Statement at the Conclusion of the 2012 Article IV Consultation Mission to Saudi Arabia

Mr. Masood Ahmed, Director of the Middle East and Central Asia Department, made the following statement at the conclusion of the 2012 Article IV Consultation mission that visited Riyadh during May 14–26:¹

Economic performance has been exceptionally strong and the outlook remains buoyant. Oil production has been raised to ease pressures on global oil prices, and increased government spending coupled with accommodative monetary policy has supported continued acceleration in non-oil activity. Overall real GDP is estimated to have grown by 7.1 percent in 2011, with 8 percent growth recorded in the non-oil sector— the highest since 1981—and private sector growth at 8.5 percent. Saudi Arabia has provided important support to the global economy during a period of high global uncertainty, including through its actions in stabilizing the global oil market. Higher imports and increased workers’ remittances linked to the strong growth of the Saudi economy, together with expanded financial assistance have exerted a positive spillover and helped support other economies in the region and beyond.

Reflecting prudent economic management, the economy is likely to remain buoyant. On current trends, real GDP is projected to grow by 6 percent in 2012. The private sector is again expected to lead the way, reflecting the increased role of the private sector in the economy, a clear break from the past. Inflation is likely to remain modest at about 5 percent in 2012, but should be monitored carefully for signs that the economy is overheating. Fiscal and external surpluses are expected to remain very strong at almost 17 and 27 percent of GDP, respectively. However, given the current external environment and possible spillovers to global oil markets, the outlook is subject to some uncertainty.

Taking advantage of the strong state of the economy to advance the reform agenda and further strengthen institutions will help sustain growth in the years ahead. While there has been progress on diversification, the Saudi economy remains dependent on oil exports, and growth has been driven mainly by factor accumulation. Targeted government investment alongside product and labor market reforms can facilitate a more dynamic private sector and stimulate job creation for nationals. A strong and resilient financial sector also supports this process, with the 2011 Financial Sector Assessment Program (FSAP) Update providing a number of options that together with the ongoing implementation of Basel III will further strengthen risk management and promote capital market development.

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¹ In accordance with Article IV of its Articles of Agreement, the IMF holds bilateral consultations with its members, generally once a year. An IMF staff mission visits the country, gathers economic and financial data, and meets those responsible for the country's economic development and policies. Once they have returned to headquarters, the members of the mission draw up a report to be submitted to the Executive Board for review. Following this review, the Managing Director, as Chairman of the Executive Board summarizes the opinions of the Executive Directors, and this summary is forwarded to the country's authorities.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-at-conclusion-of-2012-article.html

Slovak Republic—Concluding Statement for the 2012 Article IV Consultation Mission

Slovakia enjoyed one of the strongest recoveries in the region, reflecting its sound economic fundamentals and prudent policies. However, the economic outlook is clouded by spillovers from the euro area crisis. Policies should focus on mitigating risks and promoting growth. The government’s commitment to fiscal consolidation is welcome, but durable adjustment will require complementary reforms. Continued strong financial oversight is essential. Boosting employment is a top priority. The government’s economic program now being elaborated provides an opportunity to put in place the needed reforms to promote vibrant and inclusive growth.

1. The economy is expected to continue growing at a healthy pace. Buttressed by strong external demand, real GDP expanded by 3.3 percent in 2011—among the highest growth rates in the region—despite a sizable fiscal consolidation. Strong growth continued into the first quarter on the back of expanded auto production. Amid a worsened external environment, growth in 2012 is projected to slow to 2.6 percent. This relatively benign slowdown reflects strong trade linkages with Germany, continued external competitiveness, a still-moderate government debt ratio, and a sound banking system. Growth is projected to pick up to about 3½ percent over the medium term as the external environment strengthens and rising domestic demand closes the output gap.

2. However, risks to this outlook are mostly to the downside. Externally, an intensification of the euro area crisis would reduce demand for Slovak exports and increase bond spreads, reducing growth and weakening banks’ balance sheets. Working together with European partners in creating a more complete monetary union would help allay this risk. Domestically, a loss of market confidence in government’s commitment to fiscal consolidation would increase funding costs and result in tighter credit conditions. An early parliamentary approval of durable deficit reduction measures would reassure markets.

