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OCTOBER 1999 WORLD ECONOMIC OUTLOOK
Michael Mussa, Economic Counsellor and Director of Research
Flemming Larsen, Deputy Director, Research Department
Graham Hacche, Formerly Assistant Director, Research Department,
Currently Deputy Director, External Relations Department
Thomas Dawson, Director, External Relations Department
Wednesday, September 22, 1999, 9:00 a.m.
MR. DAWSON: Good morning, ladies and gentlemen. In order to reward punctuality, why don't we start?
Welcome to the press briefing on the 1999 World Economic Outlook. As in the past, the remarks are embargoed and the report itself embargoed until 11 o'clock this morning.
The WEO, as it's known around the building, draws extensively on the ongoing work of the Fund's area and specialized departments and is coordinated under the general direction of Mike Mussa, Economic Counselor and Director of Research. The WEO project is directed by Flemming Larsen, Deputy Director of the Research Dept, together with Graham Hacche, who has been the Assistant Director of the Research Department and has recently joined External Relations as my deputy.
Before we get underway, let me introduce our guests. Immediately to my right is Mike Mussa, to his right Flemming Larsen, and to the far right Graham Hacche. To my immediate left is Graham Newman, Acting Division Chief for Media Relations. And for those who don't know me, I'm Tom Dawson, the Director of External Relations.
Before we get underway, a few housekeeping matters. When you are recognized, please wait for the microphone to be presented to you, as we are making a transcript, which will be put on our Web site.
And now we'll turn the floor to Mike, who will have some opening remarks before we take questions. Mike?
MR. MUSSA: Thank you, Tom.
Well, for the first time in two years, we are in this World Economic Outlook reporting an upgraded assessment of global economic performance and prospects. We now anticipate that real GDP growth in the world economy this year will be 3 percent--that's seven-tenths of a percent above the estimate in the May WEO--and we expect with increasing confidence that growth in the world economy will strengthen further next year to reach 3.5 percent.
Those of you who were here a year ago will remember that the financial market turbulence post-Russian default and LTCM difficulties created a bit of tension in the global economy. Due in part to timely policy actions by the world's leading central banks, those difficulties were overcome. And that, I think,is one of the important reasons why today we are looking at a more favorable performance in recent months and solidification of prospects for more favorable performance going forward.
The U.S. economy, of course, has continued to perform quite strongly, and we anticipate that U.S. growth will hold up very well through the end of this year, will slow down somewhat next year, and one of the question is how much it will slow down and what may be needed to slow it down sufficiently in the event that that does not occur as a natural process.
In Japan, we have now seen two quarters of positive GDP growth, signaling a clear end to recession, with considerable assistance from public sector demand since late last year. We believe that a Japanese recovery is now underway; however, there are risks that that recovery could be knocked off course, especially if we were to see substantial appreciation of the yen from recent levels that might undermine business and consumer confidence. Nevertheless, we think the base for recovery of the Japanese economy has been set, and the outcome next year could well exceed not only our but also others' forecasts, provided that policy remains appropriately supportive of Japanese recovery in the near term.
In the euro area, an economy effectively the same size as the United States, we are seeing increasing signs that growth is beginning to pick up after the slowdown late last year and early this year. In emerging markets, the Asian crisis economies--leaving aside Indonesia, which has recently been experiencing renewed difficulties from a variety of sources--the Asian emerging economies are giving increased signs of strengthening growth performance, most spectacularly in Korea.
Latin America clearly is suffering a difficult period this year, but we expect a bottoming-out by the end of this year and an upturn in growth in Latin America next year.
Other emerging market economies--emerging market economies more generally--are presently still under tension from the sharply reduced flow of private capital to emerging market countries. And tension in this area appears to be, if anything, picking up some in light of concerns about Y2K problems or fears of Y2K problems.
But here, again, we expect that these difficulties will be overcome. Mr. Larsen will have a little bit more to say about that as he comments on some of the special topics that we discuss in this edition of the World Economic Outlook.
MR. LARSEN: Thank you, Mike.
I want to talk briefly about two of the topics we have analyzed in this issue of the World Economic Outlook. The first topic is a theme that is running through much of the report, and it's developed in particular in Chapter IV. It concerns the difficult but very important issue of safeguarding macroeconomic stability at low rates of inflation.
The achievement of approximate price stability in much of the world in the 1990s is a major accomplishment. But as we have seen in quite a few cases now, price stability by itself does not appear to be sufficient to ensure strong growth on a sustained basis. It is still a challenge to avoid macroeconomic and financial instability.
In this context, the report discusses both the policy challenges that are present when an economy suffers a protracted recession--policy challenges partly due to the zero floor on the nominal and, therefore, also on real interest rates at very low rates of inflation--and we also discuss the polar opposite case, the challenges of gauging the appropriate stance of monetary policy when prices of currently produced goods and services are stable, but when asset prices may be rising strongly.
