Transcript

With James Daniel, Assistant Director, European Department, and
Ceyla Pazarbasioglu, Deputy Director, Monetary and Capital Markets Department
Friday, July 27, 2012
Washington, D.C.

MS. GAVIRIA: Good morning. Welcome to the conference call on the IMF’s 2012 Article IV Consultation with Spain. The lead speakers today are James Daniel, who is the mission chief for Spain, and Ceyla Pazarbasioglu, who is deputy director in the Monetary and Capital Markets Department and who led the recent mission to Spain that produced the country’s Financial Sector Assessment Program or FSAP that was published a few weeks ago. James will start with brief remarks and then they will take your questions.

MR. DANIEL: Thank you very much, Angela, and good morning, everyone. Thank you for listening in. You have a bunch of documents before you. If I may, can I just have a couple of minutes to walk you through them and give you a bit of perspective?

The bottom line is that the first document at the top of your pile, the one called Supplementary Information, is our latest thinking. And that’s a very important document. If you want to know what our latest thinking is on where the economy is going, it’s in the table on page 3, with GDP growth at -1.2 for 2013, for example. But let me give you some perspective on that.

We visited Spain in the first two weeks of June. The economy was in a very difficult situation. We had seen some progress being made on policies, especially on the labor market, but we still saw a major shortfall on the fiscal area and, indeed, also in the financial area. That’s where our concluding statement came from. Since then, the Spanish authorities requested a €100 billion from the euro area to backstop their banks, which is positive.

And indeed, there was a European leaders summit where there was discussion on the possibility of direct bank recapitalization by the European rescue fund. Still, though, we didn’t see a roadmap for the financial sector. We were still concerned at that stage about the fiscal path, and it was on that basis that we wrote our staff report. That’s the big report underneath the Supplementary Information.

Now, we sent that staff report to our board, I think on the 6th or 7th of July. Since that date a number of very important things have happened. First of all, we’ve had a Memorandum of Understanding on the financial sector to support the euro area financial assistance, which does provide exactly the roadmap we were looking for. There’s also been a change on the fiscal sector, very significant. There’s been a much more reasonable fiscal target path set and a well-designed fiscal package taken up in the last week or so. And that’s also led us to modify our macroeconomic projections, for example, for the deficit. So if you want to know what is the IMF’s projection for the deficit this year, it’s -6.3%. That’s the overall balance in the table on page 3.

Since we couldn’t go back and revise our staff report, we issued a supplement. However, in the staff report you’ll see a number of footnotes. For example, on the very first page under Key Issues, you’ll see a footnote saying that significant developments have occurred since the staff report and that they’re discussed in the supplement. So that’s the story behind these footnotes.

Now, where are we now? Obviously, there’s still significant market stress and here you may want to look at paragraph 11 in the staff report. That does, indeed, talk about this kind of risk. For example, the second bullet talks about the threat of continued outflows and renewed financial market stress. The third bullet talks about how the materialization of these risks could threaten sovereign market access. And this underlines our core message of this consultation, which is that, first of all, Spain needs to implement the reforms now.

If you turn to the Survey article, you’ll see there’s a question there about why financial markets aren’t convinced. And here what I talk about is that it’s not enough to announce ambitious fiscal deficit targets, for example. The government now needs to hit these targets. But it also refers to another central message of this consultation and that is that Europe also needs to help Spain. And here I would refer you to paragraph 15 in the staff report, that talks about the need for a lasting resolution to the euro area crisis requiring a convincing and converted move towards a complete and more robust EU.

And I’ll also refer you to the euro area staff report on the Article IV Consultation that was published last week, where my colleagues in the European Department went through these issues in much more detail, including on the ECB, for example, saying it should provide further defenses against an escalation of the crisis and listing a number of policies.

So just to underline, there’s been major and very positive policy changes since the staff report was first written, and it is the supplement that reflects our latest thinking on Spain.

MS. GAVIRIA: Thank you, James. We’re ready for questions now.

QUESTIONER: James, a couple of things. I believe that there have been some reports saying that there wasn’t really a kind of a banking crisis in Spain before Rodrigo Rato, the former IMF chief, in fact, was dismissed by the finance minister. I was wondering if you might have any comments on that.

But also, I was at the Conference de Montreal here, obviously in Montreal, in June, and we had the governors of the banks of Canada, Portugal, and France say that what you really need is to have a banking union or a kind of banking financial union in the euro zone. And I was wondering if you have any comments on that as well as what kind of effect that would have and how it might work.

MS. PAZARBASIOGLU: I think as James said, what one has to concentrate on is the strategy, the policies that the authorities are taking. Clearly, there are financial sector strains in Spain. These have been increasing since some decisions were made, especially in terms of resolution of the fourth largest bank, which is Bankia.

