Transcript

Washington, D.C.
Friday, October 10, 2014

Participants:
Poul Thomsen, Acting Director, European Department
Mahmood Pradhan, Deputy Director, European Department
Phil Gerson, Deputy Director, European Department
Aasim Husain, Deputy Director, European Department
Jörg Decressin, Deputy Director, European Department

MS. GAVIRIA: Good morning. Let me introduce the speakers. In the center, Poul Thomsen, Acting Director of the European Department; to his right, Mahmood Pradhan, who is Deputy Director in the same department; to Poul’ left is Phil Gerson, also Deputy Director; to his left, Aasim Husain, Deputy Director; and finally, Jörg Decressin at the end of the table, also Deputy Director in the European Department. Poul will start with some remarks and then we’ll move to your questions. Poul?

MR. THOMSEN: Thank you very much, Angela. Good morning to all of you and thanks for joining us here this morning. Before taking your questions, let me provide some context on developments in Europe, touching on a few key topics.

Let me start in the West. Western Europe continues to grow, but second quarter and subsequent high-frequency data suggest that the European economy, especially the euro zone, is facing stronger headwinds than we had expected at the time of our spring meetings here in Washington. For sure by comparison to where we were a few years ago in 2011 and 2012, Europe has certainly turned the corner, but the recovery is weaker than we had hoped for. Domestic demand is recovering too slowly, with some notable exceptions, and external demand has also disappointed.

On the positive side, financial market conditions have improved, especially for sovereigns and to a lesser extent for corporates, too. The euro has depreciated in real effective terms. These latter factors should provide an impetus to growth.

Taking all of this into account, on balance, what does it mean? We have marked down our forecast and now expect the euro area to grow by 0.8 percent this year, down from 1.2 percent in our spring forecast. Assuming recovery elsewhere in the world as forecast in the World Economic Outlook, we still expect a gradual acceleration of activity in the euro area -- growth of 1.3 percent in 2015 and 1.7 percent in 2016.

As to inflation: We project euro area inflation of just 0.5 percent, almost a half percentage point lower than we did in April, and indicators of inflationary expectations have been declining. This, of course, raises worries about the possibility of inflation expectations becoming unanchored and an extended period of very low inflation. This would make it much more difficult for those countries that have to reduce a still excessive public sector debt burden; it would make it much more difficult for households and companies to clean up balance sheets; and it would make it much more difficult for those countries in the euro zone that still have to deal with competitiveness problems. An extended period of high real interest rates is clearly not what Europe needs now.

What are the policy implications of the outlook? On monetary policy, we welcome the wide-ranging step by the ECB to counter low inflation and support demand, and its willingness to take further action if needed. As I said, experience has shown that it’s very hard to get out of a situation with low inflation or very low inflation, and attendant low inflationary expectations once they get entrenched.

Fiscal policy is in aggregate now only slightly contractionary for euro area countries, striking a much better balance between demand support and debt reduction. In the event of further negative shocks to our revised baseline, automatic stabilizers should in our view be allowed to operate.

Structural reforms: The need for structural reforms to boost potential growth and address weaknesses is, of course, well recognized, and the potential for early payoff has been demonstrated by Spain and Ireland, two relatively bright spots in the current situation. Operating on all these fronts is essential. It’s particularly important to persist with strong structural reforms. Beyond the direct benefits of higher potential growth, progress on structural reforms is critical to building and sustaining broad political support for accommodative monetary and fiscal policies in the euro zone. It might be obvious for those looking at the euro zone that there is a demand issue. For those who understand the political economy of Europe, it’s equally obvious that an essential political precondition for Europe’s ability to deal with its demand problem is that structural reforms are pursued vigorously now.

Let me turn to the East. We are releasing today our Regional Economic Issues update for Central Eastern and Southeastern Europe. It shows that geopolitical tensions are beginning to take a toll on the region. We have marked down our forecast for growth in 2014 to 1.2 percent from 1.8 percent in April. The largest markdowns have been for Russia and other CIS countries where the effects of Russia-Ukraine tensions and related sanctions are most acutely felt.

However, while growth is slowing in much of the region, we are seeing acceleration in Central European countries on the back of stronger domestic demand.