The second topic I wanted to talk a bit about is the Y2K issue. This is a question that we take very seriously here at the Fund. There has clearly been a great deal of effort around the world among our member countries to address Y2K concerns, including more recently in the form of contingency plans if there were to be failures in critical areas. And we are particularly encouraged to see that central banks around the world are also adopting contingency plans, both by stocking up on currency in case there is an extra demand for cash toward the end of the year, but also by putting in place liquidity facilities in case the banking system demands additional liquidity toward the end of the year.
Here at the Fund we have been studying closely the potential consequences for our member countries and for financial markets, and this work is described in an appendix to Chapter I, which you may find interesting.
Our conclusions, I think, are really quite reassuring because the scenario and the sensitivity analysis we have carried out suggest that even on relatively pessimistic assumptions, there's good reason to believe that the consequences of Y2K problems should be manageable in most cases, both in terms of the impact on output and in terms of the impact, the potential impact, on financial markets and on foreign exchange reserves.
At the same time, we do recognize that there could be pressures and problems developing in some cases, not necessarily because of actual Y2K-related disruptions to economic activity, but even simply because of fears of possible problems developing. And we, therefore, have concluded that we need to be prepared to assist our member countries against this contingency.
A clarification of the Fund's policy in the case of Y2K pressures developing is in progress and is expected to be announced in connection with the Annual Meetings, perhaps in the next few days.
MR. DAWSON: Questions?
A QUESTIONER: Mr. Mussa, about Japan's monetary policy, you wrote in the Outlook, and I quote, "The main monetary policy levers still available involve liquidity injections to the banking system through, for example, open market operations and exchange market intervention."
Could you, Mr. Mussa, tell us how effective you believe those measures would be if taken by the Bank of Japan to achieve sustainable growth in Japan and prevent a further rise in the value of the yen? And what are the risks for the Japanese central bank not taking those measures?
MR. MUSSA: I think it's important to understand that the situation with respect to monetary policy in Japan that we confront today is not the usual situation confronting most central banks. We have an economy that has experienced its deepest post-war recession and is now beginning to recover. We have short-term nominal interest rates effectively at their theoretical floor of zero. So there's really no further room for monetary policy to affect economic conditions through the traditional channel of influencing short-term interest rates. That means that if monetary policy is to have an additional effect, it needs to look beyond the traditional measures.
Now, the question of whether it should, and how far it should, move beyond the traditional measures does depend upon what the economic situation is now and is prospectively going forward. I think we do have a recovery underway, and I don't think now is the occasion for extreme measures--for the central bank to buy real estate or other exotic transactions of that kind.
Normally, the exchange rate for a country like Japan is not a central concern of monetary policy--normally. But when your short-term interest rates are at zero and when the price level is stable or even declining, and when your currency has already appreciated very substantially and threatens to appreciate more, then I believe the central bank in its conduct of monetary policy needs to pay some explicit attention to the exchange rate.
If the rest of the world gives the indication that it wants to hold more Japanese yen--and this is the factor that is pushing up the value of the yen in terms of foreign currency--then the central bank can accommodate that demand to hold additional yen by creating the additional yen that people wish to hold.
This is sometimes described as "non-sterilized intervention." However, there need not necessarily be any rigid link between intervention in the foreign exchange market and the creation of base money.
However, I think in these circumstances, if there is intervention in the foreign exchange market to relieve unreasonable upward pressures on the yen, then to sterilize completely the monetary effect of those interventions is not really appropriate, that monetary policy should provide some support to actions designed to resist an unwarranted appreciation of the yen.
A QUESTIONER: Two questions.
Following up on Japan, given what you've just said and given the state of the yen and given the fact that there are discussions underway among central banks and finance ministries of the G-7 concerning possible joint action, which we are expecting in the course of the next few days to get more clarity on, is it, Mr. Mussa, your view that coordinated international intervention would be a good thing, would be desirable, would be necessary--would be an option that is worth considering seriously in the near term? That's question one on Japan. Is intervention on a coordinated basis in your opinion--I know that you can't tell the G-7 what to do, but in your opinion--would it be desirable?
A second question concerning the United States, two aspects there. The current account deficit and what in your view the risks of the current account deficit's current size might be in terms of U.S. economic growth and global financial stability: in particular, whether those, whether that current account deficit could have a precipitous impact on the value of the U.S. dollar and whether that might have an impact in turn on Wall Street asset values. And then, as you were mentioning the soft landing in the report on the U.S. front, what's your annual advice on U.S. interest rates and whether, all things considered, it would be a good thing for the Fed to move in one direction or another?
MR. MUSSA: Well, a lot of questions there.
First, on coordinated intervention, the G-7 countries do meet regularly to consider the situation in their economies and consider what, if any, policy actions might be in their joint interest to improve the performance of their economies and of the global economy.
