IMF Survey: Eurozone: Carrying Out Agreed Policies Can Help Restore Confidence

IMF News, October 14, 2012

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IMF Survey: Eurozone: Carrying Out Agreed Policies Can Help Restore Confidence

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• Published: October 14, 2012

Europe-wide assessment and immediate challenges

• Europe remains a focus of efforts to restore confidence and revive the global economic recovery; the IMF forecasts that real GDP in the euro area will decline in 2012.
• European policymakers have taken unprecedented actions, including creation and strengthening of a firewall through the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), and measures to strengthen fiscal discipline such as the Fiscal Compact.
• The European Central Bank (ECB) actions cited:
  • provided substantial liquidity to banks,
  • intervened through Securities Markets Program (SMP) purchases,
  • announced policies for Outright Monetary Transactions (OMT), described as potentially a "game-changer."
• Remaining issues:
  • Borrowing costs remain high in some areas.
  • Further adjustment is necessary.
  • The damaging link between banks and sovereigns has not yet been severed.
• Key implementation needs:
  • Further implementation at both the country and euro area levels is required, against a backdrop of weak growth and challenges in sustaining political support across the euro area.

IMF-supported programs: country cases and program effects

• General approach:
  • Programs are country-specific, outlining paths back to economic health while providing financing to cushion adjustment.
  • IMF financial expertise has been applied to banking sector cleanups and program design.

• Ireland:
  • Actions taken: drew a line under banking sector problems, unwound competitiveness loss from the boom, seen modest growth, begun work to reduce large deficits from the downturn and banking cleanup costs, started to address debt distress of some households and SMEs.
  • Outcomes/signals: Much lower borrowing spreads and new bond issuance (albeit limited) signal progress.
  • Recommendation: Further support, aligned with euro area leaders’ statements on improving program sustainability, could help lock in gains.

• Portugal:
  • Performance: strong performance under its program; undertook a successful bond exchange which helped smooth its maturity profile.
  • Progress: improvements in long-standing competitiveness challenges; primary fiscal balance on an improving path.
  • Risks/needs: more is needed on competitiveness and fiscal fronts; economic weakness complicates fiscal task.
  • Political context: broad political backing for the program is important but not guaranteed.

• Greece:
  • Challenges: array of fiscal, competitiveness, and banking issues plus high initial debt level.
  • Progress: substantial improvement over past few years in Greece’s primary fiscal balance, labor costs, and current account balance.
  • Remaining issues: debt still very high; further improvements in competitiveness and fiscal adjustment needed.
  • IMF engagement: Greece team will continue to work with authorities to chart a course toward stability and renewed confidence.

• Spain:
  • Situation: serious challenges following credit and housing booms.
  • Government actions: assessing banking sector needs and addressing weaknesses with a backstop in place; identifying further fiscal measures to strengthen the primary balance and reduce overall deficit; undertaking reforms, including to the labor market, to boost competitiveness and reduce unemployment.
  • Guidance: Financial Sector Assessment Program (FSAP) by the Fund provided useful guidance.
  • Policy stance: some calibration of fiscal adjustment pace may be appropriate; direction on financial sector, fiscal, and growth-enhancing structural policies is clear.
  • Key: implementation is critical; government determination is encouraging though a long road lies ahead.

Balance between consolidation and growth

• Core view: fiscal adjustment is needed, but the critical issue is getting the pace of consolidation right; circumstances differ by country.
• IMF approach: continuous dialogue with countries and partners; country-by-country calibration depending on growth pace, market pressures, debt levels, and the broader package of monetary and structural measures.
• Tone: pragmatic, emphasizing tailoring of policies to country conditions.

Banking union: design, rationale, and recommended elements

• Rationale:
  • Free financial flows across EU borders while keeping bank responsibility national made it harder to spot/address brewing trouble and intensified crisis effects.
  • Governments absorbed banking cleanup costs while higher government debt and funding costs spilled over into higher bank funding costs.
  • Creating a banking union is described as the logical conclusion to needing a more integrated prudential approach for deeply interconnected banking systems.