What are the risks to the outlook in the East? First, there are two risks that stand out now. First, as mentioned, geopolitical tensions and sanctions are having a marked impact on Russia, Ukraine, other CIS countries and the Baltics. Direct effects elsewhere in Eastern Europe and also in Western Europe have been more limited to date, but there are signs of broader negative effects on confidence that bear very close watching. Further, given the region’s very high reliance on energy imports, any price hikes or lengthy disruption in oil and gas supplies could have potentially serious consequences. Secondly, developments in the euro area are very important for Eastern Europe through low imported inflation, potentially weaker export demand, or lower financing and investment flows. These two risks come on top of the ongoing need to repair private sector balance sheets, bring down high levels of nonperforming loans, and the possibility that a tightening of global financial conditions could lead to market volatility.

As to the policy implications, I’ll be very brief. Reducing fiscal and external imbalances as well as enhancing the credibility of policy frameworks will put the region in a much better position to withstand these potential shocks, including from financial market volatility and possible further weakness in Western Europe. Throughout the region there is scope to raise growth prospects and lessen vulnerabilities, whether by tackling NPLs or high private debt burdens, or completing the transition agenda to improve efficiency and transparency.

On the latter issues, while the transformation in the region has been astounding in many respects, there’s still much to do; the convergence of incomes with Western Europe was largely put on hold during the global crisis. These countries, thus, still have very significant untapped potential for catch-up gains in productivity. How to unlock this potential will be an important focus of a conference that we’re having in Warsaw in a few weeks, co-hosted with the National Bank of Poland, on the occasion of the 25th anniversary since the fall of the Berlin Wall. I hope that you’re going to join us there.

Let me stop here and we’ll be happy to take your questions.

QUESTIONER: Two questions, if I may. First of all, how concerned are you about the recent data on Germany? How do you assess the risk of a slowdown? And second, what’s your take on how much more effective the ECB’s ABS plan would be if they managed to secure guarantees from governments on the mezzanine tranches of ABS?

MR. THOMSEN: Mahmood, these are both in your area.

MR. PRADHAN: Thank you. On your first question on Germany, as you will see from our World Economic Outlook we are quite concerned about the slowdown, particularly for euro area economy as large as Germany. We have revised down our forecast. The negative Q2 numbers have been followed by a number of soft indicators that point to further weakening in Germany, and I think this speaks to Poul’s general point that the euro area recovery looks much weaker than we had anticipated last spring.

Your second question was on the mezzanine tranches. It would be more effective if member states were able to provide guarantees on these tranches. It’s not clear to us at this point how this will come out. The discussions as you know are still going on. There may be one or two countries that are willing to put those guarantees in place, but across the euro zone it’s not a decision that most member states have taken yet.

QUESTIONER: My question is about the growth forecast for Portugal. It was one of the few I believe in the euro zone where the forecast was trimmed for this year. I would like to know what were the reasons for that, what has been done wrong, and what can be done better? Thank you.

MR. THOMSEN: On growth in Portugal, the external environment is somewhat more adverse than when this forecast was made, particularly a slowdown in the contribution to growth from the external sector. I think this points to the need to continue with policies that began under the program, to continue with a reform agenda, and stick to the path of gradual fiscal consolidation. So I don’t think there’s any other policy lesson than to continue what Portugal has done under the program.

QUESTIONER: Was there something done wrong?

MR. THOMSEN: No. As I said, the external environment is somewhat weaker. That’s it.

QUESTIONER: Hello. Could you be more specific on the structural reforms you’re calling for? For instance, if they’re related to the liberalization of the labor market, do you think that the countries will have enough support in the population to pass this reform?

MR. THOMSEN: The nature of the reforms I think are generally well understood. We published a book on it in the past year. I will refer you to that. It’s broad ranging reforms. It’s implementation of the Services Directive, product market reforms, labor market reforms, and varies from country to country. Italy, for instance, is doing labor market reforms right now that we think are very important. I understand that some of these reforms will be difficult, but I also think that by showing a determination to do these reforms, even if it’s gradual, a strong determination to do these reforms can actually have a relatively important and early impact on growth. As I mentioned, Spain is a good example of it. And, again, it’s not just a question of the political support in the affected countries, but political support inside the euro zone more generally for accommodative policies is very much linked to the willingness to do these reforms.

QUESTIONER: I was wondering whether you could elaborate more on the procedure for precautionary support that Madame Lagarde mentioned yesterday so we can understand whether it’s a new agreement, an extension of the existing one under new terms, or the same terms. Is there a transitional phase that eventually leads to exit? Is it another credit line from the IMF and ESM?

MR. THOMSEN: I don’t have much to add to what the Managing Director said yesterday. The good news in Greece is that it is gradually regaining market access, as we have seen. The fact is that market access still is somewhat precarious, as evident from the fairly significant increase in spreads recently. So our view is that in that situation, it’s preferable to keep some kind of relationship. As the Managing Director said, it’s an evolving relationship and discussions are getting underway. So I have nothing to say on concrete modalities at this stage.