Certainly the behavior of exchange rates is an issue which they have discussed in the past, and I expect that they will reflect once again on that issue now. We believe here in the Fund that over the medium term the dollar does need to correct downward if we are to adjust the U.S. current account deficit downward. It needs to correct downward against virtually all other currencies.
This year, so far this year, it has moved in the opposite direction against the euro; and over the medium term, that movement plausibly needs to be reversed and perhaps a little bit more than that.
We have already seen, since the spring of last year, a very substantial correction of the yen upward, from about 145 to the dollar to around 105 to the dollar.
If we take account of the further appreciation of the yen over the next four or five years that is already built into market interest rate differentials, then the yen is today about where it should be in terms of its medium-term adjustment path, and further significant appreciation of the yen from present levels would represent overshooting on an anticipated basis in the medium term.
Such appreciation of the yen also might have some meaningful effect in terms of forestalling a much needed recovery in the Japanese economy, a recovery that is being very strongly supported by fiscal policy action of the Japanese Government.
So this is a situation where it does make sense, provided credible means are available, to resist market developments that would undermine the preferred path of economic performance.
One of the difficulties with intervention is that if intervention has no backing at all or no perceived backing from monetary policy, then the markets tend to believe--and I think probably with good reason--that its effect will not be very large or very enduring. And there is a reluctance, and I think an understandable reluctance, in the official sector to engage in intervention operations which are not going to be perceived as effective. That not only embarrasses you in the short term, it tends to make that instrument less effective in the longer term.
So one of the key questions is: Well, is there going to be some type of monetary policy backing behind exchange market intervention? It would not seem at this stage that there is a powerful case for raising interest rates in the euro area as a means of resisting upward pressure of the yen versus the euro.
In the United States, I'll comment in a moment, perhaps a modest further interest rate adjustment would be called for. But the exchange rate of the dollar is not a problem for the U.S. economy or for U.S. monetary policy at this stage.
In contrast, the exchange rate of the yen, given the particular situation in Japan and the particular situation with respect to monetary policy in Japan, is much more legitimately a concern of Japanese monetary policy at this stage. I would have little doubt that if there was a clear indication that intervention policy was to be backed in a meaningful way by monetary policy, it would be effective and persuasive in the market.
Now, with respect to the U.S. current account deficit and the risks that it poses, first, I think it is important to understand that up to this point the growth of the U.S. current account deficit has not only been benign, it has been beneficial. The U.S. economy has supplied over the past 18 months or so roughly half of the total demand growth in the global economy at a time when demand growth in the rest of the world was quite weak, and has supplied somewhat less than that--but it's still been a net positive factor--over the past three years when, on average, growth elsewhere has been weak. And that has been a positive thing for the U.S. economy and for the global economy. But it has left the heritage of a large and probably still rising U.S. current account deficit that over the medium term must somehow be reduced.
Now, we discuss this issue in the World Economic Outlook, and we think there is an entirely plausible scenario where gradually, over the medium term, the U.S. current account deficit can shrink while the surpluses of Europe and Japan move in the opposite direction, and while with further recovery in Asia and other emerging markets, the large surpluses in the Asian emerging market economies contract somewhat along with their economic recoveries.
In order for that to happen, domestic demand growth in the United States, which has been running a little bit below 5 percent for the last three years, needs to slow significantly, to something in the range of 2.5 percent or thereabouts, a little bit below the potential growth rate of the U.S. economy, so that demand grows a little bit more slowly than output.
There are good reasons to believe that there will be, because of the increase in nominal interest rates, because of the reversal of real terms of trade gains, because of the end to the boost to consumption from mortgage refinancing and so forth, a natural slowing of demand growth in the U.S. economy. And the two interest rate increases that we've seen earlier this year from the Federal Reserve will contribute to that result.
Whether that will be enough to slow demand growth to the requisite extent in the U.S. economy remains to be seen.
Now, you asked about interest rate policy, our annual advice on interest rate policy. Well, we don't give annual advice on interest rate policy because interest rate policy is something the Federal Reserve sets every six weeks, and it does not make sense now to try and say, well, this is the path that interest rate policy should follow over the course of the next year.
The fact of the matter is we don't know and the Federal Reserve doesn't know how much or how little they may need to change the federal funds rate next year. It's certainly entirely possible that with 5 1/4 percent they could sail through the rest of the year and the natural slowing of the U.S. economy would take care of the problem.
My guess is that interest rates probably will need to become a little bit firmer next year than they are now in order to produce the requisite slowing in demand growth in the U.S. economy. That would forestall a rise on an enduring basis of inflationary pressures.
The judgment about how much is needed is something that does need to be made as the data comes in. At this stage, I guess my personal preference would be to take another step of tightening before year-end and then to be on hold through the Y2K uncertainties, and then to review the situation again probably in March or May of next year after we have a better sense of whether there's some weird inventory swing in the U.S. economy between the first quarter and--between the fourth quarter and the first quarter.
But there's no plausible case for a cut in interest rates at this stage, and there's no plausible case for a substantial increase in interest rates at this stage. Any significant action really needs to await evidence that significant action is called for.