3. Policies should focus on mitigating risks and building a foundation for a strong and inclusive growth. Durable fiscal consolidation would put public finances on a sustainable footing. Continued strong oversight of the financial sector and close cross-border supervisory cooperation would maintain financial stability. Mutually reinforcing structural reforms to the labor market, education, and the business climate would boost employment and promote more inclusive growth.

Durable fiscal consolidation to promote sound public finances

4. The significant fiscal retrenchment in 2011 is welcome, but further adjustment will be needed to ensure debt sustainability. In 2012, adjustment stalled amid the election cycle and expenditure overruns, and the deficit is expected to remain broadly unchanged at 4¾ percent of GDP. In the absence of further fiscal consolidation, public debt ratio will remain on a rising trajectory and become increasingly vulnerable to shocks. Stabilizing the debt at 40 percent of GDP in the long run—a level that would leave room for the expected increase in ageing-related costs and other priority spending—would require a structural fiscal effort of about 2½ percent of GDP relative to 2011.

5. While the government’s deficit reduction plans are appropriate, policies should be prepared to let automatic stabilizers work fully. Though the details are still being worked out, it appears that the planned measures would be sufficient to lower the deficit to below 3 percent of GDP in 2013, while not unduly constraining growth. If growth turns out lower than expected, policies do not need to counterbalance the resulting revenue shortages, but should instead be allowed to operate automatically (for example, through higher unemployment compensation and social assistance), thereby limiting the effects on the economy. At the same time, if growth surprises on the upside, the higher revenue should be saved to facilitate the adjustment.

6. The focus of the planned adjustment mainly on boosting revenues is broadly appropriate. Following a sizable expenditure-based consolidation in 2011, the room for additional spending cuts without fundamental public sector reforms is limited, necessitating focus on revenue measures in the short run. These include shifting pension contributions from the second to the first pillar, introducing a progressive personal income tax, increasing the corporate income tax rate, extending the bank levy on corporate deposits to retail deposits, as well as broadening social insurance and income tax bases.

7. However, complementary reforms are essential to ensure a durable fiscal consolidation. The planned shift of pension contributions brings with it increased future government pension obligations. We therefore welcome the authorities’ plans to combine it with a parametric reform of the first pillar. The reform should be underpinned by an actuarial analysis to ensure the system’s financial solvency. The proposed increase in direct taxes may reduce incentives to invest, underscoring the need for a more welcoming investment climate. The envisaged numerous changes to the tax system could raise collection risks, while the bank levy could discourage financial intermediation.

8. In the medium term, considerable savings could be achieved by improving tax administration and expenditure efficiency. Removing nonstandard exemptions and strengthening VAT administration could generate some 1½ percent of GDP in additional revenue. The planned unification of revenue collections would aid in this regard. International comparisons suggest that increasing efficiency in health spending could generate some 1¾ percent of GDP in savings. The planned reform of public administration could result in additional efficiency gains. The generated savings could be used to further reduce debt, to improve the quality of public sector outcomes, and to finance improvements to public infrastructure in less developed regions of the country.

9. The recently adopted fiscal responsibility legislation (FRL) is welcome, but there is scope to further strengthen the fiscal framework. The Slovak FRL is broadly in line with best international practices: it enhances transparency and accountability, covers a broad definition of government, and includes appropriate enforcement mechanisms. However, making the FRL fully operational requires anchoring the budget in a sound medium-term fiscal framework. Moreover, collecting and publishing in the budget financial information of public entities, including hospitals, would improve the monitoring of fiscal risks.

Strong oversight and cross-border cooperation to maintain financial stability

10. Slovakia’s banking system is sound. Strong fundamentals and effective supervision have helped the sector weather the crisis well. Banks are liquid, well-capitalized, and largely funded by domestic deposits.

11. Nevertheless, risks call for continued supervisory vigilance. The largely foreign-owned banking system is exposed to risks stemming from potential renewed stress in Europe and deleveraging by parent banks. Sizable holdings of Slovak government bonds leave banks’ balance sheets vulnerable to a widening of bond spreads. Close cooperation with home supervisors is essential to mitigate cross-border risks. Recent steps by the National Bank of Slovakia to strengthen bank capital and liquidity buffers are welcome.

