## Conclusions of the Financial Sector Assessment Program (FSAP) — United Kingdom (content unit _cr16168)

## Source details

**Canonical URL:** [Conclusions of the Financial Sector Assessment Program (FSAP) — United Kingdom (content unit _cr16168)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16168.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16168.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16168.pdf.json)

---

### Focus of the consultation
- UK economy performed well in recent years but faces important challenges and risks.
- Key recent developments:
  - Economic growth consistently near the top among major advanced economies.
  - Employment rate risen to a record high.
  - Fiscal consolidation cut the deficit by more than half.
  - Monetary policy remained accommodative.
  - Financial sector policies required banks to increase buffers.
  - Structural reforms aimed to ease regulatory impediments to housing construction.
- Important remaining challenges and risks:
  - Productivity growth well below pre-crisis rates.
  - Current account deficit widened to a record high in 2015.
  - Household saving rate low and fell further.
  - Loan-to-income ratios on new mortgages rising again.
  - A referendum on EU membership to be held on June 23, 2016; outcome has important economic implications.
- Consultation focused on recent macroeconomic evolution, outlook and risks, and how policies can support growth and limit risks.

### Macroeconomic context — A. Developments and outlook
- 2015 performance and normalization:
  - Output grew by 2.3 percent.
  - Growth was the third straight year in the 2–3 percent range.
  - Output gap nearly closed; capacity utilization and unemployment returned to pre-crisis levels.
  - Employment rate at a record high.
  - Net lending by MFIs to nonfinancial corporates turned positive for the first time since the crisis.
  - Mortgage rates at new lows.
- Near-term uncertainty and 2016 outlook:
  - Factors heightening uncertainty: EU referendum, global market volatility, global growth downgrades.
  - Growth slowed to 1.6 percent (saar) in Q1 2016; PMI surveys suggested further slowdown in April 2016.
  - Staff baseline (UK remains in the EU): full-year 2016 growth projected at 1.9 percent; rebound later in 2016.
- Medium-term projections:
  - Growth projected to average around 2.2 percent (staff estimate of potential).
  - Labor productivity:
    - Recently around 0.8 percent.
    - Staff projects rise to around 1.6 percent over the medium term.
    - Pre-crisis historical average: 2.2 percent (1960–2007).
  - Inflation and wages:
    - As of April 2016: headline inflation 0.3 percent; core inflation 1.2 percent.
    - Nominal private-sector wages growing by 2.3 percent as of March 2016.
    - BoE policy rate at 0.5 percent; markets expect no rate rise for several years under baseline.
    - Staff expects inflation to rise to 2 percent by early 2018.
    - Planned minimum wage increase of 34 percent during 2015–20 will contribute to higher wage and price inflation.
- Demand-side outlook:
  - Offseting forces roughly neutral for growth over next few years.
  - Baseline support: reduction in uncertainty after a Remain vote, real estate price run-up, gradually rising global growth, monetary accommodation.
  - Ongoing headwinds: steady fiscal consolidation.

### Macroeconomic context — B. External assessment
- Current account and NIIP:
  - Current account deficit: 5.2 percent of GDP in 2015 (widest among advanced economies).
  - Household saving rate: 4.3 percent in 2015.
  - NIIP: -3.5 percent of GDP at end-2015.
- EBA model and REER assessments (2015):
  - EBA CA regression: cyclically adjusted CA balance -4.8 percent of GDP; CA norm -0.6 percent of GDP; implied CA gap -4.2 percent of GDP; implied sterling overvaluation 18 percent.
  - EBA REER models estimate overvaluation of 12 percent.
  - Staff estimated CA gap: -1.5 to -4.5 percent of GDP and REER overvaluation of 5–20 percent in 2015.
  - As of April 2016, REER depreciated by 7 percent relative to average 2015 level.
- Contributors to CA gap:
  - 1.1 percentage points reflect fiscal balance looser than optimal medium-term level.
  - Low household saving rate (4.3 percent in 2015).
  - Post-crisis deterioration in income balance partially reflects unusually low returns on British investments abroad and structural factors (e.g., corporate tax competitiveness attracting inward FDI).
- Mitigating factors:
  - BoE inflation-targeting framework helps anchor inflation expectations absent major regime shifts.
  - Currency composition of NIIP acts as an automatic stabilizer (foreign assets more foreign-currency denominated than liabilities).
  - Valuation effects have kept NIIP relatively neutral despite persistent CA deficits.
- Policy implication:
  - Persistent, high CA deficit is a concern; policies to assist orderly and gradual external adjustment would be helpful.

### Macroeconomic context — C. Risks and spillovers
- Baseline relatively benign but subject to significant risks (see Risk Assessment Matrix).
- Global risks:
  - Global downturn could depress exports and tighten financial conditions, lowering GDP via consumption and investment channels.
  - Persistently low energy prices: modest net positive growth effects but lower headline inflation; risk of second-round deflationary effects requiring more accommodative monetary policy.
- UK-specific risks:
  - Persistently low productivity growth would adversely affect long-run output and push up inflation.
  - Real estate risks: house-price growth > three times income growth; LTI ratios rising; continuation increases household and bank vulnerabilities.

### Referendum risk and withdrawal process
- A Leave vote would create uncertainty about long-term economic relationships and could crystallize baseline risks.
- Withdrawal would require negotiation of terms and new relationships; reverting to WTO rules would raise trade barriers.
- EU-level agreements cover UK trading relationships with 60 non-EU economies and prospective arrangements with another 67 countries; these would need renegotiation or revert to WTO rules.
- Bilateral trade agreements typically take 3 or more years to negotiate.
- Article 50 provides a two-year negotiation period but extensions require unanimous consent of remaining EU governments; ratification of new deals may require unanimous support.

### Near-term market, confidence, and investment effects (referendum-related)
- Protracted uncertainty could weigh on confidence, investment, and increase market volatility.
- Possible market reaction channels:
  - Higher borrowing costs due to higher risk premia.
  - Downward pressure on equity and house prices.
  - Sudden stop of investment inflows (e.g., CRE, finance).
- UK vulnerabilities amplify these risks (record-high CA deficit, reliance on external financing).
- Possible self-reinforcing cycle: adverse market reaction → lower activity → asset price declines → expenditure-switching toward net exports after FX depreciation → possible temporary inflation above target.
- Market evidence (recent months):
  - CRE transactions plunged about 40 percent in Q1 2016.
  - Nominal effective exchange rate depreciated 9 percent between November 2015 and April 2016.
  - UK sovereign CDS spreads rose more sharply than the G7 average.
  - Cost of hedging exchange rate volatility around the referendum spiked.
- Historical experience limited; expected market reaction negative and possibly severe.

### Possible steady-state arrangements and trade-offs
- Range of outcomes:
  - EEA-type arrangement (Iceland/Norway): maintain EU regulations on free movement with reduced influence.
  - WTO rules: significant curtailment of single market access and creation of non-tariff barriers.
  - Intermediate arrangements: trade-off between EU market access and regulatory autonomy.

### Transmission channels of steady-state economic effects
- Reduced trade and financial flows could curtail gains from cooperation, reduce UK attractiveness for investment, and trigger relocation of activities (loss of “passport” for UK financial firms).
- Over time, London’s status as Europe’s preeminent financial center could erode.
- Regulatory changes: maintaining substantial single market access may require alignment with many EU regulations; scope for domestic deregulation is limited.
- Domestic-controlled regulations (e.g., housing construction restrictions) are major growth constraints; exit could allow domestic capture and potentially more restrictive regulation.

### Fiscal effects of exit
- UK would save net contributions to the EU budget of around ⅓ percent of UK GDP if it left.
- UK budget would likely need to cover activities currently financed by the EU (agricultural support, regional development, R&D).
- Fiscal savings from not contributing to the EU budget likely outweighed by fiscal losses from output declines due to reduced trade and investment.
- If steady-state output falls by just 1 percent or more, associated revenue loss would exceed fiscal savings from not contributing to the EU budget.

### Quantitative estimates, scenarios, and economic costs
- Quantifying exit effects is difficult; qualitative assessment suggests exit very likely to adversely affect the UK economy.
- IMF staff illustrative scenarios (Selected Issues paper):
  - Limited uncertainty effects scenario: level of output 1½ percent below baseline at peak deviation in 2019.
  - More adverse scenario: level of output 5½ percent below baseline at peak deviation.
- Majority of quantitative estimates point to sizeable long-run losses from increased barriers.

### Spillovers to other economies and markets
- Other EU economies would experience reduced gains from trade, less efficient capital-labor matching, and heightened transition uncertainty depending on linkages with the UK.
- Losses may rise if a UK exit increases support for higher barriers elsewhere in Europe.
- Effects on the UK financial sector and markets may produce outward spillovers given London’s global financial importance.

### Authorities’ views and outlook
- Authorities broadly shared staff’s baseline outlook and key risks.
- OBR actions:
  - March 2016: OBR revised down 2016 growth projection from 2.5 percent to 2.0 percent.
  - OBR revised down medium-term potential and actual growth by about ¼ percentage point due to weak productivity growth.
  - OBR projections now close to IMF staff, BoE, and consensus.
- Other authority work:
  - HM Treasury published estimates of long-term effects of an exit in April 2016.
  - BoE discussed EU membership effects in October 2015 and May 2016 Inflation Report.

### Policy recommendations under a Remain baseline
- Overall: promote steady growth while reducing vulnerabilities; remain flexible and adjust policies if circumstances change.
- Monetary policy:
  - BoE policy rate at 0.5 percent and QE assets of £375 billion (20 percent of GDP) — unchanged since 2012.
  - Monetary policy should stay on hold until inflationary pressures are clearer to help offset fiscal consolidation headwinds.
  - Rationale: headline and core inflation below target; forward-looking indicators contained; neutral rate may be much lower; asymmetric risks favor accommodation.
  - Conditional guidance: tighten earlier if core inflation or wage growth in excess of productivity rises quickly; ease (policy rate cuts to at least zero and/or additional QE) if demand weakens and inflation undershoots persist.
- Fiscal policy:
  - Consolidation should remain sufficiently gradual and be compositionally more pro-growth and pro-stability.
  - Structural reforms should boost productivity and incomes to reinforce the policy mix.
- Financial stability:
  - Complete implementation of financial supervisory reform agenda.
  - Adopt robust and intrusive supervision as the financial cycle matures.
  - Mortgage-related macroprudential policies may need tightening later in the year if housing and mortgage markets re-accelerate.
- Objective: maintain growth while reducing vulnerabilities and support orderly current account adjustment.

### Key fiscal and macro statistics cited
- Commercial real estate transactions plunged about 40 percent in Q1 2016.
- Nominal effective exchange rate depreciated 9 percent between November 2015 and April 2016.
- Policy rate: 0.5 percent.
- QE assets: £375 billion (20 percent of GDP).
- 30-year government bond yield: 2.2 percent as of end-May.
- Net contributions to the EU budget saved if leaving: around ⅓ percent of UK GDP.
- Steady-state output fall threshold for fiscal loss exceeding EU net contributions: just 1 percent or more.
- IMF staff illustrative scenarios: 1½ percent and 5½ percent below baseline (peak deviations).
- OBR growth projection revision: from 2.5 percent to 2.0 percent for 2016.
- Public sector fiscal deficit: about 4 percent of GDP in FY15/16.

