Transcript

Mexico City
Thursday, July 24, 2014

SPEAKERS:
Olivier Blanchard
IMF Economic Counsellor and Director of Research Department
Gian Maria Milesi-Ferretti
Deputy Director, Research Department, IMF
Jennifer Beckman
Senior Communications Officer, Communications Department, IMF

MR. BLANCHARD: Good morning. First I would like to thank our host, and how delighted we are to give this presentation in Mexico.

The recovery continues, but it remains a weak recovery, indeed a bit weaker than we forecast in April. The headline number, namely the revision of the forecast of world growth in 2014 from 3.7 percent in April to 3.4 percent today, makes things look worse than they really are. To a large extent, it reflects something that has already happened, namely the large negative U.S. growth rate in the first quarter. But it is not all due to that. It also reflects a number of small downward revisions, both in advanced and in emerging economies.

The overall story remains largely the same as before:

Advanced economies are still confronted with high levels of public and private debt, which act as brakes on the recovery. These brakes are coming off, but at different rates across countries.

Emerging markets are slowing down from pre-crisis growth rates. They clearly have to address some of the structural problems that they did not address earlier in time and have to take a number of structural reforms. And they have to do this in an environment which is a world environment which is changing due to the normalization of monetary policy in the United States, which has implications for the rest of the world.

So this is the broad picture but let me now do what I typically do, which is to give you a tour of the world starting with advanced economies.

So let me start with the U.S. Growth in the first quarter in the U.S., as currently reported, and I must say that the number is so surprising that I would not be surprised if it was revised up when the statistics are available, but the number as it was, was a large negative growth rate of the U.S., far worse than anybody, including us, had forecast. In retrospect, it looks very much like a one-off type of event, which is due to the undoing of eventual accumulation earlier, which is due to unusually harsh weather, so factors which do not have obvious implications for the future, but just explain why growth was so bad in that quarter.

Now to give you a more optimistic view of things, which is, as you know, we have a growth rate for 2014 for the U.S. of 1.7 percent, but if we look at the rest of the year, starting in the second quarter, we have an annual rate, a growth rate of about 3 percent, and for next year, a growth rate also of about 3 percent. So looking forward, growth in the U.S. is reasonably strong.

One of the main policy issues at this point, I think they are mostly on the monetary policy side. The main one is the speed of monetary policy normalization, and that’s a hard one because there is a lot of uncertainty about, for example, how to interpret the low level of labor participation, uncertainty about what the natural equilibrium unemployment rate is. For the moment, we think the current plans, which is the end of tapering later this year, and then an increase in the policy rate sometime in the middle of next year, are appropriate plans, based on what we know today. But there’s enough uncertainty that we should not be surprised if there was some adjustment which was made along the way—if the policy rate was increased a bit earlier, or a bit later. I think this is the kind of uncertainty that we’re clearly facing.

There’s another issue in monetary policy which comes from the BIS report that some of you may know about, which has drawn attention to the potential for excessive risk taking, due to very low interest rates, the argument being that when safe rates are very low, there is a reach for yield, there is excessive risk taking and the BIS has worries quite a bit about this. So we have looked and we come to a different conclusion which is that it is true that we see, in some financial markets, valuations which are, we think, fairly optimistic.

The reason we are not that worried is that this is happening in an environment where the leverage of the principal actors, the investors, is not very high. So that even if there was an adjustment, say in stock prices, it would not be catastrophic in the sense of leading to bankruptcies of financial actors. It would look a bit like what we saw in 2001 with the bursting of the tech bubble. We don’t have such a bubble, but what happened then is that there was a bursting of the bubble. It didn’t have much effect because there was very little leverage and therefore very little second round effects.

Let me turn to the Euro Area. The numbers are not great. The recovery remains weak and inflation remains far below the implicit target of the ECB, so our forecast for the Euro Area are roughly unchanged from April. It’s 1.1 percent for 2014. It’s 1.5 percent for 2015. These numbers hide a number of differences across countries and not always in the way that you would have predicted them. So for example, we have revised the forecast for Germany on the upside. We have revised the forecast for France on the downside. We have revised the forecast for Spain up, for Italy down. So there is a lot of diversity in the evolution of these different countries. Now this being said, it’s clear that the job is not done in the Euro Area, and that there is a lot more to do, both on the demand and the supply side.

