Transcript of the Press Briefing on the Fiscal Monitor

September 20, 2011

Washington, September 20, 2011
Webcast of the press conference Webcast

Ms. Nardin - Good morning and welcome to the press conference on the launch of the September 2011 Fiscal Monitor. To present the Monitor we have here Carlo Cottarelli, Director of the Fiscal Affairs Department; Phil Gerson, who is a Senior Advisor in the same department; and Paolo Mauro, who is a Division Chief, also in the Fiscal Affairs Department.

Mr. Cottarelli - Thank you. You will find on the screen the cover of the Fiscal Monitor. Again, the color is red because the fiscal accounts of many countries in the world are still in the red, particularly advanced countries. I am going to say a few things on advanced countries because that is where many weaknesses are. In spite of this, I would like to start with some relatively good news. Some optimism is necessary these days.

The first point I want to stress is that there has been progress in fiscal adjustment in advanced economies with a decline with respect to two years ago of the deficit, the average deficit, by 2 1/4 percentage points of GDP. This is the general government deficit in percent of GDP two years ago and this is where we are now. So, you see for most countries there has been a pretty sharp decline, average decline by about 2 1/4 percentage points.

Now, in most cases, the improvements in the fiscal accounts were either as expected, in line with expectations, or larger than expected. To show you this, I want to focus on this chart.

This is the increase in the public debt to GDP ratio that we were projecting two years ago in the Fiscal Monitor of the fall 2009 for the following two years. So, this is what we were projecting and this is what has happened for these countries. So, the increase has been in line with expectations.

But there has been a much larger number of countries in which things were actually better than expected. So, in all these countries, the increase in the public debt to GDP ratio was smaller than had been projected. Of course, there are exceptions and the three exceptions—perhaps it is not a surprise—are Greece, Ireland, and Portugal, where the increase was actually greater than expected.

If we look ahead, in most countries the fiscal outlook now is stronger than what we were expecting two year ago. Here, I want to focus on the five largest European countries. This shows the increase in the public debt to GDP ratio that we were projecting two years ago for the next three years, for the period 2012, 2013 and 2014. This is what we are projecting now. The projected increase in the debt to GDP ratio now is smaller than it was before, because a number of measures have been undertaken. For Italy and Germany, we are actually projecting now a decline in the public debt to GDP ratio over the next three years.

If we look at long-term spending pressures, this chart focuses on pension spending, and reports for countries that have introduced reform, the net present value, which is the value today of future increases in pension spending in relation to GDP. This is what was the net present value before the reforms and this is what is after the reforms. So, again, there has been progress in this area.

Of course, a lot remains to be done in the pension area. Even more needs to be done in taking care of the projected increase in healthcare spending. But some progress has been made.

In spite of all this progress, financial markets are worried. Markets are worried about growth essentially. You know that there is a very strong link between the fiscal accounts and growth, but it is a two-way link. Growth affects the fiscal accounts and the fiscal accounts affect growth. A key point of this issue of the Fiscal Monitor is to ask how fiscal policy can help in this situation. There is one basic thing that fiscal policy can do in this situation and that is to strengthen confidence. There is a problem of confidence now. That is why people do not invest enough, do not spend enough.

Fiscal policy can do two things to strengthen confidence. The first thing is to ensure that the public sector itself, that public sector insolvency is not a source of instability. For this, countries need to have a clear plan on how first to stabilize the debt to GDP ratio and then how to bring the debt levels down.

Now, these plans will involve some fiscal tightening, and this is the second point. It is important to ensure that excessive fiscal tightening is not a source of instability, because if you raise taxes too rapidly, or if you cut spending too rapidly, there is a drag on domestic demand and this slows down the growth of output.

So, if we put all this together, our advice can be summarized as follows: Have a plan; countries should have a plan and should actually start reducing their deficit, but adjustment should be at the right speed, not too fast, not too slow, depending on country circumstances. Some countries have no option but to tighten fiscal policy, they actually need to tighten it quite rapidly because they are subject to market pressures. Others have some more flexibility.

I would like to stop at this point and thank you for your attention.

QUESTION: Your assessment on whether or not Greece is also in a situation where excessive tightening is contributing to instability.