But to bring this back in line with the policies and the strategy going forward, if you look at the Memorandum of Understanding by the Spanish and the European authorities, which was published on July 20th, it’s an excellent blueprint in terms of what exactly needs to be done. It draws from international best experiences in successful resolution of banking system stress. And we really think that as long as these measures are implemented, and our understanding is that the authorities are fully committed to implement them, that this would really bring the Spanish banking system to a much more sustainable and sound level in the near future.

In terms of what you mentioned about Europe as a whole, yes, it is true and we have been public with our statements, both in Global Financial Stability Report and the euro area policies, which was published last week, about the need for a much more comprehensive banking union in the context of Europe, which would have not only unified supervision and regulation, but also a common deposit insurance framework, as well as a common resolution framework similar -- like the case in the U.S., where you have similar types of institutional structures.

QUESTIONER: Hi. Good morning. This is a question for Mr. Daniel. How much time is there for Spain to fulfill its commitments? Because the cost of financing the debt is super high. It’s true that in the last days, especially after the comments of Mario Draghi, spreads have come down, but they have stayed really high. Do you have any estimate or how fast they have to do it? You say now, but this now is before the end of the summer?

MR. DANIEL: I really don’t want to get into that kind of speculation. Obviously, market conditions are very difficult. I would also point out, though, that the maturity structure of Spanish debt is long, so it takes a long time for changes in interest rates to actually turn up in the higher interest bill. It also underscores the need for Spain to establish its track record and for Europe to play a proactive role in this situation. And I think, as the mentioned euro area staff report said, there’s a need for the ECB to strengthen defenses against escalation of the crisis.

QUESTIONER: But if Spain has no access to the market, ultimately you have to ask for a rescue, an international rescue, like is being done with Portugal, Ireland, and Greece. Do you see that threat in today’s situation when you have the prime risk over 400 points?

MR. DANIEL: I would go back to what I said before, and that’s the importance of implementing policies and for a European response.

QUESTIONER: I would like to know if you think that the Spanish government should approve another labor reform to change things in Spain, and if so, which kind of reform are you looking for

MR. DANIEL: Thank you for that question. Unemployment is quite rightly a center of attention, and it is certainly at the center of our concerns as well on Spain. It’s unacceptably high, especially for youth, and today’s numbers where I think youth unemployment went up to 53%, are particularly concerning. I think you asked the question of whether another labor market reform might be warranted and if so, what? Let me first say that we think the labor market reform that was done in February is potentially really quite strong, and these things take a long time to have effect, especially when you’re still on the downswing of the cycle. So at this stage it’s more about mitigating the inevitable downswing rather than looking for strong gains in employment. So I think we need to temper our expectations accordingly.

Is another labor market reform needed now? I think that would be premature. They do need to monitor very carefully whether or not this reform is working. I’m not talking here about seeing or expecting large falls in unemployment. I think you need to look at the intermediate goals. Are firms able to adjust to the more difficult situations by mechanisms that don’t involve sacking people, like adjusting working conditions, adjusting wages, et cetera, and are still having to sack people? Now, we do discuss in the report possible areas that might be strengthened, and I would refer you here to paragraphs 37 and 38 that flesh out a bit some of the areas where there could be more targeted mechanisms. We say here that “the reform could be strengthened by reducing the difference between protection for open-ended and temporary contracts.” So I’d refer you to those areas in terms of specific policies, please.

QUESTIONER: I have a fairly simple question regarding the projections for real GDP that you have on the Article IV because, in the first part, in the supplementary information, you have some numbers regarding 2012 and 2013 that are different from the ones you have on page 10 at the same document. And I wanted to know which ones are the most recent and usable. Actually, that’s just it for now.

MR. DANIEL: Thank you for giving me the opportunity to clarify. The numbers in the supplement, which is pages 1, 2, and 3, are our latest thinking. If you want to know what is the IMF’s latest projection for 2013 for real GDP, the answer is -1.2%. It is not -0.6%. So page 10 was what we thought back in the beginning of July. Page 3 is what we think now. So, please use the table on page 3 for our latest projections. I’m sorry we don’t have more tables, but we kind of only had time for a summary update, which you see in that table on page 3.

QUESTIONER: Two questions. You mentioned in a couple of parts of the report the possibility of Spain losing market access, the Spanish government losing market access. If that were to occur, what is your view on the best way to support Spain? Is it the traditional, full-fledged bailout, like Greece and Portugal have received, or perhaps putting into use the new capabilities agreed at the European Council, allowing EFSF to step in and provide support in the secondary market, or perhaps a more active ECB, which I think you also mentioned?

