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BRICs Drive Global Economic Recovery

rafael — Mon, 09 Jul 2012 11:30:24 GMT

BRICs Drive Global Economic Recovery

July 22, 2009

Dear IMF Survey:

The L’Aquila summit might well have been the last G-8 summit of its kind. You’d never guess (thanks to long-standing arrogance and Western egocentricity), but L’Aquila also hosted the heads of government of the emerging nations known as the BRICs (Brazil, Russia, India, and China).

From now on we should talk about the G-20 and actually mean what we say, and not simply pay lip service to the idea. Shifting balances of power, economic importance, and geopolitical strategies make this imperative.

The BRICs, with 40 percent of the world’s population spread out over three continents, already account for 25 percent of global GDP. Last June 16, the BRIC leaders met in Yekaterinburg (Russia), and their meetings also included representatives of the governments of the Shanghai Cooperation Organization (SCO), whose members include not just China and Russia, but also Kazakhstan, Kyrgyz Republic, Uzbekistan, and Tajikistan, in addition to India, Pakistan, Iran and Mongolia as observers. Sooner or later, the economic importance of the BRICs and the SCO will have to be taken adequately into account.

In its June 20 issue, The Economist took note of this situation in an article entitled "Not Just Straw Men,” and asked if we were not witnessing a kind of separation—a "decoupling”—of emerging markets from the "advanced” Western economies.

The article recognizes that significant trends in this direction were already present and are re-emerging in the wake of the global financial shock. These trends are not simply reflected in growth rates that exceed those of the industrial countries. This phenomenon also implies that to some extent the two groups "dance to different tunes, with emerging markets growing or shrinking autonomously, not just under the influence of rich ones.”

For one thing, the BRICs are less dependent on exports. (In Brazil and India, exports are less than 15 percent of GDP. China, too, exports less than many people think.)

The presence of a sizable domestic market, industrial and technological diversification exceeding normal expectations, major government programs of investment in infrastructure, and smoother handling of the liberalization of their own financial systems in the wake of the devastating Asian crisis in 1997-98, are all hallmarks of the BRICs’ increasing autonomy.

By November 2008, China had launched a program involving $600 billion of investment in the sectors of the real economy. Despite a 25 percent decline in exports, the Chinese economy in the first half of 2009 grew by 6 percent. Today, the Chinese automobile market has surpassed the U.S. market, whereas only three years ago it was at 50 percent. India too, with 4 percent growth, is performing well not just in textiles and cheap electronics but is also forging ahead in shipbuilding, chemicals, steel, and communications.

Conversely, Russia has suffered greater fallout from plunging commodity prices. Brazil’s own economy is undergoing consolidation. Unquestionably, the global crisis is bound to cause adverse effects everywhere; however, the BRICs enjoy greater potential for stability and recovery.

With respect to the financial crisis, the BRICs are pursuing a four-pronged approach: decisive regulation of global financial markets; an orderly move away from the existing global monetary system based solely on the dollar; reorganization of the IMF, including a more important role for Special Drawing Rights as a transitional instrument in international reserve facilities; and the longer-term creation of a new multipolar monetary system based on a basket of currencies.

In all of these initiatives, the BRICs are no longer simply being carried along by the industrial countries. Nor are they waiting for the United States to call the shots. Instead, they are operating with a high degree of independence in an effort to consolidate their relationships with one another as a group. Trade among the BRICs is surging and is often now settled in local currencies rather than in dollars. Who would have guessed five years ago that China would become the primary trading partner of Brazil and India?

The BRICs have figured out that the engine of growth and development—including for heavily indebted countries—lies in the execution of major infrastructure projects, investment, and technological innovations carried out in an environmentally conscious fashion. Europe should take note.

Mario Lettieri, Former Undersecretary for Economy
Paolo Raimondi, Economist
Italy

Goal Is Efficient Credit Delivery, Not Just Profit

rafael — Mon, 09 Jul 2012 11:27:23 GMT

RESTARTING SECURITIZATION MARKETS

Goal Is Efficient Credit Delivery, Not Just Profit

October 13, 2009

Dear IMF Survey:

I read only Chapter 2—"Restarting Securitization Markets: Policy Proposals and Pitfalls”—of the latest Global Financial Stability Report (GFSR), but this article is by far the best I have read (and, I suppose, agrees with my own thoughts the most) on creating a new, workable framework for securitization.

I like covered bonds, and always have, but U.S. firms that benefit most from the complexity of thousands of deals and tens of thousands of tranches seem to forget that the purpose of the exercise is to deliver credit and credit investment efficiently, not just to make profit for intermediaries.

In fact, there are so many good ideas in this piece that it should be required reading for every G-20 participant and pundit.

So where’s your leverage to get this implemented?

Robert Kent
SF Solutions, LLC
New York City, United States

When Resources Come from 'Partners' Instead of 'Donors'

rafael — Mon, 09 Jul 2012 11:24:23 GMT

Rising levels of development financing by major emerging market economies have intensified the debate on aid effectiveness and debt sustainability.

Unlike aid from advanced-economy donors, financing from the major emerging market economies excluding Russia focuses on mutual benefits without involving policy conditions on how the funding is used.