Mr. Cottarelli - Greece needs fundamentally three things: adjustment, growth, and financing. It needs fiscal adjustment. Greece is still a country that is running a primary deficit so it needs to clearly strengthen its fiscal accounts. The pressure from the markets is just too strong at this point to slow down the pace of the adjustment.

At the same time, we need to look at Greece’s potential growth over the medium term. So, at the same time it is important for Greece and for other European countries, for all advanced countries actually, to put in place structural reforms that will boost economic growth over the medium term. Potential growth, high potential growth over the medium term is very important for the fiscal accounts. But in the short run there is no option for a country like Greece other than continuing on the fiscal adjustment path.

QUESTION: What is your view about President Obama’s latest plan to cut the deficit and to raise taxes on the rich? What does the U.S. government need to do to address fiscal challenges?

Mr. Cottarelli - First of all, it is very important that the U.S. Administration presented a plan which is actually more ambitious in terms of objectives than what is being discussed by the Joint Deficit Reduction Commission. It is very important; it is a very specific plan that focuses—I think correctly—both on the revenue side and on the spending side.

For a country like the United States where tax rates, the tax pressure is not particularly high, it is possible, it is necessary that the fiscal adjustment, medium-term fiscal adjustment plans also look at the revenue side given the magnitude of the overall adjustment that is needed in the United States.

On the specific issue of taxing the rich, what I can say is that it is a perfectly legitimate goal of tax policy to make sure that the burden of taxation is distributed fairly. So, all the countries in the world look at this aspect. I do not want to comment on the specific measures but I think fairness in income distribution is a perfectly legitimate goal for tax policy.

QUESTION: You long preached that adjustment should be made more on the expenditure-cutting side than on the tax-raising side for the benefit of growth. I was wondering in that context you would assess Italy's recent announcement of measures.

Also, I would be curious to know if the figures both in the Fiscal Monitor and the WEO, which I believe must be the same, are based on which one of the many announcements of measures that were made by Italy. Is it based on the latest measures or one of the previous versions because they change quite considerably over time, and very fast.

Mr. Cottarelli - Let me start with the second question because it is easier to answer. The answer is yes, it is based on the measures that were approved, the most recent version of the measures, so we are fully updated.

On the question of the plan, let me say that the plan that has been approved by the Italian parliament a few days ago is a very important plan, as was underscored in the WEO press conference. This plan is sufficient, in our view, to lower the deficit to GDP ratio to about 1 percent of GDP in 2013. This is not the balanced budget target that was announced, but this is primarily due to different hypotheses, assumptions about the growth. We are more cautious about growth.

At the same time, even if the fiscal deficit were 1 percent of GDP in 2013, it would still be the second lowest deficit in the G-7, very close to the deficit of Germany. We project for Germany 0.8 percent of GDP and Italy will be about 1 percent of GDP in 2013. The debt to GDP ratio would be declining already in 2013.

This said, when we look at the composition, of course one could have wished a better composition with more on the spending side than on the revenue side. The world is not perfect, so I think it is important in any case that action was taken to reduce the deficit, although it would have been, in our view, preferable to have something more on the spending side.

QUESTION: What scope do you think the UK has for changing its deficit reduction program given historically very low bond yields at the moment? I guess another way of asking the same question is, is it one of those countries which you identify as going too fast?

Mr. Cottarelli - I think that if we look at the current macroeconomic situation, including the inflation pressure—inflation is still fairly high in the UK— the current plans are appropriate. I do not think they need to be changed. However, of course, one needs to keep flexibility in managing fiscal policy. First of all, there is scope to let the automatic stabilizers operate and then perhaps also to slow down the pace of adjustment, but this is not what we think should happen now. In case there is further bad news about the economy, there may be scope for slowing down the pace.

QUESTION: I would like to know why suddenly, after 2013, the fiscal deficit in Spain still remains flat until 2016, 4.1 percent, the government's objectives are not achieved. I would like to know why and what needs to be done, and also the role of a possible political change in Spain could play in achieving those objectives.

Mr. Mauro - First of all, to put things in context, a lot of very important measures have been taken in Spain. Most recently, as you well know, there is a balanced budget amendment to the Constitution and this came about with a lot of social consensus on that, and it was done very speedily. What is in these projections is very much based on policies as already kind of embedded in the law.