A QUESTIONER: A couple of questions about the U.K. economy.
In the World Economic Outlook, you sort of heap praise, really, on the new monetary circumstances in Britain, the Monetary Policy Committee and the way it's acted. Yet there is a debate in Britain which suggests that perhaps it's acted a little bit too fast in raising interest rates again now, when they're already substantially higher than in most of the rest of Europe at a time when the manufacturing industry in Britain is still not yet out of recession. So that's the first question.
And the second question is: Britain seems to be building up some quite substantial budgetary surpluses at the moment, and we wondered if you as the IMF had any suggestions about how best those budgetary surpluses could be deployed in the same way as you make some suggestions in the report as to the how the U.S. surpluses could best be deployed.
MR. MUSSA: Well, of course, we have the ESAF/HIPC Initiative which is a deserving recipient of at least a modest part of budgetary surpluses. I think I'll ask Mr. Hacche maybe to comment on that a little bit more. But let me say a little bit about the interest rate issue.
There is a question about sort of the rhythm of monetary policy actions. In the United States, the Federal Reserve acts swiftly when swift action seems to be called for. But, typically speaking, the movements in the federal funds rates occur at roughly cyclical frequency, so you see long periods in which there's an upswing of interest rates and then long periods in which interest rates are basically moving downward.
The Bank of England seems to have adopted a more activist frequency for interest rate adjustments, being prepared to move much more quickly up and much more quickly down. And that may well be appropriate for the circumstances of the U.K. economy, which is somewhat different from those of the U.S. economy. So I think it remains to be seen.
It is important that the Bank be symmetric in its monetary policy response, particularly in an era of quite low inflation. That is to say, if it's going to be active in tightening when it sees the preliminary signs that inflationary pressures may be picking up down the road, then it needs to be--to act with equal alacrity if the signs move in the other direction.
The indications in terms of the management of monetary policy in the period of independence of the Bank of England suggest that they have moved in the direction of a more activist manipulation of interest rates than has characterized, say, the policy of the Federal Reserve or the Bundesbank for most of the past two decades or so. And it remains to be seen whether that is the best form of policy or not.
Certainly, it's possible to justify a quarter-point rise. It's possible to argue on the other side it is fundamentally in the nature of monetary policy that if you've got it right, there's a very good argument that you should move a little bit more in both of the directions that are possible. And the U.K. is probably in that situation now where one could make a good argument they should have moved and a good argument that they shouldn't have moved. And that's a sign that monetary policy is very near the appropriate stance given the present situation.
QUESTIONER: On fiscal policy?
MR. MUSSA: Let me ask Mr. Hacche to say a little bit more about that.
MR. HACCHE: Well, I don't think we would want to exaggerate too much the size of the surpluses in the U.K. To a large extent, they reflect the strength of the economy, and as you will see in Table 1.4 of Chapter I, what we call the structural balance, which takes out cyclical effects, shows that we are projecting rough balance next year rather than a large surplus. And, of course, tight fiscal policy does or should help the problem with the exchange rate that you referred to.
A QUESTIONER: I wanted to ask first of all how you explain the very sharp revision of your forecast for Hong Kong GDP this year? In the last year, you were predicting over 1 percent contraction. Now you are saying that there should be more than 1 percent growth. I am just interested to find out how there was such a sharp turnaround.
Also, on China, how sustainable do you think is the constant pump-priming that the government is indulging in to try and support the economy there is? Do you feel that the pace of restructuring that you have been calling for for several years in the banking sector, in the state enterprise sector, is happening quickly enough to avoid any recurrent sharper downturn in China which could, in fact, feed into the rest of the region?
MR. MUSSA: Let me ask Mr. Larsen to comment on those questions.
MR. LARSEN: Hong Kong's recovery shouldn't be seen just in isolation. It is for the entire region that we have been revising up our projections. Remember that at the outset of the crisis, there was a lot of talk about whether the Asian crisis economies would be experiencing a V, U, or L-shaped recovery. And the optimists, including some here in the Fund, particularly Mike Mussa, argued that it would probably be a V-shaped recovery. The pessimists thought it would be a U or perhaps more likely an L, a protracted downturn as we have seen in Japan for much of the 1990s.
I think based on where we are now, it is clear that Mike Mussa was right, once again, that what we are seeing in Asia is essentially a V-shaped recovery. It was a very deep, very severe recession that has been very costly, but we are seeing the type of rapid rebound that we have seen very often in other cases where countries have experienced a financial crisis.
As confidence returns, then there is also scope for a rapid recovery. And essentially what is happening in Hong Kong as in much of the region is that this pickup, this return of confidence, has moved the timing of the recovery up by one or two quarters and this can, of course, give you a huge impact on the annual growth rate that we report in these tables.