12. A speedy resolution of nonperforming loans (NPLs) would support an expansion of credit. NPLs have been slow to come down, particularly in the corporate sector. Removing tax obstacles—such as allowing loan losses to be tax deductible in the year they were incurred—would reduce delays in loan write-offs and free up capital. In this regard, recent amendments to the Act on Bankruptcy and Restructuring would encourage timely restructuring and speed up NPL resolution by allowing creditors to take a more proactive role in bankruptcy proceedings.

13. Curtailing risks in housing lending would further strengthen banks’ balance sheets. The less-stringently regulated “other housing loans”—which are not subject to the regulatory limit on the loan-to-value (LTV) ratio and not financed by mortgage bonds—have surged, driving up the average LTV ratio. Subjecting all types of housing loans to the same LTV limit would ensure loan quality and help prevent excessive risk-taking.

14. Promoting deeper financial markets would bring economic gains by enhancing investment efficiency and broadening access to finance. This could be facilitated by further relaxing investment restrictions for the Pillar II pension funds and by developing a secondary market for government bonds.

Structural reforms for a vibrant and inclusive growth

15. Boosting employment should be a top priority.Unemployment remains in double digits, largely unaffected by the improvements in output. Effective implementation of the reformed Labor Code should help reduce unemployment over the longer run. Better-targeted vocational training through occupationally-oriented curricula, informed by cooperation with employers, would reduce skill mismatches. A sharper focus on market needs in tertiary education would spur innovation and increase productivity.

16. Addressing persistent regional economic imbalances calls for mutually reinforcing structural reforms. Regional development could be enhanced through policies to expand and improve infrastructure. Consideration should also be given to increasing employment incentives by differentiating labor costs by region according to the cost of living, including by supplementing future lower increases in minimum wages in less developed regions with means-tested social benefits and targeted reductions in social insurance contributions. Measures to enlarge the rental housing market, including by easing rental regulations, could help address shortages that inhibit mobility. Addressing lingering corruption and weak property and contract rights enforcement would reinforce ongoing efforts to improve business climate.

The mission would like to thank the authorities for their warm hospitality and cooperation.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/slovak-republicconcluding-statement-for.html

IMF Executive Board Concludes 2012 Article IV Consultation with New Zealand

On June 6, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with New Zealand and considered, and endorsed, the staff appraisal without a meeting on a lapse-of-time basis.²

Background

The New Zealand economy continues to grow at a modest pace. Output grew by 1 percent in 2011, as elevated export commodity prices and favorable agricultural conditions helped offset the adverse impact of large earthquakes in Canterbury in late 2010 and early 2011. Continued aftershocks have delayed earthquake-related reconstruction. Domestic demand has remained soft as households and businesses continue to deleverage amid a weak housing market and an uncertain outlook. Elevated rates of unemployment, currently above 6 percent, and spare capacity have helped contain inflation.

The Reserve Bank of New Zealand (RBNZ) lowered the policy rate in March 2011 by 50 basis points to cushion the impact of the February earthquake. Since then, it has kept the policy rate on hold given the deterioration in the global economic position, subdued domestic activity, and the expected impact on future domestic activity of the strong exchange rate.

The nominal effective exchange rate has appreciated by around 30 percent since its trough in early 2009. The appreciation reflects the effects of higher export prices, positive interest rate differentials, and, although currently volatile, some increase in global risk appetite since end-2011.

Reflecting the slow recovery, past revenue and spending decisions, and accrued earthquake-related spending, the fiscal deficit in 2010/11 reached a record high of 9¼ percent of GDP on an accrual basis. Net government debt increased to 20 percent of GDP by mid-2011 from a low of 5½ percent in 2008.

The current account deficit in 2011 remained low at 4 percent of GDP, well below the 8 percent level in 2005-08, reflecting terms of trade gains, weak domestic demand, and low world interest rates. Net external liabilities have declined, but remain high at 72 percent of GDP at end-2011.