You will see that for the next couple of years the projections envisaged that the authorities' targets will be met whereas in the outer years, 2013 and 2014, there is a bit of a difference in the sense that the projections by the Fund for economic growth are a little bit more on the low side, so that accounts for the difference.

Going even further to 2015 and 2016, as you were saying, at that point we are very far out, but we only assume policies that are in place. That is why you see that the deficits are not coming down at a very distant point.

For the next couple of years, we think that it is all about implementation. For the outer years, if growth comes about the way the government is assuming, then again it would only be a matter of implementation. If there is a shortfall in economic growth, then one would have to reconsider, but that is, again, for 2013, 2014.

QUESTION: You asked in the report if fiscal policy in emerging markets is too good to be true. I wonder if the Brazilian fiscal policy is sustainable when you adjust it for cyclical factors.

Mr. Gerson - Well, first, to deal with the question of is fiscal policy in emerging markets too good to be true, it was not our intention to say, yes, there is something going on that people are not aware of. It is just to recognize that challenges remain in emerging market economies. There is a sense, I think, that this was a crisis for the advanced countries and emerging markets were basically getting through unscathed. We did not want to give the impression that there were not challenges that remained for emerging market economies.

In the case of Brazil, there are longer-term fiscal challenges that need to be met. We think the policy stance right now is appropriate. We welcome the tightening that the authorities have announced for the fiscal target this year which will help rebalance the policy mix and take some of the pressure off of monetary policy.

Going forward into 2012, again we think the primary surplus target on the order of about 3 percent of GDP is appropriate, but it will be important for the authorities to make sure that they have measures in place to achieve it, particularly given some of the pressures that may come from a possible increase in the minimum wage going forward.

Then if you look at longer-term fiscal challenges in Brazil, there are issues related to the rigidity of expenditure, to the structure of taxation and earmarking, and generally, as in many emerging markets and practically all advanced economies, pressures related to population aging and growth of healthcare expenditure because of technological change.

So, our point about is it too good to be true is not that there is something funny going on with the accounts, but rather that there are still challenges that need to be addressed. Brazil, like many other emerging market economies, still has work to do.

QUESTION: On Italy, has Italy done enough to encourage growth to really change the parameters of their debt profile?

Secondly, on Greece, the growth projections have obviously been much lower than expected since the last or even within the last review. Economists previously had already projected that Greece's debt was unsustainable under that growth profile even with private sector involvement under the July 21st Agreement.

How would you respond to economists that say Greece's debt is now that much more unsustainable even considering private sector involvement of the July 21st agreement?

Ms. Nardin - If I can just to add on Greece that we also have a question online from Ta Nea newspaper asking about whether there can be an orderly pre-approved default of Greek debt and also what is the best-case scenario for Greece.

Mr. Cottarelli - Italy, first. You are asking whether the Italian government has done enough for growth. Let me first of all underscore that the Fiscal Monitor projection and the WEO projection assume a relatively growth rate of the economy for the next few years, so that is already reflected in our projection of the fiscal accounts. Should more be done to boost potential growth? The answer is yes. We have been very clear in our recommendation to Italy, including in our latest Article IV consultation, about the need to do more to boost potential growth in Italy through reforms of the goods market and the service market. More competition is needed in the service sector. Also, reform in the labor market. You still have a very big duality between those who are fully protected and those who have temporary jobs. There is a need for more homogeneity, so reform to the wage negotiation process through more privatization, particularly at the local level. So, more needs to be done and, if more is done, potential growth will be higher in the medium term; revenues will be larger; and this will be good also for the fiscal account, not only for income.

On Greece, a key question is what is needed in Greece at the moment. I want to complete the answer I gave earlier, because now you raised the question about financing. Greece, as I said, needs three things. Strengthen the fiscal account; it is still running a primary deficit. If a country is running a primary deficit, that is a deficit net of interest payments, the fiscal situation would need to be adjusted even if debt were zero. So, there is clearly a need for further significant fiscal adjustment.