The second question relates to Bankia, Spain’s fourth largest entity. You mentioned that also. I don’t know if there’s anything you can comment on the government’s handling of Bankia. It’s been a very controversial event in Spain, especially with regard to moving on the resolution of this large-scale recapitalization of Bankia without having the money in place to do so. I don’t know if there’s anything you can comment on that. Thank you.

MR. DANIEL: In terms of your first part of the question, I really don’t want to speculate about such things. It’s true that we do raise the threat of this risk toward market access, but I would just go back, if I may, to the need for Spain to keep delivering and for Europe, as you mentioned yourself, for example the ECB, to play a more active role here.

MS. PAZARBASIOGLU: Just briefly on the issue of Bankia, but more broadly in terms of resolving weak banks, as I mentioned before, in the FSAP we had recommended that the government and also the central bank take action in terms of providing a roadmap as to how they would deal with weak banks, those that are non-viable, those that are viable but need some temporary support, and those banks that are likely to go through this crisis on their own. And the Memorandum of Understanding is very detailed on this issue. There’s a very specific timeline in Figure 1, which shows what the different steps are in terms of independent evaluations, capital injections to these institutions, restructuring plans, dealing with legacy assets, and also going forward improving supervision and regulation. So we minimize these types of problems going forward. And I think these are all, as I said before, in line with what we had recommended in the context of the FSAP. And if implemented, it will form a good blueprint in the future for other countries to follow.

QUESTIONER: Thank you. Yes, can you clarify or quantify the risk of the regions requesting central government bailouts and how that might affect Spain’s debt burden? I assume when you talk about the ECB bond support, you’re talking about now and not later. So that’s a question on that.

I just want to confirm that you say implementation risks are high, and I’m wondering how long you think Spain can stand 7% borrowing costs?

MR. DANIEL: Thank you. On the regional question, just if I may for perspective, regional debt is part of general government debt. So how it gets financed does not affect the amount of general government debt. And we at the IMF look at a general government debt concept and that’s the same as what Eurostat does. So the mere fact that Region X may get financing via the new centralized system as opposed to going to a bank itself does not affect the level of debt that’s being discussed.

It is true that regions are facing significant financing constraints, and that’s why the government is setting up these new centralized mechanisms. These mechanisms are not unusual. In fact, you can make an argument that they’re an improvement because they could even help lower costs in general for regions in their financing.

But the point being, this makes sense if you’re going to provide financing for regions, regions have to keep up their side of the deal. And here, if I may, I’d like to point you to Box 6, where we talk about the changes that have happened in the framework that deals with regions and many of them are very positive. There are now many more controls. And I think our point would be that regions are now having to keep their side of the deal, to deliver on their side of the bargain. And if they don’t, these controls need to be proactively used to show that Spain as a whole is meeting its commitments.

On your second question, I think I would go back to a question we had before about speculating and I’d rather not get into that, please.

QUESTIONER: And the other one? Just to confirm that you were saying that implementation risks are very high.

MR. DANIEL: Correct.

QUESTIONER: The last time I saw these types of warnings was in the Greek programs where the IMF staff warned that implementation risks were high. And I’m wondering if that ultimately proved to be the reality?

MR. DANIEL: I just would like to talk about the Spain Article IV and the implementation risks that I was referring to there, especially, for example, to your previous question about regional governments. As you know, for example, last year the regional governments missed their targets by quite a long way. And I think the international community, and indeed markets, would like to see those kinds of implementation risks addressed and for the regions to get a record of meeting their targets.

MS. PAZARBASIOGLU: If I can add on the financial sector, in terms of implementation, I think the track record is actually quite positive. You see that the authorities are very seriously working with external parties, independent advisors, as well as ou selves, to really deliver on what their commitments have been.

So, in terms of restructuring of the Spanish banking sector, this is a challenging timeline, but if you look at the evidence so far, it has been very positive in terms of what they promised to do. Tey published this timeline, they have a specific website explaining what their commitments are under this Memorandum of Understanding, and, you know, these things take time. It’s not overnight that but you can restructure a banking system, especially after a long period of a boom-bust. But so far if you look at what has been done in terms of announcing the top down stress test results, in terms of coming up with the facilities, these have been, in terms of implementation of the banking system strategy, quite positive.

MR. DANIEL: If I could just go back and clarify my comments on implementation risk. I think it was in paragraph 7 and implementation became challenging with the risk of slippage, in particular by the regions, and that was my reference there.