So if you look at most Euro countries at that stage, it is clear that the unemployment rates far exceed reasonable equilibrium rates so that there is a lot of unemployment slack, there is a lot of output slack. Typically you’d have two instruments, fiscal policy, monetary policy. Fiscal space is very limited. Debt levels are high, so the norm would still be fiscal consolidation at the slow rate with fiscal consolidation. So the help has to come from monetary policy. The ECB has taken a number of steps and has introduced a number of measures in the last month, which strike us as potentially very good for demand. It’s too early to tell how these measures are going to work and it may be that if inflation remains very low, more measures should be considered. There’s still a bit of margin to play with.

The point to make here is that monetary policy cannot do the job alone. This is something that central bankers keep repeating, that is correct. In the case of Europe, there are many more things which need to be done in order to increase demand and then increase supply. One thing which is crucial is the asset quality review, which is now in train and run by the ECB to look at the balance sheet of banks and do whatever has to be done in order to make them healthier. That’s a very important process. It will repair the financial intermediation part of the economy, which is playing a central role in slowing down the recovery. And then looking beyond this, there are clearly structural reforms to be taken. The potential growth rate in the Euro Area is very low. It has to be increased. The reforms will vary from country to country. It may be reforms to re-enfranchise the youth; the unemployment rate of the youth is extremely high in many of these countries. It may be to increase competition in the non-tradable sector. It may be in some countries to increase infrastructure spending which could be done and help both demand in the short run and supply in the longer run.

Let me end the review of advanced economies by talking a bit about Japan. So as you’ll see, we have revised our forecasts for Japan to 1.6 percent in 2014. That’s a revision upwards. This reflects I think the success of economics so far. We’re seeing increases in consumption, partly due to the VAT shifts but we’re also seeing increases in investment, which we were not seeing before so there is some reason for optimism here. The fundamental challenge of Japan remains how to both decrease the level of public debt, which is, as you know, extremely high, and increase growth, not only in the short run, through demand measures, but also in the longer run with structural measures.

A glimpse of the difficulty that Japan is facing is reflected in the forecast that we have for Japan in 2015, which is 1.1 percent only and that reflects the fact that one of the factors which is going to lead to lower growth we think is the increase in the consumption tax, which is going to come at the end of the year, showing the difficulty of taking measures to make debt sustainable while maintaining growth. So, so far, so good, but one has to watch out.

Let me turn to emerging market and developing economies. So our forecast for growth for emerging markets and developing economies is 4.6 percent in 2014. That’s a small revision down, and 5.2 percent for 2015, a small revision down, but again, let me emphasize that these are fairly high numbers in the first place and aren’t quite as good as the forecast we had last April, but they are still fairly strong.

Let me not go through the whole set of countries, but just through the largest downward revision relative to the April WEO forecast, is Russia, where we have revised growth for 2014, from 1.3 percent, 2.2 percent, 0.2 percent and for 2015 from 2.3 percent to 1 percent. Some of these revisions actually have been announced earlier, after the April WEO, but before today, but those are revisions relative to the April WEO. What does this reflect? For the moment it reflects a deterioration of business confidence. There is nearly a freeze in investment decisions by domestic investors. There is near freeze in terms of FDI. There are large capital outflows. All this I think is easily explained by the geopolitical uncertainty which affects Russia at this point.

Let me turn to China. So what we have seen there is a slowdown in housing investment. And we think this is going to go on for a while and it's going to have an impact on growth in China. However, the government seeing this slowdown has taken a number of measures, stimulus measures such as railway investment, social housing. In the recent months we have seen an increase in credit flows. We have seen an increase in infrastructure investments, so the government is taking measures to partly offset the effect of the decreasing housing. The result is that our forecast for China is more or less the same as it was in April, around 7.5 percent, so we do not see a major increase in growth in China, in the short run.

