Transcript

Singapore, September 14, 2006

Participants:
Raghuram Rajan
Economic Counsellor and Director of the Research Department
Charles Collyns
Deputy Director, Research Department
Timothy Callen
Chief, World Economic Studies Division
Graham Hacche
Deputy Director, External Relations Department

MR. HACCHE: Good morning, and welcome to this press briefing on the IMF's latest report on the World Economic Outlook. My name is Graham Hacche. I am Deputy Director of the IMF's External Relations Department. To my right, to answer your questions, are Mr. Rajan, the IMF's Economic Counsellor and Director of our Research Department; Mr. Collyns, Deputy Director of the Research Department; and Mr. Callen, who is Chief of the World Economic Studies Division also in the Research Department.

Before turning to your questions, Mr. Rajan has some opening remarks. These will be made available to you in hard copy at the conclusion of the briefing.

Raghuram Rajan

MR. RAJAN: Good morning. Let me start by thanking our hosts in this beautiful city for the excellent arrangements and the hospitality we have experienced. Also, I should note that I have been told to smile more often. Now, since my natural disposition is to be serious, I might seem a little schizophrenic, but this in a sense accords well with the state of the outlook, which is fairly strong growth projected surrounded by important risks, especially for the downside. So, let me start by saying that this is really the fourth year of very strong global growth and growth which has been maintained in the face of headwinds such as strong commodity prices. Our central forecast, nevertheless, is of 5.1 percent growth in 2006, which is up from our forecast in the spring, and this slows mildly to 4.9 percent in 2007. The good news in addition to this is that growth is becoming more balanced even if the U.S. economy is beginning to slow, the euro area has gained momentum, Japan's expansion continues, and emerging markets and developing countries are delivering very impressive growth rates.

Now, this strong central forecast is surrounded by more uncertainty than usual, with risks tilted to the downside. The key short-term risks are, first, a sharper than projected slowdown in the U.S., coupled with some uncertainty about the extent to which the rest of the world's growth is autonomous of the United States'; second, a further increase in global inflationary pressures stemming from tight labor and commodities markets that could induce central banks to tighten more than currently envisaged, which might alter the currently benign conditions in financial markets; and third, an abrupt unwinding of global imbalances. These risks, of course, are not unrelated.

The key medium-term risk-these were short-term risks I was talking about-is that we are doing too little to support worldwide growth and productivity that accounts for the robust health of the world economy. Let me summarize quickly how we see the major regions, starting with the United States. The forecasted housing slowdown is well and truly here, with house price appreciation close to zero by most metrics. Indeed, rising inventories of unsold houses suggest things will get worse before they get better. The rapidly slowing housing construction suggests the supply side is also responding appropriately. Importantly, the slowdown in housing is yet to translate into significantly lower consumption. Proxies for consumption, with the notable exception of auto sales, are holding up thus far. Now, one reason for this may be that labor income is growing robustly. This, along with lower gasoline prices, may be buffering the effect of the slowing housing market on consumption. Also, we may be experiencing the usual lags from interest rates to housing activity, and from housing activity to consumption. It is therefore appropriate that the Fed has paused to study the incoming date, but pausing too long carries its own risks. Tight labor markets, especially at the high end, rising wages, and falling productivity all imply that unit labor costs are increasing. Coupled with pipeline pressures from past increases in commodity prices and limited slack elsewhere in the world, it is clear that even as the economy slows, inflationary pressures are rising. If these become entrenched in expectations, the Fed will have to raise interest rates even higher and for longer. So, the Fed may soon be on the horns of a dilemma and monetary policy will need to be skillfully managed if the economy is not to be gored.

Overall, we project growth of 3.4 percent for the U.S. this year and 2.9 percent next. In the euro area, growth in the recent quarter has finally matched survey indicators. Investment, rather than net exports, is now the main driver of recovery, but consumption will have to pick up especially if the U.S. economy slows sharply. Unfortunately, employment and wage growth are still lagging, which is likely to constrain growth prospects in the short term. Over the medium term, Europe needs to improve its growth potential through further structural reforms. Greater labor market flexibility and greater competition in the services sector, including in finance, are key. Some progress has been made, but more is needed, especially because of the rapidly aging population. Europe's leaders need to find the will to take on vested interests in both labor and in the corporate sector at the same time. This necessary but difficult domestic battle is constantly postponed until after the next election but, as you know, the next election never comes. We project growth of 2.4 percent this year before slowing modestly to 2 percent in 2006.