The banking sector remains sound. Bank profits are strong and nonperforming loans have fallen to less than 2 percent of total loans. Capital adequacy has improved since 2007, with the Tier 1 capital ratio reaching 10 percent in September 2011. Banks have made steady progress in lengthening the maturity profile of their wholesale funding since 2008 and increasing the share of retail deposits, but the total stock of banks’ gross external liabilities remains above 70 percent of GDP and loan-to-deposit ratios remain high.

The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat to 2⅓ percent in 2012 as earthquake reconstruction spending gains pace, although the size and timing of this spending is still uncertain. Growth is projected to rise to 3¼ percent in 2013, led by reconstruction. The key risks to the outlook are largely on the external front and on the downside, related to emerging weaknesses in the global economy and a possible upheaval in the global financial system.

Executive Board Assessment

In concluding the 2012 Article IV consultation with New Zealand, Executive Directors endorsed staff’s appraisal as follows:

Outlook and risks. The pace of New Zealand’s economic recovery is likely to remain modest. Output growth should pick up somewhat in 2012 as earthquake reconstruction spending is expected to gain pace, but the size and timing of this spending is still uncertain. High household debt is likely to weigh on the growth of private consumption as households will need to save to strengthen their balance sheets. The spare capacity and elevated unemployment will contain wage and inflation pressures in the near term. The risks to this outlook are on the downside and largely external, stemming mainly from emerging weaknesses in the global economy and a possible upheaval in the global financial system. The flexible exchange rate would provide an important buffer against shocks.

Monetary policy. The current accommodative monetary stance is appropriate. If the recovery remains on track and downside risks dissipate, monetary policy will need to tighten gradually to contain inflationary pressures. However, if the global recovery stalls or international capital markets are disrupted, the RBNZ has scope to cut the policy rate and provide liquidity support for banks.

Fiscal policy. The planned deficit reduction path strikes a balance between the need to contain both public and external debt increases while limiting any adverse impact on economic growth during the recovery. The authorities’ plan to return to budget surplus by 2014/15 should put New Zealand in a better position to deal with future shocks and the long-term costs of aging. Moreover, it will relieve pressure on monetary policy and thereby the exchange rate, helping contain the current account deficit over the medium term. New Zealand’s relatively modest public debt gives the authorities some scope to delay their planned deficit reduction path in the event of a sharp deterioration in the economic outlook.

External vulnerabilities and the exchange rate. New Zealand’s large net liabilities present a risk. Despite recent improvements, the current account deficit is projected to increase over the medium term as earthquake reconstruction activity gains pace and global interest rates normalize. To contain this increase and limit a further buildup of foreign liabilities over the longer term, the New Zealand dollar would need to be weaker than its current level. However, part of its current strength may dissipate over time with the eventual tightening of policy rates by major central banks. Increasing national saving, including through the planned fiscal deficit reduction, would reduce external vulnerability.

Financial sector issues. Banks remain sound, but they are exposed to highly leveraged households and farmers and rollover risks associated with large short-term offshore funding needs. While New Zealand’s bank regulatory norms are more conservative than in many other countries, the authorities should assess on an ongoing basis the balance between banking sector vulnerability versus efficiency to minimize the risk that systemically important banks pose to the economy. Options to strengthen prudential norms if needed could include setting banks’ capital requirements above the Basel III minimum or raising the core funding ratio more than the planned 75 percent to reduce short term external debt further. The RBNZ’s continued work on the costs and benefits of macroprudential measures is welcome, as is the authorities’ intention to implement key features of Basel III in early 2013.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/imf-executive-board-concludes-2012_19.html

Finland—2012 Article IV Consultation Concluding Statement

Despite strong fundamentals and a track record of good policies, Finland’s near-term outlook is threatened by intensifying external strains. Economic activity in the euro area is expected to weaken markedly in 2012 on the back of financial sector deleveraging and fiscal consolidation in several European countries. Spillovers to Finland could be significant given its highly open economy and trade and financial linkages with Europe. Thus, the key immediate policy concern is to cushion the downturn, including through a nimble fiscal policy, while mitigating any lingering vulnerabilities. Financial integration and complexity have created new risks and test supervisory abilities, not least in light of Finland’s close linkages with other Nordic financial markets. In the longer run, Finland faces challenges from a rapidly aging population, slowing productivity growth, and eroding competitiveness.