Second, reforms to boost competitiveness. There is a competitiveness problem that is being addressed through reforms, which would also boost over the medium term the potential growth rate of the economy.

The third point, equally important, Greece needs sufficient financing from abroad. On this, the July 21st agreement from European partners was very clear about the fact that financing will be available for Greece as long as reform takes place. I think these are the three components of a package that will make public debt sustainable in Greece.

QUESTION: I have a question on privatization. I would like to hear the importance of privatization in your programs and in particular in Portugal, given that countries are selling assets probably at lower prices than they would sell at normal times and also that it is kind of a one-off measure on debt instead of deficit. So, how important are they in these programs. The other one is on fiscal devaluation. You have an annex here in your report. You also say that it is not that they have that big an effect on growth or external accounts. So, how do you evaluate the risks in terms of fiscal performance that derives from fiscal devaluations? That is one of the points that is being discussed in Portugal.

Mr. Cottarelli - I will take the part of your question on fiscal devaluation and perhaps Paolo can say something about privatization.

First of all, fiscal devaluation, for those who do not know, is a shift from taxing labor to taxing consumption essentially and is, therefore, a fiscally neutral shift if it is probably implemented. The idea is to have tax reform that is not aimed in itself at raising revenues for this component. Of course, raising revenue is important, but for this purpose the main focus is to change the composition of taxation. So it does not have any effect on the deficit.

If it works, it helps improving competitiveness and growth. We discuss this in our appendix. In normal circumstances it has some effect. It is not a panacea; it is not something that solves everything, but it can be useful. It can be useful particularly in a situation in which, when you raise VAT, you do not have a large response from wages and, therefore, terms of competitiveness if you lower the labor cost, you become more competitive.

Ms. Mauro - Just to complement that, on the aspect of privatization, one thing about the programs in general, but particularly for Portugal, this is not just about fiscal adjustment. It is also about promoting economic growth and efficiency. So, both privatization and fiscal devaluation are part of the many things that can be done to promote economic growth.

Again, privatization is not just motivated by raising revenues. Ideally, one undertakes privatization if the privatized firm is more efficient in private hands than it was under public property.

The other thing I would highlight is the importance of the process for privatization and making sure, for example, that you have a good regulatory framework before you privatize the firm.

QUESTION: I am just a little curious about your thinking processes and how you evaluate information coming in from external sources, such as financial markets, which take a markedly different view of the evolution of the problem to the one that you just outlined, where the signs you put up suggest that the situation has improved in prospect in a range of European countries, including in Greece. Financial markets say otherwise and are increasing bets on a default by Greece and increasing the likelihood or the prospect of defaults in other peripheral countries, and even in Italy, from remote, material, but not as high as Greece's level.

I think you said before that you think markets are worried about growth but it seems to me they are worried about debt and default. I wondered to what extent that enters into your thinking in the case of countries such as Italy or Greece which announced various fiscal adjustment programs. Do you take them at face value or to what extent do you qualify them for the past record of the recent past, the likelihood of default and the bets made by financial markets on the likelihood of their being achieved.

Mr. Cottarelli - You asked many questions. I will try to answer most of them.

The information that comes from financial markets is obviously very, very important. We certainly take it into account not least in making our interest rate projections. It is true that the markets are worried about growth. You said they are worried about the fiscal accounts. Growth is very much having an important effect on the fiscal accounts, so the two things are clearly connected.

But they are also worried, I believe, when you talk about Europe, about the way the crisis is managed in Europe. That is very important. I think I would underscore two things that are missing in the way crisis is managed in Europe. First of all there is a clear communication problem. I think there is the will and it has been clearly stated, the will of supporting countries that are proceeding with fiscal adjustment.

But there is also what I would call a sort of cacophony of voices. When you have 17 countries in the Euro Area and each Minister of Finance or central Governor expresses his views in a nuanced way, you create a sort of uncertainty that is not taken very well by markets. So, this is a communication problem that needs to be addressed.

The second problem is speed. The July 21st agreement is very important, but it needs to be implemented. Any delays in implementation create uncertainty in the markets and this is what markets are responding to, uncertainty. So, there is a need to move quickly toward the complete approval of what was agreed on July 21st. That is why even when there is relatively good news on the fiscal accounts, it may get lost in this situation of uncertainty.