Despite mixed incoming data, the Japanese economy looks likely to grow at 2.7 percent this year, moderating to 2 percent next year. Consumption is still lagging, but business is on a solid growth path with investment by small firms picking up. We expect this to translate into faster job growth and private consumption going forward. Japan has taught Asia the art of extraordinarily rapid development. Japan is again entering uncharted territory as it learns to cope with rapid population aging, and we hope it will again map a path that others can follow. Its strategy must include fiscal rectitude, greater workforce participation by women and the elderly, some immigration and, above all, greater productivity growth. Improvements in service sector productivity which have been trending downwards will be essential, and a key step will be to open services to foreign and domestic competition so that these sectors have the impetus to become more productive, much as manufacturing did. This is also relevant for the newly industrializing economies such as Korea.

Turning to emerging markets, overall growth has remained very strong and short-term prospects are good. Emerging Asia has once again been the world's most dynamic region in early 2006, driven by buoyant China and India. For China, we project growth of 10 percent for both this year and next. The economy remains heavily reliant on fixed asset investment, however, with excess liquidity contributing to the problem. Ultimately, in the market economy that China is rapidly becoming, administrative methods to curb investment are only temporary fixes, akin to using band aids to staunch a gaping wound. As the Fund has been saying for sometime, the best means of control in a market economy is to alter incentives via prices. But when a number of prices, including the exchange rate and interest rates, are not set by the market, altering any one price may have a limited effect in the desired direction. Moving all prices steadily to market levels may cause pain, but it is ultimately the only way to go and it is best to do it when growth is strong.

Expansion is more domestic demand-led in India. While the authorities should be commended for seeking to spread the benefits of growth, experience suggests this is best done by expanding opportunity through improvements in education, healthcare, finance, and infrastructure, and by adopting clear and stable rules for business rather than offering often misdirected subsidies, guarantees, and tax sops that a stretched budget can ill-afford. Growth in emerging Europe is still very robust, typically fueled by large external borrowings by the private sector and rapid growth of bank credit. Vigilance is in order to ensure that countries do not become vulnerable to a possible deterioration in global financing conditions. In Latin America, growth has picked up in 2006, but it remains modest compared to other developing regions. Macroeconomic management has been largely commendable in a supportive global environment, and it is important to ensure it continues to be so if the environment deteriorates. Improving the capabilities of the wider population, even while removing barriers to competition, have to be key to improving long-run growth.

For oil producers in the Middle East, Africa, and the CIS, the challenge is to manage currency inflows carefully, spending on oil-related capacity even while improving the economy's ability to diversify into new areas. For metal producers, including those in Sub-Saharan Africa, caution is warranted in undertaking hard to reverse long term public expenditure commitments, given that prices are unlikely to persist at current levels into the medium term.

I have talked thus far about short-term risks. Given this is my last WEO press conference, let me dwell a little on medium-term risks. In my view, global productivity growth fostered in part by the revolution in information technology, but also in part by the rationalization of production through the creation of global supply chains, has played a critical role in the current expansion. It will be key going forward to address problems like poverty and aging. Unfortunately, we are doing too little to sustain it. In fact, strong political forces are gathering, strengthened by rising inequality to combat the influence of technology and global competition, and far too many politicians are pandering to the discontents. The collapse of the Doha Round, the rising tide of economic nationalism coming in the way of cross-border mergers, the strengthening resistance to immigration, all these are signals pointing in the same direction. In the name of national advantage, and attitude of me, my, mine, politicians are once again ensuring collective disadvantage. The solution for the responsible politician is not to preach liberalism but to understand those who fear being left behind and to find ways to allow them to share in the prosperity. Often, good policy does not produce immediate and widespread growth, and political leadership is needed to communicate this. The strong world economy we enjoy today is because policies to enhance competition, economic sustainability, and flexibility were implemented in the past. For the good times to continue today and to continue into the future, today's leaders should refocus from spending the dividend to reinvesting for the future.

