Transcript of the Updates to the World Economic Outlook/Global Stability Report/Fiscal Monitor Press Briefing

January 24, 2012

With Olivier Blanchard, IMF Economic Counsellor and Director of Research Department
José Viñals, our Financial Counselor and Director of the Monetary and Capital Markets Department
Carlo Cottarelli, Director of our Fiscal Affairs Department
Jorg Decressin, Deputy Director, IMF Research Department
Phil Gerson, Deputy Director in the Fiscal Affairs Department
Chris Walker, Deputy Division Chief in the Monetary and Capital Markets Department
Tuesday, 24 January 2012
Washington DC
Webcast of the press briefing Webcast

MS. BHATT: Good morning, everyone, and good day to those of you online. I'm Gita Bhatt with the IMF's External Relations. Welcome to this press conference on the release of our update of the World Economic Outlook, the Global Financial Stability Report and the Fiscal Monitor. These are the IMF's principal economic surveillance documents. This is a live briefing. We are as has become usual in our briefings also connected online and invite journalists who are watching on our webcast to submit questions through our Online Media Briefing Center.

If I may introduce the panel, to my right is Jörg Decressin, Deputy Director of the Research Department; Olivier Blanchard, our Economic Counselor and the Director of the Research Department; José Viñals, our Financial Counselor and Director of the Monetary and Capital Markets Department; Chris Walker, Deputy Division Chief in the Monetary and Capital Markets Department; Carlo Cottarelli, Director of our Fiscal Affairs Department; and Phil Gerson who is a Deputy Director in the Fiscal Affairs Department.

We will have some brief opening remarks from Carlo, José and Olivier, after which we will open the floor to questions. Carlo?

MR. COTTARELLI: Thank you very much, Gita. This update of the Fiscal Monitor has three main messages. The first message is that fiscal adjustment is proceeding at a fairly good pace in both advanced and emerging economies. The second message looking ahead is that fiscal adjustment should continue, but should continue at the right pace because both too little adjustment and too much adjustment will be bad for growth. Both extremes are bad for growth, and in this issue of the Fiscal Monitor, we are discussing in particular the risk of excessive fiscal tightening or over tightening within the context of weaker economic growth. The third message is that the countries that are under pressure will therefore have to go ahead with strong fiscal adjustment, this would be necessary but a strategy that is based only on fiscal tightening will not be optimal. There is a need to complement fiscal adjustment with structural reforms, to boost potential growth and to boost competitiveness and productivity. There is also the need of the availability of sufficiently strong resources to support the adjustment process and facilitate the decline in interest rates.

Allow me to elaborate a bit on these three points. Fiscal adjustment is proceeding. The deficit in both advanced and emerging economies declined last year by about 1 percentage point of GDP. This year we are not projecting a major further decline in the deficit in emerging economies, but it definitely is far less than half of the deficit in advanced economies. For advanced economies, in the absence of action, the decline in the deficit will be about 1-1/4 percentage points of GDP which is pretty sizable particularly in the context of a decelerating economic activity. It will be difficult to manage it.

This brings me to my second point. The pace of fiscal adjustment must be just right. Too little fiscal adjustment is not good because it will raise concerns about the credibility of fiscal policy and will lead to an increase in interest rates which would be bad for growth. Too much adjustment however would also be bad for growth because there will not be enough demand for goods and services in the economy. So you really need to strike the right balance between these two extremes. We have been saying this for a while.

In this issue from the Fiscal Monitor we have discovered more than in the past there is a risk of over tightening of fiscal policy in the context of a deceleration of economic activity—we see this as the most concrete risk. This risk exists on both sides of the Atlantic. In the United States in the absence of supportive action, the fiscal deficit will decline this year by over 2 percentage points of GDP, which would be the largest decline in a single year in about four decades. We think some action is needed to support economic activity and allow for a more gradual deceleration, a more gradual decline in the deficit. Political agreement is also needed on a medium-term fiscal adjustment plan that will first stabilize and then bring down the debt-to-GDP ratio. In Europe we see the need for countries with sufficient fiscal space to slow down the pace of adjustment to support economic activity. Of course if there were additional shocks to growth, countries with fiscal space should let the automatic stabilizers operate and of course the case for slowing the pace of adjustment will be stronger in countries with fiscal space.