Economic situation

1. After the deep recession of 2008-09, the Finnish economy rebounded robustly in 2010 but stalled at the end of 2011. The recovery was supported by a strong surge in domestic demand, propelled by rising consumer confidence, low interest rates, and renewed wage growth, although exports never regained their previous vigor. As the euro area sovereign debt turmoil intensified, dwindling demand from trading partners dragged the economy to a standstill in late 2011, despite overall growth of about 3 percent for the year. Activity in the first quarter of 2012 was slightly stronger than expected, but weak investment suggests weakening growth in the near term. Albeit still adequate, competitiveness has worsened significantly in recent years, with contracting export market shares and a small current account deficit in 2011, the first in nearly two decades.

2. The financial sector has remained generally sound despite the turbulence in the euro area, but vulnerabilities persist. Bank capital ratios are comfortably above minimum requirements and non-performing loans are manageable. However, banks’ operating profits have declined amid weakening interest income and increased competition for retail business. Moreover, the Finnish banking sector is highly concentrated with a majority of assets controlled by subsidiaries of foreign Nordic banks, with attendant large exposures to the latter. These factors contribute to sizable spillover and deleveraging risks for banks owing to the financial strains in the euro area, though direct exposures to periphery countries remain minimal. Credit growth, while slower than before the crisis, is faster than in the rest of the euro area. The insurance and pension fund sectors are weathering well the ongoing crisis, but their solvency margins—though still relatively high—have been reduced.

3. The housing and mortgage markets appear relatively stable, albeit vulnerable to high and rising household debt.Household balance sheets have been made riskier by fast increases in indebtedness as a share of disposable income during the last decade. However, default rates have remained low, even if they could deteriorate if unemployment were to perk up markedly. In any case, highly-leveraged households could be forced to curtail their consumption, particularly when current low interest rates return to more normal levels given the dominance of floating rate mortgages, with a negative impact on activity. After some retrenchment in 2009, house prices returned to their pre-crisis growth path. In real terms, they are now comparable to those prevailing at the 1990s peak, though still broadly in line with fundamentals, according to various analyses.

4. The fiscal position deteriorated sharply during the acute 2009 recession, and while consolidation has now begun, the costs of population aging loom large. In 2011, the budgetary stance tightened by around 1 percent of GDP in structural terms, but weakening growth still put the headline deficit at ¾ percent of GDP and gross debt ended 2011 at 48½ percent of GDP. Over the longer run, aging costs for the general government are estimated to rise by about 5 percent of GDP, adding to fiscal pressures.

Outlook and risks

5. The mission expects GDP growth to decelerate markedly to around ½ percent in 2012 before picking up again in 2013. Negative growth in the middle of the year reflects weak consumption and investment, marred also by continued sluggish exports. Though activity should start to recover late in 2012, volatile financial market conditions and to a lesser extent structural fiscal consolidation (also in trading partners) will be a continuing drag. Accordingly, output will fall further below potential in 2012 and inflation will moderate. The supply potential of the economy may have been significantly curbed by the crisis as low investment has taken its toll. Potential growth may also be hindered by the recent deterioration in competitiveness.

6. Risks to the outlook are tilted to the downside, with heightened uncertainties. In the short run, they primarily relate to uncertainty about financial market developments, with possible tensions for bank funding leading to deleveraging and tighter credit, as well as spillovers from a deeper and more protracted slowdown in the euro area than now projected. Similar negative impacts could derive from a significant reduction in Finnish real estate prices or continued competitiveness erosion. In the longer run, persistence of expansionary monetary conditions in Finland, along with repercussions from safe-haven inflows into the financial system, may overheat the economy and fuel asset price bubbles. Limited expansion of working age cohorts in a rapidly aging population could also constrain potential growth.