This being said, the challenge of China remains the same. They have an economy in which the share of investment is very very large, the share of investment in consumption is small. They have to rebalance and this rebalance is still to come. The plan is to do it, but it really hasn't started on a visible scale. Let me end my presentation by talking about the challenges that face emerging markets and developing economies more generally and I’ll take two.

The first one is to implement reforms, to rebalance the economies and re-strengthen their growth. In a number of countries, such as Brazil or South Africa, the investment rate is very low and clearly due to structural impediments. Now the good news here is that some countries, and here, I must mention Mexico, which clearly is at the forefront here, have taken or are embarking on a set of very ambitious structural reforms and we think that these reforms will help lift both investment and growth.

The second challenge, my last point, facing emerging market countries, is the changing world environment, which comes from the recovery in the U.S. and the normalization of policy. That’s mixed news. On the one hand, recovery in the U.S. implies higher exports from emerging market countries and clearly Mexico is the prime beneficiary of what happens in the U.S. But it also implies that the normalization of monetary policy is going to lead some of the capital flows which had gone to emerging market countries because of very low rates in the U.S. to actually, at least in part, go back to the U.S. And what this means is we are likely to see a tighter financial environment in a number of emerging market countries.

If everything goes well, this will be a relatively smooth process and everybody's hoping that it will be, but given what I said about the complexity of the exit from unconventional monetary policy in the U.S., the uncertainty about the exact timing of the increase in the policy rate, I think you have to expect that there will be bumps in the road, of a type and of a magnitude that we saw in May of 2013. But I think we have to be ready for periods of volatility much higher than what we are now seeing.

So let me conclude. I think in short, the recovery continues. There is no stalling here. But it remains weak and it is still in need of I would say tender and loving care, namely policies to help both on the demand and on the supply side. Let me stop here and take questions.

QUESTIONER: I would like to know what are the effects of the current crisis in Iraq and in Ukraine on the world economy?

MR. BLANCHARD: For the moment, the geopolitical risks are making the front page of the newspapers and rightly so. The economic effects have been local. They haven’t been systemic. In the case of Ukraine, it’s clear that it has had a major impact on Ukraine obviously, and as I discussed, it is having an effect on Russia. The effect on Russia itself is having an effect on countries that depend directly on Russia, be it through remittances, or be it through exports to Russia, but so far it hasn’t had major impact, say on central or western Europe. If things got worse and the conflict escalated, then anything having to do for example, with gas supplies to western Europe could have a much larger effect. But for the moment, these effects are not there.

For the moment, the conflict in Gaza doesn’t seem to have large effects beyond the effect on Israel. The effects of other conflicts in the Middle East are clearly keeping oil prices relatively high, so we now forecast, we have a slow decline in oil prices. But it’s clear that the escalation of conflict in Iraq could have effects on oil prices and therefore in the world. We’re not there yet.

QUESTIONER: I'd like to ask about the impact of the sanctions in Russia. Is there any risk of recession? What are the other risks for the region if you can elaborate?

MR. BLANCHARD: That forecast is 0.2 percent. It doesn’t take much to get 0.2 percent to become a negative number, if there were more sanctions to be taken. This forecast does not integrate the effect of the sanctions which have been taken by the U.S. in the recent past, nor do they take into account the sanctions which might be taken by the EU over the coming days. These sanctions could probably further decrease the growth rate of Russia. These sanctions make it more difficult for two banks and two large firms to have transactions with the West. This clearly could lead to revision downwards.

QUESTIONER: You said a bit about Iraq. Is there any risk of wider economic impacts yet from the conflict in Israel and Gaza and could you say a bit more about how big the risk is that we see stagnation in the United States and Europe?

MR. BLANCHARD: So on potential economic implications of the Gaza conflict, we have not done more work than what I said, so we don’t have anything useful to say at this point. On the risk of recession in the U.S., it seems to be extremely low.

QUESTIONER: The risk of stagnation, I'm sorry. Could you talk about the risk of stagnation in advanced economies?