A new IMF study examines the philosophies and methods of development financing by the major emerging market economies, and examines the implications for low-income economies and for future engagement between low-income countries and emerging market countries.

Competing paradigms

The major emerging market economies, with the exception of Russia, provide financial assistance based on the principle of "mutual benefits” and in the spirit of South-South cooperation.

Brazil, China, and India see themselves as development partners, not donors. Their experience as recipients of traditional development assistance and their identification with other recipients also contribute to their sensitivity to the term ‘aid’. Indeed, the term is sometimes contentious: China does not regard itself as providing aid.

In addition, these major emerging market economies do not attach to their financing any conditions related to governance, economic policy and performance, or institutional reforms. Conditionality, they argue, would undermine the principle of respecting national sovereignty and promoting solidarity. Partly reflecting China’s own recent development history and its policy of noninterference, it believes that the long-term development of a country is ultimately the responsibility of the recipient and not of the development partners—as noted by African Development Bank economist Richard Schiere.

While traditional donors attempt to improve governance by attaching policy conditions to aid, China argues that "tied aid”—financing that is tied to purchases from the source country—helps lower the risk of financial mismanagement and misappropriation of funds.

Though conditionality has often been criticized as intrusive and weakening country ownership of reforms, tied aid has reportedly not been able to address concerns about transparency and corruption, especially given the general lack of comprehensive, meaningful, and timely statistics. The IMF’s Nkunde Mwase finds that these countries lend more to countries with weak institutions, underscoring concerns that emerging markets’ financing could undermine efforts to improve governance in low-income countries.

Approaches to sustainability

Most of the major emerging markets’ development financing is concentrated in the infrastructure sector, although there are some differences among them. Russia, similarly to traditional donors, has recently focused on social spending, seeing poverty reduction as the main objective of its official development assistance. Some emerging markets note that there has been an overemphasis on "social projects” in the provision of aid, at the expense of building productive capacity and of faster poverty reduction in the long run.

Different approaches to development financing have also led to divergences over the concept of debt sustainability between some emerging market countries and traditional donors. China and India generally focus on a project’s economic viability while traditional partners emphasize long-term debt sustainability at the economy level.

China distinguishes between productive and nonproductive investments; the latter are generally financed through grants and the former generally by loans. In contrast, traditional partners pay more attention to debt sustainability at the macroeconomic level, often based on the results of IMF–World Bank debt sustainability analysis, which also takes into account the recipient’s ability to repay based on fiscal revenue that the investment project would generate.

Overall, the differences are, however, narrowing with emerging market countries increasingly appreciating the importance of overall debt sustainability and traditional donors the need for investing in physical capital.

Seizing on the opportunities

The scaling up of public investment associated with most development financing by major emerging market countries is likely to have large positive growth effects. Indeed, emerging market financing is starting to play an important role in alleviating infrastructure bottlenecks in many low-income countries and this has helped them tap their natural resources as well as reduce costs of doing business in general.

The World Bank’s Vivien Foster and the University of Nairobi’s Joseph Onjala have noted that emerging market financing for low-income countries has resulted in a 35 percent improvement in electricity supply, a 10 percent increase in rail capacity, and reduced prices for telephone services.

To the extent that emerging market financing of infrastructure reduces domestic costs of production and increases productivity, there could be positive supply side effects that could improve export competitiveness.

Emerging market development financing can help strengthen regional trade linkages. In addition, the IMF’s Montie Mlachila has noted that the strong focus of emerging market financing on improving access to trade and natural resources has been associated with a sharp increase in trade flows and foreign direct investment between low-income countries and major emerging market economies. The IMF’s Issouf Samake and Yongzheng Yang find significant growth spillovers from emerging markets to poorer countries, both through direct channels such as bilateral trade and indirect channels such as global commodity prices.

Meeting the challenges

While emerging market development financing has generated significant economic benefits for low-income countries, it also poses challenges that call for better economic management to minimize the associated risks and expand future benefits.

Policy issues raised by emerging market financing are not new; similar issues arose in the past in relation to aid from traditional donors. Nevertheless, given the recent scaling up of emerging market financing and some of its unique characteristics, it is worth highlighting some of the key policy issues.

• Ensuring high returns on projects. As with other sources of financing, it is critical that low-income countries align projects with national development priorities.

• Improving transparency and governance. Efforts should be made to improve data on the size and terms of financing flows and the structure and conditions of packaged deals, as well as the rights of concessions for natural resources.

• Safeguarding debt sustainability. Macroeconomic analysis of total project financing, including assessments of risk, implications for public finances (including how maintenance costs will be financed and contingent liabilities associated with some foreign direct investment projects) and growth impact, is critical to avoid potential debt sustainability problems while ensuring adequate public investment.

• Deepening project linkages to the local economy. Low-income countries and major emerging market economies could work together to build incentives, as part of a total package for development financing, to encourage local employment, foster skills development, and improve technology transfer.

IMF, World Bank Back $4 Billion Côte d'Ivoire Debt Relief

rafael — Mon, 09 Jul 2012 11:20:24 GMT

The IMF and the World Bank approved debt relief with a present value of $4.4 billion for Côte d’Ivoire. Combined with other debt relief, the total will be $7.7 billion.