(from left to right) Mr. Callen, Mr. Collyns, Mr. Rajan, and Mr. Hacche

QUESTIONER: Two questions. First, how self-sustaining really is the economy, the global economy outside the United States, or as the U.S. slows, are we going to see a leveraged slowdown through China, through Japan, and so on, and has that process only just begun? Secondly, I think you said it is possible that we are not doing enough to maintain growth. You obviously did not mean through fiscal or monetary stimulus, so what did you mean by that?

MR. RAJAN: First, is the rest of the world autonomous? I think my intuition is that it is more autonomous at this juncture, partly because domestic demand is picking up around the world. The question is looking at those components of domestic demand, to the extent that some of it is investment, how much of that investment is driven by investment for exports, which would slow down considerably if the U.S., one of the largest importers in the world, slows down. So, that is to my mind the biggest question. Consumption is picking up around the world, Japan to some extent, to a very small extent in Europe, but also in a number of emerging markets it is picking up. So, that leads me to believe that there is strength there.

On the issue of what else, I think the issue is really twofold. One is structural reforms to improve flexibility and to improve efficiency in the economy. I mean, there is immense need for this around the world clearly in many emerging markets, but also in Japan and the euro area, and to some extent even in the United States. But, apart from that, we also should not create barriers to the good things that have happened so far, which is increasing barriers to trade, increasing barriers to capital flows, and it is that second part which I fear more at this point which, in a sense, also the increasing openness, increasing competition has been beneficial in increasing structural reforms as countries improve their economies in order to compete, once you put these barriers that reduces the incentive to improve your economies which would add to the lack of progress.

QUESTIONER: In today's report you talk about the unwinding of global economic imbalances and how it is less likely to be disorderly. And the language seems to be less dire than April's report, and I am wondering if you could explain what has changed between now and then?

MR. RAJAN: Well, I would not read the language as being less dire. I would not say that is our intent. The language may be different and perhaps the reading is unintentionally different. Our sense is this is, as it was before, a risk. The risk of a more abrupt unwinding is not, in our view, a very high probability event, but it is a very costly event if it occurs. We think the primary forces to narrow the imbalances have to be through the private sector, including through a movement in exchange rates. But the public sector should not get in the way of that adjustment, which is why it is important that countries do what is necessary. Our suggestions on that front are well-known, that countries do what is necessary to get out of the way or to support the private sector-led adjustment which will take place. So, that continues to be our statement and we continue to be worried that we are not doing enough.

Some developments have take be place; it is not completely neutral since. We started talking about imbalances a few years ago, countries for one do recognize that this is an important problem and countries have taken steps in order to further progress on this. The U.S., for example, is projecting a more rapid reduction in its fiscal deficit at this point. China has increased the flexibility of its exchange rate, and there have been structural reforms in Europe and Japan. The issue is, is this enough, and our sense is no, we need more.

QUESTIONER: How serious is the breakdown in the Doha Round talks and what does the Fund think should be done now in order to put the talks back on track?

MR. RAJAN: Well, let me put it this way. I think there could not be a more serious event, even though the markets took the breakdown in their stride, in fact stock markets by and large went up the next day after the collapse was announced, but it seems to me for the medium-term health of the world economy we need continuous improvement on the trade front and, therefore, the breakdown of the Doha Round is clearly a problem. What is needed going forward is certainly compromise on all sides. For one, we do not think that countries that have put a proposal on the table should withdraw it; in fact, they should seek to improve on their proposal, and to recognize that, you know, in order to favor a small, relatively small group in a number of countries, they are hurting the majority. I think we should see the consequences and, as I said, the consequences are not merely for trade; they are also for domestic reforms, because the impetus for domestic reforms will be far more muted if in fact we have a setback to global trade.