MR. BLANCHARD: So this is a different issue. This is a longer run issue, so this is an issue that has been put on the table by Larry Summers in the United States and it’s the notion that looking—not this year, maybe not next year—but looking over the next five to ten years, it may be that we need extremely low interest rates to maintain demand, so that we achieve potential output. I think this is a very important question. We have done some work on it. We had a chapter in the World Economic Outlook, the last one, in which we actually tried to guess what the interest rates might be over the next five to ten years, and we came to the conclusion that there are a number of factors which suggest that indeed, the interest rate needed to sustain demand may be very low.

It’s very hard to be sure of anything, but there is a number of factors which play in that dimension. We know for example that investment post-financial crisis tends to be very low, so the demand for funds is very low. Quite possible that saving as a result may be fairly high; both of them will imply a low equilibrium rate. There is also a demand for safe assets as a result of regulation, which would further decrease the safe policy rate. So we think it is an important issue to look at and continue to look at. If it were the case, it has substantial implications for policy. It makes fiscal adjustment easier because the governments or any debtor has a smaller interest rate to pay, but it may make monetary policy harder, because of the zero lower bound.

MS. BECKMAN: I am getting questions from some journalists online and I’d like to take a moment and ask one of the questions: “What is the biggest challenge that China’s economy is facing right now?”

MR. BLANCHARD: I think there are three challenges. The short-term one is how to react to the construction slow down and they have discussed it and they are taking measures. The next one, which is also relatively urgent, is how to deal with the shadow banking system and make sure that some of the excesses we have seen are reduced. I think they are taking a number of measures to do that but they are not there yet. And then the longer challenge which is the one I mentioned, which is to rebalance the economy from investment to consumption. We think they want to do it, they are going to do it, but it’s going to take some time. As they do it, this probably implies that the growth rate that China will maintain will be lower than the current growth rates. Our estimates are that if they rebalance in this way, the growth rate will be closer to six than it is to seven.

MS. BECKMAN: I’m going to take another question online and then I’ll come back to questions in the room:

“How do you explain the significant improvement on the outlook for Spain, especially for 2015 and how does the high unemployment rate effect the outlook and what can be done?”

MR. BLANCHARD: In Spain, the improvement is due to three things I would say. The first one is exports have done quite well, so the notion that Spain is re-establishing competitiveness is becoming much more plausible. That’s good news. On the internal front, there is a sense that the government knows what it’s doing, that fiscal sustainability is not a major issue at this point, and this, what I’ve referred to in previous conferences that goes all the way back to Keynes, is animal spirits, which is that there is a sense in Spain that the corner has been turned, that unemployment is still obscenely high, but that the economy is growing, that things are going in the right direction, so that you see confidence improving and this in turn leads to more consumption, more investment demand. The result of this is that Spain has done a bit better than we anticipated earlier.

QUESTIONER: In the emerging markets, they also had a significant reduction regarding the outlook for this year, but especially Latin America. Can you elaborate on this topic and in Mexico’s case, can you tell us if the outlook is only short term, and will it be changed in the future?

MR. MILESI-FERRETTI: The outlook for the region which is a reflection of that revision for 2014 for both the two largest economies Brazil and Mexico. There are different stories in Brazil. We have had a weakness in investment in the last quarters and at the same time, we have inflation pressure that took the Central Bank to raise the rates by more than 3 percentage points and this has an effect on demand of course. In a way, the animal spirits, as Keynes used to say, are not operating very well this time. In Brazil, the confidence of investors and consumers is relatively low and that’s why the outlook has been revised downward.

The growth has been very weak in the first quarter and this affects the rate for 2014. In Mexico, it’s weak the first quarter. Two reasons: because of the progress in the construction sector but also the fact that the U.S. economy has had a very large contraction in the first quarter that has an effect on the Mexican economy. But we see that as a short-term effect. On the U.S. side, we see a strong recovery in the second half of the year, in the beginning of the third quarter, and that will be reflected in a positive way on the Mexican economy. Going forward, the outlook for the Mexican economy has been improved very much, due to the very ambitious structure and reforms that have been approved and also the secondary legislation which is almost approved. We don’t think that will have a direct effect, an immediate effect on confidence. The most practical effect will be seen in a few years, but surely they will be positive effects. That is why the projection for the growth rates in Mexico is higher in the medium term than what we see in the next two years.

