Concluding Statement of the IMF Mission on Euro-Area Policies
IMF News, June 20, 2011
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- Published: June 20, 2011
Overview
- Date: June 20, 2011.
- Context: Preliminary findings of IMF staff at the conclusion of missions in the context of the 2011 Article IV Consultation Discussions with Euro Area Countries. Missions include regular consultations under Article IV of the IMF's Articles of Agreement and other staff reviews of economic developments.
- Central assessment: A broadly sound recovery continues, but a sovereign crisis in the periphery threatens to overwhelm the favorable outlook and could spill over to the core of the euro area and produce large global spillovers.
Major findings on the euro-area outlook
- Divergence between core and periphery:
- A strong core is pulling ahead of a periphery facing very high debt levels, severe competitiveness problems, and fragile banking systems.
- Recovery character:
- Recovery in many ways is healthy, with growth better balanced in the core economies and becoming less dependent on public support.
- Potential growth needs to be boosted significantly across the euro area.
- Risks:
- Deeply intertwined fiscal and financial problems create the risk that failure to undertake decisive action could rapidly spread tensions to the core and cause large global spillovers.
- Uncertainty remains about the final outcome despite courageous policy attempts.
Fiscal policy recommendations
- Continue fiscal consolidation broadly as planned to support confidence.
- Implementation imperative:
- Ensure announced plans are implemented to meet the targets agreed under the Excessive Deficit Procedure (EDP).
- Role of automatic stabilizers and timing:
- Faster growing economies should let automatic stabilizers work and reach their EDP targets earlier than planned.
- Crisis countries may need to extend plans in line with program requirements, but consolidation must continue.
- Confidence effects from fiscal adjustment could be sizable for the euro area and global spillovers.
Crisis management and crisis-country policies
- Cohesive and cooperative approach needed to manage periphery crisis.
- Program countries must commit to:
- Immediate and far-reaching structural reforms.
- Ambitious opening of the economy to foreign competition and foreign ownership per program commitments.
- Privatization as supportive of debt sustainability and broader objectives.
- Financial support and instruments:
- Rapid implementation of the commitment to scale up the European Financial Stability Facility (EFSF) and extend its potential uses (e.g., to secondary market purposes and term funding guarantees) is needed.
- Close debate on debt re-profiling or restructuring quickly; avoid impressions that European Stability Mechanism support will be conditional on debt restructuring.
- Policies to stop contagion from sovereign debt adjustment or re-profiling are a priority.
Monetary policy and market functioning
- Normalization of interest rates should proceed gradually given recovery path.
- Gradualism helps keep inflation expectations anchored and limits stress from higher interest rates in the periphery.
- Unconventional monetary measures should remain in place until financial market tensions are addressed, including completing stress test follow-up and solving private illiquid asset funding problems.
- Many banks rely heavily on European Central Bank (ECB) financing; market access might not be immediate even after recapitalization.
Banking sector, deleveraging, and market finance
- Strengthening the banking sector is a top priority:
- European banking model traditionally has high leverage; capital positions must be strengthened fundamentally.
- The stress tests provide an opportunity; terms of follow-up need to be announced well before results are published.
- Preference for market-based solutions: private capital raising and cross-border mergers and acquisitions.
- Public support may be necessary and should be coordinated across the European Union (EU).
- Deleveraging and market-based finance:
- Re-develop securitization markets, appropriately regulated and based on high quality standards, to safeguard credit supply as banks deleverage.
- European regulators should support development of market-based alternatives for corporate finance to reduce dependency on the banking system.
- A conditional term funding facility for private illiquid assets, possibly operated by the ECB but with explicit backing of euro area sovereigns (e.g., via the EFSF), would smooth the transition while protecting ECB independence and reinforcing incentives to tackle banking problems.
Financial integration, regulation, and supervisory architecture
- More economic and financial integration is essential for a dynamic and stable EMU:
- Complete the single market; continue integration of labor, goods, and services markets; progress particularly important in capital market integration.
- Apply and review Directives for Cross-Border Acquisitions and Takeovers to overcome obstacles to free flow of equity capital.
- Strong and common rules required for the single financial market:
- Strong support for the single rulebook and rapid progress toward common supervisory practices focused on activity risk rather than institution location.
- Capital Requirements Directive 4 (“CRD4”) should implement Basel III swiftly and without exceptions.
- Capital requirements should be set at an ambitiously high level, with significantly topped-up capital demands on systemically important financial institutions.
- Consideration should be given to exceeding Basel III minima given an incomplete European financial stability framework.
- Maintain flexibility for macro-prudential tools to fend off future asset price bubbles, with the European Systemic Risk Board playing a prominent coordination role.
- Given market perceptions of sovereign risk, the zero risk weight for sovereign bonds in bank balance sheets will need to be reconsidered.
Institutional reform and crisis-resolution framework
- Faster progress toward a unified European financial supervisory and stability framework is beneficial:
- The European Banking Authority should become effective quickly to guarantee high supervision standards for cross-border banks, build a prudential database, and share data with national authorities.
- Accelerate progress toward an integrated framework for crisis prevention, management, depositor insurance, and resolution.
- Ultimate goal: a European Resolution Authority backed by a deposit guarantee and resolution fund to address burden sharing and provide a euro area-centered backstop for liquidity and solvency support.
- Governance and fiscal risk sharing:
- Without political union and ex ante fiscal risk sharing, stronger governance of the euro area is indispensable.
- Support efforts to strengthen the Stability and Growth Pact’s preventive and corrective arms and upgrade national budget processes.
- The Excessive Imbalances Procedure (EIP), European Semester, and Euro Plus pact should improve policy coordination and bolster political will for structural reforms.
- To be effective, governance tools need to be made more binding and relevant for national decision making (for example, through consistent application of Reverse Qualified Majority Voting).
- The in-depth investigation to start the EIP should be activated automatically based on a small set of scoreboard indicators, with the ensuing process operating under tighter deadlines.
- The European Parliament plays a crucial role in reform, but application should remain the domain of the Commission and Council.
Structural reforms to boost growth and competitiveness
- Execute a structural reform agenda emphasizing contestability and competition to bolster growth:
- Adjust tax and benefits systems, collective bargaining systems, and employment protection to increase labor market participation and create and sustain jobs.
- Open services and goods markets to lift competitiveness.
- Lower opening and closing costs for firms to improve the business environment and foster entrepreneurship, innovation, and productivity.
- In non-core economies, up-front structural reforms are particularly important to rebuild competitiveness, rekindle growth, and combat unemployment.
- Strengthen the banking system, develop capital markets faster, deepen economic and financial integration, and strengthen economic governance.
Global implications
- Success in addressing the sovereign crisis and raising growth in the euro area has significant external impact:
- A cohesive and cooperative approach containing the periphery crisis will limit global spillovers.
- An intensification of the crisis, especially if it spreads to the core, would have major global repercussions.
- Policies that lift the euro area’s growth potential would yield positive, though modest, external spillovers.
- Trade policy:
- The EU’s continued support for a successful completion of the Doha round of trade liberalization remains essential.
Concluding Statement of the IMF Mission on Euro-Area Policies (June 20, 2011)