Relief under the Enhanced Heavily Indebted Poor Countries (HIPC) Initiative, and additional multilateral and bilateral relief, will reduce the external debt of one of West Africa’s largest economies by slightly more than 60 percent in present value terms.

The Executive Boards of the IMF and the World Bank agreed, on June 25 and 26 respectively, that Côte d’Ivoire had satisfied the requirements to reach the final stage, or completion point, of debt relief under the HIPC Initiative.

Côte d’Ivoire will benefit from $7.7 billion in total debt reduction in present value terms, consisting of $3.1 billion in HIPC debt relief, $1.3 billion in debt relief from multilateral creditors under the Multilateral Debt Relief Initiative, and a further $3.3 billion in additional relief from the Paris Club of official bilateral creditors.

Total HIPC debt relief from the IMF and the World Bank would be $38.7 million and $412.6 million, respectively. Côte d’Ivoire’s graduation from the HIPC process brings to 33 the number of countries that have attained completion point under the HIPC Initiative since 1996 (see box).

The thirty-three

Afghanistan
Benin
Bolivia
Burkina Faso
Burundi
Cameroon
Central African Republic
Republic of Congo
Democratic Republic of Congo
Cote d’Ivoire
Ethiopia
The Gambia
Ghana
Guinea-Bissau
Guyana
Haiti
Honduras
Liberia
Madagascar
Malawi
Mali
Mauritania
Mozambique
Nicaragua
Niger
Rwanda
São Tomé and Príncipe
Senegal
Sierra Leone
Tanzania
Togo
Uganda
Zambia

"Reaching the HIPC completion point represents a milestone for Côte d’Ivoire and its population,” said Doris Ross, IMF mission chief for Côte d’Ivoire. "It reflects the significant progress achieved in economic management since the Ouagadougou peace accord of 2007 and the end of the post-election crisis in April 2011,” she added.

Ross stated that reaching completion point would also help Côte d’Ivoire normalize relations with its external creditors, which would entail an increase in debt service payable in the medium term and help further catalyze support from donors and potential investors (see chart).

"Judicious macroeconomic management will remain critical to make the country’s enormous growth potential a reality and bring prosperity to its people, while maintaining debt sustainability,” Ross said.

Engagement with IMF

Côte d’Ivoire reached the HIPC decision point, under which the country was declared eligible for debt relief, in April 2009 but progress toward the completion point was delayed in part due to the 2010–11 post-election crisis.

Since then President Ouattara’s government has maintained a sustained engagement with the IMF, starting with $129 million in support under the Rapid Credit Facility in July 2011 that served as bridge toward further support under anExtended Credit Facility arrangement of $600 million in November 2011. Prompt technical assistance also promoted capacity building and contributed to post-crisis recovery.

To reach the HIPC completion point, the authorities have advanced policy in a number of areas, including

• Poverty reduction: Preparation of a poverty reduction strategy in a participatory process, and satisfactory implementation;

• Macroeconomic stability: Satisfactory performances under the Rapid Credit Facility and the Extended Credit Facility arrangements;

• Public financial management: Publication of budget execution reports and establishment of a public procurement regulation authority;

• Health care: Increase in number of childbirths assisted by trained personnel;

• Education: Distribution of textbooks in public primary schools;

• Debt management: Quarterly publication of external and domestic public debt data;

• Transparency: Regular publication of: (i) report on payments made to, and revenue received by, the government from extractive industries—mining, petroleum, and gas—in line with Extractive Industries Transparency Initiative criteria; and (ii) certified financial accounts of the national oil company;

• Cocoa reform: A new institutional and regulatory framework, coupled with lower taxation of cocoa production.

Reaching the HIPC completion point complements Côte d’Ivoire’s economic revival and ongoing political and social normalization. Economic performance since May 2011 has surprised on the upside, with a lower than anticipated economic contraction in 2011, a fall in inflation, and rebounding fiscal revenues coupled with prudent spending, while including increases in pro-poor spending and public investment.

Business climate

The institutional strengthening that has begun will continue over the medium term to enhance economic planning, budgeting, and transparency, and to improve the business climate. Mobilizing domestic revenue and grants, and keeping nonconcessional borrowing within a sustainable range, will be crucial to finance the envisaged significant scaling up of investment that should help to raise economic growth, fulfill the country’s potential, and create jobs and thus help reduce poverty.

In anticipation of the debt relief decision, Charles Diby, Côte d’Ivoire’s Minister of Economy and Finance, said that the debt relief is a platform of opportunity for a new era of growth and prosperity for his nation. "For almost 30 years, our country has had financial problems, stemming particularly from the unsustainable burden of external debt. Under these conditions, it has not been possible to envisage a viable development program,” Diby said.

"Debt relief should permit the debt burden to reach an acceptable level. The completion point will permit the country, through hard work, transparency, and sound management, to define and execute a financeable development program to benefit all Ivoiriens,” Diby added.

Country's Wealth Depends on Citizens' Share of National Pie

rafael — Sat, 07 Jul 2012 14:07:40 GMT

Why are some countries rich and others poor?