This brings me to my third point. Some countries do not have much fiscal space and will have to go ahead with strong, relatively frontloaded fiscal adjustment. These are countries that borrow at fairly high rates and these are countries where public debt is already high. These countries will have to tighten fiscal policy more rapidly than others and they are tightening fiscal policy more rapidly than others. For example we are projecting for Italy and Spain an improvement in the cyclically adjusted primary balance this year respectively of more than 3 percentage points for Italy and about 2-1/2 percentage points for Spain. These are large adjustments and these are necessary adjustments. But as I mentioned, a strategy that will center only on fiscal adjustment will not be optimal. The reason is that although markets are worried about high deficits, they also get worried when they see not enough growth in the economy. So there is a need to complement the fiscal adjustment in these countries with two things. First of all, structural reforms to boost potential growth, to boost competitiveness and productivity and this is already happening. The second thing that is needed is the availability of strong financing to support strong firewalls to support the decline in interest rates as fiscal adjustment is implemented. This will be good for the fiscal accounts of course, but will also be good for growth and for the credibility of the overall strategy. So I'll stop at this point.

MR. VIŃALS: Thank you and good morning to all of you. What I want to do is present the changes in the outlook for global financial stability since our September Global Financial Stability Report. I will start by saying that risks have deepened since then, notably in the Euro Area as I will detail in a minute. But over the past few weeks markets have been encouraged by measures to provide liquidity to European banks and sovereigns. But I would like to warn that this recent improvement should not be taken for granted as some sovereign debt markets remain under stress and as bank funding markets are on life support from the European Central Bank.

I will first describe the main risks and then the policy recommendations that we have in the report. Many of the root causes of the euro area crisis still need to be addressed before the system is stabilized and returns to health, and until this is done, global financial stability is likely to remain well within the danger zone where a misstep or failure to address underlying tensions could precipitate a global crisis with grave economic and social consequences.

Let me now say something about the main risks in the sovereign markets and on the banking side. As regards sovereigns, despite recent improvements, sovereign financing stress has increased for many countries compared to 3 months ago, with almost two-thirds of outstanding euro area bonds trading at spreads in excess of 150 basis points and financing prospects are challenging. Markets remain very volatile and long-term foreign investors have sharply reduced their exposure to a number of euro area debt markets including some in the core. As you can imagine, keeping these investors involved is essential to stabilizing markets. As regards banks, deleveraging by European banks may ignite an adverse feedback loop to euro area economies and beyond, even if acute pressures have been mitigated by recent extraordinary measures by the European Central Bank. Like cholesterol, deleveraging can be good and can be bad. European banks have had excessive levels of leverage and had expanded in a number of noncore areas before the crisis. So increasing bank capital levels, shedding bad loans and withdrawing from noncore business should be encouraged. But there is also the danger that deleveraging could be too fast, overly concentrated in some areas, and that it could cut off credit at the expense of the economy.

All these risks will not be restricted to the euro area but could spill over beyond it. Among emerging economies, emerging Europe would be most affected regarding these potential problems in the euro area in deleveraging and this reflects the substantial presence of euro area banks in these countries. Nor is the United States immune to spillover risks given the close transatlantic financial and trade linkages. A large shock from the euro area could be magnified by existing weaknesses, notably in the still fragile U.S. housing market.

Let me now turn to detailing what are the policy priorities. I think that with these risks, policymakers need to press ahead and bolster plans to restore financial stability in the Euro Area and beyond and, thus, urgent policy action is needed on several fronts.

First in the euro area, the firewall needs to be sufficiently large and convincingly built to avoid abnormally high funding costs for sovereigns and banks. To do this it will be important to strengthen in advance work on the European Stability Mechanism, the ESM, as soon as possible. Action by the European Central Bank to provide the necessary liquidity support to continue stabilizing bank funding and sovereign debt markets will also be essential. Beyond the euro area at the international level, the IMF aims to raise up to $500 billion in additional lending resources to create a global firewall which would further help not only regain confidence in the euro area but also address potential spillovers.

Second, a macroprudential gatekeeper is needed to ensure that bank deleveraging plans are consistent with sustaining the flow of credit to support economic activity and to avoid a downward spiral in asset prices. The potentially harmful effects of deleveraging should be addressed at both the national and at the international levels and in the European Union. Such a role should be coordinated by the European banking authorities.

Third, a credit increase in banks' capital buffers remains necessary to restore market confidence. Banks should increase their capital levels, and not just their capital ratios, in line with recent European banking authority recommendations.

Fourth, for those solvent and otherwise viable banks that cannot raise sufficient private capital, public funds should be made available based on strict conditionality. And to limit the additional burden on some sovereigns, a pan-euro area facility should have the capacity to take direct stakes on banks.