### March 2016 budget: stance and fiscal path
- March budget avoided near-term additional tightening after OBR growth downgrade, implying modest easing of structural adjustment in FY16/17 and backloading additional adjustment to FY19/20.
- Fiscal rule: achieve and maintain a budget surplus starting in FY19/20 unless a significant negative shock occurs (projected real GDP growth < 1 percent on a rolling four quarter-on-four quarter basis).
- Under new path:
  - Pace of consolidation broadly constant at around 1 percentage point of GDP per year through FY19/20 (after timing adjustments).
  - Public sector net debt projected to start declining as percent of GDP from FY16/17 onward.
- Composition:
  - Consolidation remains mostly expenditure-based.
  - New measures: higher taxes on commercial property, tighter restrictions on tax avoidance, lower business taxes, accelerated infrastructure spending.
  - Foreign development assistance maintained at 0.7 percent of GNI.
- Appropriateness:
  - Backloading judged appropriate given weaker near-term outlook and need to support demand.
  - UK has fiscal space to ease further if necessary under a Remain baseline; automatic stabilizers should operate freely and symmetrically.
- Structural fiscal reform options (pro-growth and pro-stability):
  - Boost infrastructure (public investment below advanced-economy average).
  - Scale back distortionary tax expenditures (e.g., nonstandard zero VAT rates).
  - Property tax reform (rebalance away from transaction taxes toward property values).
  - Reduce tax code bias toward debt (e.g., Allowance for Corporate Equity).
  - Pension reform: moving from “triple-lock” to CPI indexation could save over 0.5 percent of GDP by end of 10 years, enough to increase gross public investment by 20 percent.

### Financial sector: structure, resilience, and regulation
- Key facts:
  - Total financial assets of UK domiciled banks and nonbank financial institutions ~ ten times UK GDP.
  - Four banks and two insurers classified as globally systemically important.
  - UK insurance sector largest in Europe and third largest globally.
- Balance sheet and performance:
  - Major UK banks aggregate CET1 ratio: 12.6 percent; aggregate Basel III leverage ratio: 4.8 percent at end-2015.
  - Aggregate NPL ratio: 1.4 percent at end-2015 (about one third of post-crisis peak).
  - Bank credit growth normalizing; bank credit-to-GDP near pre-boom levels (circa 2000).
  - Profitability low relative to historic levels due to lower trading income, lower net interest income, and legacy misconduct costs.
- Stress tests and resilience:
  - BoE 2015 and IMF FSAP 2016 solvency stress tests: major banks would satisfy regulatory capital requirements under severe but plausible scenarios.
  - 2016 liquidity stress tests indicate resilience to sizeable funding withdrawals.
  - Nonbank subsectors analyses relatively reassuring but less detailed; need improved data, models, and supervisory risk monitoring for interconnectedness.
- Regulatory reform progress and priorities:
  - Macroprudential oversight:
    - FPC framework assigns clear roles; raised CCB from 0 to 0.5 percent (effective one year later); increase will not raise overall buffers for most banks in 2017 due to offsetting Pillar 2 reductions.
    - Continue tightening CCB proactively with the financial cycle; FPC considers 1 percent appropriate for normal phase.
  - Microprudential oversight:
    - PRA supervises banks, insurers, and large investment firms; FCA supervises conduct.
    - Recommendation: robust, intrusive supervision—prudent dividend review, intensified on-site inspections, scrutiny of asset quality at less systemic banks, review of internal models, international agreement on risk-weight standards.
  - Resolution and resolvability:
    - Special resolution regime overhauled and broadly aligned with international standards.
    - Priorities: complete ring-fencing for core retail activities; phase in MREL; develop operational funding principles for firms in resolution; international work on effective resolution for insurance firms.

### De-risking (Box 1)
- Global banks, including UK banks, scaling back correspondent banking relationships (CBRs).
- Potential adverse effects:
  - Impaired cross-border financial intermediation (remittances, trade finance) with certain jurisdictions.
  - Migration of customers/activities to less transparent/unregulated providers.
- Account terminations among: money transmitters, non-profit organizations, FinTech firms, defense-related firms, politically-exposed persons.
- Spillover risks: loss of accounts could impair remittances (notably Somalia-UK corridor) and aid flows.
- Drivers: business strategy/cost-benefit, regulatory enforcement (capital/liquidity, AML/CFT), conflicting regulations between jurisdictions, uneven application of international standards.
- Recommended mitigation:
  - Improve understanding of scale/drivers.
  - Promote dialogue with stakeholders.
  - Encourage banks to work with customers to strengthen AML/CFT controls.
  - Clarify regulatory expectations for management of higher risk customers.
  - Enhance AML/CFT supervision of money transmitters.
  - Work with other jurisdictions to resolve conflicting regulations impeding cross-border information-sharing.

### Real estate markets and macroprudential guidance
- Housing and mortgage markets:
  - Re-accelerated since mid-2015; house-price growth reached 9 percent in March 2016 (more than three times income growth).
  - Share of new mortgages at high LTI ratios ticking back up; aggregate household debt-to-income ratio above other G-7 countries.
  - Possible temporary drivers: urgency before April 1, 2016 stamp duty surcharge on non-primary residences; RICS data suggest cooling ahead.
- Macroprudential guidance:
  - Authorities should wait for greater clarity given tax changes and referendum uncertainty.
  - If buoyancy persists, further tightening of LTI and/or LTV limits on new mortgages needed later in year.
  - Priority: consolidate household-level credit data to shift from LTI limits to debt-to-income limits.
  - Ensure macroprudential policies remain sufficiently tight to promote higher household saving and CA adjustment.
- Buy-to-let (BTL) market:
  - Since 2012, BTL stock grew ~four times owner-occupied mortgage stock; BTL accounts for > one-third of gross mortgage growth since 2012.
  - BTL dominated by small landlords (≤ 3 properties), more sensitive to interest-rate increases; rental yields declined relative to house prices.
  - Evidence: higher default probability on BTL and prevalence of interest-only terms.
- Recommendations for BTL:
  - Extend FPC’s powers of direction to BTL market.
  - Strengthen minimum underwriting standards for BTL mortgages (affordability testing, minimum stressed interest rate).
  - Disseminate rental-price data by region and property type.
- Supply-side:
  - Address restrictive planning and loss of building capacity; mobilize unused publicly-owned lands; consider property tax reform.

### Commercial real estate (CRE)
- Recent trends:
  - Rapid price growth in 2014–15, especially prime London; early 2016 marked slowdown with transactions down 40 percent (likely referendum-related).
- Macro-financial implications:
  - CRE used as collateral; price falls could tighten corporate credit and reduce investment.
  - Post-crisis CRE funding shifted away from domestic banks to international investors and nonbanks, reducing domestic bank channel but increasing cross-border spillovers.
- Authorities continue to monitor real-estate related financial stability risks and will act as warranted.

### Structural reform priorities and progress
- Priorities:
  - Fiscal structural reforms: tax reform, pension reform, boost infrastructure investment.
  - Housing supply: ease planning restrictions, mobilize publicly-owned land, property tax reform.
  - Vocational training: expand to boost human capital; only four-fifths of 15–19 year-olds enrolled in education (below OECD average).
  - Female labor force participation: increase support for childcare; participation rising but below OECD average.
- Corporate transparency:
  - Reforms: register of persons with significant control (beneficial ownership); automatic sharing initiatives.
  - Recommendations: enhance AML/CFT compliance among trust/company service providers, lawyers, accountants; strengthen supervision; engage Crown Dependencies and British Overseas Territories on beneficial ownership registries and access.
- Authorities broadly agreed with staff’s priorities and noted significant actions underway (National Infrastructure Commission, planning reforms, childcare adjustments, apprenticeship expansion, beneficial ownership reforms).

### Contingency planning: scenarios and policy options
- Macroeconomic policies must remain flexible; policy adjustments tailored to scenarios.
- Example: Exit from the EU:
  - Policies to support stability and reduce uncertainty.
  - Ensure financial system liquidity; BoE plans additional liquidity auctions around referendum.
  - Potential activation of swap facilities for FX liquidity shortfalls.
  - Trade-offs between stabilizing inflation and output.
  - Plans for additional medium-term consolidation may be needed to offset long-run fiscal effects.
- Example: Protracted demand shortfall and hysteresis:
  - Options: cut interest rates, restart QE, halt structural fiscal adjustment and move to stimulus, redouble structural reforms.

### Authorities' readiness and trade-offs
- Authorities stand ready to tailor responses to a wide range of shocks.
- In event of Leave vote, macro response depends on magnitudes of supply vs demand effects and impact of currency depreciation on prices and expectations.
- Potential trade-off: stabilizing inflation versus stabilizing output and employment.
- If weak productivity predominates, tightening may be required to contain inflation and adjust to adverse fiscal effects.

### Staff appraisal: summary
- Recent performance: strong relative growth, record high employment, reduced fiscal deficit, major financial reforms adopted.
- Baseline: steady growth over next few years with inflation returning to target; staff baseline assumes Remain vote.
- Key vulnerabilities and risks: global shocks, low household saving rate and household debt, possible reversal in property markets, wide CA deficit, risk of prolonged low productivity.
- Largest near-term uncertainty: upcoming EU referendum.
- Policy guidance under baseline:
  - Monetary: remain accommodative.
  - Fiscal: gradual consolidation to rebuild buffers; March budget avoidance of near-term tightening appropriate given weakness and uncertainty.
  - Macroprudential: remain sufficiently tight; tighten mortgage-related measures and use CCB actively.
- Financial sector supervision priorities: strengthen analysis of interconnectedness, complete resolution reforms, scrutinize internal models, ensure resolvability of large complex institutions.
- De-risking and AML/CFT: deepen understanding and develop tailored responses (dialogue, clarify expectations, enhance supervision of money transmitters).
- Structural reforms: boost housing supply, infrastructure investment, reduce distortionary tax expenditures and debt bias, expand vocational training, increase childcare support, enhance corporate transparency.

### External sector assessment (additional details)
- Staff assesses 2015 cyclically-adjusted CA balance to be 1.5 to 4.5 percent of GDP weaker than CA norm.
- 2015 REER: staff assesses 2015 REER as 5 to 20 percent above level consistent with fundamentals and desirable policy settings.
- 2015 average REER 15 percent more appreciated than in 2013; as of April 2016 REER depreciated 7 percent relative to 2015 average.
- Recommendations for external rebalancing: structural reforms to broaden skills and invest in infrastructure; maintain accommodative monetary stance and medium-term consolidation to support rebalancing; ensure macroprudential policies support private saving.