Over the years, experts have pointed to a range of factors they considered crucial—from the relative freedom of markets, through the size of the population, to geography.

James Robinson, coauthor of the newly published Why Nations Fail and contributor to The Occupy Handbook argues that the wealth of a country is most closely tied to how far the average person is able to share in its overall economic growth. He calls that "inclusive growth.”

However, he notes that there is always a tendency in any society for a small group of people to try and concentrate power and wealth in its hands.

In an interview with IMF Survey, Robinson elaborated on his theory of economic development.

IMF Survey: What can countries do to achieve economic success?

Robinson: To have economic success, you need a particular sort of configuration of economic and political institutions in society that sort of back them up and underpin them.

What you need in terms of the economy is a structure of economic institutions which can harness the talents and skills and ideas of its people. We call that inclusive because it has to allow everybody to have property rights and economic opportunities, to take advantage of their skills and talents, to open business, and get an education. But behind that, you need to have a set of political institutions which distributes power broadly in society.

But there are always incentives to oligarchize power, and for some groups of people to try to capture power or take over power. Many are concerned that this big increase in economic inequality in the United States signifies a sort of oligarchization of the society.

IMF Survey: If the increase in inequality in the United States. is a potential signal of America becoming an oligarchy, would you say the Occupy Movement is a protest against this?

Robinson: Historically, there are many examples of how there have been challenges to the inclusive nature of U.S. political institutions. We tried to put Occupy Wall Street into that same sort of tradition of objecting and fighting back.

That is something which is very healthy about the society. It is very good for the long-run health—economic health and political health—of the U.S.

IMF Survey: How did previous social movements succeed in achieving what they struggled to do?

Robinson: One lesson for Occupy Wall Street is that they project this antipathy towards politicians and political parties.

Perhaps one can sympathize with some of that sentiment, but I think the reality is that if they want to have an impact, they need to build bridges with political parties and politicians who are sympathetic with their agenda.

In the book, we also give the example of the French student movement from 1968, which was incredibly successful at mobilizing and grabbing everybody’s attention, but was very bad at building a bigger coalition to get what it really wanted.

IMF Survey: Is the United States becoming one of these nations who fail?

Robinson: I am optimistic about the United States. One of the reasons for this optimism is that in the past the U.S. system has been very robust. We describe this as a virtuous circle.

Once there are inclusive institutions, it creates positive feedback mechanisms which stop the system going off the rails. That is our interpretation of Occupy Wall Street. It is part of the reaction by the U.S. society to this potential oligarchization.

I tend to work in very dysfunctional places. For example, I am on sabbatical in Colombia and South America, I work a lot in Sub-Saharan Africa and I have been doing some research in Haiti. When you spend some time in rural Colombia, or in Sierra Leone, or the Congo, then you really begin to appreciate the functionality of U.S. institutions.

I think history does create scope for optimism about the resilience of inclusive institutions in the U.S.

IMF Survey: I want to move on a little bit to your book, Why Nations Fail, the one you cowrote with your current coauthor Daron Acemoglu. In that book you argue that the wealth of a nation is correlated to the degree of which the average person shares in the overall growth. Do you have examples of countries that have actually successfully done so and, as such, have grown?

Robinson: I will give you a somehow controversial example which everyone usually thinks is against us: China. People always say that Chinese economic growth in the last 30 years has been due to the genius of the Communist Party.

However, the reality of Chinese economic growth since the late 1970s is that the economy in China started growing when the Communist Party started disentangling itself from every aspect of people’s lives.

The first thing they did was to introduce incentives into agriculture and allow people to do what they want instead of planning everything. This was enormously successful in terms of productivity. In fact, there was a boom in rural productivity.

The retreat of the Communist Party, and allowing people to use their talents and skills as well as start businesses and live where they want and take the job they want: that is what has generated economic growth in China.

But it is a controversial example. Why is it so? Because people often think that the Chinese case does not fit with our view of the world. The Beijing Consensus is very successful in terms of getting the Chinese economy moving, but ultimately it is unsustainable.

In the 1960s and 1970s, everybody thought that the Soviet Union was a poster child for economic growth. When I was an undergraduate at the London School of Economics in the early 1980s, we were still being taught that if you wanted to have rapid economic growth, you had to have Soviet-style central planning.

Every economics textbook was full of pictures of the Soviet Union’s income overtaking the United States’. Now everyone laughs about that.

However, the Soviet experience has many things in common with the Chinese experience. One of these things is that it was completely unsustainable, but everyone seems to have forgotten about that, so we want to remind them.

IMF Survey: Finally, your thesis suggests that by experiencing deep economic and political changes, a country can drive its economic growth. Should we have a radical change from the current development policies?

Robinson: In our book, we do emphasize much more on the political side. I think the economic institutions are crucial for generating economic growth and development, but it is the politics that underpins particular sets of institutions.

One way of thinking about it is to ask why so many attempts by international institutions and states to reform policies or institutions have been unsuccessful.

Take the Washington Consensus for example. It was implemented in Latin America in the 1990s. Some people are of the opinion that these policies were tried but failed, therefore were wrong.