Fifth, adjustment remains essential, but the short-term impact on growth should be taken into account. The solvency of sovereigns must be assured, and as Carlo mentioned, governments have to implement credible medium-term fiscal consolidation strategies and I would add within a solid euro area framework. And over the long-term, initiatives to strengthen fiscal and financial union will be crucial to restoring market confidence. In the United States and in Japan, they also need to address fiscal challenges as was discussed, but in the United States they need to do more because they still must solve the problems of the housing market and of the mortgage debt overhang.

Last, policymakers in emerging markets should stand ready to counter funding and credit strains and to deploy countercyclical policies where headroom is available. For example, emerging markets in many cases have built ample cushions of reserves that could be used to counter external liquidity shocks.

Let me conclude. The global financial system remains fragile and this makes it urgent to restore confidence in the euro area and beyond. Otherwise we run the risk of a deepening of the crisis, with far-reaching global economic and social consequences. Fortunately it is not too late to put into place the right policies that take us out of the danger zone, but for this we need good politics and the collective determination to reach now a cooperative solution both within Europe and at the global level. Thank you.

MR. BLANCHARD: Thank you, Gita. Good morning to all of you. After the speech by our Managing Director in Berlin yesterday and building on the earlier two presentations by Carlo and José, my main messages will not surprise you.

Let me start with the bad news. The world recovery, which was weak in the first place, is in danger of stalling. The epicenter of the danger is Europe, but the rest of the world is increasingly affected. There is an even greater danger, namely that the European crisis intensifies. In this case, the world could be plunged into another recession. This was the bad news. Let me turn to the good news. With the right set of measures, the worst can definitely be avoided and the recovery can be put back on track. These measures can be taken, need to be taken and need to be taken urgently.

With this as the introduction, let me now go into the numbers starting at the epicenter. Our forecast for growth in the Euro Area for 2012 is -0.5 percent, a decrease of 1.6 percentage points relative to our September 2012 forecast. In particular, we predict growth of –2.2 percent for Italy, and –1.7 percent for Spain. We have also revised downward our forecast for other advanced economies, although by less. The only place where our forecast is the same as it was in September is the United States with 1.8 percent--a mix of good and bad news more or less cancelling each other. Turning to emerging and developing economies, our forecast is also down at 5.4 percent, a decrease of 0.7 percentage points relative to our September forecast. If you look, the revision is particularly sharp in Central and Eastern Europe, reflecting their links with the Euro Area. But it is substantial in a number of other countries, for example, China and India, although this is much for internal reasons than the exposure to what is happening in Europe.

Having given you the numbers, the next question is what are the forces which hide behind these numbers.

I would start by saying that most advanced economies are operating with two major brakes on. The first, which was discussed in the presentation of the Fiscal Monitor by Carlo, is fiscal consolidation. Consolidation is necessary, debt levels are very high, but in the short-run it is a drag on demand, it is a drag on growth and that explains some of the revisions that I have talked about. The second brake, which was discussed in the presentation of the GFSR by José, is tight credit. In many countries especially in Europe, banks are still weak and as a result they are deleveraging. In many cases, not all as José discussed, deleveraging means tighter credit to households or firms and that's another drag on growth. With those two brakes on, the recovery cannot be very strong and, indeed, if you look at past financial crises, this is something that you see in the past where recovery is slow. But what has happened in Europe over the past year and what will continue to happen at least for a while is making things worse.

What is going on? You have doubts about fiscal sustainability which are leading to high yields on sovereign bonds and in turn doubts about bank solvency. To reassure markets, governments have felt that they had to consolidate further. To reassure investors, banks have deleveraged and tightened credit. But both actions have further decreased growth, leading to a very dangerous downward spiral. This is what explains our forecast of negative growth for some of the Euro periphery countries and slow growth for the rest of the Euro Area.

Looking beyond Europe, spillovers through trade are already visible among Euro trade partners. And if I now turn to emerging and developing markets, bouts of risk aversion and uncertainty are leading to high volatility of capital flows to those countries and this is likely to remain.

If this downward spiral is not contained, then it can lead to much a worse outcome, be it disorderly default or Euro exit, with major spillovers first to the rest of the Euro Area, and then to the rest of the world. This is the diagnosis. Let me turn to policies.

I think in this context, the required policies are very clear. Here I shall largely repeat the main messages from the speech by the Managing Director yesterday. Three points, and again I shall repeat some of the things that Carlo and José have insisted upon. First, fiscal consolidation must proceed, but at an appropriate pace. Decreasing debt is a marathon and not a sprint. Going too fast will kill growth and further derail the recovery. It is useful to remember that it took more than two decades to successfully decrease debt from its World War II levels. We should expect that it will take as long in this case or longer.