### Debt sustainability and stress-test findings (selected)
- Public sector gross debt about 92 percent of GDP in FY15/16; projected to decline to around 78 percent of GDP by FY21/22.
- Baseline macro projections (selected):
  - Real GDP (baseline): 2016: 2.2 percent; 2017: 2.2 percent; 2018: 2.1 percent; 2019: 2.2 percent; 2020: 2.2 percent; 2021: 2.1 percent.
  - Inflation (GDP deflator): 2016: 0.3 percent; 2017: 1.9 percent; 2018: 1.6 percent; 2019: 1.9 percent; 2020: 1.9 percent; 2021: 2.0 percent.
  - Short-term interest rates projected to rise by total of 70 basis points by FY21/22.
  - Effective interest rate (baseline projection): 2016: 2.3 percent; 2017: 2.4 percent; 2018: 2.6 percent; 2019: 2.7 percent; 2020: 2.7 percent; 2021: 2.7 percent.
- Stress-test scenarios (selected outcomes):
  - Growth shock: debt-to-GDP rises to about 93 percent by FY18/19; GFN up to ~11 percent.
  - Combined macro-fiscal shock: debt-to-GDP close to 95 percent in FY18/19; GFN ~12 percent by FY21/22.
  - Contingent fiscal shock (banking crisis): debt-to-GDP rises to 103 percent in FY18/19; GFN peaks at 20 percent.
  - Stagnant growth/low inflation: revenue-to-GDP ratio lower by one percentage point; debt not on clear downward path; GFN ~10 percent.
- Debt indicators and composition:
  - Nominal gross public debt (percent of GDP): 2014: 67.3; 2015: 91.1; 2016: 91.5; 2017: 90.6; 2018: 89.2; 2019: 87.5; 2020: 84.5; 2021: 81.7.
  - Public gross financing needs (percent of GDP): 2014: 10.4; 2015: 11.6; 2016: 10.7; 2017: 9.7; 2018: 9.1; 2019: 8.5; 2020: 6.8; 2021: 7.6.
  - Average maturity of government debt: about 14 years.
- Stress-test input assumptions preserved from scenario tables (real GDP growth, inflation, primary balance, effective interest rate).

*Italic: UNITED KINGDOM — INTERNATIONAL MONETARY FUND (IMF staff report excerpts and FSAP/FSSA findings as provided in content unit _cr16168).*

### conclusions of the Financial Sector Assessment Program (FSAP).

### conclusions of the Financial Sector Assessment Program (FSAP)

### FOCUS OF THE CONSULTATION
- UK economy performed well in recent years, but faces important challenges and risks.
- Key recent developments:
  - Economic growth has consistently been near the top among major advanced economies.
  - The employment rate has risen to a record high.
  - Fiscal consolidation has cut the deficit by more than half.
  - Monetary policy has remained accommodative.
  - Financial sector policies have required banks to increase buffers.
  - Structural reforms have aimed to ease regulatory impediments to housing construction.
- Important remaining challenges and risks:
  - Productivity growth is still well below pre-crisis rates.
  - The current account deficit widened to a record high in 2015, driven in part by a further decline in the already-low household saving rate.
  - Loan-to-income ratios on new mortgages are again rising.
  - A referendum on EU membership will be held on June 23, 2016; its outcome is expected to have important economic implications for the UK, the rest of Europe, and the global economy.
- Consultation focused on:
  - Recent evolution of macroeconomic conditions.
  - Outlook and main risks for the economy.
  - How UK economic policies can support growth and limit risks domestically and globally.

### MACROECONOMIC CONTEXT — A. Macroeconomic Developments and Outlook
- 2015 performance:
  - Output grew by 2.3 percent.
  - Growth was the third straight year in the 2–3 percent range.
  - Growth driven by strong private domestic demand that more than offset headwinds from gradual fiscal consolidation and weak external demand.
- Macroeconomic and macrofinancial normalization indicators:
  - Standard models suggest the output gap is now nearly closed.
  - Capacity utilization and the unemployment rate have returned to pre-crisis levels.
  - Employment rate reached a record high.
  - Net lending by monetary financial institutions (MFI) to nonfinancial corporates turned positive for the first time since the crisis.
  - Mortgage rates fell to new lows.
- Near-term uncertainty and 2016 outlook:
  - Several factors heightened uncertainty in the first half of 2016, foremost the referendum on EU membership.
  - Volatility in global financial markets in early 2016 and downgrades to the global growth outlook increased uncertainty.
  - Growth slowed to 1.6 percent (saar) in Q1 2016.
  - PMI surveys suggested further slowdown in April 2016.
  - Under staff’s baseline (UK remains in the EU), growth projected to rebound later in 2016 with full-year 2016 growth of 1.9 percent.
- Medium-term projections:
  - Growth projected to average around 2.2 percent—approximately staff’s estimate of the UK’s potential growth rate—over the medium term.
  - Labor productivity growth:
    - Recently running around 0.8 percent.
    - Staff projects productivity growth to rise over the medium term to around 1.6 percent.
    - Pre-crisis historical average was 2.2 percent (1960–2007).
  - Inflation:
    - As of April 2016, headline inflation at 0.3 percent; core inflation at 1.2 percent.
    - Nominal private-sector wages growing by 2.3 percent as of March 2016.
    - BoE policy rate was 0.5 percent.
    - Markets do not expect the BoE to raise its policy rate for several years under the baseline.
    - Staff expects inflation to rise gradually to 2 percent by early 2018, as commodity price effects dissipate and wages rise with tighter labor markets.
    - A planned gradual increase in the minimum wage of 34 percent during 2015–20 will also contribute to higher wage and price inflation.
- Demand-side outlook:
  - Offseting forces expected to have a roughly neutral effect on growth over the next few years.
  - Baseline support factors: reduction in uncertainty following a Remain vote, run-up in residential and commercial real estate prices encouraging investment, gradually rising global growth supporting net exports, monetary policy accommodation, and supportive financial conditions.
  - Ongoing headwinds: steady fiscal consolidation.

### MACROECONOMIC CONTEXT — B. External Assessment
- Current account and external balances:
  - Current account deficit reached 5.2 percent of GDP in 2015—the widest deficit among advanced economies.
  - Increase due almost entirely to a weaker income balance.
  - Household saving rate fell to 4.3 percent in 2015.
  - Net international investment position (NIIP) was -3.5 percent of GDP at end-2015.
- EBA model results and exchange rate assessment (2015):
  - EBA current account regression model yields:
    - Cyclically adjusted current account balance of -4.8 percent of GDP in 2015.
    - Current account norm of -0.6 percent of GDP.
    - Implied current account gap of -4.2 percent of GDP.
    - Implied sterling overvaluation of 18 percent.
  - EBA REER models estimate overvaluation of 12 percent.
  - Taking model differences and uncertainty into account yields an estimated current account gap of -1.5 to -4.5 percent of GDP and REER overvaluation of 5–20 percent in 2015.
  - As of April 2016, the REER had depreciated by 7 percent relative to its average 2015 level.
- Factors contributing to the current account gap:
  - Part of the gap (1.1 percentage points) reflects the fiscal balance being looser than its optimal medium-term level.
  - Part reflects relatively low household saving rate (4.3 percent in 2015).
  - Post-crisis deterioration in the income balance may not be entirely permanent; unusually low returns on British investments abroad contribute.
  - Structural factors—e.g., increasingly favorable corporate tax rates attracting inward FDI—may affect income balance measurements.
- Mitigating factors:
  - BoE’s inflation-targeting framework should help keep inflation expectations anchored if exchange rate depreciation occurs, absent a major regime shift such as an exit from the EU.
  - Currency composition of the NIIP acts as an automatic stabilizer: foreign assets have a higher foreign-currency component than foreign liabilities, so sterling depreciation tends to improve the NIIP and income flows via valuation effects.
  - Valuation effects have kept the NIIP relatively neutral despite persistent current account deficits.
- Policy implication:
  - Persistent, high current account deficit is a source of concern; policies that assist orderly and gradual external adjustment would be helpful.

### MACROECONOMIC CONTEXT — C. Risks and Spillovers
- Baseline described as relatively benign but subject to important risks (see Risk Assessment Matrix, Annex 2).
- Globally originating risks:
  - Global downturn:
    - Weak global demand could depress exports.
    - Tighter global financial conditions (higher risk premia and lower asset prices) could depress GDP by weighing on domestic consumption and investment.
  - Persistently low energy prices:
    - Could have modest positive net effects on growth (boost to consumption partly offset by negative effects on energy-sector investment).
    - Headline inflation would remain lower for longer.
    - If second-round deflationary effects occur, more accommodative monetary policy may be required to anchor inflation expectations.
- UK-specific risks:
  - Medium-term productivity growth:
    - Productivity growth remains well below pre-crisis rates; failure to recover would have a major adverse effect on long-run output and put upward pressure on inflation.
    - A return to pre-crisis productivity rates would yield substantially higher output than the staff baseline.
  - Real estate market-related risks:
    - House-price growth has risen to more than three times income growth.
    - Loan-to-income ratios on new mortgages are again rising.
    - Continuation of these trends would increase households’ and banks’ vulnerabilities to house-price, income, and interest-rate shocks.

*conclusions of the Financial Sector Assessment Program (FSAP).*

### 15.      However, the largest near-term risk relates to the referendum on EU membership. A

### _cr16168 - 15.      However, the largest near-term risk relates to the referendum on EU membership. A

### Referendum risk and withdrawal process
- A vote to leave the EU would create uncertainty about the nature of the UK’s long-term economic relationship with the EU and the rest of the world and could crystallize baseline risks.
- Following a decision to exit, the UK would need to negotiate withdrawal terms and a new relationship with the EU—unless it abandoned single market access and relied on WTO rules, which would significantly raise trade barriers.
- EU-level agreements also cover the UK’s trading relationship with 60 non-EU economies, with prospective arrangements with another 67 countries in the works; these would need renegotiation or else revert to WTO rules.
- Relatively simple bilateral trade agreements have typically taken 3 or more years to negotiate.
- Article 50 provides for a two-year process for negotiating withdrawal and future relations, but there is no requirement that remaining EU countries reach agreement; extensions require unanimous consent from other EU governments.
- Ratification of a new deal could require unanimous support depending on the agreement’s nature, increasing political risk.

### Near-term market, confidence, and investment effects
- A protracted period of uncertainty could weigh on confidence and investment and increase financial market volatility.
- Potential market reaction channels include:
  - Higher borrowing costs for households and individuals due to higher risk premia.
  - Downward pressure on equity and house prices.
  - Sudden stop of investment inflows into key sectors such as commercial real estate and finance.
- The UK’s record-high current account deficit and reliance on external financing exacerbate these risks.
- Possible self-reinforcing cycle: adverse market reaction → lower economic activity → further asset price declines, partly offset by expenditure-switching toward net exports following exchange rate depreciation, which could push inflation above target for some time.
- Market evidence noted in recent months:
  - Commercial real estate transactions plunged about 40 percent in the first quarter of 2016.
  - The UK’s nominal effective exchange rate depreciated 9 percent between November 2015 and April 2016.
  - UK sovereign CDS spreads have risen more sharply than the G7 average.
  - The cost of hedging exchange rate volatility around the referendum has spiked.
- Historical experience with similar events is limited; market reaction uncertainty is wide, but the reaction is expected to be negative and could be severe.