Our view is completely different. We believe that lots of these policies in the Washington Consensus were actually eminently sensible policies. But the politics in those countries did not change. If the politics do not change, then you cannot change the economy.

Rise of Inequality at Center of Global Economic Crisis

rafael — Sat, 07 Jul 2012 14:06:22 GMT

The rise of inequality is at the center of the current economic and financial crisis, says economist Robin Wells.

Since the onset of the global crisis, there has been much agonizing about the growing inequality found in many parts of the world.

Wells and economist Paul Krugman blame this increasing inequality for destructive, self-perpetrating spiral of social polarization, growing divisions in crisis. In their essay published in the newly released The Occupy Handbook, which analyzes the grassroots Occupy movement, the two authors argue that the response to the crisis continues to be inadequate because it ignores its root cause: America's yawning inequality.

In an interview with IMF Survey, Wells explains how growing inequality has pervaded all aspects of life.

Wells: The increasing inequality in the United States has frozen the political apparatus. The economics profession has been woefully inadequate. What appears to lie at the root of the lack in the economics profession is that up until the time of the crisis, we papered over the differences in the profession.

We did not really address income inequality. I would not say it was a taboo topic, but we did not know what to do with it so we did not bring it up.

Once the crisis hit, once income inequality became so great that we could not ignore it, the cracks in the profession became pronounced and we saw ourselves refighting the old economic questions that had been solved by Keynes back in the 1930s.

We have been fighting about concepts such as the fact that the economy needs fiscal stimulus but also concepts resolved by Irving Fisher who taught us about debt overhang.

Debt overhang is what is keeping this economy stuck. Households have enormous amounts of debt. The way to solve that would be a direct principal writedown but we could not do that with the banks fighting that tooth and nail and the administration being unwilling to take that on.

IMF Survey: Can you explain by which channel of transmission inequality has pervaded all aspects of society?

Wells: There are two questions there. The first question is: How did we get such an extreme level of inequality so that we are now back to what we call in the United States "The Great Gatsby" days right after World War I?

That is a bit of a puzzle. There are various mechanisms by which it could happen, one being the decline in unions, which tends to level out wages. Some also think that it is due to skills, meaning that there is a bigger premium for skills in the economy.

But what those arguments really cannot explain is this explosion at the very top. The explosion at the top is not the 1 percent pulling away from the 99 percent, it is the .01 pulling away from the rest.

Some of this 0.1 per cent is Steve Jobs and entrepreneurs in Silicon Valley, but a lot of them are Wall Street. We can argue that it is a function of deregulation, which in many ways looks like it was the result of increasing pressure from moneyed interests.

I think that one can begin to tie, at least through that channel, income inequality. But it is certainly not the only thing.

IMF Survey: Is this issue specific to the United States, or do the same dynamics apply in other countries?

Wells: We definitely see income inequality going up in other countries. We have certainly seen it go up in the U.K., Brazil, China, and India. In fact, what we can see there is an explosion of income inequality.

What singles out the United States though is that, even as a historically long-term advanced country, we can’t deal with it.

IMF Survey: What policies can be adopted to ease inequality and its distorting effects on economic recovery?

Wells: First of all, I think we need to do something to help alleviate the present-day suffering which is overwhelmingly concentrated among the working class. An economic stimulus would do that. You could do that with virtually very low-cost money. You could also do it in a way which helps our future growth by investing in school teachers, school buildings, and infrastructure that is needed very, very badly.

We can also make sure that health care gets implemented. These are very basic things to lower the extreme amount of anxiety and suffering that people are experiencing in the future. These are win-win things.

We can refuse to renew the Bush tax cuts for the upper income. These policies not only worsen the existing level of income inequality, but they exacerbate it because they make forever increasing income at the top. They also give resources to the top to continue fighting.

One of the reasons that some people attribute to the rise of income inequality is that we as a society and particularly in the economics profession thought that greed is good. Money is the just reward to work and effort.

Sometimes that is definitely true, but many times, as we see particularly in financial markets, it is not. On the other hand, even if it is, we have to counterbalance the effect that it has on our society.

IMF Survey: Is there any hope that this situation will change?

Wells: In order to not be demoralized, one has to understand that these are long-standing forces that we are engaged with. These forces existed before the Great Depression and they were provoked into action again. One has to gird oneself for the longer term and maybe hand it off to younger people at some point.

Unregulated Financial Systems Make Unstable Economies

rafael — Sat, 07 Jul 2012 14:05:01 GMT

In the years since the global crisis of 2008, the economics profession has been in turmoil.

Many have written about the mistakes that were made but also about the challenges and the reforms needed to sustain the global economic system.

One of these voices is Martin Wolf. In The Occupy Handbook published recently,Financial Times columnist Wolf explained what he sees as the biggest challenges to the current economic system.

In an interview with IMF Survey, Wolf presented a blueprint for the reform of the economic system.

IMF Survey: What is the biggest challenge to the current economic system?

Wolf: One of the biggest issues, really for centuries, but certainly over the last 80 years or so, in economics has been stabilizing the economy itself. How do you stabilize the economy? That was the main issue in the ’30s, then it became a huge issue again in the ’70s, and economists have given a number of answers to that.