What is of the essence is not so much the speed now but the existence of a credible medium-term plan, something which is still missing in the United States and in Japan. Once such a plan is in place, in most countries there is some room, automatic stabilizers should be left to play. In some countries, as Carlo said, slower consolidation—if growth really slows down—may even be feasible and appropriate.

Second, a credit crunch must be avoided. Where banks need to increase their capital ratios, they should do it, as José said, through an increase in capital rather than a decrease in credit. Recapitalization through public funds will help credit, sustain activity and may actually improve the fiscal outlook.

Third, to the extent that they are taking the tough measures they need to take, European periphery countries such as Italy or Spain must be able to borrow at low interest rates. As many investors have left the market and are unlikely to return anytime soon, public liquidity provision may be needed. It can be provided in various ways, by the ECB, by the European Union and by the IMF. Whichever combination is used, the available funds must be large enough to maintain low interest rates and fiscal sustainability.

To conclude, you may ask what our forecasts are based on. They are based on the assumption that the measures that I've talked about will be adopted and that the Euro crisis will slowly decrease in intensity. If these measures are not adopted, then one can fear the worst. If they are adopted decisively, then the world economy may actually perform better than our forecasts.

One should be under no illusion however: The brakes will still be on and unemployment will decrease slowly at best. We have a long way to go before the world economy has fully recovered. Thank you.

MS. BHATT: Thank you, and on that note let’s open the floor for questions.

QUESTIONER: The €500 billion that the E.U. has in its bailout fund including a 130 billion package for Greece, is that enough to solve the crisis in your view?

MR. VIŃALS: The short answer is in our view no. I think that it is very important as we have emphasized that there are sufficiently solid firewalls, and that means having sufficient resources and we think that going beyond this €500 billion would be very important, but also having a large degree of flexibility to use that money. This is why I have explicitly mentioned that it will be important that there are instruments available at the euro area level to be able to take direct stakes in banks, instead of the money going through a program or through the national government. You should be able to have some direct participation in banks, bonds, equities, so that you can better break the link between national sovereign risk and national bank risk.

QUESTIONER: My question is for Mr. Blanchard. Sir, I was struck by your comparison of the current debt situation with the debts after the Second World War. Are the current debts in your opinion the debts of the Cold War or the indulgence after the Cold War or something else? The question I came here with beforehand was a week ago the World Bank gave us their own projections. The difference in figures is sometimes significant including for my own country. Whom should we believe and why?

MR. BLANCHARD: The answer to the second question is you should believe us. On your first question, the levels of debt that we have are due in large part to the crisis, as we know, and in part to not the best behavior before the crisis; not the financing of war. Looking forward, you should look at how debt was decreased after World War II. It was a combination of primary surpluses, high growth and low interest rates. I think the ingredient that is potentially missing in this case, and that will make it harder, is the high growth. That's why we have insisted on the need for structural reforms. It is very much a cliché to ask Europe to do structural reforms, but I think in the current context, anything that can increase the potential growth rate of Europe is really of the essence not only for itself but to get debt under control and to decrease it over time.

QUESTIONER: The bank recapitalization debate was going on for a lot of last year and through much of that the IMF was pushing on the Europeans to proceed with bank recapitalization. Now you seem to be saying that it's causing problems. I guess my question is, did the Fund make a mistake in pushing them into this or did they make a mistake in the sort of pacing of the design of the program itself?

MR. VIŃALS: I don't think the Fund made a mistake. I think that the price of having banks with the capital levels that they had would have been running the risk of having many banks getting into trouble down the road. Deleveraging would have happened with banks having insufficient capital because they would not have been able to get the funding, or they would not have had the muscle which is needed to provide credit to the economy. The important thing is to increase the solidity of banks and to do so through a number of actions. One very important one is to increase capital levels. You increase the ratio, but you increase the capital level so that you have the ability to provide more credit. So that's why it is fundamental to increase capital ratios but to do it the right way which is mostly by increasing capital levels. And that's what we said at the time, and that's what we continue to say, because only a strong banking system can support the economy. What we don’t want is that credit drops or that increasing the capital ratio goes through decreases in credit, and this is why we think it is very important to follow the guidelines provided by the European Banking Authority.

Now beyond that, there are other actions that need to be taken in a number of cases beyond recapitalization, which is to restructure certain banks and to resolve institutions that need to be resolved and this action still needs to be taken. So I will talk of the three “Rs:” Recapitalize, but recapitalize well; restructure; and resolve.