QUESTION: Do you think that the Northern European countries, the fiscal policy of the Northern European countries can play a role in reducing the imbalances in the Eurozone, improving the positions of the countries in the periphery, and, if so, what measures should countries like the Netherlands take to bring this about?

Mr. Cottarelli - I can take this one. The question that you are raising I do not think can be answered directly. I think that all countries in the European Union have to do something to support the growth process. Some countries in Northern Europe have very strong current accounts. In a way, they can become an example for the other countries.

But, also given the size of these countries, I think for Europe what needs to be done is a matter of taking a decision on how to resolve the crisis. Communication and speed is critical.

QUESTION: You said that the Italian budget plan is sufficient to reduce the deficit, but the growth figures are still very, very low. Do you not think that in the long run also the objective of fiscal consolidation will be halted or not achieved, and, if so, what else should the government do? I am surprised you did not mention anything on health and the pension system. Is that because it is okay?

Mr. Cottarelli - Again, on the projections, interaction between growth and the fiscal projection for Italy, as I noted, the growth projections for Italy are quite prudent. So, it is not that we expect a very strong recovery of growth. In spite of this, we project the deficit to decline to about 1 percent of GDP in 2013. As I said, it is larger than what is projected by the Italian authorities by about 1 percentage point precisely because we assume lower growth. On the longer-term trends in public finances, Italy has already implemented very important reforms in the pension system and more recently has strengthened this—the numbers are published in the Fiscal Monitor—and has one of the lowest increases in terms of pension spending over the next 20, 30, or 40 years among advanced countries.

Italy has also one of the lowest projected increases in healthcare spending among advanced countries, because the current system has allowed it to contain healthcare spending in the past. It has worked quite well. Italy in the last 20 years has had one of the lowest increases in health spending as a share of GDP.

So, for healthcare spending and pension spending at the moment something has to be done but it is not the major problem. The major problem is the high level of public debt. Again, the current plan would allow a reduction in the debt to GDP ratio starting in 2013. The other problem is the low growth of the economy, I already discussed this.

QUESTION: In your view, how can policymakers say advanced economies can walk the fine line between over-cutting in the near term and shoring up badly needed growth. Secondly, in the United States, Obama's latest fiscal package with higher taxes for wealthy Americans stands a small chance to be passed by Congress with strong opposition from Republicans. So, in your perspective, can the United States get its house in order and also speed up its economic growth?

Mr. Cottarelli - It is a good question. What countries need to walk this fine balance is to clarify a medium term plan that first stabilizes the debt to GDP ratio and then brings it down. Once you have a credible plan, and by "credible" I mean not only targets but also measures to achieve those targets, in that case, particularly for a country that has a lot of credibility like the United States, then it is possible to slow down the pace of fiscal adjustment in the short run.

You also raised a question of whether there will be a consensus on the plan that has been put forward by the administration. That I do not know. I am not a political expert. What I hope is that a consensus will be found, an agreement will be found in Congress on a plan that ensures that the public debt to GDP ratio in the United States, which is now quite large, projected this year for the general government, that is the central government, local states and local government, to be about 100 percent of GDP. I think this plan should aim at stabilizing the debt to GDP ratio first and then bringing it down.

QUESTION: Mr. Cottarelli, on your table on page 30, which looks at the advanced economies and the general level of debt, it is striking to me that in the United States you are calling for a required adjustment of nearly 11 percent of GDP between now and 2020, nearly as large as what Greece is projected to need to do. The Bowles-Simpson plan and the President’s plan, they would cut the deficit by what percent of GDP? As a supplement to that, what is the likelihood of US interest rates rising dramatically if those debt projections persist?

Mr. Cottarelli - The overall cut that is discussed in terms of the plans you refer to in the next ten years is to cut the deficit on a cumulative basis by about 4 trillion. I want to underscore that our calculation in the table is an illustrative calculation. It looks at what would be needed by the United States as well as by other countries to lower the debt to GDP ratio to where it was before the crisis, in 2007. In 2007, the debt to GDP ratio was about 60 percent of GDP in the United States and the table is trying to show what would be the effort needed to bring the debt to GDP ratio down to 60 percent within 20 years.