### Possible steady-state arrangements and trade-offs
- Range of outcomes:
  - Outside the EU but in the European Economic Area (like Iceland, Liechtenstein, Norway) — would maintain EU regulations on free movement of persons, goods, services, and capital with greatly reduced influence.
  - Revert to WTO rules — would significantly curtail access to the EU single market and create non-tariff barriers not covered by WTO rules (e.g., loss of customs union membership).
  - Intermediate arrangements — trade-off between EU market access and the degree of unilateral regulatory autonomy.

### Transmission channels of steady-state economic effects
- Reduced trade and financial flows:
  - Increased barriers likely to curtail benefits from cooperation (economies of scale, specialization, trade-related productivity gains).
  - Could reduce the UK’s attractiveness as an investment destination and trigger relocation of activities elsewhere in the EU (e.g., loss of “passport” for UK financial firms; euro-denominated business may move to the continent).
  - Over time, these effects could erode London’s status as Europe’s preeminent financial center.
- Regulatory changes:
  - Some proponents expect more pro-growth regulatory policy outside the EU, but maintaining substantial single market access may require alignment with many EU regulations.
  - Many EU regulations implement global agreements (e.g., Basel III) that would likely be maintained post-exit.
  - The UK already has relatively flexible labor and product market regulations; scope for making these more flexible is limited.
  - Regulations under domestic control (e.g., housing construction restrictions) are major growth constraints; exit could allow domestic special interests to capture regulatory decision-making, potentially making regulation more restrictive and less pro-growth.
- Fiscal effects:
  - The UK would save net contributions to the EU budget of around ⅓ percent of UK GDP if it left the EU.
  - The UK budget would likely need to cover activities currently financed by the EU (agricultural support, regional development, R&D).
  - Fiscal savings from not contributing to the EU budget would likely be more than offset by fiscal losses from output declines resulting from reduced trade and investment.
  - Specifically, if steady-state output falls by just 1 percent or more, the associated revenue loss would exceed the fiscal savings from not contributing to the EU budget.

### Quantitative estimates, scenarios, and economic costs
- Quantifying exit effects is difficult and depends on post-exit arrangements; however, qualitative assessment suggests exit is very likely to adversely affect the UK economy.
- The vast majority of quantitative estimates point to sizeable long-run losses from increased barriers that reduce trade, investment, and productivity; the wide range of estimates reflects differing assumptions about future relationships.
- IMF staff illustrative scenarios (accompanying Selected Issues paper):
  - Limited uncertainty effects scenario: level of output is 1½ percent below the baseline at its peak deviation in 2019.
  - More adverse scenario: level of output is 5½ percent below the baseline at its peak deviation.
- Several studies find short- and medium-term effects would also likely be negative.

### Spillovers to other economies and markets
- The UK would be most affected, but other EU economies would experience reduced gains from trade, less efficient capital-labor matching, and heightened transition uncertainty depending on linkages with the UK.
- Losses from reduced trade and integration may rise if a UK exit increases support for higher barriers elsewhere in Europe.
- Effects on the UK financial sector and markets may produce outward spillovers to Europe and beyond, given London’s global financial importance.

### Authorities’ views and near-term outlook
- Authorities broadly shared staff’s baseline outlook and key risks.
- Office for Budget Responsibility (OBR) actions:
  - In March 2016, OBR revised down its 2016 growth projection from 2.5 percent to 2.0 percent, in part due to a softer global outlook.
  - OBR revised down medium-term potential and actual growth by about ¼ percentage point due to continued weak productivity growth.
  - OBR projections are now very close to IMF staff, the BoE, and consensus forecasts.
- Other authority work:
  - HM Treasury published estimates of long-term effects of an exit in April 2016.
  - Bank of England (BoE) discussed EU membership effects on monetary and financial stability in October 2015 and short-term implications for monetary policy in its May 2016 Inflation Report.

### Policy recommendations under a Remain baseline
- Overall: focus on promoting steady growth while reducing vulnerabilities; remain flexible and adjust policies if circumstances change or risks are realized.
- Monetary policy:
  - Current monetary policy settings cited: policy rate of 0.5 percent and QE assets of £375 billion (20 percent of GDP)—unchanged since 2012.
  - Monetary policy should stay on hold until inflationary pressures are clearer to help offset headwinds from fiscal consolidation.
  - Rationale:
    - Both headline and core inflation are below target.
    - Forward-looking indicators (inflation expectations, wage growth in excess of productivity growth) are well-contained; market-based inflation expectations drifted downward in recent months.
    - Output gap is nearly closed, but accommodation likely needed to prevent re-opening given fiscal consolidation headwinds.
    - Very low long-term interest rates noted: the 30-year yield on government bonds was 2.2 percent as of end-May.
    - Neutral interest rate may be much lower than in the past.
    - Risks to policy errors are asymmetric; costs of inflation undershooting likely exceed those of overshooting due to easing complications near the effective lower bound.
  - Policy stance: remain data dependent; tighten earlier if core inflation or wage growth in excess of productivity rises quickly; further easing (policy rate cuts to at least zero and/or additional QE) likely needed if demand is weaker and inflation undershooting persists.
- Fiscal policy:
  - Fiscal consolidation should remain sufficiently gradual to avoid overburdening monetary policy and be supported by measures to make its composition more pro-growth and pro-stability.
  - Structural reforms to boost productivity and incomes should reinforce the policy mix.
- Financial stability:
  - Complete implementation of the ambitious financial supervisory reform agenda.
  - Adopt a robust and intrusive approach to supervision and regulation as the financial cycle matures.
  - Mortgage-related macroprudential policies may need to tighten later in the year if re-acceleration of housing and mortgage markets persists.
- Objective of the combined monetary, fiscal, and macroprudential policy mix: maintain growth while reducing vulnerabilities and support orderly current account adjustment.

### Key fiscal and macro statistics cited
- Commercial real estate transactions plunged about 40 percent in Q1 2016.
- Nominal effective exchange rate depreciated 9 percent between November 2015 and April 2016.
- Policy rate: 0.5 percent.
- QE assets: £375 billion (20 percent of GDP).
- 30-year government bond yield: 2.2 percent as of end-May.
- Net contributions to the EU budget saved if leaving: around ⅓ percent of UK GDP.
- Steady-state output fall threshold for fiscal loss exceeding EU net contributions: just 1 percent or more.
- IMF staff illustrative scenarios: 1½ percent and 5½ percent below baseline (peak deviations).
- OBR growth projection revision: from 2.5 percent to 2.0 percent for 2016.
- Public sector fiscal deficit: about 4 percent of GDP in FY15/16.

*UNITED KINGDOM — INTERNATIONAL MONETARY FUND (content unit _cr16168).*

### 28.       The March 2016 budget continues to target consolidation, but further smoothes the

### _cr16168 - 28.       The March 2016 budget continues to target consolidation, but further smoothes the pace.

### March 2016 budget: stance and fiscal path
- The March budget avoided undertaking additional tightening in the near term to offset lower revenue projections following the growth downgrade by the OBR.
- This lack of an active near-term response implied a modest easing of the pace of structural fiscal adjustment in FY16/17, given that part of the growth downgrade was deemed to be structural.
- Additional adjustment was backloaded to FY19/20 to keep the budget consistent with the government’s main fiscal rule: achieve and maintain a budget surplus starting in FY19/20, unless the economy is hit by a significant negative shock, defined as projected real GDP growth of less than 1 percent on a rolling 4 quarter-on-4 quarter basis.
- Under the new fiscal path:
  - The pace of consolidation is broadly constant at around 1 percentage point of GDP per year through FY19/20, especially after adjusting for effects of shifts in the timing of corporation tax payments.
  - Public sector net debt is projected to start declining as a percent of GDP from FY16/17 onward.

### Composition of consolidation and notable measures
- Consolidation remains mostly expenditure-based.
- New measures in the 2016 budget include:
  - higher taxes on commercial property,
  - tighter restrictions on tax avoidance,
  - lower business taxes,
  - accelerated infrastructure spending.
- The budget maintains foreign development assistance at 0.7 percent of gross national income.
- New measures do not address some deeper reform needs highlighted in past Article IV reports, such as reforming distortionary tax expenditures.

### Appropriateness of smoothing and fiscal space
- The increased backloading and lack of near-term tightening was judged appropriate given:
  - the weaker near-term outlook,
  - the need to support demand,
  - heightened near-term uncertainty.
- The baseline where growth strengthens later in the year following a Remain vote supports the chosen pace of structural adjustment, given:
  - the output gap is essentially closed,
  - the employment rate is at a record high,
  - financial conditions continue to ease in line with stronger bank balance sheets.
- The UK has fiscal space to ease further if necessary:
  - In a Remain-vote baseline, moderate fiscal easing is unlikely to trigger a significant rise in sovereign bond yields.
  - In an extended period of sluggish demand and inflation undershooting, the government should use fiscal space and framework flexibility to halt structural adjustment and, if necessary, move to stimulus.
  - Automatic stabilizers should be allowed to operate freely and symmetrically.
  - The government may need flexibility in finding alternative fiscal measures if anticipated spending efficiency gains fail to materialize.

### Structural fiscal reform options (pro-growth and pro-stability)
- Boosting infrastructure:
  - Public investment remains below the average in other advanced economies; higher infrastructure spending could be funded by other reforms listed below.
- Reforming taxes:
  - Scale back distortionary tax expenditures (e.g., nonstandard zero VAT rates) to improve efficiency, increase tax neutrality, and free resources for growth-enhancing expenditure.
  - Property tax reform (Mirrlees Review–style): rebalance taxation away from transactions and towards property values to boost mobility and more efficient use of the housing stock. The 2016 budget reformed transaction taxes on commercial properties to eliminate cliff-edges in marginal tax rates, but high reliance on transaction taxes remains.
  - Reduce tax code bias toward debt to promote financial stability (example: adopt an Allowance for Corporate Equity with offsetting corporate tax parameter changes to ensure revenue neutrality).
- Reforming pensions:
  - The “triple-lock” requires state pensions to rise each year by the highest of CPI inflation, wage inflation, or 2.5 percent.
  - Staff simulations suggest moving to CPI indexation could save over 0.5 percent of GDP by the end of a 10-year horizon, enough to increase gross public investment by 20 percent.

### Authorities’ views on fiscal plans
- Authorities view fiscal plans as key to bolstering buffers while growth rates remain near potential and the output gap is closed, to preserve capacity for automatic stabilizers in future shocks.
- They stress maintaining fiscal flexibility and note the FY19/20 budget-surplus rule includes an explicit escape clause for significant negative shocks.
- Authorities see the composition of consolidation as supporting growth via a competitive, lower-tax environment while prioritizing spending in health, science, education, infrastructure investment, and foreign development assistance.