QUESTIONER: The Greek government has made clear its intention to exit the IMF program. My first question is: have you been officially notified of such an intention? And the second question is if that happened, in the following days or weeks will that affect the sixth review? Do you believe that in such case the sixth review will not be completed?

MR. THOMSEN: We have not received any official notification about cancellation of the arrangement. As you know, the discussions on the review are just getting underway, and we had some technical discussions before the Annual Meetings. A review is both backward and forward looking. To complete the review one would need understandings on objectives and policies going forward and on the framework for implementing these policies. That discussion is starting.

QUESTIONNER: What do you see as three main challenges for the new Slovenian government to sustain the growth momentum that was seen in Slovenia this year? Do you think that this growth is sustainable?

MR. GERSON: As you pointed out, Slovenia, after a very deep recession, has now managed to turn the corner and output is beginning to grow. In terms of the three priorities for them, they need to continue cleaning up the banking sector and proceed with corporate restructuring. They need to work to continue to solidify the fiscal stance. The deficit is elevated. In addition, the debt ratio grew substantially, partly related to bank recapitalization costs. So they need to work to continue to restructure the corporate sector and the financial sector and particularly the state financial sector. They need to reduce the fiscal deficit. And the third element is to proceed with privatization. As you know, the Parliament has approved a list of 15 enterprises that are slated for privatization in the near future and we see that as important, not just to provide resources to the budget to help bring down that high debt ratio that I mentioned, but also as a way to stimulate FDI and productivity growth to establish the basis for growth going forward. So I would lay those out as the three main priorities for the new government.

QUESTIONER: My question is about potential growth. I would like to know what is the target forecast for potential growth in the next years, and what are the main reasons for the slowdown this year.

MR. DECRESSIN: I don't have the exact numbers for potential growth with me right now but it's clear that potential growth has been slowing, partly because actual growth is slowing, so you have unemployment moving up, people becoming detached from the labor market. It proves hard to get them back into the labor market and that means that there is less potential growth for some time. We call this the hysteresis effect and that's why it's very important that we step up the fight against unemployment in Europe. The second challenge for Europe is of course, and we emphasize this all the time, the implementation of more structural reforms to stem the decline in potential growth. In about five to ten years populations will be aging at a faster pace and so growth will be slowing even further, and that's why we are stressing the importance of structural reforms, not only to get out of the crisis but to put Europe on a stronger growth trajectory over the medium to long term.

QUESTIONER: What has Spain done to be in such a bright spot right now from the last meetings? Also, now that the labor reform is completed, some international agencies are saying that maybe it's time to increase salaries. Do you agree with that? And then with a 40 percent possibility of a recession, should Spain do more to avoid going down with the rest of the euro zone?

MR. THOMSEN: I will ask Phil to answer this. I said it was relatively a separate bright spot.

MR. GERSON: As Poul mentioned, Spain is a relatively bright spot in Europe, and I think the authorities have done a number of things well. I would point in particular to the recapitalization of the banking system, which was extremely effective under the financial program; the labor reform has been an important step forward. The public finance authorities have made important steps to improve public finances, so I think Spain has done a lot well. The benefits of that are showing up in the restoration of growth. To your question about wage moderation, the challenge for Spain going forward is to sustain the growth that has finally come and to deal with the unemployment crisis. I use the word crisis advisedly because there was a dramatic jump in unemployment during the downturn, something close to one in five Spaniards lost his or her job during the downturn. So the challenge for Spain is to keep growth going and to keep employment recovering. That means preserving the competitive gains that they've made and continuing to ensure that as opportunities arise, firms, are able to respond to expanding business by taking on new workers. Part of the recipe therefore has to be continued wage moderation. That's not the only element of the recipe and it comes back to your question about what Spain has done well. What does Spain need to do besides that? Spain needs wage moderation but it also needs reforms to improve the business environment further, to enhance efficiency. It needs training for the unemployed to make sure that they have the skills that they need to get back in the labor force. There are changes to the tax code that could be adopted to reduce the cost of hiring low wage workers or low skilled workers. So again, wage moderation is part of the recipe, but it's not the only ingredient in the recipe. And in terms of what Spain needs to do to avoid the risks of a double dip, Spain needs to keep doing what it's been doing and it needs to take action on that set of priorities that I've just laid out. I think those are the best guarantees the Spanish authorities can have that growth will continue going forward.