I think this recent experience has underlined the thesis that there are deep, inherent instabilities in a market economy with an open, unregulated financial system. At the level of straight macroeconomic policy, the experience has made it very clear that we need a very full weaponry of stabilization policy.

The crisis has meant quite extraordinary monetary policy actions but it is absolutely clear to my mind that in circumstances like this one needs to use fiscal policy as well, very aggressively.

In addition to the fact that although the financial sector and its inherent fragility is crucial—both at the macroeconomic and the microeconomic levels—without a more stable financial system, it is basically impossible to achieve a greater stability in the economy as a whole.

The consensus that was reached in the last 20 years—that one just lets monetary policies stabilize inflation, does not need to use fiscal policy at all—has turned out to be really quite profoundly false.

IMF Survey: Despite its flaws, the financial system is an essential part of the market economy. What kind of policies would you advocate for its fixing?

Wolf: Most economies look at these questions in terms of incentives and, when something goes wrong, they immediately say it is because of perverse incentives of some kind.

There’s no doubt in the case of our financial sector they’re extremely perverse incentives. They come from the role of limited liability companies with very, very high leverage and with management rewarded for raising the returns on equity, which they can achieve by taking risks and by, among other things, by leveraging their banks, their financial institutions to an extraordinary degree. So these incentives all have to be dealt with.

But in addition to that, I became convinced that, quite simply, in these sorts of bubbles we’ve seen, people make mistakes. Human beings are enormously influenced by recent experience—they’re influenced by herd movement. They all convince themselves that everything’s fine. That means that you actually need policies—it’s very difficult to do because the regulators get captured, too—but you do need policies that lean against the wind of conventional opinion at any particular moment. And that’s, I think, what good macroprudential policy is about.

Now, beyond this there’s a big issue I haven’t touched, which is the system is global, it’s very highly globally integrated, and it’s become very, very difficult for regulators to control. I believe that this is actually an area where we’re going to have to deglobalize finance in some ways.

IMF Survey: Two issues that really have come in the forefront in the past year or so are those of inequality and unemployment. These have come forward in the form of data and also as the prime concern of people. So what could be done to address them?

Wolf: Well, I focus in this discussion on inequality. In the case on the unemployment issue, I think the core issue now is inadequate aggregate demand. The macroeconomic response to the crisis has been inadequate in many countries, including the U.S., the U.K., many others. The inequality issue is a structural one. I think what’s happened is partly for profound economic reasons to do with the changes in the demand for skills in globalization, but also because of institutional changes which have shifted the balance in favor of management in a profound way, and shareholders in the corporate sector. We’ve seen enormous increases in inequality.

Now, I think this is proving politically as well as socially destabilizing. And in an ideal world—again, this may be very naïve—something has to be done about it. We have to look at the institutions of corporate governance. We have to look at the way the labor market is regulated. I think that’s a relatively small issue. We have to start thinking about tax policy as being a mechanism for redistribution. I think it’s particularly important that there be massive assistance given to, as it were, the children of the poor. We want to prevent this sort of generation after generation of disadvantage being inherited, creating a permanent underclass, as it were, a permanent class of very poor people.

This obviously is incredibly ambitious, but I think in a number of developed countries—I think the U.S. is a prime example, but also my own, the U.K.—the concern that we are creating a highly stratified society is very profound and I think it’s ultimately incompatible with the survival of what I think of as a working democracy.

IMF Survey: So in the face of all these challenges, do you have any hopes or does it look incredibly dangerous?

Wolf: Honestly, I am pretty depressed, but I’m mainly depressed about the political responses. The agenda I put forward is what I think of as an intelligent centrist response. Now, some of these things are happening to a limited degree: reregulation of finance to some degree, things like that. But politicians have been extraordinarily timid.

And the agenda has changed, in my view, in terms of running corporate governance, running the financial sector—surprisingly little, given the scale of the crisis. I don’t know whether that’s because the power distribution just got completely out of whack or whether it’s because actually the technocrats did a reasonable job of preventing a total depression, which I think was the risk. So people now think that wasn’t a terribly important event at all, so they don’t think big changes are needed.

But what I’m disappointed by is the level of political discussion. What is coming forward where there is complaints, as in France, is incredibly naïve and simpleminded, I think. And in a number of countries there’s really no intelligent debate about these issues at all. If we can’t address problems when they’re obviously in front of us, then, of course, one fails. That’s how states and societies fail.

IMF Urges Eurozone to Make More Determined, Collective Response to Crisis

rafael — Sat, 07 Jul 2012 14:01:25 GMT

The crisis in the euro area has reached a critical stage, the staff of the International Monetary Fund said in its latest assessment, and urged the 17 countries of the eurozone to remain strongly committed to a robust and complete monetary union, including a unified banking system and more fiscal integration.

A strong collective commitment to "a robust and complete monetary union” would help restore faith in its viability, the IMF statement said. It should encompass a credible path to a banking union as an immediate priority, and greater fiscal integration, with better governance and more risk sharing.

Elements of the banking union would include

• a common supervisory and macroprudential framework

• a deposit guarantee scheme, and

• a bank resolution authority.