QUESTIONER: Can you explain what you mean on page 7 of the WEO when you talk about the bailout mechanism when you say, “By adding substantial real resources to what is currently available, folding the EFSF into the ESM and increasing the size of the ESM would help greatly?” It seems to me you’re saying boost the size of the current ESM -- so that’s €500 billion plus -- and fold in the €300 billion on that of that. Secondly, in your September report you said, “The Italian debt to GDP could rise by 20 percentage points for every 1 percentage point from deviation from your forecast.” Does that mean we expect a 40 percentage point increase in their debt-to-GDP ratio? And finally, Greece increasingly looks like it’s heading to default. What’s the likely consequence if it does? And I just would preempt any non-answer on that because of hypothetical reasons by saying your entire report is hypothetical. Thank you.

MR. BLANCHARD: Good. I think there were three questions. I’ll take the first one to the extent that I understood it. I think this is a discussion, which is taking place in Europe, which is: will the resources of the EFSF be added to the ESM or will the overall constraint be €500 billion? As you know at this stage, the decision was to cap it at €500 billion and it is now, I think, something that they are reconsidering. The second question I think I’ll leave to Jorg.

MR. DECRESSIN: On your second questions, we don’t see a 40 percentage point increase in debt, if I understood you correctly, or with the revision that we have which is on the order of 3/4 percentage point for the world or 1.5 percent in the euro area. There’s no question you will have some increase in the debt ratio relative to our original projections, but it will be limited.

MR. BLANCHARD: And then I can take the question on Greece. I think it’s important to understand what problems Greece is facing. It’s facing two problems. The first one is a public debt problem, and the second is a competitiveness problem. In order to get out of the hole, it has to solve both problems, and at this stage I think everybody’s working hard on making sure it happens. The current discussion about private sector involvement (PSI) is about trying to resolve the debt problem and reduce debt to an acceptable level, a level that Greece can actually sustain. As you know, the goal here is to achieve PSI, a level of debt to GDP of 120 percent, which is already very high, in 2020. And we think that the PSI negotiation should achieve that. If this is so, that’s only half of what needs to be solved. The other is competitiveness, and here it is clear that what is needed is a set of structural reforms as well as moderate or limited wage growth. And realistically this is going to take a long time, which implies that there will be a need for funding by official creditors for quite some time.

What we are working on at this point is making sure that the first happens and making sure that the second happens as well in the sense of making sure that the Greeks are willing to take on the structural reforms they need to take and that the Europeans, as they have indicated, they are willing to front Greece for as long as it takes as long as Greece does the structural adjustment. That’s where we are. That’s the plan. Thank you.

QUESTIONER: But what would be the consequences of a Greek default? So I understand what the problem is; I’m asking you to forecast, given your worst-case scenario forecast in the WEO, what is the forecast for a Greek default?

MR. BLANCHARD: I think that that’s where the discussion about funds comes in, which is that we have to make sure that if there was a disorderly default in any country, Greece or any other, contagion would be limited and other countries would be able to adjust to it. That’s part of what we’re thinking about when we say that funds are needed.

QUESTIONER: You’ve pointed out that your euro area scenario from a year ago, your downside scenario, has proven true. Given where we are now, what conditions do you think will lead to the downside scenario again proving true? It seems like a lot of the same conditions are in place in terms of the bad deleveraging and the severe fiscal austerity that we’ve seen over the past year.

MR. BLANCHARD: Again, we thought a year ago that there was a way out, and I think it’s still there. It’s still that the countries where fiscal sustainability was in doubt take the measures such that the doubts are largely eliminated, so this is the case for Italy and Spain. That’s part of what is needed, and then after this, making sure that they can then borrow at an interest rate which allows them to achieve the sustainability. I think that if these two conditions are met, and we’re getting closer to it I think, then we will avoid the worst and the recovery will be back on track.

MR. VINALS: Let me just add something to what Olivier said, which is that we have been calling for quite some time for the European authorities collectively to put in place a comprehensive plan to stabilize the situation once and for all. And what we have had in the past few months have been very important steps towards that comprehensive plan. And as the Managing Director recognized in her Berlin speech yesterday, these are important pieces, but we still need to complete the process in order to have a clear picture. And in order to restore confidence, markets need to have a very clear picture of what is the roadmap and what are the actions that are taken and to have the certainty that these actions are going to be taken very soon. So I think that this comprehensive strategy is still needed. It needs to be completed. This is now in place, but we need to finish the job. And the danger is that the more you wait, the longer it takes before the job is fully finished, that things may deteriorate. So the more you wait, the worse it may get. So it is in the interest of the euro area and of the world to put in place urgently -- and I would like to underscore the word “urgently” that we have used -- put in place the comprehensive strategy that stabilizes market expectations and makes confidence come back to the euro area. That’s what we need for the good of the euro area and for the good of the world.