QUESTIONER: I have a couple of questions on the Italian economy. You say that in order to get the 2.8 percent of targeted reduction of deficit, it is necessary to implement structural fiscal reforms covering key expenditure areas. The question is: the 30 billion that the government has targeted at this moment can that be considered enough to achieve this target? The second question is on taxation on capital gains. The government has just announced that it will raise tax rates on capital gains and withholding tax on Treasury bonds at 20 percent. Do you think that this kind of measure could raise fiscal revenues or that there is a risk of an outflight of capital flows toward other European countries?

MR. RAJAN: Let me ask my colleague, Mr. Callen.

MR. CALLEN: Let me take the second part of the question first. I think what we said in the WEO is that we believe fiscal adjustment in Italy should very much focus on the expenditure side of the budget. Tax rates are already very high in Italy and we do not see that there is much scope for raising revenue further there. So, expenditure reforms are very important, focusing on public administration, healthcare, pensions. More broadly, clearly Italy faces a very difficult fiscal situation, with public debt over a hundred percent of GDP. The corrective package that has been put in place so far we think will only have a marginal impact on the deficit this year. Nevertheless, it is certainly true that short-term fiscal prospects have brightened somewhat, because revenue has been quite buoyant, so there a chance of overperformance relative to this year's budget if the expenditure side can be held, but clearly achieving the target for next year of 2.8 percent of GDP is going to be a big challenge for the government.

QUESTIONER: On Latin America, in the report you say that there has been an increase in political uncertainty and populism, and I wonder if you could expand on that, what you mean by populism, what countries are you talking about. On Bolivia and Ecuador, you are quite critical of their recent measures against multinationals in the energy sector. Of course, they say it is right to do so and to gain more income from the high oil prices. Why are they wrong?

MR. RAJAN: Let me take a first crack at an answer and then turn it over to Mr. Collyns. On populism, there are moves across the continent and I think they reflect, to some extent, the high inequality on the continent and the desire to participate in the fruits of progress, which they clearly see that some sections of society are gaining. Growth in Latin America has been reasonable, not as strong as Asia but reasonable. But it is also unequally spread. Clearly there is a desire for access to this, access to more education, access to better healthcare, access to finance across the board, and that is finding its voice in the more populist movements.

Now, my sense is a retreat to the old populism will probably be in the wrong direction for Latin America, that there is a need to respond to this demand for sharing the fruits of prosperity, but it has to be done in a way that increases opportunity all around rather than takes from one to give to the other. In this regard, talking about the investment climate, in the best of worlds it would be good to set a clear investment climate for companies, including energy companies. These are companies making investments for the long run. They want some predictability in revenues. So, it is quite important to make sure that the taxation system, even if it is a taxation system that fluctuates with the price of oil, that it be clear and well understood so that they can make investments in a predictable atmosphere. The danger of altering the terms of the contract down the line, and this applies to every country, including advanced countries, the dangers of altering the terms of the contract is you make the investment climate more uncertain and therefore people more reluctant to invest. At this point, looking at the oil companies, you say they are making windfall profits, that is wonderful, we should tax them, but remember they were also making very poor profits when the price of oil was very low and one has to think about taxation over the entire cycle rather than at the peak. That is really why we would suggest more certainty.

MR. COLLYNS: I think you have covered the ground pretty well. Let me just expand on one aspect of your response on fiscal policy. We see Latin America has been making very good progress over the last 4-5 years toward strengthening its fiscal situation, particularly in 2003-04, move towards sustaining high primary surpluses based on expenditure control. However, more recently, as we have highlighted in the WEO, we see a pick-up in public spending growth and we see that as a concern. At this time, that increase in spending growth can be financed with buoyant revenues, but as the global environment becomes less benign and less favorable to Latin America, there are maybe more challenges for fiscal policy to maintain the necessary primary surpluses and continue to reduce public debt. What we would prefer to see would be efforts to target public spending more at social priorities and infrastructural needs. Work done recently shows that targeted social programs can be very effective at helping to alleviate poverty and to raise the opportunities for the poorest segments of society. It is much less effective, however, to provide overall subsidies and price controls, which a number of countries are doing. What we would like to see is much more vigorous action to reform public spending across Latin America to provide more effective ways of meeting social needs.

QUESTIONER: I have a question about Mexico. Mexico will have a new government next December and the question is, how does Mexico need to fast grow in the future?

