thus further confirming the integration existing between the Italian and San Marino economies.