### Financial sector: structure and resilience
- Key facts:
  - Total financial assets of UK domiciled banks and nonbank financial institutions are about ten times UK GDP.
  - Four banks and two insurers in the UK are classified as globally systemically important.
  - The UK insurance sector is the largest in Europe and the third largest globally.
- FSAP and FSSA assessments:
  - The balance sheets of UK banks continue to strengthen, reflecting tougher regulatory capital and liquidity requirements.
  - Major UK banks had an aggregate common equity Tier 1 capital ratio of 12.6 percent and an aggregate Basel III leverage ratio of 4.8 percent at end-2015.
  - Aggregate nonperforming loan ratio was 1.4 percent at end-2015, about a third of its post-crisis peak.
  - Bank credit growth has continued to normalize and is projected to converge to nominal GDP growth over the medium term; the bank credit-to-GDP ratio has returned near pre-boom levels (circa 2000).
  - Profitability remains low relative to historic levels due to lower trading income, lower net interest income, and still-high legacy misconduct costs.
- Stress tests and sectoral resilience:
  - BoE 2015 and IMF FSAP 2016 solvency stress tests indicate major UK banks would continue to satisfy regulatory capital requirements and domestic bank credit demand under severe but plausible adverse scenarios.
  - Liquidity stress tests in 2016 indicate major UK banks are resilient to sizeable withdrawals of funding.
  - Nonbank subsectors (insurers, asset managers, CCPs) analyses by BoE, PRA, FCA, EU authorities, and FSAP are relatively reassuring but less detailed; scope remains to improve data, models, and supervisory risk monitoring tools.
  - Interconnectedness across subsectors could amplify and propagate destabilizing effects; further analytical tools to assess interconnectedness risks are a priority.

### Regulatory reform progress and priorities
- Reforms since the crisis have raised resilience and reduced the likelihood and societal cost of institution failures; many reforms are embedded in law and EU Directives/Regulations.
- Key elements and near-term priorities:
  - Macroprudential oversight:
    - Financial Policy Committee (FPC) framework assigns clear roles, powers, and accountability and promotes coordination across agencies.
    - The FPC raised the countercyclical capital buffer (CCB) from 0 to 0.5 percent, effective one year later; this increase will not raise overall regulatory capital buffers for most banks in 2017 due to offsetting reductions in Pillar 2 supervisory capital buffers.
    - The FPC justified the CCB increase as improving transparency of existing buffers rather than increasing overall capital levels.
    - It will be important to continue tightening the CCB proactively in line with the financial cycle; further tightening may be needed later in the year if near-term uncertainty resolves and macro-financial conditions remain stable.
    - Authorities need to sustain focus and willingness to act on financial stability risks and promote public understanding of the FPC’s role.
  - Microprudential oversight:
    - Prudential Regulation Authority (PRA) in the BoE supervises banks, insurers, and large investment firms; Financial Conduct Authority (FCA) supervises other financial institutions and conduct.
    - Supervisory focus on the most important firms is appropriate systemically but reduces individual attention to small and mid-size companies; continued vigilance is required.
    - Recommendations include a robust, intrusive supervisory approach as the financial cycle matures: prudent review of dividend payouts, intensified on-site inspections, scrutiny of asset quality at less systemically important banks, broader supervisory review of banks’ internal models, and international agreement to maintain effective standards for risk-weights.
  - Resolution framework and resolvability:
    - The special resolution regime has been overhauled and is broadly aligned with international standards; resolution powers and coordination arrangements are stronger than before the crisis.
    - Remaining cross-jurisdictional differences could impede orderly cross-border resolution; UK authorities are active internationally in addressing this.
    - Key domestic implementation priorities: complete ring-fencing requirements for core retail activities of large banks and phase in minimum requirements for own funds and eligible liabilities (MREL) for all banks.
    - Ongoing efforts are needed to ensure resolvability of large, complex, globally interconnected institutions as business models evolve, including developing operational principles for funding of firms in resolution and working with international partners to develop an effective resolution regime for insurance firms that could be systemically significant at the point of failure.

*Source: IMF staff staff report excerpt (March 2016 budget and 2016 FSAP/FSSA findings).*

### 40.      The authorities should continue to improve their understanding of the scale and

### 40.      The authorities should continue to improve their understanding of the scale and 

### De-risking: overview and implications (Box 1)
- Global banks, including those based in the UK, have been scaling back correspondent banking relationships (CBRs).
- While the number of CBRs has been declining, there are some indications that the global volume of transactions may be rising overall.
- Potential adverse effects of curtailment of CBRs:
  - Impair cross-border financial intermediation, including remittance transfers and trade finance, with certain jurisdictions.
  - Cause customers and/or activities to migrate to less transparent and unregulated service providers.
- Account terminations reported among certain customer categories:
  - Money transmitters, non-profit organizations, FinTech firms, defense-related firms, and politically-exposed persons.
- Specific spillover risks noted:
  - Loss of accounts by money transmitters and non-profit organizations could potentially impair remittances, notably across the Somalia-UK corridor, and aid flows to conflict zones.
- Potential drivers of withdrawal of financial services:
  - Business strategy and/or cost-benefit analysis, including enforcement of regulatory obligations (e.g., capital and liquidity rules), AML/CFT, economic and trade sanctions, and tax transparency.
  - Conflicting regulations between jurisdictions (e.g., between data privacy and AML/CFT) that prevent correspondent banks from conducting adequate customer due diligence.
  - Unevenness in the way international standards are applied and enforced globally, rather than lack of clarity in the laws that implement the standards.
- Recommended mitigation actions for authorities:
  - Continue efforts to understand the scale and drivers of de-risking and engage with concerned stakeholders.
  - Further promote dialogue with stakeholders.
  - Encourage banks to further work with their customers (e.g., respondent banks, money transmitters) on strengthening their AML/CFT controls.
  - Clarify regulatory expectations, notably in regard to the management of higher risk customers.
  - Enhance AML/CFT supervision of money transmitters.
  - Work with other jurisdictions to resolve conflicting regulations that impede cross-border information-sharing between correspondent banks and their respondents.

*UNITED KINGDOM 24 INTERNATIONAL MONETARY FUND*

### Authorities’ views on de-risking
- The authorities welcomed the analysis in the FSAP and broadly agreed with its main recommendations.
- The authorities agreed that post-crisis reforms had significantly bolstered financial sector resilience, though challenges remain.
- The FPC expected to gradually raise the countercyclical capital buffer over time, as it considered a buffer of 1 percent to be the appropriate level for the normal phase of the financial cycle.
- The authorities noted that non-traditional risks, such as those related to cyber-security, were gaining prominence and required close attention.
- On “de-risking,” the authorities agreed that it was important to better understand the drivers of this phenomenon and were undertaking substantial analysis in this area.

*UNITED KINGDOM INTERNATIONAL MONETARY FUND 25*

### Real estate markets and related macroprudential policies
- Recent developments:
  - Housing and mortgage markets have re-accelerated since mid-2015.
  - Between mid-2014 and mid-2015, house-price growth decelerated somewhat, and the percentage of new mortgages with high loan-to-value (LTV) or high loan-to-income (LTI) ratios declined.
  - In recent months, house-price growth re-accelerated, reaching 9 percent in March 2016—more than three times income growth.
  - The share of new mortgages at high LTI ratios has started to tick back up and remains well above pre-boom levels (i.e., circa 2000).
  - Aggregate household debt-to-income ratio is above the levels in other G-7 countries and its rate of decline has recently slowed.
- Risks:
  - High leverage exposes banks and households to interest-rate, income, and house-price shocks.
- Possible temporary factors:
  - Recent acceleration could partly reflect urgency to purchase before the April 1, 2016, implementation of a three percent stamp duty surcharge on properties that are not primary residences (e.g., buy-to-let properties).
  - RICS data on expected house prices suggest a cooling of house prices going forward.
- Macroprudential policy guidance:
  - Authorities should wait for greater clarity on market conditions given uncertainty from tax changes and the referendum on EU membership.
  - If mortgage markets remain buoyant beyond this period, further macroprudential tightening (tighter LTI and/or LTV limits on new mortgages) will be needed later this year.
  - Priority should be given to consolidation of household-level credit data to allow a shift from LTI limits to debt-to-income limits.
  - Ensuring macroprudential policies remain sufficiently tight should promote higher household saving and current account adjustment.
- Buy-to-let (BTL) segment:
  - Since 2012, the stock of outstanding BTL mortgages has grown approximately four times as fast as the stock of mortgages in the owner-occupied segment, with BTL accounting for more than one-third of gross mortgage growth since 2012.
  - The BTL segment is dominated by small-scale landlords (owning 3 properties or less), who are significantly more sensitive to interest-rate increases than owner occupiers.
  - Decline in rental yields, shown by divergence between rents and house prices, magnifies sensitivity as BTL borrowers tend to rely on rental income to cover mortgage payments.
  - Studies find the probability of default on BTL mortgages is higher than for owner-occupied mortgages and that BTL mortgages are typically extended on interest-only terms (BoE, 2015; McCann, 2014; HMT, 2015).
- Recommendations for BTL:
  - Extend the FPC’s powers of direction to the BTL market to mirror those the FPC currently has over the owner-occupied market.
  - Strengthen minimum underwriting standards for BTL mortgages, including guidelines for testing the affordability of interest payments and a minimum stressed interest rate for affordability tests.
  - Disseminate data on rental prices differentiated by region and type of rented property to advance analysis of the rental market, buy vs. rent decisions, and extent of house price overvaluation.
- Supply-side recommendations:
  - Continue efforts to address supply constraints caused by restrictive planning and the post-recession loss of building capacity.
  - Build upon initiatives to boost housing supply by exploring mobilization of unused publicly-owned lands and property tax reform.

*UNITED KINGDOM 26–27 INTERNATIONAL MONETARY FUND*

### Commercial real estate (CRE)
- Recent trends:
  - Price growth was rapid during 2014–15, especially in prime London locations, where indicators point to some CRE overvaluation.
  - Indicators suggest a marked slowdown in early 2016, with transactions falling by 40 percent, though this likely reflects at least in part referendum-related uncertainty.
- Macro-financial implications:
  - CRE prices matter because many firms use CRE as collateral to support borrowing; a fall in prices could tighten corporate credit constraints and reduce business investment and economic activity.
  - A sharp reversal of CRE prices could adversely affect financial stability via banks’ exposure to commercial real estate, though post-crisis rebalancing of CRE funding away from domestic banks towards international investors and nonbanks has lessened this channel.
  - This rebalancing implies adverse shocks to CRE may have significant negative outward spillovers via the sector’s cross-border financial linkages.
- Authorities’ view:
  - Authorities continue to monitor real-estate related financial stability risks closely and will take further action as warranted.
  - The stamp duty change, PRA action (e.g., consultation on BTL underwriting standards), and possible referendum-related effects make it difficult to ascertain underlying trends; clarity may come later this year.
  - On the BTL market, the FPC has requested powers of direction; the Treasury expected to publish a consultation response document, including final legislation, in the coming months.
  - The PRA expected to follow-up soon on its consultation on minimum underwriting standards for BTL mortgages.