MR. RAJAN: What does Mexico need to grow fast. I think one of the messages from the election, given how close it was, is that certainly the new government has to be inclusive in its policies to try and draw in and speak to the voices of the other side. As Mr. Collyns said, this does mean, to some extent, more targeted programs, certainly Mexico has shown the way with some of its programs on how social expenditures can be targeted, and more of that would be in order. Also, I think more generally Mexico needs to move up the value chain in its production and, therefore, this implies tremendous investment in education, in improving human capital. Clearly, that will be an important facet as it moves up the value chain in production. So, I think focusing on expanding opportunities again in education, healthcare, finance, these are the things that the government needs to focus on while, of course, maintaining the appropriate macroeconomic management, some of which it has shown. Certainly, there is some need for reforms on the fiscal side, on pensions and so on, but also there is a need to expand opportunity.

QUESTONER: This question is in reference to India. You talked about how the government can ill-afford to offer tax sops and subsidies. One of the policies that is being aggressively pursued in the country is that of special economic zones, where investment is being encouraged by offering mostly tax sops. Do you think that policy is not in the best interest of the country given the amount of tax revenue the government loses because of that?

MR. RAJAN: I think special economic zones are a good idea to the extent that you can move faster on creating infrastructure, you create infrastructure clusters, you create clearer-if you can sort of change the regulations there, labor laws for example, there was some talk initially when these were set up that you might allow experimentation of labor laws state by state. I think all those are good things and therefore the special economic zones may be appropriate for those reasons, less red tape, faster infrastructure and so on. The concern is if you focus on tax incentives to set up these special economic zones, the incentives diminish and you hurt the revenues of the government. Overall, it becomes yet another give-away which the government cannot afford. Far better to make people compete on the basis of the quality of the infrastructure they create in the special economic zone and the kind of rules and regulations that they set up in order to attract capital than have them attracting capital because the tax laws are more beneficial. This may also divert a lot of activity from the rest of the economy into these zones, which creates problems of inequitable regional development, also something that the Reserve Bank has focused on. So, I think these are concerns that deserve to be taken up. Clearly, when you have economic zones of the size of ten hectares being set up, it is not clear that all these benefits of infrastructure, regulation, and so on, can in fact be implemented in those ten hectares. It seems more like tax sops are the only reason for them. So I would think those are reasons why we should think about this very carefully.

QUESTIONER: Mr. Rajan, how do you see the situation and further development risk for Germany?

MR. RAJAN: Well, I think at this point Germany is on a roll. I think exports are doing very well, investment is picking up. What still remains is consumption. To some extent, the export comparativeness has been gained by wage compression in some sense, not letting wages grow as fast as productivity, and so on. The concern going forward for Germany really is the need for structural reforms which improve the growth potential of the economy. Amongst these structural reforms, first, for example, Hartz IV has been implemented, but to make Hartz IV work better so as to give more people incentives, especially in the longer run, to reduce long-run unemployment, give more people incentives to work than currently exists in Germany. Also, reduce the tax burden on businesses, reduce the payroll tax and spread the burden more widely in the economy. In this sense, the VAT is a step in the right direction.

The other reforms so as to make businesses better able to compete not just in the manufacturing sector which is doing quite well but also in the service sector. For example professional, you know, sort of professional qualifications, the professional fees that are set essentially, those kinds of things, reducing the barriers to doing business, especially in the service sector, I think that would be important for Germany's continued growth.

QUESTIONER (through interpretation): I would like to ask my question in French, please. I am from West Africa and I come from a fairly poor country, Burkina Faso. It is a cotton-producing country and, therefore, its export earnings are constantly declining. It is also a country, like other countries in the region, that is suffering from rising oil prices and therefore they are somewhat strangled at this point in time. So, what do you see as the outlook for Burkina Faso and other in West Africa?