MS. BHATT: I want to take a question online and then I’ll get back to the floor. The question is: “Since projections to eurozone are worse, does the IMF consider a revision of fiscal goals in countries such as Portugal?” Carlo, do you want to take that?

MR. COTTARELLI: As I said at the beginning, I distinguished between countries that have fiscal space in their forecast and can slow down of the pace of adjustment, and countries that are under pressure from markets, that have to borrow at high interest rates, and their fiscal accounts are weaker. So I don’t want to comment specifically about the one specific country, but I think one has to clearly draw a difference between some countries that can afford slowing down the pace of fiscal adjustment and other countries that are under pressure and cannot. At the same time, even for these countries, I want to underscore it is important not to forget the growth objective. But in those countries the growth objective needs to be pursued through structural reforms that boost competitiveness, productivity, and growth.

QUESTIONER: I’d like to go to Italy, as has been mentioned many times, is the epicenter at this moment and what Mr. Cottarelli was saying about the need of implementing other measures than fiscal adjustment. Based on the measures that have been approved and that are on the verge of being implemented by the government, whether IMF assessed the situation in Italy and what would be the need specifically, if you can articulate what other measures compared to the one that has just already been approved to bring back good interest? Thanks.

MR. COTTARELLI: Italy needs essentially three things. The first one is fiscal adjustment, and it’s happening at a fairly good pace as I mentioned earlier. We project the cyclically-adjusted primary balance, which is the balance net of interest payments adjusted for the cycle, to improve by more than 3 percentage points of GDP this year, and this is a very large adjustment. In addition to this, as you know, Italy has put in place reforms that affect long-term spending growth. Over the next 20 years, Italy will have a decline in the spending for pensions over GDP, while most other advanced countries are going to have an increase in the spending to GDP ratio. Of course, Italy was starting from a level of spending that was fairly high, so there was a need to reform the pension system.

The second thing that Italy needs, and this is happening, is structural reforms to boost productivity, competitiveness, and potential growth. This is also happening. As you know, the Italian government has already identified some steps to liberalize the economy. Further steps are coming or announced for the next few days.

The third thing that is needed -- and this goes beyond what Italy can do on its own-- and this has been mentioned by both Jose and Olivier -- is a need for the availability of stronger firewalls in Europe, stronger financing, because this will facilitate greatly the decline in interest rates. And again, which will be good for the fiscal accounts, and it will also be good for the economy.

QUESTIONER: Do you think that the Greek debt is sustainable with a 50 percent haircut and the rate that the IMF offered to the Greek government? And also can you in your view tell us your opinion, I mean IMF’s opinion, on the Greek private labor market? Thank you.

MR. BLANCHARD: Well, we’re not going to comment on the ongoing negotiations, but we’ve made clear that we think that the level of debt, the ratio of debt to GDP, cannot be more than 120 percent in 2020 on the realistic macro assumptions, macro and fiscal assumptions. That’s what the PSI has to achieve. How it does it is not for us to decide. And I think the other part of your question speaks to structural reforms, reforms of the labor market. They have to happen. Greece clearly has to grow more than it has in order to solve its problems.

QUESTIONER: My question is on the PSI again because I have some statements of the IMF executives some months ago saying that a Greek restructure, a restructure of the Greek debt, is not necessary and it’s something that should be avoided. What has changed in the meantime in the private sector to take up these issues and to implement this restructure? Thank you.

MR. VINALS: Let me just mention something. What the IMF has been saying is that in order to come to a solution in Greece, you need several pieces to be put on the table. One is to come to a reasonable agreement between the private sector and Greece regarding debt, and this is the negotiation that we have now and which is not yet concluded. So we need to wait until the end of these negotiations. So this is the private sector involvement. The second piece is that you have to have an adequate degree of official sector involvement in terms of the external public financing that comes into place. And the third is the macroeconomic adjustment of Greece, as Olivier was saying. Implementation in all dimensions is absolutely key -- financial, fiscal, structural reforms. And these are the key pieces, and this is what the IMF has been saying all along -- three months ago, one month ago, and at present.

QUESTIONER: If you could put the U.S. economic forecast into the context of all of this. You briefly mentioned some good things and bad things were offsetting each other. But given that there appears to have been a little bit of a strengthening in the U.S. economy in the last three months of last year, how is the U.S. going to be affected by sort of the dire pronouncements that you have made for the larger global economy? Thank you.