QUESTIONER: Well thank you very much. The questions have to do with Mexico. I would like you to tell us if you are so kind, what was the outlook for GDP for Mexico and what is the adjustment that you are considering, because this is what we need in the electronic media. And does the IMF have an outlook of how many GDP points we are improved; let's say the Mexican economy, after the energy reform begins to be implemented, as well as the telecommunications reform. On the other hand, you’re saying that Russia looks rather hard in the near future. What does the IMF think about the BRICS new bank? Is it dangerous to create a bank of this nature when we have such a [inaudible] for the future?

MR. MILESI-FERRETTI: The forecast for Mexico for 2014 was 3 percent in the April report. Also in the April report, growth for the U.S. was close to 3 percent. Now the forecast for Mexico for 2014 is 2.4 percent. We have revised much more, the outlook for U.S. for the year to 1.7, down from 2.8. It is very difficult to have a very punctual answer about the effects on the long term of structural reforms, but being conservative, I see a potential growth of about close to 4 percent in a five year horizon. But I would like to clarify, that it is very very difficult to have a very precise outlook on the effects of this type of reforms.

QUESTIONER: The question about the BRICS bank--

MR. BLANCHARD: The structures are put in place not for this year but for the future, so one has to take a longer view. It’s not because one member is in trouble that the idea doesn’t make sense. In general, there has been an evolution of the time in the creation of regional arrangements of that sort. This is not the first one. You probably know about the arrangement called Changmai and this is very much along the same principles.

We welcome the development of such regional arrangements. They have indicated that they want to work with the IMF in the case of this new arrangement, this so-called CRA. They have indicated that large disbursements to a member would have to come with a Fund program, so we would work together. So we welcome this development. It’s just the beginning of something. We’ll see where it goes, but we are happy with it.

MS. BECKMAN: I think we have time for maybe one more question online and maybe one or two in the room. I'm going to go to a question online:

“Argentina could be forced into a technical default, if it doesn’t reimburse the so called vulture funds before the end of the month. How concerned are you by this scenario and what could be the impact on future debt restructurings around the world?”

MR. BLANCHARD: So I think that for Argentina, if it goes into default and doesn’t pay the holdouts, there might be substantial costs in being basically unable to access markets for some time. So I think the cost to Argentina will be substantial, or can be substantial. But there is a cost, and this was the second part of the question. There is a cost to the world in the sense that we need resolution systems which work well when countries are in trouble and one of the implications of this Argentina episode is that there is much more uncertainty as to how we’ll be able to restructure debt for other countries in the future. So this really tells us that we have to work on improving resolution mechanisms when countries are in trouble and that could be a trigger.

QUESTIONER: With this reduction of 0.6 percent in the outlook of the GDP for 2014 of Mexico, my question is, do you see a scenario where before the year comes to an end, the IMF could be doing a movement downward, once again, given the growth of the country? Number two just like you mentioned, some challenges for China and other regions—can you tell us something more about the main challenges that you are foreseeing for the Mexican economy, not only for this year but also for the year 2015? And you have nnot said what to expect regarding Mexico’s growth for 2015.

MR. MILESI-FERRETTI: 2.4 percent. We think this is a realistic forecast and clearly depends not only on what happens in the Mexican economy but also what happens in the world economy, and especially for Mexico, what happens in the U.S. economy. Of course we can expect surprises on both sides and they will have huge implications, especially whatever happens in U.S.

In terms of challenges, for the Mexican economy, the macroeconomic framework is very stable. The major risks are external. As Olivier mentioned before, the possibility of an increase in the low volatility in financial market with a faster adjustment of long-term interest rates in the U.S. that will have repercussions on the natural conditions on emerging markets, on capital flows, makes excessive pressure on the exchange rate, but we think the macroeconomic framework makes it very difficult to respond to these type of challenges. And similar to what happened last year—that type of financial shock may have an impact on the real economy. I believe this is a major issue and the other challenge of course is what happens if the U.S. economy does not reach a strong growth rate like in our forecast. And that, of course, because of the integration of both economies, it will have an impact on Mexico.

MS. BECKMAN: With this we finished the press conference. Thank you for participating and submitting questions online for the press conference.