Regarding China, I think it is normal that when growth has been slowing as in China, there has been some concern about the ability to maintain the pace of structural reform. But I would say that in general we are very encouraged by the continuing commitment of the authorities to address the problems of the state-owned enterprises and to begin to restructure and reform the financial system.
I think it is our assessment at present that this process is essentially on track, that it is continuing but it is, of course, going to be a process that is going to take a number of years to resolve completely.
On pump-priming, I would say: up to a point. You are looking at an economy that has exhibited signs of mild deflation recently. And in such a situation, it is clearly appropriate to use both monetary and fiscal policy to stimulate the economy. But there are obviously limits to that, and this is why it is so important to get going with the restructuring and the reforms more generally.
A QUESTIONER: I would like to ask you please in Spanish.
Two very concrete questions. First, concerning the Latin American region. After Colombia declared itself in a recession, are we not going to, in Latin America, see again a movie that we have already seen many times--a recession, with all markets going to decline in a snowball effect? Is that the picture we are going to see again? Is it going to repeat itself again?
My second question concerns Mexico specifically. Do you think it is healthy for stringent monetary policy to continue to bring down inflation? This is something also that the Central Bank of Mexico is selling us but unfortunately this has eliminated the credit circuit, has prevented productive industries from recovering and we are in quite an adverse situation now. Inflation they say for the next year will be about 10 percent. And I would like to know if you could remove this monetary stringency and reactivate the economy and in some other way would it be possible for us to avoid the possibility of the currency being overvalued with this situation? What do you think, Mr. Mussa?
MR. MUSSA: Well, first, as a former advisor to President Ronald Reagan, let me say I am a fan of old movies, and I like to see them many times over and over again. Of course, Ronald Reagan's movies tended to have happy endings, and I think that in the case of Latin America we are going to be looking at a much happier ending of this decade that characterized the lost decade of the 1980s.
That being said, it does need to be recognized that South America is experiencing a particularly difficult year in 1999, to some extent because of common problems across the region, to some extent because of individual difficulties in particular countries. But the story is not all dark.
Many of us, myself included, expected the recession in Brazil to go on at least a quarter or two longer than has actually been the case. And the WEO forecast last May was for the economy to shrink about 4 percent. That was the forecast in the original Brazilian program of late last year. And the present WEO forecast is that the Brazilian economy has already hit bottom, and started to turn up. And so, the year-over-year number will be only minus one, and a number of private forecasters are revising their numbers up to around zero.
So, the recession in Brazil has turned out to be significantly less severe than was widely anticipated only a few months ago. At the same time, inflation in Brazil has been much less aggressive than was anticipated at the time the exchange rate was floated last January.
Now it is true that other South American economies, the other large South American economies--Argentina, Colombia, Venezuela and also Chile--are experiencing tough times, and in many cases it is by no means clear that the bottom has yet been hit.
However, as the experience after the tequila crisis, for Mexico and for Argentina, indicates, once the bottom is hit, the turnaround can be quite rapid. Now we do anticipate that stringencies in terms of the availability of capital through the remainder of this year are going to be a complicating factor for some of these countries. The IMF is considering this week putting in place a new facility that may help alleviate some of the Y2K-related credit stringencies.
But we think prospects after the turn of the year are for a significant upswing in most of the main South American economies.
Now with respect to Mexico, Mexico has been much better shielded from recent difficulties in emerging markets than have the other principal countries of Latin America. And growth in Mexico this year, partly sustained by continued strong exports to the United States, is well into positive territory, at around 3 percent, and that growth rate or something near that or a little bit better is expected to be sustained next year.
Your suggestion is that monetary policy has been particularly tight in Mexico. I think that that is mainly a misreading of the situation. It is true that the credit mechanism in Mexico has not been functioning very effectively for smaller businesses and households, but that is to a very large extent the heritage of the disruption of the financial system that occurred at the time of the 1995 crisis. And, as you know, Mexican banks remain with very large quantities of non-performing loans on their balance sheets. And as a consequence of the disruption in the banking and financial sector, they have to a large extent not gotten back into the business of intermediating credit.
Many other Mexican businesses, however, have been able to access credit through alternative means, including credit from the companies to which they supply exports and components. And overall, the Mexican economy has recovered quite strongly and consistently from the tequila crisis of 1995.
And the effort to bring down inflation gradually from the 52 percent that it reached in 1995, next year hopefully into the upper single digits, has not been an effort that has fundamentally undermined recovery of the Mexican economy.
That being said, the management of monetary policy with an eye on how the exchange rate is behaving, but without an effort to peg or control the exchange rate too minutely, does seem to be a policy that has served Mexico's interest pretty well in recent times. And, as I said, this has helped to shield the Mexican economy from some of the difficulties that have confronted other Latin American countries over the past year or eighteen months.
A QUESTIONER: Regarding Latin America and Argentina particularly, Mr. Larsen mentioned that the Hong Kong recovery is in some part due to the regional recovery. But according to your prediction, that is not the case in Argentina vis-a-vis Latin America. So my question is: Why are you predicting this very timid recovery for Argentina next year, when at the same time you are getting a much stronger recovery for Latin America in general?
