United Kingdom—2013 Article IV Consultation Concluding Statement of the Mission
IMF News, May 22, 2013
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- Published: May 22, 2013
Activity and outlook
- Recent indicators show improvement: purchasing indicators, demand for vehicles, and consumer and business sentiment surveys indicate an uptick in activity.
- Private sector employment growth has been notably strong.
- Per capita income remains 6 percent below its pre-crisis peak, making this the weakest recovery in recent history.
- Capital investment (as a share of GDP) is at a postwar low; youth unemployment is high.
- The most likely scenario is a prolonged period in which output is below potential (similar to the Office for Budget Responsibility).
- Risks tilted to the downside:
- Persistent slow growth could permanently damage medium-term prospects if private deleveraging is larger than expected, credit conditions fail to improve, external demand does not pick up, or the drag from fiscal consolidation is greater than anticipated.
- Weak euro-area growth and potential re-emergence of market tensions could cause spillovers via depressed exports, higher bank losses and funding costs, and reduced confidence.
Policy priorities and challenges: restoring strong and balanced growth
- Restoring growth momentum and rebalancing the economy is vital to:
- restore incomes,
- ensure sustainability of public debt,
- restore bank balance sheets,
- diversify the economy away from reliance on domestic consumption.
- Both supply- and demand-side measures are needed to raise long-term expectations of potential growth and transform the economy toward higher investment and more exports.
- A coordinated multi-pronged strategy is required given constraints: monetary policy at the zero bound, impaired bank balance sheets, and rising public debt with consolidation weighing on growth.
Monetary policy: maintain accommodative stance
- Actions taken:
- Bank of England cut policy rates, made substantial purchases of gilts, and introduced the Funding for Lending Scheme (FLS) jointly with the Treasury.
- The March 2013 Budget reaffirmed the 2 percent inflation target and permitted unconventional policies; it requested the Bank to explore thresholds to guide policy.
- The FLS was modified to encourage lending to SMEs and its term extended.
- Effectiveness and transmission:
- Transmission of accommodative policy has been weak: credit flows remain negative overall; some retail rates for unsecured lending remain higher than pre-crisis.
- Funding rates, lending spreads, and surveys suggest both supply and demand factors are limiting credit flows.
- Recommendations:
- Monetary policy should remain accommodative for an extended period given the persistent output gap.
- Consider further gilt purchases and provide assurance that policy rates will be kept low until recovery reaches full momentum.
- Enhance monetary effectiveness through complementary measures: strengthen bank health, and adopt fiscal and structural measures to boost long-term income expectations.
Financial policy: resolve the uncertainty over banks
- Current position:
- Financial sector repair has advanced: funding is more assured and regulatory capital ratios continue to edge up.
- Non-performing assets remain elevated at some major banks; underlying profitability is weak.
- Concerns include lender forbearance, under-provisioning for risky assets and conduct costs, and aggressive use of risk-weights.
- Actions needed to restore lending:
- Following the Asset Quality Review, the PRA is identifying capital shortfalls to meet an equity capital ratio of at least 7 percent (on a fully-loaded Basel III basis) by end-2013, plus any additional bank-specific requirements.
- Banks should build capital (new equity issuance), reduce dividend payouts, restrain remuneration, and restructure balance sheets without reducing net lending.
- The planned 2014 system-wide stress test should cover a broad range of risks, use sufficiently stringent scenarios, and be anchored in supervisor-approved capital plans; transparency on methodology, results, and bank-by-bank capital plans is important.
- Strategy for government-intervened banks:
- RBS and LBG together account for two-fifths of the stock of UK net private sector lending.
- A clear strategy is needed to return these banks to private ownership in a way that maximizes taxpayer value, strengthens confidence and competition, and minimizes spillovers.
- If a sovereign backstop is required to meet a capital shortfall, it should be provided, as this would have a high multiplier.
Fiscal policy: bring forward growth initiatives while preserving the fiscal framework
- Fiscal track record and outlook:
- The government set out discretionary deficit reduction measures of about £130 billion from FY 2010/11 to FY 2015/16; more than half of those measures have been implemented.
- The government has shown flexibility: slowed structural consolidation, allowed automatic stabilizers to operate, and public sector net debt is forecast to fall in 2017-18 (two years later than the Supplementary Debt Target).
- Several growth-supportive measures have been introduced, including increases in personal tax allowances and reductions to corporate tax rates; guarantees have been used to provide support.
- Near-term headwinds:
- Discretionary measures for this fiscal year amount to £10 billion, posing headwinds to growth amid domestic deleveraging and weak external demand.
- Policy trade-offs and recommendations:
- Balance debt sustainability with growth: further consolidation risks permanent loss to productive capacity, but lack of consolidation risks debt accumulation.
- Capitalize on nascent momentum to bolster growth through measures that address supply constraints and provide near-term support.
- In the current context (underutilized labor and cheap funding), net returns from growth-enhancing measures are likely favorable.
- Growth-enhancing initiatives to consider within the medium-term framework:
- Bring forward planned capital investment where possible to catalyze private investment; use well-designed public guarantees to facilitate private investment.
- Modify the composition of consolidation to boost growth, e.g., reduce marginal effective corporate tax rates and introduce tax allowances for raising equity; offset medium-term budgetary impact by reforming property taxes and considering broadening the VAT base.
- The 2013 Budget’s Help To Buy scheme may temporarily boost housing-market confidence but risks raising house prices absent supply response; mitigate by considering fiscal disincentives for holding land without development.
- Credibility:
- Government investment in supply-side measures will enhance, not damage, credibility given the UK’s commitment to medium-term consolidation, the Office for Budget Responsibility’s credibility, and long-duration debt.
Structural policies: the essential pillar for long-term rebalancing and prosperity
- Structural reforms recommended (drawing on LSE Growth Commission, Heseltine Review, and government initiatives):
- Provide retraining, including vocational training, for low-skilled workers to transition to high value-added, high-wage work; reform immigration policy to improve skills and competitiveness.
- Invest in infrastructure (transport and energy) by streamlining planning processes and removing regulatory uncertainty; devolve more planning authority to local authorities and provide financial incentives via greater revenue sharing.
- Reduce concentration in the banking sector to better serve firms and households and expand funding options for start-ups and smaller enterprises.
Financial regulation: clarity and consistency
- Transition to the “twin peaks” regulatory and supervisory structure has been well managed, but:
- Ensure greater coordination between the Financial Policy Committee (FPC) and the Prudential Regulation Authority (PRA), especially around the 2014 stress tests, to reduce regulatory uncertainty.
- Ensure the PRA’s operational independence and adequate resourcing for intrusive supervision of globally-systemic institutions to minimize adverse spillovers.
- Toolkit and international coordination:
- Expand the FPC’s toolkit, including powers to limit loan-to-value and loan-to-income ratios, as higher capital requirements alone may be insufficient to restrain property bubbles.
- Internalize cross-border spillover effects when applying macroprudential tools to enhance resilience of globally-active banks.
- Coordinate structural banking reforms internationally and address gaps: the efficacy of ring-fencing relies in part on progress toward robust cross-border supervisory and bank resolution frameworks and attention to regulatory arbitrage and migration of activity to shadow banks and non-banks.
United Kingdom—2013 Article IV Consultation Concluding Statement of the Mission (May 22, 2013).