*UNITED KINGDOM 27–28 INTERNATIONAL MONETARY FUND*

### Structural reforms: priorities and progress
- Structural reform priorities:
  - Fiscal structural reforms: tax reform, pension reform, and boosting investment in infrastructure; continued focus on transport bottlenecks and the National Infrastructure Commission’s mandate.
  - Housing supply: ease planning restrictions, mobilize unused publicly-owned lands for construction, and reform property taxes to encourage efficient use of the housing stock.
  - Vocational training: expand vocational training to boost human capital; only four-fifths of those aged 15–19 are enrolled in education, below the OECD average.
  - Female labor force participation: continue efforts to increase participation for single women with children, including increased support for childcare; participation has been increasing in recent years but is still below the OECD average.
- Corporate transparency:
  - Government reforms adopted to enhance corporate transparency and combat tax evasion, corruption, and other financial crimes include establishment of a register of people with significant control (beneficial ownership) of UK companies and limited liability partnerships and a new initiative for automatic sharing of beneficial ownership information between countries.
  - Recommendations to complement reforms:
    - Enhance AML/CFT regulatory compliance among trust and company service providers, lawyers, and accountants.
    - Strengthen the effectiveness of AML/CFT supervision for these sectors.
  - Engage Crown Dependencies (CDs) and British Overseas Territories (BOTs) on enhancing corporate transparency and access to beneficial ownership information.
    - CDs and BOTs with financial centers have committed to establishing central beneficial ownership registries or equivalent systems.
    - Government has concluded arrangements with these CDs and BOTs on effective and unrestricted access to this information by law enforcement and tax authorities.
    - Key success factors: ensure quality of beneficial ownership information, make registries publicly accessible, enforce compliance adequately, and pursue similar initiatives with respect to trusts.
- Authorities’ view on structural reforms:
  - Authorities broadly agreed with staff’s structural reform priorities and noted significant actions in many areas:
    - National Infrastructure Commission expected to strengthen infrastructure investment quality.
    - Reforms to planning system and other measures to boost housing supply; authorities committed to going further.
    - Childcare benefits adjusted in the 2015 Autumn Statement to support those on low incomes.
    - Apprenticeship opportunities expanded.
    - Major reforms adopted to enhance transparency of beneficial ownership, placing the UK at the forefront of such efforts.
    - Authorities actively engaging with CDs and BOTs to strengthen transparency, while noting CDs and BOTs set their own financial services and AML/CFT regulation in line with self-governance arrangements.

*UNITED KINGDOM 28–29 INTERNATIONAL MONETARY FUND*

### Contingency planning: scenarios and policy options
- Macroeconomic policies will need to remain flexible and adjust if circumstances change.
- Specific policy adjustments should be tailored to specific scenarios (Appendix II). Examples provided:
  - An exit from the EU:
    - Policies should be geared toward supporting stability and reducing uncertainty.
    - If markets reacted sharply and adversely, ensure the financial system has adequate liquidity.
    - The BoE has announced plans to hold additional liquidity auctions in the weeks around the referendum.
    - There may be a need to activate swap facilities with other major central banks in the event of a shortfall of foreign exchange liquidity.
    - Implications for macroeconomic policies are not clear cut due to potential trade-offs between stabilizing inflation and output.
    - Scope for macroeconomic policies to cushion a fall in economic activity will depend on assessment of supply and demand and extent to which longer-run inflation expectations remain well-anchored.
    - Plans for additional medium-term budget consolidation may need to be developed to offset longer-run adverse fiscal effects.
  - Protracted demand shortfall and hysteresis:
    - If aggregate demand is protractedly short and potential output weakens due to hysteresis effects, policy options include:
      - Cutting interest rates.
      - Restarting quantitative easing.
      - Using flexibility in the fiscal framework to halt structural fiscal adjustment (and, if necessary, move to stimulus).
      - Redoubling structural reform efforts to boost potential output.

*UNITED KINGDOM 29–30 INTERNATIONAL MONETARY FUND*

*Italic: IMF staff report content as provided in the source PDF.*

### 54.      The authorities stand ready to provide tailored responses to a wide range of shocks. In

### _cr16168 - 54.      The authorities stand ready to provide tailored responses to a wide range of shocks. In

### Authorities' readiness and trade-offs
- The authorities stand ready to provide tailored responses to a wide range of shocks.
- In the event of a vote to leave the EU, the macroeconomic response would depend on:
  - the relative magnitudes of supply and demand effects, which the authorities view as difficult to judge beforehand, and
  - the impact of the expected currency depreciation on prices and inflation expectations.
- Potential trade-off: stabilizing inflation versus stabilizing output and employment.
- Response to a protracted period of slow growth depends on whether weakness is due to deficient demand or continued weak productivity growth.
  - If weak productivity growth predominates, tightening may be required to contain inflation pressures and adjust to the adverse fiscal effects resulting from lower potential output.

### Staff appraisal: recent performance
- The UK economy has performed well in recent years:
  - Economic growth has consistently been near the top among major advanced economies.
  - The employment rate has risen to a record high.
  - The fiscal deficit has been reduced.
  - Major financial sector reforms have been adopted.

### Baseline outlook and assumptions
- Steady growth is expected to continue over the next few years under the baseline scenario, with inflation gradually returning to target.
- Staff’s baseline assumes that the UK votes to remain in the EU.
- Under staff’s baseline:
  - Growth is projected to strengthen in late 2016 as referendum-related effects wane and then to average near the potential rate over the medium term.
  - The output gap appears nearly closed.
  - Inflation is expected to return gradually to target as effects of past commodity price falls dissipate and as low unemployment and minimum wage increases help push up wages.

### Key vulnerabilities and risks
- Notable risks include:
  - possible shocks to global growth and asset prices;
  - a low household saving rate and still-high levels of household debt, despite a substantial reduction in the latter since the crisis;
  - a possible reversal of recently buoyant residential and commercial real estate markets;
  - a wide current account deficit; and
  - risks that productivity growth may remain low for an extended period.
- In the near-term, the largest risks and uncertainties relate to the upcoming EU referendum.

### EU referendum: analysis and implications
- Context:
  - This year’s Article IV consultation occurs as the British people prepare to make a momentous decision.
  - Staff has analyzed potential macroeconomic implications, while recognizing the choice is for UK voters to make and that decisions reflect both economic and noneconomic factors.
- Exit (Leave) risks and effects:
  - While much uncertainty exists, effects of an exit from the EU are likely negative and substantial.
  - An exit would precipitate a protracted period of heightened uncertainty that could weigh on confidence and investment and increase financial market volatility.
  - Negotiations on new arrangements could remain unresolved for years.
  - Long-run effects on UK output and incomes would also likely be negative and substantial, as increased barriers would reduce trade, investment, and productivity.
  - Markets may bring forward medium- and long-term negative effects via an adverse reaction in the immediate aftermath of a vote.
  - Contagion effects could result in spillovers to regional and global markets, although the primary impact would be felt domestically.
- Policy guidance in the event of a Leave vote:
  - Policies should be geared toward supporting stability and reducing uncertainty.

### Policy recommendations under the baseline (Remain vote)
- Macroeconomic policies should focus on promoting steady growth while reducing vulnerabilities.
- Monetary policy:
  - Should remain accommodative to support demand.
- Fiscal policy:
  - Fiscal consolidation—which will help rebuild buffers—should remain sufficiently gradual to avoid overburdening monetary policy.
  - The decision in the March budget to avoid near-term tightening was appropriate given present growth weakness and heightened uncertainty.
- Macroprudential policy:
  - Should remain sufficiently tight to mitigate financial stability risks that could arise if financial conditions turn overly expansionary.
  - Mortgage-related macroprudential policies (e.g., LTI/LTV limits) will need to be tightened later this year if housing and mortgage markets remain buoyant, with similar limits applied also to the buy-to-let market.
  - The authorities should actively use the countercyclical capital buffer, which may well need to be increased later this year.

### Policy responses to shocks
- Macroeconomic policies will need to respond flexibly to any shocks:
  - In the event of protracted demand weakness and inflation undershooting, monetary and fiscal policies should be eased.
  - Conversely, monetary tightening may need to be initiated earlier than currently envisaged if core inflation or wage growth in excess of productivity growth begins to rise sharply.

### Financial sector supervision and regulation priorities
- Imperative to have a robust and intrusive approach to prudential supervision and regulation as the financial cycle matures and memories of the crisis fade.
- Financial sector soundness has improved notably since the crisis, owing in large part to a wave of welcome post-crisis regulatory reforms.
- Stress tests suggest that the major elements of the financial system appear resilient to shocks.
- Ensuring the safety of the UK financial sector is critical domestically and for global financial stability, given the UK’s importance as a global financial center.
- Priorities (in line with recommendations of the accompanying FSSA):
  - Interconnectedness across financial system sectors can amplify shocks and turn sector-specific distress systemic; priority to further strengthen analysis and data on interconnectedness and related risks.
  - Further efforts are needed to complete the resolution reform agenda:
    - Authorities should build on current arrangements to develop operational principles for funding of firms in resolution.
    - Authorities should work with international partners to develop an effective resolution regime for insurance firms that could be systemically significant at the point of failure.
  - Authorities should ensure close scrutiny of banks’ internal models and seek international agreement on maintaining effective standards for risk weights.

### "De-risking" and AML/CFT
- Authorities should continue efforts to deepen their understanding of the “de-risking” phenomenon and develop tailored responses.
- Possible responses include:
  - further promoting dialogue with stakeholders;
  - clarifying regulatory expectations, notably in regard to the management of higher risk customers; and
  - enhancing AML/CFT supervision of money transmitters.

### Structural reform priorities
- Further structural reforms are necessary to complement the macroeconomic policy mix and promote growth and stability.
- Priorities include:
  - Boost housing supply by further easing planning restrictions, mobilizing unused publicly-owned land for construction, and reforming property taxes to encourage more efficient use of the housing stock.
  - Increase investment in infrastructure.
  - Reduce distortionary tax expenditures and the debt bias in the tax code.
  - Boost skills by further expanding vocational training.
  - Raise labor force participation through increased childcare support.
  - Build on recent reforms to further enhance corporate transparency and combat financial crimes.

*Source: STAFF APPRAISAL and related text in the provided document excerpt.*

### 64.      It is recommended that the next Article IV consultation be held on the standard 12-

### _cr16168 - 64.      It is recommended that the next Article IV consultation be held on the standard 12-

### Recent macroeconomic developments
- Real GDP growth:
  - Historical and projected series shown with staff projecting growth to stabilize near the trend rate from next year in a baseline that assumes the UK remains in the EU.
  - Series: 2010–2020 plotted; headline text notes slowing of growth in H1 2016 perhaps due to referendum-related uncertainty.
- Inflation and inflation expectations:
  - CPI, end-period: 2012: 2.7; 2013: 2.0; 2014: 0.9; 2015: 0.1; 2016: 1.3; 2017: 1.9 (Table 1).
  - Implied forward CPI inflation rate, 5 years ahead on inflation-indexed bonds, assumes RPI inflation exceeds CPI inflation by 1 percentage point (figure note).
- Labor productivity and wages:
  - Output per hour worked shows weak labor productivity growth (y-o-y percent change series).
  - Private sector nominal wages, ex. bonuses: nominal wage growth remains well below pre-crisis levels (Mar-16 data point shown).
- Current account and external balances:
  - Current account balance (percent of GDP): 2015: -5.2 (Table 6, Table 1).
  - The current account has widened substantially since 2011, mainly due to lower net investment income.