QUESTIONER: Oh, okay. I was referring to Table 10, which notes high implementation risks on an overall scale. If I could go back to the question… you’re talking about the ECB should be helping out. I take that to mean now, that it’s an urgent action. I think José Viñals said that there are about 200 basis points in the yields that are not based on fundamentals. So, am I assuming correctly that when you say the ECB should be acting, you’re saying that that’s an urgent action rather than having to wait several months?

MR. DANIEL: I wouldn’t want to add anything to the euro area discussions that we’ve reported on last week, or Mr. Viñals’s, just that from a Spanish perspective I’ll refer you to the need for Europe playing a supporting role. And I wouldn’t want to get into more detail at this stage, if you don’t mind, about the ECB.

SPEAKER: As you’re aware, one of the debates within the euro zone is about when the €100 billion loan moves from the EFSF to the ESM, whether or not Spain would be liable to support a guarantee, to put up guarantees for that. And I believe IMF staff have said that they would prefer that Spain not have to put up that guarantee. What are the consequences to Spain’s outlook if Europe does require that guarantee for the €100 billion loan?

MR. DANIEL: Thank you for that question. I appreciate the opportunity to clarify that a bit. You’re absolutely right in the characterization of staff’s views on this. We do think it would be very important for Spain, and indeed, for Europe, if this direct recapitalization option were to be made concrete and for it to help. And, of course, I think Spain is one of the countries that would benefit the most.

You had a question about how would that affect the way we view things. If I may turn your attention to page 3 and the little graph at the top with the dotted red line and a blue line. In our projections for Spain we’ve been conservative and assumed, just for the sake of argument, and to be prudent, that the direct recapitalization does not occur. However, that’s not a policy position by us, it’s just a prudent assumption. We’ve also done a scenario where that €100 billion, if it is €100 billion, were not to hit the government books at all, and that’s the blue line. So the red line is with €100 billion and the blue line is without. You can see that change of the debt ratio hits the max of about 97 or so, if they don’t get direct recapitalization, and if all the money is taken off the government’s books, it would be, I think, about 9 percentage points. So, it does make a significant difference.

QUESTIONER: And so would it be right to assume that if the guarantees were required, and I think they’re talking about a €30 billion guarantee, it would push that blue line up by a third towards the red line?

MR. DANIEL: The difference between the red line and the blue line is €100 billion, so, of course, guarantees don’t affect the actual measured debt stock.

QUESTIONER: Mr. Daniel, let me ask you please about growth projections. I just can’t see how with the austerity measures that are being put in place, growth can improve a bit to -1.2% next year. How did you get to that number?

MR. DANIEL: When you say “improve,” I wonder what you are referring to because…

QUESTIONER: Well, it’s less of a decline than occurred or will occur in 2012.

MR. DANIEL: Oh, I see your point. Because the way we look at it is… if you turn to page 10, which is our projections a month ago, we were actually expecting growth in… is 2012 the question?

QUESTIONER: 2013.

MR. DANIEL: 2013, of -0.6%. Since then we’ve had the new package of measures and we’ve deteriorated our outlook to -1.2%. We agree with you that these fiscal consolidation measures will affect growth. Just on a small digression on that, this package has actually been reasonably well targeted in terms of its growth impact. The measures have been,it looks to us, chosen deliberately to minimize the negative impact, so it’s quite well designed from that perspective.

Why do we think growth will be less negative than this year? That’s a fair question, I’m sure. We’re seeing considerable strength from the external sector. We’d also expect, for example, the drag from the construction sector to minimize. So, we do see, perhaps, a little bit of an improvement in some of the underlying trends or, rather, should I say, a less negative trend.

QUESTIONER: Mr. Daniel, I’m sorry, you were saying that you don’t want to speculate, but can you give me an idea of the liquidity position of the central government, because even if the regions don’t increase government debt, they still need the money, and also they are already on the threshold of the 7% interest rate on public debt. So do you have an idea that you can give us about the liquidity position of the Spanish government, the Spanish central government? And also if these results, especially of the labor market reforms, take so long, how can Spain handle this pressure and for how?

MR. DANIEL: I would just draw your attention to paragraph 11 where we say, and this was that we did view back in the beginning of July, that the sovereign and banks have significant buffers, but materialization of these risks could threaten market access. Don’t have a lot to add to that really.

And then I think your second question was how long Spain can survive with high unemployment. That’s, indeed, a very pressing concern and it’s very difficult, we understand. However, it would also be probably unreasonable to think that unemployment could fall very fast. So I think this speaks to our original messages of needing to implement very strongly other policies and to strengthen market confidence and to show the economy is turning around.

MS. GAVIRIA: Thank you, James. With this, we conclude our conference call today. Thank you all for participating.