In some parts of the WEO, you mention in the case of Argentina two conditions -- the flexibility of labor markets and the question of reform and the fickle relation between the central government and the provinces.
So my question is: What if it doesn't reform, because the present government was telling you basically in the last two years that it was going to do that? What if that doesn't happen? Is the present exchange rate arrangement sustainable?
MR. MUSSA: First of all, we need to keep in mind that the numbers that are reported in the WEO are the year over year forecasts. So what happens in the second half of 1999 has a very important influence on what the growth rate is, year over year, between 1999 and 2000.
The numbers so far do not yet indicate that we have a clear bottom to the recession in Argentina. And we are not projecting that we are going to have a sharp upturn in activity beginning either in the summer quarter, which is just concluding, or in the fourth quarter, of this year. We think the recovery will begin early next year.
Once it does start, the growth rate of the economy moving forward from the bottom of the recession will be more substantial, significantly more substantial than is indicated by the year-over-year number.
Now with respect to the issue of labor market reform, this is not an instantaneous cure to the recession in Argentina. And it was not put forward two years ago and three years ago on the basis that it was going to cure a recession.
The key concern over the medium- or longer-term is that Argentina does have the convertibility plan monetary policy, which ties the peso's exchange rate very tightly to the U.S. dollar. That we expect will continue to be Argentina's exchange rate and monetary policy.
If you are going to run that type of exchange rate and monetary policy, then it is very important to make your economy as flexible as possible so that it can react, and respond in a constructive way, to a variety of external and internal shocks.
If labor market reform is not pursued in Argentina, I do not believe the primary effect will be to forestall a recovery next year. I think we will get that from standard macroeconomic forces. But the Argentine economy will perform significantly less well over the medium- and longer-term if flexibility in the economy is not enhanced.
A QUESTIONER: This year, as usual, the WEO asks for more reforms in India. It seems to be an annual call. What happens if India goes at her own pace of pragmatic, slow but steady pace?
Secondly, there has always been a dispute between the Government of India and the International Monetary Fund as to how to define the public sector deficit. India says that you take into account only the central and state budgets, while the IMF also wants to take into account the public sector deficit. And the combined total this year is as high as 10 percent.
What will be a sustainable level of public sector deficit for India including the public enterprises?
MR. MUSSA: Well, since he did such a good job on China, let me call on Mr. Larsen to respond.
MR. LARSEN: Well, that is, of course, one comparison that one can make if one looks at India's long-term growth performance. It is true that India has been doing relatively well in this crisis. India has been cautious in opening up for short-term capital flows, and this has helped to shield India from the turbulence in financial markets.
But the fact that India remains relatively less integrated into the world economy than many other Asian countries also means that India benefits less from the positive forces of competition in world markets. And this is clearly one issue where the Fund is urging the authorities to proceed faster to open up more for trade and to liberalize the economy more generally through a process of structural reform.
The fiscal problems you mentioned indeed are a long-term issue. We have been debating this for years with the Indian authorities and we continue to argue that the very large borrowing requirement of the public sector overall is a very costly drain on the country's relatively moderate level of national saving. And it is clear that if India is going to grow faster, it will need much higher levels of investment in the economy generally and particularly in the private sector. And to finance those investments, you will need to reduce the public sector's borrowing requirement.
I don't think I want to suggest any specific number in terms of what is sustainable. But we would like to see it reduced considerably from the 10 percent GDP level that we have seen in recent years.
A QUESTIONER: I notice that in the WEO you have upgraded what you regard as the trend growth rate for America, which was very interesting. But I would like to ask if you have done a similar exercise for other countries. I am particularly interested whether you have done the same for the United Kingdom.
And in that context, could you make some comments on the new paradigm case for longer periods of strong growth?
MR. MUSSA: I think maybe I will ask Graham to comment on that subject, which is taken up really in Chapter III. We have in the Fund -- we continually reestimate both potential output and potential output growth rates, and some major revisions have been made recently not only for the United States but we have also examined other countries as well.
MR. HACCHE: As Mr. Mussa said, we keep this issue under review continually. There has not been an exercise similar to the research done on the United States conducted on the U.K. And I believe the staff's view is that the underlying growth rate, the trend growth rate, of the U.K. economy is in the 2-1/4 to 2-1/2 percent range, and that we have seen not much clear sign of an acceleration in the trend.
On the other hand, we think that there is clear evidence of an improvement in the behavior of the labor market. We are seeing far, considerably, lower rates of increase in wages at the very low unemployment levels that we have now than we have seen in the past, which does indicate the benefits of reforms that have been conducted over the past decade or two.