QUESTIONER: The ECB seems to think that credit will pick up in the euro zone once the comprehensive assessment of banks is out of the way, and with their measure that they've done recently with credit easing. Is that a view that you share? And I have another question on the same subject. If you talk to national authorities, especially national central banks, they seem to think that everything's fine with the state of health of their banking sectors; yet if you read the GFSR, it paints a much less optimistic view of the health of European banks. Could you please elaborate on this?

MR. PRADHAN: On your first question, credit has been very weak, very subdued. But the most recent data suggest that the slowdown in credit is moderating. So we're at some kind of bottom here. It should start recovering. How fast it recovers from here is very difficult to tell. That's partly to do with what you pointed to in your second question, how able are banks to extend credit. But also, what we have been emphasizing is the weak demand in the euro area; credit is also very weak in those economies in the euro area that have not suffered from some of the banking system problems or financial fragmentation, so it's not only a function of the health of banks. Following the AQR, it is quite clear that given the timetable the ECB is going to follow, the banks that are short of capital will have to come up to the required level in a fairly short space of time. We're talking about six months or so, six to nine months depending on their particular results, whether it's the actual AQR or they're short of capital under the stress scenarios. We're looking at a fairly short space of time to restore banks to adequate capital levels. So in principle yes, credit conditions should improve.

Secondly, the ECB's current measures of targeting credit, providing banks with a very favorable cost of finance with the TLTROs should help banks to meet the credit demand. In terms of your second question about what the national central banks say and what the GFSR says, you should wait to see what the AQR results give in terms of the specific condition of banks in the euro area, which banks are short. And of course we, like you, don't know what the results will show. But we'll wait to see what they come up with and how quickly banks can raise capital.

Finally, we're just not waiting for one snapshot assessment. We have to bear in mind that over the last year or so, while the AQR process has been underway, banks have raised a very substantial amount of capital already. So it's not like they're just going to wait and see. You will have seen figures that the ECB has released, but they're also in the GFSR. We're looking at something in the region, in excess of 50 billion just in the last nine months, which we should not ignore in terms of how banks are becoming stronger as we go forward.

QUESTIONER: Do you have or already received any good or bad news from the Cyprus program? For example, the results are better than expected until now? But some politicians in Cyprus say that this will not continue, that your predictions will once again prove wrong, and this time on the negative side.

MR. GERSON: Developments in Cyprus so far in the program have been stronger than we had expected. Output has declined. Output is continuing to decline, but the decline is less deep than we had projected and in fact we have reduced our estimate now for the amount of the contraction this year. And fiscal performance under the program has been, again, better than we anticipated, partly reflecting the stronger macro environment. So our experience under the Cyprus program has been that things are proceeding quite well. There's still a significant amount of work that needs to be done in Cyprus, including in particular dealing with the very high level of NPLs in the banking system. But we are quite encouraged by the progress in Cyprus so far and are pleased with what's been accomplished and look forward to working with the authorities on the remaining challenges.

QUESTIONER: I know you've already talked a little bit about Ukraine, but if you can give us some sense of the different potential places for the financing for Ukraine that Madame Lagarde spoke about yesterday. Are we talking about debt reprofiling? Is that needed at this point, as many economists suggest? And secondly, can you elaborate on what sort of flexibility Europe should be showing in terms of fiscal consolidation, how we should see that in light of the deficit targets?

MR. THOMSEN: On Ukraine, let me give a little bit of background. You know, clearly the Ukrainian program is facing significant headwinds, but we also need to recognize that they have some good news here. We have a government that has shown a very, very strong determination to stay with the program. We do not have the early implementation problems that we had on the previous programs. And to give you an example, for instance, the fiscal targets are being met, despite the fact that the government is not collecting taxes in part of the country, and despite the fact that there is a need for higher security spending. Fiscal targets are being met and I think it speaks to the government's determination. Now, it is a situation where there is major uncertainty and we are seeing that there are capital outflows. We also see that the conflict is beginning to take a toll on the real sector on exports and on imports, spreading all the way into the balance of payments and into funding needs. So what Madame Lagarde was referring to is that we do see a somewhat higher financing need. It is too early to say how much. The mission will go out there after the election and review the program. The only message here was that Ukraine's international partners need to start thinking about how they can provide more support for the country. On the fiscal question, Jörg, do you want to answer that?

MR. DECRESSIN: Europe has already made a good deal of progress with respect to fiscal adjustment. Our estimate of the structural fiscal balance for the euro area in 2013 is close to a deficit of a little over one percent of GDP, which reflects a very large adjustment that's taken place since 2010. Looking ahead to 2014 and 2015, we foresee much less structural adjustment. We think that given the economic situation in the euro area, this is broadly appropriate. As a result, some governments will meet their deficit targets. Others may miss them because growth turns out to be unexpectedly low or inflation turns out lower than expected. But we think that this should not be made up with new measures. What is in the current programs for fiscal adjustment in Europe is broadly appropriate.