So, there is nothing magic in these numbers. It is not necessary for a country to bring the debt to GDP ratio to where it was in 2007 within 20 years. A more modest target could be acceptable, could be appropriate.

What we wanted to underscore, however, is that there is a need not just to stabilize the debt to GDP ratio but to lower it. Over the long run, a country that has a high debt to GDP ratio—the the number that economists, including us, are considering is about 80 percent, 90 percent threshold... Clearly, countries with a debt to GDP ratio above those thresholds have a lower growth rate in the long run. So, 60 percent is not a magic number. It is a reference point. I think it was useful anyway to compare countries on the basis of this scenario.

QUESTION: I was wondering how would you advise governments to be able to deal with the need for fiscal adjustment and the growing social unrest around the world, and if you could elaborate on the situation in the MENA region.

Mr. Gerson - Let me answer the second of your questions and in the course of that answer I will respond to your first one as well.

Within the MENA region, the situation depends on whether one is talking about oil importers or oil exporters. Oil exporters right now are benefiting from high oil exports and in some cases from increased production. The challenge for them in the short term is to take advantage of these additional oil revenues and use them in a way that helps to develop the nonoil sector of the economy.

For oil importers, the situation is to some extent the opposite. They are now facing the dilemma of trying to stabilize public finances at a time when expenditure demands are quite high. One of things that they need to do is to move away from a system of generalized subsidies that are not sufficiently targeted to those who are most in need, and to move to a system of much more targeted subsidies where the money that is being spent is going directly to those who need it. There is also scope for greater revenue mobilization within some of those countries to try to stabilize the short-term fiscal situation.

From a longer-term perspective, for all of these countries, the challenge is to move to a growth model that allows for more inclusive growth; that is, for growth that addresses the problems of high unemployment, particularly among the young. That requires a whole different model of growth in some sense and ways to try to maximize human capital development and to try to focus on investment in areas that are consistent with developing the nonoil sector of the economy.

QUESTION: I would like to draw your attention to this report where you said that low-income countries have absorbed the increase in international oil and food prices without major stress on government finance. The question now is, how do you view the difficult economic situation in advanced countries where part of government financing in developing countries have been in the form of aid? How do you view that? Would not the difficult economic situation affect the inflow of trade that has been subsidizing the fiscal situation in the developing countries? If I can give you an example. In Uganda now we are looking at a fiscal deficit of about 13 percent of GDP. So, what is your view on that?

Mr. Gerson - Without commenting specifically on Uganda, I think overall the situation in low-income economies right now is quite encouraging. The crisis in 2008 was the first occasion where low-income countries as a group were able to respond with countercyclical policies and that was because of the significant improvements that had been made in improving the fiscal situation of those countries leading up to the crisis.

Over the last couple of years there has been steady progress on unwinding of that stimulus. That is expected to stabilize next year. Growth, nevertheless, in those economies, in low-income economies in general, and particularly in Sub-Saharan Africa, has been quite strong in 2011 and is expected to remain so in 2012.

I think the challenge for those countries, as in some of the oil importers that I talked about, is coming up with a model to deal with pressures for higher spending, particularly from high food and oil prices, in a way that is compatible with maintaining the fiscal balance over time. Again, the issues that I spoke to in the case of some of the oil importers in the MENA region in terms of moving toward more focused subsidies and away from general subsidies, and increasing revenue mobilization internally, which can also offset some potential loss of support, of external support, is all part of the package of dealing with it.

Another issue that we discussed in the Monitor is measures that can be taken to improve the efficiency of public investment. One of the things that is reported in a box in the Fiscal Monitor is a study done by the Fiscal Affairs Department that looks at the interaction between the quality of project management and the effectiveness of investment in boosting output. One of the things that we find is that better project management, not surprisingly, makes investment more effective.

So, another approach that low-income countries need to look at is ways to improve project management through more transparent purchase arrangements, through more effective overall management, from better processes and project selection. So, that whole combination of making better use of domestic resources by more targeted subsidies, by better investment management, and by generating internal resources more effectively can all contribute to keeping the positive momentum of growth in Sub-Saharan Africa and in low-income countries more generally.


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