(from left to right) Mr. Callen, Mr. Collyns, and Mr. Rajan

MR. RAJAN: Well, I think the current environment of rising oil prices and falling commodity prices in some areas, as you said, such as cotton, is certain a very difficult one. Organizations like the Fund and the World Bank are ready to help. But the issue really on the cotton side is how do you get more remunerative prices and that certainly implies reducing subsidies, both export and domestic, in developed countries so that farmers can get a better price. It also means down the line of moving to more value-added production, not just producing the cotton but also perhaps the textiles and eventually the clothing. How to create a business environment for that, I think the World Bank, the IFC, with its tremendously influential business climate reporting, the Doing Business report, suggests that Africa is making progress here, but I think more needs to be done, including creating infrastructure which can take the exports from Africa to the rest the world. So, I think these are important steps which could help countries like Burkina Faso go on the right path.

QUESTIONER: I would like to ask you a question related to Vietnam. In the report you said that Vietnam could be a newly emerging market. Why do you say so, and are the Vietnamese prepared to join the WTO this year? What is the prediction about Vietnam's economy next year, and what does Vietnam need to grow faster?

MR. RAJAN: Well, let me offer a line and then turn it over to my colleagues. Certainly, Vietnam is considered by many to be the "Emerging China." I do not know if you consider that a compliment, but I think it is one. Vietnam is doing a number of the things that China did and is progressing faster at relatively strong rates of growth. So, in that sense, I think there is a part which is chalked out. The issue is to do it better. Let me turn it over to Mr. Collyns.

MR. COLLYNS: As you say, Mr. Rajan, Vietnam is doing very well, it is growing fast. As one can see, Vietnam is quite rapidly attaining the status of an emerging market country. Of course, there are a number of issues facing Vietnam. Inflation is picking up, given the strong growth. There are a number of structural issues. As you say, there are good prospects now for Vietnam to gain entry to the WTO, but this then raises the issues as the economy opens up, for example, reforms in state-owned enterprises will need to be speeded up and also there are issues in state-owned commercial banks which will be exposed to global competition. So, we see Vietnam's prospects as being very favorable, but as it increasingly integrates into the global economy, it will need to make sure that all sectors of the economy are fully ready to meet the additional competition.

QUESTIONER: I have a couple of questions. The first one is you say that pausing for too long carries risks for the Federal Reserve. I wonder if you could elaborate on that. You say that the window of opportunity for the Federal Reserve is going to close pretty soon. The second question relating to the Spanish economy is you have cut the forecast for 2007 but at the same time you have increased the inflation forecast and the current account deficit. I was wondering if you could explain why is that and if it is a signal that the Spanish economy is losing competitiveness with its other European area economies?

MR. RAJAN: First, on the pause, the notion there is, I mean this is an environment of a fair amount of uncertainty. We do have inflationary pressures building, unit labor costs are going up, of course to some extent offset by the fall in energy prices that will feed through into inflation at some point and bring down inflation. The question is are people going to start forming higher inflationary expectations. The point right now is it is much harder, given the environment, to bring down inflation than it was in the past. The amount that you have to raise interest rates to bring down inflation by a certain amount is higher now than it was in the past, for a variety of reasons. So, in that sense, if you wait, which I think is necessary, to see how demand is progressing, how the housing market is cooling, you may give the opportunity for inflationary expectations to become more entrenched. Then it becomes harder to bring them down. So, it is sort of a very delicate situation for the Fed, watching both at the same time and knowing when to move rather than waiting too late.

MR. CALLEN: It is certainly true that growth in Spain has become increasingly lopsided, with domestic demand growing very strongly, the current account widening sharply. Indeed, in dollar terms, I believe it is now the second highest in the world, and inflation above the euro area average. So, against that background, we are concerned about the poor productivity and competitiveness losses rooted in market rigidities, and the government is trying to address these through its structural reform program, but we think accelerated implementation of that program is needed to address these competitiveness losses going on.

QUESTIONER: In your opinion, Mr. Rajan, how really dangerous is the housing situation in United States in terms of consumption and growth, etc.?

MR. RAJAN: It is a good question, how dangerous is the housing situation in the United States. Thus far, I mean it has been about a year since the housing market has started slowing. Consumption is still growing quite strong. The question is, is consumption sort of unrelated? I think that is not true; consumption will be related. The question is, what are the lags. So, it may be that people sort of face up to the fall in their house when they actually want to move or when they refinance, or when the interest rates go up. So, that may take time to filter through. This is what I was talking about in terms of lags. There might be lags from housing to consumption. Of course, there could be a story in the other direction, which is, yes, the wealth will perhaps fall, but incomes are growing stronger because of strong job growth and because of higher wages. The question is, is that enough to offset. If it is, then does that raise a question about whether the Fed has to raise interest rates higher to cool down activity. So, it is a fairly complex situation.