"The IMF's assessment supports a positive agenda in the short and medium term," IMF Managing Director Christine Lagarde said.

"These steps should be supported by wide-ranging structural reforms throughout the euro area to raise growth, while demand support should be maintained in the short term to cushion the impact of the region’s adjustment efforts,” she added during her participation in the Eurogroup meeting in Luxembourg on June 21.

The annual policy consultations with the euro area are part of regular discussions with all 188 members of the IMF and come at a particularly difficult time for Europe. Within the euro area, the IMF, along with the European Central Bank (ECB) and the European Commission, is providing financial support toGreece, Ireland, and Portugal. It recently was asked to monitor eurozone support for Spain’s financial system.

Determined collective commitment needed

The IMF recognized the importance of the actions that have been taken to contain the crisis, including the ECB’s special liquidity interventions, the larger European and global firewall, the adoption of the Fiscal Compact, and the national governments’ commitment to fiscal consolidation and debt sustainability.

Low growth rates and rising market stress are hindering the reduction in debt levels, the IMF warned, adding that contagion from further escalation of the crisis would have a substantial global impact, especially on neighboring European economies.

Higher and more balanced growth

The IMF said that stronger steps toward a complete monetary union require wide-ranging structural reforms throughout the euro area to raise growth. Such reforms would include

• Reforming job markets to raise labor force participation rates

• Increasing competitiveness in the tradable goods sectors in Southern Europe

• Boosting investment in infrastructure and human capital to support growth and employment

• Reforming product markets to help generate a "more vibrant services sector and raise overall productivity” in Northern Europe.

Substantial competitiveness gaps between countries also need to be addressed. To do so, the IMF called for reforming the service sector, lowering unit labor costs, and fostering relative price adjustment between the North and the South with the help of monetary policy.

Short-term support

Since structural reforms take time to revive growth, support for demand should be maintained in the short term to cushion the impact of the region’s adjustment efforts. The IMF highlighted that the following actions should be taken in the short-term:

• Implementing fiscal consolidation "decisively and credibly” where market pressure is high, but more gradually elsewhere to help support demand in the region.

• Committing to a more accommodative monetary policy for an extended period.

• Recapitalizing weak banks—including through direct support from the European Financial Stability Facility and European Stability Mechanism resources—to address the adverse feedback loop between sovereign and banking stress at the national level.

German Economy Fares Well But Reform Agenda Still Unfinished

rafael — Sat, 07 Jul 2012 13:59:59 GMT

Despite looming risks, Germany continues to perform relatively well, the IMF said in its annual report on the state of the economy.

The IMF called for policies to steer the recovery while guarding against downside risks, and noted that speeding up structural and financial reforms—along with rebalancing sources of growth—should help raise both Germany’s growth potential and generate positive outward spillovers.

According to the IMF’s assessment of Europe’s largest economy, economic activity is relatively robust, wages are rising, the unemployment rate (5.3 percent) is at post-reunification lows, and inflation expectations are well anchored. Furthermore, the fiscal deficit is narrowing (from 4.3 percent in 2010 to 1 percent in 2011) while corporate and household balance sheets are healthy. In addition, banks have ample liquidity and maintain adequate levels of regulatory capital, and lending rates are lower than elsewhere in Europe. This implies that the conditions are now in place for a domestic demand-led recovery.

Growth is projected at 1 percent in 2012 and 1.4 percent in 2013, but the outlook remains uncertain due to downside risks, the IMF said, urging measures to ensure financial stability and allowing the rebalancing of sources of growth as a means to protect the economy against external risks. "Germany is one of the world’s largest and most open economies, making it prone to external developments in both the euro area and the broader world economy,” said Subir Lall, IMF mission chief for Germany.

Over the medium term, structural and financial reforms would help raise Germany’s potential growth, with positive spillovers to the rest of the euro area, IMF report said.

Challenges and policy priorities

Germany has strong links with the euro area through the common currency and trade and financial linkages, and is a regional safe haven, the report noted. "The main risk facing Germany is a strong intensification of the euro area crisis. Lower global growth prospects more broadly would also hamper growth prospects in Germany,” Lall said.

"But under the baseline, the fiscal stance is appropriate given Germany’s cyclical position and Germany’s status as a guarantor for the European Financial Stability Facility/European Stability Mechanism”, added Lall. According to the IMF’s assessment, the key near-term policy priorities are to allow the transition to domestic demand-led growth to proceed, secure financial stability, and help address the challenges facing the euro area.

• Rebalancing sources of growth: looking ahead, the rise in wages and some asset prices would contribute naturally to the process of rebalancing growth from being dependent mainly on exports to relying more on domestic demand. Allowing this rebalancing to unfold would help further reduce Germany’s high current account surplus and, hence, its exposure to external risks stemming from the euro area and elsewhere.

• Securing financial stability in the face of external risks: the banking system remains exposed to adverse external developments given the large size of its loan portfolio, the low quality of bank capital, and significant exposures to other economies in the euro area. Hence, it would be important to take steps to enhance the supervisory and regulatory framework to safeguard the banking system following European Union initiatives.