• Recommended elements of a banking union:
  • A strong single supervisory mechanism, such as the ECB, cooperating with national supervisors.
  • An effective single resolution mechanism with powers to close or restructure banks and intervene well ahead of insolvency.
  • Support from common backstops.
  • A pan-euro area deposit insurance scheme.
  • Broad coverage of European banks, with possible initial focus on banks posing systemic risk or needing near-term recapitalization.

• Expected benefits:
  • Break the sovereign-bank linkages.
  • Bring uniformly high standards of supervision and enforcement.
  • Reverse financial fragmentation to improve monetary policy transmission across the euro area.

Outright Monetary Transactions (OMT) framework

• Market impact:
  • Announcement of the ECB’s OMT framework had a substantial positive effect on market conditions, bringing spreads down for pressured countries.
• Rationale and conditions:
  • OMT can reverse financial fragmentation and remove doubts about the monetary union by allowing ECB intervention in secondary bond markets of countries that have market access and demonstrate strong policy commitment and implementation.
  • Strong emphasis on policy implementation creates incentives for confidence-enhancing actions.
  • OMT purchases not having seniority compared to private investors is key to helping countries sustain market access.
• Further steps:
  • Elaborating how OMT might cement a return to markets for countries implementing economic programs (example countries: Ireland and Portugal) would be helpful.
  • Use of OMT could involve the IMF; the IMF stands ready to cooperate within its frameworks.

Central and Eastern Europe: performance, risks, and policy priorities

• Recent performance:
  • Growth in 2010 and 2011 was around 4¾ percent, rebounding from the deep 2009 crisis.
  • Rebound drivers: strong adjustment efforts and relatively flexible economies; reduction of dangerously high current account deficits; reallocation across sectors (construction shrunk, manufacturing gained).
  • Market perceptions: risk premia for the region have narrowed; for some (Estonia and Poland), risk premia now lower than those of France.

• Spillovers and near-term outlook:
  • In second half of 2011 and 2012, eurozone crisis spillovers: eurozone banks withdrew funds from Central and Eastern Europe; exports hit when eurozone slipped into recession.
  • Forecast: “we expect weaker but still positive growth this year and next of around 3 percent.”
  • Intra-regional differences: Poland, Turkey, Russia and the Baltic countries holding up relatively well; most countries in Southeastern Europe experiencing very low or negative growth.

• Vulnerabilities and downside risks:
  • Residual vulnerabilities from the 2008–09 crisis and preceding boom: sizable non-performing loans, increased public debt, pervasive foreign-currency lending.
  • Central and Eastern Europe could face formidable challenges if the eurozone crisis is not resolved; significant downside risk to projections.

• Policy recommendations:
  • Push ahead with reducing vulnerabilities (non-performing loans, public debt, foreign-currency lending).
  • Monitor financial sectors closely in cooperation with authorities in home countries of cross-border banking groups.
  • Continue IMF bilateral work and multilateral engagement (in the context of the “Vienna Initiative”).
  • Eurozone policymakers are expected to contain and resolve the crisis given important spillovers.

IMF’s role in Europe and core functions

• Continued roles:
  • Surveillance of economic policies for all member countries.
  • Program support for countries undertaking adjustment efforts.
  • Provision of technical assistance to help build government capacity.
• Value-add:
  • The Fund brings expertise, cross-country experience, and an independent perspective to assist countries in designing sound economic policies and delivering stability and growth.

IMF Survey interview with Reza Moghadam, Director of the IMF’s European Department — October 14, 2012.

References

• https://www.imf.org/en/News/country-focus
• PRESS CENTER
• IMF Country Focus
• IMF Survey Interview
• Europe and the IMF
• Europe: act to revive growth
• Post-crisis roadmap
• Uncertainty hits growth
• Annual Meetings website
• Global outlook deteriorates
• Rising risks fuel instability
• Vigilance on public finances
• IMF Survey
• Reza Moghadam
• Ireland
• Portugal
• Greece
• Spain
• FSAP
• withdrawing funds
• weaker but still positive
• Vienna Initiative
• surveillance of economic policies
• https://www.imf.org/en/home