### Indicators of spare capacity
- Capacity utilization:
  - Capacity Utilization (Percent, SA) series indicates utilization is back to pre-crisis levels (2007Q1–2016Q1 plotted).
- Labor market slack and underemployment:
  - Percent of part-time workers that could not find a full-time job plotted; underemployment may imply slight residual slack (Feb-16 reference).
  - Ratio of Vacancies to Unemployment (3-month centered moving average) supports tightening.
  - Unemployment rate (percent): shown falling; unemployment gap described as closed.
- Output gap and real earnings:
  - Output Gap (Percent of potential output) shown as now essentially closed based on standard models.
  - Real Earnings (Index, 2007 = 100) have risen (Feb-16).

### Housing market developments
- Mortgage lending and rates:
  - Mortgage Lending (Y-o-y percent change) series (1995Q1–2016Q1) shows net mortgage growth remains well below pre-crisis levels despite recent acceleration.
  - Interest Rates (Percent): Bank rate, Base rate tracker, 5-yr fixed, 75% LTV — mortgage rates continue to fall (Apr-16).
- Affordability and leverage:
  - Mortgage Payment/Earnings (Percent, for the average new borrower): UK and Greater London series (2016Q1).
  - Loan-to-income and loan-to-value ratios: percentage of new lending at high LTIs has started to tick back upward (2015Q4). Plotted series include LTI ≥ 4 (Single), LTI ≥ 3 (Joint), LTV 90 <= 95% (rhs), LTV ≥ 95% (rhs).
  - Price-to-Income Ratios: UK and London series (2002Q1–2015Q3) outpacing income growth, raising affordability concerns (2016Q1).
  - Real House Prices (2008:1=100) show house prices accelerated in the second half of 2015 (Mar-16).

### Fiscal developments and public finances
- Fiscal consolidation and deficits:
  - Public Sector Net Borrowing (Percent of GDP): deficit fell to about 4 percent of GDP in FY15 (figure caption).
  - 2016 Fiscal Consolidation Plan (Percent of GDP) shows net borrowing: Net borrowing (2015 Autumn Statement) vs. Net borrowing (2016 March Budget) with near-term deficits higher than previously envisaged due to weaker growth prospects.
  - Change in CAPB (Percent of GDP): March Budget vs Autumn Statement series indicate a slower pace of structural adjustments in next few years.
- Debt and projections:
  - Net Public Sector Debt (Percent of GDP): estimated to rise slightly in FY15, projected to fall steadily thereafter (figure).
  - Table 1: Public sector net debt: 2012: 78.9; 2013: 81.1; 2014: 83.4; 2015: 83.5; 2016: 82.6; 2017: 81.5.
  - Table 3: General government gross debt (Maastricht basis) and Public sector net debt series provided for 2010/11–2020/21.
- Composition of consolidation:
  - Public Sector Discretionary Consolidation Plan (Percent of average FY2010-FY2015 GDP): consolidation so far mainly driven by expenditure measures.
  - Public Sector Spending (Percent of GDP): more spending cuts are planned with some sizable cuts in some categories.

### Banking sector comparisons (UK vs EU vs US)
- Asset quality and coverage:
  - NPA-to-Total Loans (Percent): UK's nonperforming asset ratio has been cut in half relative to its post-crisis peak (2015).
  - Reserves for Loan Loss-to-NPA (Percent): UK's NPL coverage ratio is similar to that of EU banks (2015).
- Profitability and costs:
  - Efficiency Ratio (Percent): non-interest expense/income ratios for UK banks continue to rise due to conduct/restructuring costs (2015).
  - Return on Assets (Percent): profitability weighed down (2015).
- Liquidity and funding:
  - Liquid Assets/Total Assets (Percent): share of liquid assets raised relative to pre-crisis levels despite recent declines for UK banks (2015).
  - Share of Wholesale Funding in Liabilities (Percent): EU, UK, and US banks have reduced reliance on wholesale funding (2015).
- Note: Ratios are not adjusted for accounting differences across regions (GAAP vs. IFRS). UK refers to averages for HSBC, Barclays, RBS, LBG, Standard Chartered, NBS. EU and US indicators are weighted averages of listed major banks (figure note).

### Key numerical indicators and projections (selected from tables)
- Real Economy (Table 1, change in percent):
  - Real GDP: 2012: 1.2; 2013: 2.2; 2014: 2.9; 2015: 2.3; 2016: 1.9; 2017: 2.2.
  - Private final domestic demand: 2012: 2.1; 2013: 2.3; 2014: 3.4; 2015: 3.1; 2016: 2.4; 2017: 2.5.
  - Unemployment rate (in percent) 1/: 2012: 8.0; 2013: 7.6; 2014: 6.2; 2015: 5.4; 2016: 5.0; 2017: 5.0.
- Public finance (Table 1, fiscal year, percent of GDP):
  - Public sector overall balance: 2012: -6.7; 2013: -5.8; 2014: -5.0; 2015: -3.9; 2016: -2.9; 2017: -2.0.
  - Public sector cyclically adjusted primary balance (staff estimates): 2012: -3.0; 2013: -2.7; 2014: -2.8; 2015: -2.1; 2016: -1.0; 2017: -0.1.
- Balance of Payments (Table 6, percent of GDP):
  - Current account: 2012: -3.3; 2013: -4.5; 2014: -5.1; 2015: -5.2; 2016: -5.2; 2017: -5.0; 2018: -4.9; 2019: -4.6; 2020: -4.7.
  - Trade in goods: 2015: -6.8; 2016: -6.8; 2017: -7.0.
  - Exports (percent of GDP): 2015: 15.4; 2016: 15.4; 2017: 15.6.
  - Imports (percent of GDP): 2015: -22.4; 2016: -22.6; 2017: -22.8.
- Net international investment position (Table 7):
  - Net investment position (percent of GDP): 2010: -8.2; 2011: -7.5; 2012: -20.9; 2013: -14.1; 2014: -23.7; 2015: -3.5.
  - Assets and liabilities exceed 500 percent of GDP (text: gross assets and liabilities are more than 500 percent of GDP).
- Monetary and credit aggregates (Table 8):
  - Broad money (M4), end-period: 2011: 2,089.8 (billions of GBP); 2015: 2,118.8.
  - Base money, end-period: 2011: 227.1; 2015: 386.0 (billions of GBP).
  - Net lending to private sector (12-month percent change, Table 1): 2015: 2.0; 2016 projection: 3.0; 2017 projection: 4.0.

### External position, current account, and policy assessment
- Overall external assessment:
  - The external position in 2015 was assessed as weaker than implied by medium-term fundamentals and desirable policy settings.
  - External deficits reflect insufficient public and private saving rates.
  - The REER depreciation that occurred in early 2016 goes in the direction of reducing overvaluation.
  - Uncertainty about the outcome of the forthcoming referendum and its possible effects on growth, trade flows, and the labor market have created a wider range of uncertainty in assessing the external position.
- Net international investment position:
  - NIIP at end-2015: -3.5 percent of GDP (text and Table 7).
  - Staff project the official NIIP to GDP ratio would fall moderately over the medium term, but valuation effects imply significant uncertainty.
  - Assessment: NIIP and sustainability issues are not yet a concern, but fluctuations in gross positions are a source of external vulnerability.
- Current account background and assessment:
  - CA balance deteriorated from -1.7 percent of GDP in 2011 to -5.1 percent of GDP in 2014; 2015 CA: -5.2 percent of GDP.
  - Decline driven primarily by lower income balance (fall in earnings on UK’s foreign direct investment abroad).
  - From a savings-investment perspective, the CA deficit partly reflects a relatively high general government deficit (4.4 percent of GDP in 2015) and a low household saving rate (4.3 percent in 2015).
  - EBA CA regression approach estimates a CA gap of -4.2 percent of GDP for (text truncated at end of provided content).

### Potential policy responses and recommendations (as stated)
- Rebalancing growth:
  - Sustaining strong and durable growth in the UK requires rebalancing toward greater reliance on external demand (text under "Potential policy responses").
- Fiscal and saving policy:
  - The current fiscal stance and low household saving rates are cited as contributors to external deficits (text).
- Monitoring of referendum-related risks:
  - The analysis highlights referendum-related uncertainty as a risk to growth, trade flows, and labor market outcomes.

*UNITED KINGDOM — INTERNATIONAL MONETARY FUND (content as provided in the source PDF)._

### 2015. However, the post-crisis deterioration in the income balance is not expected to be all

### _cr16168 - 2015. However, the post-crisis deterioration in the income balance is not expected to be all

### External Sector Assessment — Current Account (CA) and Cyclically-Adjusted CA
- Staff assesses the 2015 cyclically-adjusted CA balance to be 1.5 to 4.5 percent of GDP weaker than the current account norm.
- The post-crisis deterioration in the income balance is not expected to be all permanent, implying a smaller underlying CA deficit and smaller CA gap than implied by the EBA model.
- The CA assessment is subject to a wider margin of uncertainty due to uncertainty about the outcome of the June 2016 referendum on EU membership and its possible effects on projected current accounts and the CA norm.

### Real exchange rate (REER)
- Background:
  - The UK’s average REER for 2015 was 15 percent more appreciated than in 2013.
  - As of April 2016, the REER had depreciated 7 percent relative to its average for 2015.
- Assessment:
  - For 2015, the EBA exchange rate assessment implied by the EBA CA regression model indicates an overvaluation of 18 percent.
  - Both EBA REER regressions estimate an overvaluation of 12 percent.
  - Staff assesses the 2015 REER as 5 to 20 percent above the level consistent with fundamentals and desirable policy settings; this assessment is informed by and consistent with the staff’s CA assessment.

### Policy measures and structural recommendations (external rebalancing)
- Consolidation plan implemented within a medium-term framework and an accommodative monetary policy stance contribute to external rebalancing.
- Further structural reforms recommended:
  - Focus on broadening the skill base.
  - Invest in public infrastructure to boost productivity and improve competitiveness.
- Macroprudential policies:
  - Ensure macroprudential policies remain sufficiently tight to maintain financial stability and support private-sector saving.

### Capital and financial accounts
- Background:
  - Given the UK’s role as an international financial center, portfolio investment and financial derivatives are the key components of the financial account.
- Assessment:
  - Large fluctuations in capital flows are inherent to financial transactions in countries with a large financial services sector.
  - This volatility is a potential source of vulnerability.

### FX intervention and reserves level
- Background:
  - The pound has the status of a global reserve currency.
- Assessment:
  - Reserves held by the UK are typically low relative to standard metrics, and the currency is free floating.