QUESTIONER: Some economists are talking about growing income inequality in the U.S. as a result in part of real wages not keeping up with the increase in productivity. I would like to know if you see this as a potential for social conflict in the years to come, and also if you could comment about the fact that so many million people do not have health insurance here.

MR. RAJAN: Here, meaning the United States, okay. Let me start with the growing inequality. I am not an expert on the numbers. It depends on who you talk to about whether they think inequality is increasing or not. Certainly, you know, there are issues about whether the pensions and other forms of health benefits, when they add it up, whether you do find that the total compensation package is becoming more unequal. I think it would be difficult to ignore the evidence that the higher end is doing better through growth. So, the question is does that increase social tensions, especially if the lower end is completely flat, and I think it does. I think people do not just look at absolute incomes; they look at relative incomes. They feel they are being left behind. So, clearly the extent, for example, of protectionism that is going on in the United States, despite the fact that the U.S. is growing and has been growing fairly strongly over the last few years, is something that reflects, to some extent, this growing uncertainty in large segments of the workforce about whether they will remain prosperous going forward.

In terms of will this increase social tension, I think the nice thing about democracy is that it allows expression through the political arena, and I think you already see it reflected in the political arena in the debate between the Democrats and the Republicans, and I think this will be an important issue; I think it has already been flagged as an important issue going forward. So we will see more of this debate and I think it is a useful debate to have.

QUESTIONER: Can I get your opinion on Asian countries after the Asian financial crisis. To what extent have Asian countries carried out reforms to prevent a recurrence of the crisis, and what more needs to be done?

MR. RAJAN: Well, there is never an end to reforms. There is always more that needs to be done and we at the IMF always want more. But I think if you look at a number of indicators, for example we have looked closely at corporate governance indicators, not just in terms of what was done but in terms of outcomes. They do seem to suggest that Asia has done quite a bit since the crisis. Now, can it do more? Yes, of course, it can do more, and probably should do more. I think some of the factors that are being done in order to improve resilience, including, for example, improving domestic bond markets and improving the regional sort of links, including through trade, but also through capital arrangements such as the Chiang Mai Initiative, all these are goods things which improve the resilience of the region.

I think if you look at our Asia chapter in the WEO, by and large there is a lot to learn from Asia for the other emerging economies, including the fact, just in response to the last question, that Asia has kept inequality relatively low and has focused on factors like education and competition. Now, there are areas where more could be done. Certainly, competition in the services sector is quite important for a number of richer Asian economies going forward, because productivity there, growth there is slowing, but these economies are going to become more services-focused over time, so opening up more, both the domestic competition and to international competition in services, could allow services to do what manufacturing did in the past. So, I think there is room for improvement but I think there has been a lot that has gone in the right direction.

QUESTIONER: Everybody keeps talking about the BRIC countries, but Brazil so far is the weak side of the potential of the BRIC countries. Many people think that even your prediction of 3.6 percent growth this year is overoptimistic. What is the problem with growth in Brazil? What does the country need to do to pick up like China, Russia, etc.? Also, Mr. Collyns, when you talk about an increase of public spending in Latin America, do you refer also to Brazil?

MR. RAJAN: Let me ask Mr. Collyns, who was our man on Brazil, to answer the entire question.

MR. COLLYNS: I think Brazil has already done a lot in recent years to put in place the macroeconomic underpinnings for sustained growth, both in terms of putting in place a fiscal responsibility framework that is delivering high and sustained primary surpluses, and also establishing a very credible framework for inflation targeting. The fruits of these achievements are already being seen in terms of Brazil's resilience in the face of shifting financial market conditions. I would agree that so far the growth response has been somewhat disappointing. I think patience is going to be required. I think at this point the central bank is in a very good position; it has been lowering interest rates progressively over the past year. With inflation expectations coming down to within the lower part of the inflation targeting band, there is room for further reductions in interest rates, so that over time there will be increasing investment in the country.

