Transcript of the Euro Crisis Seminar, April, 20, 2012

IMF News, April 21, 2012

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• Published: April 21, 2012

Common themes and macro context

• Monetary union convergence and divergence
  • Pre-monetary union (1995): wide spreads in 10-year bond yields; net international investment positions around balance.
  • Post-union convergence: large decline and alignment of interest rates by 2005; divergence reappeared with the European crisis (2010), with spreads widening most for countries with negative net international investment positions.
• Indebtedness dispersion in the euro area
  • The three program countries sit at the upper end of the euro-area debt distribution.
• Competitiveness
  • Measured by real effective exchange rate based on unit labor cost (vertical) and export growth (horizontal). Over the first decade of the monetary union relative positions diverged, with the three program countries showing competitiveness deterioration.

Greece — diagnosis, program design, and outlook (Mark Flanagan)

• Diagnosis and pre-crisis situation
  • By the eve of the crisis: debt north of 120 percent of GDP and a primary deficit over 10 percent of GDP.
  • Estimated overvaluation in the range of 20 to 30 percent.
  • Revenue effort dropped precipitously after euro accession; spending rose sharply, notably social transfers and pensions.
• Original SBA approach limitations
  • Remaining in the euro and minimizing contagion ruled out devaluation and debt restructuring as policy levers; program relied on fiscal adjustment and structural reforms.
  • Fiscal goal: raise the primary balance from a deficit of 10 percent to a surplus of 6 percent by 2014.
  • Country removed from bond market for 18 months to allow time for reforms and spread reduction.
• Structural reform implementation
  • Initial reforms: transportation sector and labor market job entry/exit costs.
  • Second-wave reforms (service market liberalization, wage flexibility) delayed by almost a year; competitiveness gains lagged projections.
  • After five years of deep recession, the Greek economy had not experienced deflation (GDP deflator outcome lagged projection).
• Deterioration and PSI
  • Late 2010–2011: ESM/PSI discussions introduced debt restructuring to the debate, undermining investor confidence; European recession reduced export demand.
  • General government debt was revised up by over 10 percent of GDP after program start.
• New program features (post-PSI)
  • Program financing and architecture:
  • IMF offered support through a 28 billion euros, 4-year EFF arrangement.
  • PSI: 53-1/2 percent nominal reduction in the value of bonded debt.
  • Debt relief from European partners combined with substantial new program support.
  • Competitiveness strategy:
  • Direct approach to improve unit labor costs by about 15 percent by 2015 (target to close competitiveness gap); further years needed to fully adjust price competitiveness.
  • Reforms include reductions in minimum wage and liberalization of collective bargaining.
  • Fiscal recalibration:
  • Pace of adjustment slowed in 2012 to account for up-front impact of structural reforms.
  • Endpoint primary balance adjusted down to 4-1/2 percent of GDP from 6 percent (4-1/2 being the level Greece maintained on average in the 5 years leading up to euro accession).
  • Projected debt trajectory:
  • Under program baseline (full implementation) debt could fall to in the range of 116 to 117 percent of GDP by 2020.
  • Alternative (adverse) scenarios: much higher debt in 2020 if reforms, growth, or external environment are weaker than baseline.
• Near-term process note
  • First program review scheduled after elections in early May; focus on identifying fiscal measures necessary to complete adjustment.

Portugal — diagnosis, program design, and status (Abebe Selassie)

• Diagnosis and balance-sheet dynamics
  • Net international investment position: moved from broad balance in 1995 to a deficit of a hundred percent of GDP by 2010.
  • Three key problems identified as of program start:
  • Very loose fiscal policy with large primary spending increases in 2008–2009; government debt around a hundred percent of GDP circa 2010.
  • Very high corporate and household leverage:
  • Non-financial corporate sector debt of the order of 150 percent of GDP.
  • Household debt about a hundred percent of GDP.
  • Loss of competitiveness since 1999–2000, concentrated in the non-tradable sector; tradable/manufacturing showed relatively better productivity performance.
• Program pillars and design
  • Fiscal: ambitious, frontloaded consolidation driven by loss of market access; after 2012 budget measures the government was 1-1/2 percentage points of GDP short of the terminal primary balance needed to be reached next year.
  • Structural reforms: focus on labor and product markets (employment protection, bargaining framework) after fiscal devaluation proved infeasible.
  • Financial sector: address deleveraging and bank leverage; loan-to-deposit ratio at about 150 percent planned to fall to 120 percent by 2014.
  • Credit and growth calibration: path of credit growth designed to mirror program GDP growth to avoid starving the tradable sector.
• Implementation and early outcomes (about one year into program)
  • Implementation: program targets met; strong implementation attributed to broad political consensus (tripartite agreement among government, trade unions, opposition).
  • Outcomes:
  • Current account improved by 3-1/2 percentage points of GDP in the first year of the program.
  • Export growth around 12 percent; improvement driven by exports rather than a contraction in domestic demand.
  • Risks: debt trajectory highly sensitive to growth and interest rates; shocks could lead to an uncomfortable debt path.
• Clarifications on financing and recession magnitude
  • No financing gap of 16 billion euros in the staff view; program remains funded as originally cast.
  • On recession: original program envisaged a short-term contraction of the order of 5–6 percentage points overall; between 2011 and 2012 the total contraction broadly matches program expectations though sectoral indicators differ (e.g., unemployment running higher than projected).