### Technical Background Notes
- Note 1/: The official NIIP data might understate the true position—attempts to value FDI at market values suggest a higher NIIP. Market value estimates of FDI assets assume that values move in line with equity market indices in the UK and abroad. These estimates are uncertain, as actual FDI market values could evolve differently from equity markets.
- Note 2/: The income balance is expected to rise somewhat as net returns on foreign investments rise as unusually low returns partially mean-revert. See the February 2016 UK Selected Issues paper for further discussion.

### Annex II — Risk Assessment Matrix (selected risks, likelihoods, impacts, and policy recommendations)
- High likelihood risk: British voters elect to leave the EU in their June 23rd referendum
  - Expected impact:
    - An exit could pose major challenges for the UK and the rest of Europe, with potential contagion.
    - In the short run, an exit could trigger an adverse market reaction, with sterling depreciating, UK asset prices falling, and borrowing costs for firms and households rising.
    - Over the medium term, heightened uncertainty could weigh on confidence and investment.
    - In the long run, economic performance would likely diminish due to increased barriers that lessen the benefits from economic integration.
  - Policy recommendations:
    - Continue to allow liquidity policies to be a backstop against market volatility.
    - The scope for macroeconomic policies to cushion a fall in economic activity will depend on assessment of supply and demand and the extent to which longer-run inflation expectations remain well-anchored.
    - Re-double efforts to secure benefits of economic cooperation and trade.

- Medium / High risk: Tighter or more volatile global financial conditions
  - Expected impact:
    - Tightened financial conditions and market discontinuity.
    - Depressed investment, consumption, and GDP growth due to increased uncertainty.
    - Sharp reduction in asset and house prices, suppressing aggregate demand.
  - Policy recommendations:
    - Continue with accommodative monetary policy—including, if necessary, rate cuts and restarting QE—to offset market volatility.
    - Allow automatic fiscal stabilizers to operate; ease fiscal path if growth slows sharply.
    - Continue to allow liquidity policies to be a backstop against market volatility.

- Low-Medium / Medium / High-Medium risk: Sharper-than-expected global growth slowdown
  - Expected impact:
    - Slowdown in GDP growth.
    - Persistently low real interest rates complicating monetary policy.
    - Widening of the current account deficit.
    - A China slowdown’s effects via trade may be limited, as China accounts for only 3½ percent of UK exports.
  - Policy recommendations:
    - Ease monetary policy to support demand, including via further use of unconventional tools if necessary.
    - Allow automatic fiscal stabilizers to operate; ease fiscal path if growth slows sharply.
    - Implement structural policies to boost investment, productivity and competitiveness.
    - Continue to allow liquidity policies to be a backstop against market volatility.

- Medium risk: Persistently lower energy prices
  - Expected impact:
    - Lower energy prices may boost disposable income and consumption, but weigh on investment in the energy sector.
    - Headline inflation may be lower for longer.
  - Policy recommendation:
    - If persistently low energy prices produce second-round effects that depress medium-term inflation expectations and core price-setting behavior, monetary policy may need to be accommodative for longer.

- High risk: Protracted period of stagnant productivity
  - Expected impact:
    - Increase in unit labor costs, causing inflation to rise faster than expected.
    - Loss of competitiveness.
    - Slowdown of GDP growth.
  - Policy recommendations:
    - Accelerate the implementation of productivity-enhancing structural reforms.
    - Tighten monetary policy if earnings increase ahead of productivity.

- Medium risk: Financial stability risks arising from the housing market
  - Expected impact:
    - Increased household leverage.
    - Rapid growth of mortgage credit.
    - Higher exposure of the financial system to the housing market.
  - Policy recommendations:
    - Tighten macroprudential policy (e.g., LTI and LTV limits).
    - Tighten parameters of Help-to-Buy by restricting the qualification criteria.

- Low risk: The current account deficit does not decline over the medium term
  - Expected impact:
    - A build-up of large external imbalances would raise risks of abrupt capital outflows that could reduce business investment and economic activity.
    - Large external imbalances also raise risks of a sharp currency depreciation that yields a burst of inflation; this risk is mitigated by the BoE’s inflation-targeting framework and well-anchored inflation expectations.
  - Policy recommendations:
    - If the current account fails to adjust, re-double efforts to boost productivity through structural reforms and raise saving via the fiscal and monetary mix (i.e., further tighten fiscal policy; this would allow looser monetary policy, thereby facilitating adjustment of sterling overvaluation and external imbalances).
    - Ensure macroprudential policies are sufficiently tight to maintain financial stability and support private sector saving.

### Annex III — Debt Sustainability Analysis (public sector debt outlook)
- Public sector gross debt stands at about 92 percent of GDP in FY15/16 and is projected to decline steadily to around 78 percent of GDP by FY21/22.
- Fiscal consolidation will need to continue in the medium term to ensure the debt ratio stays on a downward path and to rebuild buffers over time.
- All debt profile vulnerabilities are below early warning benchmarks, but the projected debt trajectory is susceptible to various shocks, especially a negative real GDP growth shock.
- Baseline and realism of projections:
  - Macroeconomic assumptions:
    - Real GDP in FY16/17 is projected to grow by 1.9 percent, supported by private domestic demand.
    - In subsequent years, growth is projected to stay around (text truncated in source).

*Source: UNITED KINGDOM — Annex I–III excerpts from IMF staff report text provided in content unit*

### 2.1 percent. Inflation is projected to gradually rise closer to 2.0 percent in the medium term.

### _cr16168 - 2.1 percent. Inflation is projected to gradually rise closer to 2.0 percent in the medium term.

### Macroeconomic projections and monetary conditions
- Inflation (GDP deflator) projections:
  - 2016: 0.3 percent
  - 2017: 1.9 percent
  - 2018: 1.6 percent
  - 2019: 1.9 percent
  - 2020: 1.9 percent
  - 2021: 2.0 percent
- Short-term interest rates:
  - Projected to start rising several years from now, gradually increasing by a total of 70 basis points by FY21/22.
- Real GDP growth (baseline):
  - 2016: 2.2 percent
  - 2017: 2.2 percent
  - 2018: 2.1 percent
  - 2019: 2.2 percent
  - 2020: 2.2 percent
  - 2021: 2.1 percent
- Effective interest rate (baseline projection):
  - 2016: 2.3 percent
  - 2017: 2.4 percent
  - 2018: 2.6 percent
  - 2019: 2.7 percent
  - 2020: 2.7 percent
  - 2021: 2.7 percent

### Fiscal adjustment and realism of baseline
- Authorities’ fiscal objective:
  - Aim to eliminate the overall budget deficit by FY19/20.
- Staff baseline primary balance path:
  - FY16/17: primary deficit of 1.0 percent of GDP
  - FY21/22: primary surplus of 2.3 percent of GDP
- Realism of assumptions and forecast errors:
  - Median forecast error for real GDP growth (FY07/08–FY15/16): -0.2 percent (actual minus projection)
  - Median forecast error for inflation (FY07/08–FY15/16): -0.4 percent
  - Median forecast error for the primary balance: -0.3 percent of GDP
  - Envisaged CAPB adjustment of about 3.5 percentage points of GDP in FY17/18–FY19/20 described as slightly ambitious but credible if output grows in line with baseline.

### Debt level, profile, and market perception
- Debt burden and benchmarks:
  - Baseline debt level exceeds DSA benchmark of 85 percent of GDP.
  - Gross financing needs estimated at around 11 percent of GDP in FY15/16, below the 20 percent of GDP benchmark.
  - Debt profile vulnerability indicators are below early warning thresholds.
- Market signals:
  - Interest rates and CDS spreads suggest markets view debt vulnerabilities as low.
- Debt composition and indicators (selected values and trajectories):
  - Nominal gross public debt: 2014: 67.3; 2015: 91.1; 2016: 91.5; 2017: 90.6; 2018: 89.2; 2019: 87.5; 2020: 84.5; 2021: 81.7 (in percent of GDP)
  - Public gross financing needs: 2014: 10.4; 2015: 11.6; 2016: 10.7; 2017: 9.7; 2018: 9.1; 2019: 8.5; 2020: 6.8; 2021: 7.6 (in percent of GDP)
  - Effective interest rate (table): 2014: 4.2; 2015: 2.3; 2016: 2.3; 2017: 2.2; 2018: 2.2; 2019: 2.4; 2020: 2.6; 2021: 2.7 (in percent)

### Stress test scenarios and outcomes
- Growth shock:
  - Assumes real output growth rates lowered by one standard deviation in FY17/18 and FY18/19.
  - Primary balance reaches a surplus of 0.4 percent of GDP in FY19/20.
  - Debt-to-GDP rises to about 93 percent of GDP by FY18/19; gross financing needs rise slightly to about 11 percent of GDP by FY18/19 and stay similar through FY21/22.
- Primary balance shock:
  - Fiscal consolidation stalls between FY16/17 and FY17/18 (no change in primary balance).
  - Debt-to-GDP reaches about 81 percent of GDP by FY21/22 (roughly 3 percentage points of GDP higher than the baseline).
  - Gross financing needs rise to around 10 percent of GDP by FY17/18.
- Interest rate shock:
  - Assumes a 215 basis points increase in interest rates from FY17/18 on.
  - Effective interest rate edges up to 3.2 percent by FY21/22 (only ½ percentage points higher than the baseline).
  - Impacts on debt and gross financing needs expected to be mild.
- Combined macro-fiscal shock:
  - Aggregates shocks to real growth, interest rate, and primary balance.
  - Debt-to-GDP reaches close to 95 percent of GDP in FY18/19 and declines only gradually to around 91 percent of GDP by FY21/22.
  - Gross financing needs would rise to 12 percent by FY21/22.
- Contingent fiscal shock (hypothetical banking crisis):
  - One-time bailout raising non-interest expenditure by 3 percent of banking sector assets in FY17/18.
  - Real GDP reduced by one standard deviation for two years.
  - Debt-to-GDP rises to 103 percent of GDP in FY18/19; gross financing needs peak at 20 percent of GDP.
- Stagnant growth and low inflation scenario:
  - Real growth slows and remains stagnant; inflation stays well below target.
  - Revenue-to-GDP ratio lower than baseline by one percentage point of GDP.
  - Debt would not be put on a clear downward path; debt ratio stays above the FY16/17 level.
  - Gross financing needs would hover around 10 percent of GDP.

### Additional stress-test inputs and assumptions
- Average maturity of government debt: about 14 years (reducing sensitivity to interest rate shocks).
- Automatic debt dynamics contributions (selected values):
  - Interest rate/growth differential contribution (cumulative): -7.9 (percent of GDP over projection horizon, table format)
  - Real interest rate contribution (cumulative): 2.7
  - Real GDP growth contribution (cumulative): -10.7
- Composition and scenarios tables indicate alternative assumptions for underlying variables across scenarios (real GDP growth, inflation, primary balance, effective interest rate) with values preserved as shown in scenario tables.

*Source: IMF staff report (United Kingdom), as presented in the provided content unit.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16168.pdf_