• Helping address the challenges facing the euro area: articulating more clearly the Economic and Monetary Union’s shared vision of an appropriate post-crisis architecture should help restore market confidence. Moreover, the rebalancing of Germany’s economy from being export oriented to relying more on domestic demand would help reduce imbalances in the euro area. Consistent with the mandate of the European Central Bank, the incipient disinflationary pressures in the periphery economies could imply that Germany may have an inflation rate that is somewhat higher than the euro area average.

Accelerating reforms

Germany should seize the opportunity to further strengthen its economy’s growth potential and diversify the sources of growth, reinforcing reform momentum in the euro area. According to the IMF report, the reform agenda should encompass the following components:

• Stepping up structural reforms: policies need to focus on increasing the labor force, raising the quality of human capital—through reforms to education and training—and raising productivity in the services sector through greater competition, including at the regional level in network industries, such as transportation and energy.

• Building momentum for financial sector reform: this should include accelerating efforts to reduce outstanding public capital support to some banks. There is also a need for a comprehensive strategy to improve the efficiency and stability of the banking system. In addition, establishing bank resolution plans and enhancing the deposit insurance regime would strengthen the crisis management framework.

• Broadening the financial system beyond banking: stepping up efforts to broaden the channels of financial intermediation would help facilitate the allocation of resources toward innovation and new engines of growth.

Strong Polish Economy Faces Risks, Needs to Remain Flexible

rafael — Sat, 07 Jul 2012 13:58:57 GMT

The Polish economy has, on average, performed better than peers throughout the crisis despite the challenging environment in Europe, the IMF said in its annual report on the state of the economy.

This reflected very strong fundamentals, sound policies, and confidence in the economy due in part to the Flexible Credit Line (FCL) arrangement with the IMF. The report added that―given the more limited room for maneuver on the fiscal front―monetary policy should be the first line of defense in providing support to the economy in the event the eurozone crisis intensifies.

The Polish economy grew by a solid 4¼ percent in 2011 despite a substantial decline in public spending. The banking system has remained profitable, well capitalized, and liquid. Credit expanded at a healthy pace, though banks are now tightening their conditions for lending. The IMF expects real GDP growth to moderate to 2½ percent in 2012, as both external and domestic demand are expected to weaken.

Increased international reserves and the precautionary FCL arrangement with the IMF have boosted market confidence and helped sustain access to external financing, the report said.

Risks and vulnerabilities

While Poland may be less affected than some other countries by the ongoing crisis in the eurozone, a deep recession or intensification of the crisis would have a severe impact on the economy.

"Trade and financial linkages with Europe are significant: nearly 60 percent of Poland’s exports are to core euro area countries and Poland is heavily integrated into the German manufacturing supply chain,” said Julie Kozack, IMF mission chief for Poland.

In 2010, the euro area accounted for over 75 percent of Poland’s foreign direct investment liabilities. The business sector relies heavily on lending from parent firms and about 60 percent of the banking system is owned by European banks.

The Polish economy is also vulnerable because of the large share of nonresident holdings of government bonds and significant external financing needs, estimated at about 30 percent of GDP in 2012, the report said. Such vulnerabilities could be harmful if investors become even more cautious than they are now.

The high share of foreign currency mortgages―about two-thirds of all mortgages are denominated in other currencies, the vast majority in Swiss franc―also continues to pose risks to balance sheets of banks and households.

Near-term policy challenges

"Poland’s economic prospects remain bright, but the outlook is clouded by uncertainty, mainly because of the ongoing crisis in the eurozone. Policymakers should remain flexible, and be ready to adjust policies if needed” said Kozack. The IMF’s report lists the following near-term policy priorities:

• On fiscal policy: fiscal tightening should continue in order to further reduce public debt over the medium term, which would rebuild fiscal buffers. To this end, it is important to protect priority spending, especially on much-needed infrastructure. In the event of a deeper downturn, there is some scope for countercyclical fiscal policies through the operation of automatic stabilizers, but this scope is more limited than in the past.

• On monetary policy: policy interest rates should not be raised—given the projected drop in inflation and lack of upward pressure on wages. Policymakers should consider reducing rates if the economy slows significantly and inflationary pressures weaken. In the event the crisis in the euro area worsens, the central bank should stand ready to provide emergency liquidity support. A more accommodating monetary policy would help support growth. But careful attention also needs to be paid to the exchange rate dynamics, and their implications for inflation and balance sheets.

• On financial policy: mortgage portfolios denominated in foreign currency and nonperforming loans continue to pose risks. The Polish supervisory authority has taken a number of steps to contain these risks, including stronger supervision of banks engaged in this type of lending and stricter regulations to reduce it. These efforts should continue, as banks are beginning to slow the issuance of these mortgages. A more proactive approach to dealing with nonperforming loans, including by stepping up voluntary out-of-court debt restructuring by banks, would help address those risks.

Boosting potential growth

Long-term economic prospects will depend on reforming the labor market, the business environment, and state-owned companies, the report said. The labor market can benefit from better targeting job-matching services to the needs of the local population. On the business climate, the government plans to make it easier to enter regulated professions and streamline decisions on construction permits and land use. Continuing the efforts to privatize state-owned companies would help promote an economy led by the private sector, the report said