Ireland — banking-led crisis, program response, and risks (Ajai Chopra)

• Crisis characterization and macro outcomes
  • Crisis was primarily a banking crisis—classic boom and bust from rapid credit growth financed by wholesale funds and weak financial oversight.
  • Between the 2007 peak and 2010:
  • Real GDP fell by 10 percent.
  • Employment fell by 13 percent.
  • Fiscal measures before program: over 6 percent of GDP between 2008 and 2010.
  • Public debt before the crisis was under 30 percent of GDP.
• Banking sector and feedback loops
  • Banking support costs and contingent liabilities converted into sovereign liabilities; the sovereign–bank feedback loop was central.
  • Household debt over 200 percent of disposable income; high household deleveraging and mortgage arrears constrained domestic demand.
• Program architecture and bank recapitalization
  • Stress tests and recapitalization needs:
  • Rigorous stress tests, with loan-loss forecasts supported by BlackRock; central bank transparency emphasized.
  • Total recapitalization hole estimated at $24 billion.
  • Some private investment attracted; liability management exercises (LMEs) applied to subordinated debt.
  • Some failed-bank senior unguaranteed debt (e.g., Anglo Irish) was paid in full and consolidated into a new resolution company, creating public resentment.
  • Banking downsizing:
  • Deleveraging phased over three years; focus on reducing loan-to-deposit ratios and selling non-core (offshore) assets to limit domestic disruption.
• Fiscal consolidation and flexibility
  • 2010 deficit excluding bank financing costs: 11.5 percent of GDP; target to reach 3 percent by 2015.
  • Consolidation underpinned by a credible medium-term plan and strong ownership; the IMF allowed automatic stabilizers to operate on the revenue side.
• Outcomes and risks
  • Program implementation progressing well; program targets met and reviews completed on time.
  • Borrowing spreads and market access:
  • Two-year spread under 500 basis points (noted as a marked improvement).
  • Growth:
  • Positive signs: modest growth driven by exports.
  • 2011 growth: 0.7 percent (program projection 0.9 percent).
  • 2012 projection: 0.5 percent (program projection).
  • Key concerns:
  • Very high unemployment, much becoming structural.
  • Weak underlying banking profitability hindering lending revival.
  • Debt sustainability fragile if growth remains weak; scenarios where growth stalls (e.g., ~0.5 percent) would prevent debt stabilization.
  • Policy proposal highlighted:
  • Additional European support that could take direct stakes in banks (direct equity) without going through the sovereign to break the sovereign–bank loop.

Cross-cutting process, financing, and program design (Poul Thomsen)

• Troika functioning
  • Working as IMF, European Commission, and ECB: procedural complexity but benefits from three perspectives and checks and balances.
  • Debt sustainability analyses and program design benefited from multiple institutional inputs.
• Financing scale and currency-union constraints
  • Financing needs were exceptionally large due to high pre-crisis borrowing in a currency union and lack of exchange-rate adjustment options.
  • Pooling resources among troika partners allowed large-scale support and lessened adjustment depth for countries.
  • Europe’s commitment to support countries “for as long as it will take”—conditional on steady program progress—was highlighted as unprecedented.
• Policy mix
  • Troika converged quickly on diagnostics and policy mixes that aimed to avoid excessively procyclical policies; structural reforms are essential to program success, especially for Greece and Portugal.

Risks, scenarios, and investor perceptions (Q&A highlights)

• Greece market pricing and investor concerns
  • New Greek government bonds trading below par with wide spreads reflect short- and long-term uncertainty, including doubts about the pace and political commitment to structural reforms and tax administration improvements.
  • Political alignment of main parties in late 2011 noted as an important development; elections will test program support.
• Spain and cross-country comparisons
  • Caution against direct comparisons: each country’s underlying problems differ; program design is country-specific.
• Exit-from-euro considerations
  • Panelists emphasized strong political commitment in Europe to maintain the union; significant euro-area measures and financing have supported that commitment.
• Growth evidence and outlook for program countries
  • Portugal: export-led improvement (export growth about 12 percent; current account improvement of 3-1/2 percentage points of GDP in first program year).
  • Ireland: returned to modest growth in 2011 (0.7 percent); continued export-led growth remains critical.
  • Greece: internal devaluation targets (unit labor costs down ~15 percent by 2015) part of path to competitiveness; price-competitiveness improvements expected later in the decade.
• Financing gaps and program funding
  • For Portugal, IMF staff stated there is no 16 billion euros financing gap; program funding as originally cast remains intact.
• Bank regulation and capital treatment
  • Discussion noted proposals to change regulatory treatment of government bonds (no longer risk-free) and broader banking recapitalization/regulatory reforms—panel underscored potential implications but emphasized need for European-level decisions and further work.
• Central role of growth
  • Across all programs, growth is the central risk determinant for debt trajectories and program success; external euro-area and global demand conditions materially affect outcomes.

Transcript of the Euro Crisis Seminar, April, 20, 2012 — IMF EXTERNAL RELATIONS DEPARTMENT, Public Affairs

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References

• Spain and the IMF
• Greece and the IMF
• People's Republic of China - Hong Kong Special Administrative Region and the IMF
• Ireland and the IMF
• Italy and the IMF
• Portugal and the IMF
• The IMF and Good Governance -- A Factsheet
• Policy Support Instrument (PSI)
• Transcripts
• https://www.imf.org/external/spring/2012/index.htm
• PRESS CENTER
• https://www.imf.org/en/home