MR. DECRESSIN: We’ve recently seen better figures for consumption than we had expected as households have drawn down their savings. We hope to see a somewhat stronger investment. And we expect that this is going to provide some lift to the economy which will, however, be offset by the increased uncertainty in financial markets on account of the developments in Europe and also by the more subdued global demand on account of developments in Europe. So overall we left our forecasts unchanged for 2012.

QUESTIONER: I was just wondering, can you elaborate more clearly about the orderly deleveraging you expect which will not hurt markets in the future? Thank you.

MR. VINALS: As I mentioned before, the question is which type of deleveraging you’re having. And basically there are two ways of deleveraging. And I’m thinking of bank deleveraging where what you have is an amount of capital in the bank and an amount of assets, and the amount of leverage is capital vis-à-vis the total assets of the bank. And there are two ways of doing it. One is by shrinking assets. And if this shrinkage of assets takes the place of reducing credit to the economy in a way where you live without funding worthy borrowers, that’s bad for the economy and that’s going to have a negative impact on growth and you want to avoid that. The other way, of having deleveraging proceed in an orderly manner and in a good way, is to increase capital levels of banks so that they can afford to provide lending to good and worthy borrowers, and that’s what you need to keep the economy growing. That’s the sense in which I think you have to understand the good deleveraging.

MS. BHATT: I’ll just take one question from the Media Briefing Center. “ Spain’s deficit is the worst among the big economies in Europe. What else should Spain do to improve it? What do you think about the recent tax increases? Is it the way or does Spain need more spending adjustments?”

MR. GERSON: On Spain, I think it’s important to distinguish two factors that are pushing the deficit up this year, and I distinguish between them because I think the policy response needs to distinguish as well. One factor that’s pushing up deficits this year is the slippage from 2011 which was on the order of about 2 percentage points of GDP, the underperformance on the deficit target last year.

The second factor that’s pushing up deficits this year is the significant slowdown in growth, which is operating through the automatic stabilizers to put upward pressure on the deficit.

The policy response, again, differs depending on the source of it. We think there’s room to accommodate the increase in the deficit if it comes from slower growth, but not to accommodate the amount that comes from the slippage. So the goal would be to implement measures that would offset the deterioration that comes from the slippage in 2011, but to tolerate some change in the deficit target for 2012 as a result of the slower growth. What that means is there would be room to increase the deficit target for 2012 while still involving significant structural adjustment in 2012 relative to 2011, although obviously this is an issue that would need to be discussed with the European partners. The government has already taken some measures in December to offset some of the slippage from 2011 and there’d be a need for additional measures as well, again while allowing some slippage in the deficit target in 2012 because of the impact of slower growth.

QUESTIONER: Just to follow up on the question of deficit, you stepped up your message about short term, reducing deficits not too fast in the short term. Do you feel like you’re diverging with what’s happening in Europe, the whole push and the German influence on reducing faster and the whole discussion on tighter fiscal rules? And my second question is about the ECB. You mentioned the ECB a lot in this report and what it is expected to do as part of the firewall. You do mention continuing buying bonds. Do you think the ECB should continue buying sovereign bonds even when the ESM is in play?

MR. COTTARELLI: I’ll take the first part of the question. You refer to stronger fiscal rules, stronger fiscal frameworks. I think those are extremely important over the medium term. This is something that is, as you know, the fiscal compact, a stronger fiscal compact, will implement. The point I was making that like in any other good fiscal rules, there should be some flexibility towards cyclical developments and that was the point we were making. We are talking about the shorter term response to an economic shock, to a slowdown of economic growth. But it’s clear that the overall fiscal framework must be strong. You also mentioned the importance of accommodating some slowdown in economic activity in the context of a strong medium-term framework, which could be embedded in strong fiscal rules.

MR. VINALS: On the issue of the ECB, let me just mention that the ECB decisions have been absolutely vital for the euro area in the last few months, both in terms of stepping up their purchases of sovereign debt in the secondary market and also in terms of providing liquidity to banks. So I think that the decisions by the European Central Bank have been fundamental to avoid unpleasant accidents which could have caused a lot of trouble. Now once the ESM is in place, what should the European Central Bank do? Well, let’s wait for the ESM in terms of what it is, what it can do, and how large it is, because if the European mechanism comes into being in a way which provides in the eyes of markets a sufficiently solid large firewall, then there would be a very significant reduction in my view in spreads in sovereign markets, and that would make it less necessary for the ECB to support these markets. But we need to wait for the definition of what it is finally that the ESM will do and how large would be the amount of potential money that it will have at its disposal. So far the ECB has been fulfilling a range of demands, and then depending on what the ESM does then it may have to do the same or less or more than it’s done. But let’s hope that the ESM will be sufficiently stabilizing regarding market expectations to lower the need for the ECB to be present in markets.