MR. TALLEY: Thank you and I'm sorry, Poul, would you mind commenting on the debt reprofiling need in Ukraine or not?

MR. THOMSEN: Yes, that is not under discussion.

QUESTIONER: Hi there. Part of this debate on growth in Europe at the moment is centering around President Juncker's 300 billion investment plan, and one of the ideas on the table is to perhaps recapitalize the EIB and certainly for the EIB to take more risk, which is drawing into question its risk profile and its rating et cetera. Did you feel that the EIB should be encouraged perhaps to increase its risk profile in order to spur growth, considering it doesn't seem to be coming from the private sector at the moment? Thank you.

MR. PRADHAN: Yes, we're very supportive of efforts like building the infrastructure investment fund and encourage the public sector entities to take part in it. The EIB is already extending a substantial amount of credit per year, within the current capital that it has. So the EIB can contribute somewhat to this but at its current capital level I'm not sure that it can contribute the amounts that we're talking about.

QUESTIONER: Do you think this is the right time for the country [Greece] to exit the program and look for resources in the markets? Also, are you concerned about the political turmoil right now in the country?

MR. THOMSEN: I think this is more or less the same question that we had at the beginning. As I said, market access has certainly improved during 2014. But it's still a fragile situation. And in view of that, some sort of program engagement, precautionary program engagement is, in our view, advisable. On the exact modalities, as the Managing Director said, it’s an evolving relationship and those will have to be discussed.

QUESTIONER: It strikes me that some of the positive things that you mention about Spain have also happened in Greece, like the recapitalization of the banks, the labor market reforms, the fiscal adjustment… and I'm wondering, what's the difference between the two countries? Is it the high debt that some at least still deem not to be sustainable?

MR. THOMSEN: There's no doubt that in absolute terms, both in terms of the fiscal adjustment that's been undertaken and the financial reforms that have been undertaken, Greece has probably done more than anybody, no doubt about that. But the starting position was also, of course, so much worse. On the fiscal, Greece started with fiscal deficits that were above 15 percent of GDP and with strong deep structural problems. So Greece, unfortunately, because of its starting position, will have to do more in absolute terms.

QUESTIONER: If I understood well, Mr. Decressin said that in the next coming years, for some economies, and I assume like Greece, Ireland, Portugal, you would expect not as many restrictions on the fiscal side. Would that be the case for Portugal? Do you see that as a possibility? Also, is there room for Portugal to cut taxes next year? Do you have any recommendations on that side? Thank you.

MR. THOMSEN: And so the question is on taxes?

QUESTIONER: Yes, and on fiscal budget.

MR. THOMSEN: We think that Portugal should stick to the fiscal path that was agreed in the context of the program. As you know, there are a number of constitutional court decisions that make achievement of these targets more challenging. So I think it should be a priority to take whatever measures are needed to stick to these targets before one starts considering tax cuts.

QUESTIONER: I have questions about Macedonia economy. The growth forecast is the biggest from the region of west Balkans, 3.4 percent this year and 3.6 percent next year. Why is this a good forecast and where do you see the main risks for the Macedonian economy? Thank you.

MR. GERSON: As you pointed out, the forecast for Macedonia is quite strong for growth for this year and next. We believe that the authorities should see this as a window of opportunity to undertake reforms that need to be done. And I would point to two of them. One is the need to establish a fiscal anchor and to come up with a series of deficit targets consistent with that, and also consistent with rebuilding the fiscal buffers which are an essential part of the exchange rate arrangement. So part of the goal is to establish a fiscal anchor and lay out deficit targets that are appropriate.

The second part of the challenge is to improve the business environment. To me, one of the things that's striking is that the authorities have set up a number of special zones that have encouraged foreign direct investment. And this has been important in bringing FDI to the country, which is useful. What we haven't seen is the spillovers from that to the domestic economy. We haven't seen the pickup in productivity elsewhere in the economy that we would have hoped for. And to me that speaks to the need to continue to make progress in improving the business environment, to increase productivity in the rest of the economy and to encourage links between the FDI that comes to these special zones and the rest of the economy, to get all of the Macedonian economy moving forward. Those are the main challenges for the government going forward.

MS. GAVIRIA: Thank you Phil. We end this press conference here. Thank you all for participating.

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