A QUESTIONER: IMF officials have endorsed a projection for up to 4 percent economic growth in Brazil next year. The question is: What is the interest rate necessary, the average interest rate necessary to achieve that type of growth next year in Brazil, assuming that it is lower than today's interest rates? How much room do we have to get there in light of a very slow pace of fiscal reform approval in Congress and the trend of increased interest rates in the United States?
MR. MUSSA: Well, Brazil is an economy that has for many years operated in a quite high real interest rate environment. Let us say, real interest rates on the order of 10 percent or even a little bit higher have been consistent with growth of the Brazilian economy.
Right now, the short-term SELIC rate is at 19-1/2 percent. The inflation rate going forward, the inflation target going forward, is in the 6 to 7 percent range, which would suggest that at the short end of the maturity spectrum real interest rates are 12 or 13 percent, which is a little bit on the high side of what one would like to see. And our hope and expectation is that, as confidence grows, that the Brazilian authorities will, in fact, be successful and consistently successful in achieving the inflation target for their monetary policy. There will be some further easing of financial market concerns and some further room for nominal interest rates to come down and bring real interest rates down to something in the range of 10 percent or hopefully a little bit lower. As I say, a range of real interest rates in Brazil in the past has been consistent with quite strong growth performance of the Brazilian economy. Obviously, a level of real interest rates which would not produce acceptable performance in the U.S. economy, but Brazil is not the United States.
Where I disagree with you to some extent is that I think significant fiscal actions have been taken since the crisis of last fall, and we are now anticipating that the primary fiscal surplus in Brazil will actually exceed by a modest amount what is in the IMF program.
And if further progress can be made in persuading financial markets of the permanence of fiscal adjustment, if there isn't substantial backsliding, then that too would increase the room for interest rates to come down and would reduce the interest burden of the government debt, which given the quite high level of real interest rates in Brazil is quite substantial. You have got a debt-to-GDP ratio of around 50 percent and real interest rates of 10 percent or higher says you have got a real interest burden of over 5 percent of GDP.
So, there is a fiscal dividend to be earned from persuading people that fiscal policy is indeed on a sustainable course for the longer term.
A QUESTIONER: The one area for which you have not upgraded your forecasts is Europe. And I was wondering if you could tell us what you think holds back the growth in the European economy.
You also mentioned that the euro needs to reverse its course against the dollar. I wonder if you could tell us what would be the factors that would do that as there have been a number of false starts on that, and if change in the respective cyclical position of the two areas would be enough to reverse that course.
Also, as it is almost a year since the ECB started operating, I wonder if you could give us an assessment of their monetary policy stance at the moment as it seems to have created an asset bubble in some countries and being strict enough to stifle growth in some others.
MR. MUSSA: Let me ask Mr. Larsen to comment on those issues.
MR. LARSEN: Europe was affected much less than Japan and many emerging markets by the recent turbulence in financial markets and the slowdown in world growth in general in 1998. We did see at the beginning of 1999 growth slowing significantly in a number of cases, and this explains the weaker growth performance in 1999 on average.
But there are clearly now signs that Europe has turned the corner, and indicators have been quite encouraging for a number of countries in recent months, suggesting that a pickup is underway and that the previous projection we had is likely to materialize. And I would not be surprised, in fact, if we were going to see a slightly higher growth rate in the second half of 1999 and in 2000 than the one we are projecting right now.
Clearly, the risks are more evenly balanced than we assessed them to be just six months ago. If you look at the previous report issued in May, we were still worried that there were downside risks in Europe and that growth could be weaker than projected in 1999.
Those risks have not materialized and we now think that recovery is underway. It is perhaps still not quite as robust as one would like to see. But so far indicators have been very encouraging for many countries. We are still seeing Italy lagging somewhat behind, and for Germany the indicators are still quite mixed also.
So, the overall picture is not quite as strong as one would like to see, but it is improving.
You mentioned the relationship between the exchange rate adjustment that one might expect over the medium term and the cyclical divergencies between the major currency areas. This is indeed a topic we have focused on in earlier reports and also in the present one. We do seem to observe among the many factors that are influencing the pattern of exchange rates some effect from the divergences in cyclical positions. And this indeed would be one of the key factors, I believe, that over the medium term would tend to reduce the misalignment in the exchange rates among the major currencies that Mr. Mussa spoke about earlier.
Monetary conditions in the euro area are clearly now supportive of the recovery that is underway. Interest rates were eased further in the spring, and this has been helping to get the recovery underway.
Looking ahead, if the recovery indeed now strengthens and picks up further through the end of the year and into next year, of course at some point the ECB will need to revisit and reassess the appropriate stance of policy. But for the time being, certainly through the end of the year, it seems unlikely that they would need to tighten interest rates, based on the current projections. But this obviously will need to be reassessed as more information comes in.
You mentioned the problem you can have in a situation where growth in Europe overall is beginning to pick up, but there is still a considerable margin of slack in European labor markets overall, but where some countries have been growing much faster than the average and in some countries they are also experiencing the problems of asset price inflation, runups in stock prices and in property prices.