QUESTIONER: I’d like to know your views on monetary and fiscal policy in emerging markets. And in September, your recommendation was just a wait-and-see approach and some countries like Brazil were going down this road and cutting rates. What about now? What to do now for emerging markets?

MR. BLANCHARD: I think it’s more or less the same advice, and it has to be tailored to each emerging market economy. I mean some of them may want to actually have expansionary policies. Some of them should not. I think the main challenge is going to be how to deal with the uncertainty which is going to come from Europe. And, again, these are very volatile capital markets. So I think there is not one size fits all in this case. There has to be -- in each country they have to adapt to whether internal demand is slowing or not, and then they have to be ready to change tack if the world is more unstable.

MR. VINALS: Maybe just one point to add. In some countries, you would rather rely on more fiscal accommodation in order to absorb the shocks from abroad, and in others through more monetary accommodation. And I’m thinking here of some countries in Asia where more fiscal accommodation would be more appropriate because there has already been a big credit stimulus given to these economies. This would not only help these economies themselves, it would also help global demand rebalancing.

QUESTIONER: My question is Japan’s fiscal consolidation. Japan’s economy intends to increase their consumption tax from 5 percent to 10 percent in years ahead. And you mentioned in the Fiscal Monitor “This will not bring the debt ratio down.” So my question is do you support this intention to raise the consumption tax or should they raise the consumption tax more noticeably? I want to know, what is your recommendation on fiscal consolidation, especially the pace? And do you see any risk that Japanese government bond yield would be capped in near future? Thank you.

MR. GERSON: Thanks very much. We do mention in the Fiscal Monitor that the Japanese authorities do intend to raise the rate on the consumption tax from 5 percent to 10 percent over time, but that this won’t be sufficient to bring the debt ratio down overtime. Our view on Japan is that the -- well, the authorities have a plan for the debt ratio. We think they need to be much more ambitious, and in particular that they need to aim to start bringing the debt ratio down by the middle of this decade rather than by the end of this decade.

In terms of how to do that, there are a number of things they can do. We would lean towards being more aggressive in increasing the rate of the consumption tax, in particular going not from 5 to 10 percent, but from 5 percent overtime to 15 percent. And one of the reasons we favor the consumption tax as a way to strengthen the fiscal accounts is that it tends to be non-distortive. It’s a good tax. And so that’s one of the reasons why we encourage the authorities to look at a faster increase in the consumption tax.

That doesn’t mean that that’s the only move that should be considered. The authorities are considering changes to the pension system as well. And I think all advanced and many emerging market economies need to look at changes to their pension system and to their health care financing systems over time.

To get to the last part of your question, it’s clear that Japan continues to be able to borrow money and access its financial markets at extremely low rates. So we don’t see any risk of this situation deteriorating in the near term. Still, I think if you look at what’s happened in Europe, it’s a cautionary tale for some countries like the U.S. and Japan, as we mentioned in the September Fiscal Monitor, that the benefits of being able to access money at extremely low rates shouldn’t be considered to be some sort of permanent situation and that these countries do -- the U.S. and Japan in particular -- need to look at medium-term plans to reduce their debt ratios and to get their fiscal accounts back under control.

MR. WALKER: I just wanted to add a bit to Phil’s points about the funding situation, the yields at which the Japanese government can borrow. I think this consumption tax issue is now seen in Japan in the bond market as being an important determinant not of JGB yields over the short term, but in the years to come bond traders are looking at how this is resolved as a sign as to where bond yields are likely to go.

This is also -- the fiscal issue in Japan is also an important financial stability issue given that Japanese banks are major holders of Japanese government bonds. And certainly the continuation of yields at roughly the levels where they are right now is going to be very important for the condition of banks.

And just one other point on this issue which is timely, I think, is the publication of the trade data for Japan for last year, 2011. Japan has run a trade deficit for the first time in many years. And this is also another sign that people are looking for in the bond market as a possible warning sign about the government’s ability to continue to fund itself at the low interest rates now on JGBs.

QUESTIONER: Is the IMF more confident with the new government in Spain, that the adjustments that you’re asking for are going to be accomplished, or does it not make any difference between this government and the government we had a couple of months ago?

MR. BLANCHARD: The only answer I can give you is that it’s clear that the government is committed to trying to do what it needs to do, and so far all the signals are good ones.

MS. BHATT: Thank you, everyone, for joining us and thank you to Olivier, Jose, and Carlo, and the teams from the Research Department, Monetary and Capital Markets Department, and Fiscal Affairs Department.

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