Nevertheless, of course, there is still quite a large agenda of reforms to pursue in Brazil, and we in the Fund have emphasized a number of areas. I think public spending would be one of them, and indeed public spending has been growing rapidly in Brazil over the past couple of years. Tax revenues have been growing fast and has provided some space for public spending to grow rapidly, but we think it is important for public spending to be more focused, as you know, a very extensive system of restrictions on the way in which public expenditures are allocated and we think it is important to try to find some ways to focus public spending more on targeted social programs to help poor people. The government has achieved success in this area, but there is more that can be done, and also to provide more public resources for infrastructure, as well as to advance the possibilities of public-private partnerships.

One other area I would emphasize is the financial area. Interest rate spreads are very wide in Brazil and reflect a whole range of factors. In part, it is the residual from the macroeconomic instability in the past and that will be reduced in the future, but I think there are still a number of other concerns, very high unremunerated reserve requirements, extensive directed credit. Some progress has been made at improving credit information systems and improving bankruptcy laws, but further consolidation of these reforms will also be required. So, over time, I think continued perseverance in financial sector reforms will be very helpful and the combination of a stable macroeconomic environment and a more efficient financial system with lower interest rates will, I think, deliver higher growth in Brazil.

QUESTIONER: I have a question related to Indonesia. How do you see the Indonesian economic policy if you relate to the high growth in China and India, and what should the Indonesian government do in response to the debt situation? Currently we have problems especially dealing with security measures about terrorism and also natural disasters.

MR. RAJAN: Well, certainly Indonesia has had serious problems to deal with over the last few years. Also, I think Indonesia is growing fairly strongly. Now, growth looks weak only relative to, say, China, but this is respectable growth. There has been a recovery this year from the rise in fuel prices last year and the effects thereof. Inflation is generally trending downwards, both of which is good news. I think on the structural reform side, the financial sector policy package is a step in the right direction, as is the policy package for the improved investment climate. The issue is actually of implementing those packages and of making sure that they do what they are intended to do. For example, there seems to be news that Indonesia is stepping back from achieving more labor market flexibility, which will be important in improving the investment climate. One should note that the IFC rated Indonesia 135th out of 175, a fall from its ranking of 131 on the Doing Business climate. Now, that report is not a perfect assessment of the climate, but it does indicate that Indonesia needs to do more on creating a better investment climate which will help in the growth process. So, I think the government knows what has to be done and it needs to continue doing it.

QUESTIONER: We are seeing a growing need for oil in emerging economies like India and China. How do you see that affecting their monetary policy going forward and what can the IMF do in terms of easing their energy crunch?

Press approaching Mr. Rajan

MR. RAJAN: I think these countries have it within themselves to ease the energy crunch and the first thing to do is to allow prices to feed fully into the output prices, this is certainly the issue for India, rather than subsidizing these prices because, after all, when people face the full price of something they use, they alter their consumption accordingly and it goes to the people who need it the most. By subsidizing fuel prices and actually by having differential subsidies, you create substantial problems, for example subsidizing gasoline prices, a lot of it is used by the middle class so it is a very misdirected subsidy. If you subsidize kerosene a lot, then there is an incentive to adulterate the gasoline with the kerosene. I think basically let the prices reflect market realities, I think that would be a step in allowing better energy use. Of course, over time, also, these countries have to figure in the cost of the environmental damage done by economic activity and to think about how they can appropriately charge industries for it. Certainly, there are regulations in both countries which attempt to sort of reduce environmental damage, force companies to do the right thing, but it seems there is a lot of breach of this regulation. So, trying to figure out how to make the regulation as business-friendly as possible, but then implementing it extremely rigorously is something very important. In both countries you see strong environmental movements and increasing attention by the authorities to the environmental damage, and I think that is a very good development.

MR. HACCHE: Thanks. There are still a lot of hands going up, but I am afraid we have to wrap it up. Apologies to those of you we did not manage to get to this time, and thank you very much for coming.

[End of press conference.]