How to deal with that? Well, it is clear that the monetary policy decisions taken in Frankfurt for the area as a whole cannot and should not expect to be at all times suitable for all the members of the euro area. This is why in the Monetary Union there has to be more emphasis on other policy instruments to help reduce the divergences that there can be in growth if these divergences threaten to be unsustainable.
And the primary instrument available in this situation is, of course, fiscal policy. And for the countries that have been growing very rapidly and they may be concerned about emerging imbalances, it is to fiscal policy that one should be looking in order to avoid the problems that can arise.
MR. DAWSON: Maybe two more questions.
A QUESTIONER: I have a question about Russia, if I may. I was a bit surprised by a line in your report that said the decline in the Russian economy appears to have been reversed. It is hedged around with all sorts of ifs and buts, but, nonetheless, I was somewhat surprised to see that announcement at this point in time with all the fuss that is going on about what they have done with the money and programs that have not worked, and just after the IMF has finally reached agreement to unfreeze the program.
Can you give us a bit more explanation as to why you think they have managed to do this?
MR. MUSSA: What clearly has happened is that they had a very sharp recession last year, mainly after the devaluation and default, when the bottom fell out of industrial production in Russia. Then, associated with the default, we had a very sharp decline in the value of the Russian ruble, which went from 6 something to the dollar, to 25 to the dollar. And initially, there was a large inflation reaction to the depreciation of the ruble.
But where we are now is that the ruble is worth about 25 percent of what it was before the devaluation, and the price level has gone up by a factor of 2 or 2-1/2. So in real terms, the ruble has depreciated enormously. And that has made a lot of domestic goods-producing industries in Russia that previously had difficulty competing with imports much more price-competitive. And there has been a surge of output in those import-competing industries behind the protection of a very much depreciated real exchange rate, and recovering from a collapse that occurred late last year.
This is a situation that is not unknown in other countries as well. When you get a big real depreciation, it tends to make a lot of your industries a lot more competitive and we are seeing the results of that.
Also, despite all the talk about the corruption and the money that has been diverted or stolen or what have you, the fact is that fiscal policy has improved in Russia from where it was last year. Both total revenues as a share of GDP and cash revenues as a share of GDP are up, and the Russian Government is now running a primary surplus, not a huge primary surplus but a moderate-sized primary surplus, which means that on balance they are paying back their creditors, not taking on net new credits.
So I think what has happened in Russia is not entirely surprising in light of the depreciation that has been contained in nominal terms, but has been substantial in real terms, in terms of a monetary policy that has controlled the inflationary reaction, and in terms of a fiscal policy, which, while I think it is still quite weak in terms of its capacity to raise revenue to satisfy essential public goods' needs, has improved from where we were a year ago.
Now that has not made all of the problems of corruption and non-payment and all the rest of it disappear from Russian economy and society, but I think the improvement we have seen is not inconsistent with what one would have expected in light of other developments.
MR. DAWSON: Last question.
A QUESTIONER: My question is: Argentina intends next year to reduce the fiscal deficit, which grew in 1999 to $4 billion. I think to achieve this, there must be a fiscal burden reduced and tax quotas as well. So, my question is: How our country meets with the IMF and other agencies in working on a new loan for between $10 billion and $15 billion for our country? What is the purpose of this loan if Argentina in the crisis last year did not have the ESAF loan and preferred to finance itself from markets paying a high interest rate?
MR. MUSSA: The Fund has an outstanding arrangement with Argentina, which has been in place for some time and which will be coming to an end reasonably shortly. And our anticipation is that after the election and after the new government is installed, there will be discussions with the new government on a possible successor program.
Very likely, if there is such a successor program, it will be an extended arrangement, because a key aspect of it will be what we discussed earlier, the labor market reforms and other structural reforms to improve the flexibility and performance of the Argentine economy in the medium- and longer-term. And that type of multi-year financial arrangement will have a kind of headline figure,which is associated with the total size of the program over probably a three-year horizon and, consistent with the Argentine economy and the Argentina quota in the Fund, that figure that runs toward the level of $10 billion would not be inconsistent with normal Fund operations.
So we are not talking here about a Brazil-type program, a crisis program, but rather a multi-year extended arrangement to support an ongoing process of structural reform.
With respect to the fiscal deficit, of course, the fiscal deficit has grown this year. To a large extent, that has happened because of the weakness of revenues in the light of the unanticipated recession which has beset the Argentine economy. And we would anticipate that, as the economy recovers, there will be some natural improvement in the fiscal position.
It will be essential, however, to address a variety of structural fiscal issues in Argentina, including yet another look at the relationship between federal and provincial levels of government and the nature of their fiscal interrelationships.
MR. DAWSON: Thank you very much.
Remember, we have an embargo until 11:00 a.m. this morning.
[Whereupon, at 10:06 a.m., the press conference was concluded.]
IMF EXTERNAL RELATIONS DEPARTMENT