Policies

7. Against this background, Finland must address existing vulnerabilities and long-term sustainability issues, while paying due attention to short-term growth. Financial sector policies should include efforts to maintain capital at the levels envisaged under Basel III while more emphasis should be given to liquidity provisioning. Fiscal policy must strike a delicate balance between supporting economic activity and addressing the sustainability gap. Further structural reforms should be implemented to spur potential growth, while wages should rise in line with productivity, thereby preventing more declines of competitiveness.

Financial sector

8. The mission recommends improving capital and liquidity buffers and continued vigilance to mitigate risks of potential interruptions of bank funding from abroad. Finnish banks already meet in their core Tier 1 ratios the minimum capital and conservation buffer requirements envisaged under Basel III, but not all credit institutions satisfy the leverage ratio requirement. Furthermore, compliance with Basel III liquidity requirements will entail some additional effort as regards the asset composition of the liquidity buffer and the size of long-term stable funding. Indeed, the Finnish banking system is largely funded through foreign sources and wholesale markets. Hence, banks could benefit from gradually building capital buffers and shifting asset composition toward more highly-liquid instruments. These objectives should be accomplished in measured but steady steps over the medium term to avoid fostering pressures for deleveraging.

9. The mission commends the authorities’ efforts to bolster supervisory practices. Improvements are being implemented along the lines of the 2010 FSAP recommendations. New liquidity standards have been introduced. The authority of the FSA to impose fines on credit institutions was extended in 2010, while further legislative changes are expected in 2012-13 in line with the EU harmonized framework for supervisory sanctions. Top-down stress testing capacities are also being augmented and work is ongoing to strengthen the analysis of the consolidated risk profile of complex financial groups.

10. Nonetheless, the mission underscores the necessity of enhanced supervision of nationally systemic banks and reinforcement of macro-prudential tools.

• Heavy concentration in the Finnish banking sector implies high contagion risk from systemic banks. Contagion analysis based on balance sheet inter-linkages indicates that a few institutions act as liquidity hubs, thus rendering them systemically important for the integrity of the financial system. In this regard, the mission regards as beneficial closer supervision and possibly more stringent prudential requirements for nationally systemic banks, such as additional capital buffers, higher liquidity provisions, and topped-up contributions to the Deposit Guarantee Fund.

• With a majority of loans tied to depressed Euribor rates, interest margins tightened. Very low rates over a prolonged period may encourage risk-taking by banks to increase short-term profits, including by accelerating credit expansion, ultimately with adverse impact on financial sector health. We advise that supervisors scrutinize carefully bank risk-taking behavior. Plans to define national competencies for macro-prudential supervision are a recent important step in this respect. The mission similarly welcomes the in-depth survey of vulnerabilities related to the housing and credit markets as well as publication of standard definitions to calculate the loan-to-value ratio (LTV) and the planned introduction of countercyclical capital buffers. These steps should be complemented by granting the FSA authority to make LTV ceilings binding and implementing a national loan registry to guard against excessive borrowing.

11. The mission also notes that the effectiveness of supervision and crisis resolution mechanisms can be further buttressed. Memoranda of understanding (MoU) complying with best international practice have been signed with foreign (mainly Nordic and Baltic) supervisors and supervisory colleges have been active. Nevertheless, these MoU are not binding, which hampers enforcement actions, and consideration should be given to strengthen their legal status. Similarly, enhancing mutual sharing of supervisory information could facilitate preparedness in host and home countries. We recommend that joint contingency planning with other national authorities for cross-border resolution be advanced, containing the risks to Finnish subsidiary activities, with ex-ante burden-sharing guidelines defined to limit contagion. The mission shares the authorities’ preference for a common bank-resolution framework at the EU level, but advocates formulating national or regional plans in the interim. Until such frameworks are fully operational, ring-fencing the activities of Finnish subsidiaries remains advisable.

Fiscal

12. The short-term fiscal stance is broadly neutral, while substantial adjustment is envisaged through 2015, though measures still have to be identified. The mission projects the general government (GG) structural surplus to remain roughly unchanged in 2012. Over the medium term, the government program aims to set the central government (CG) debt-to-GDP ratio on a declining path and reduce the CG deficit from 3 to 1 percent of GDP between 2011 and 2015 (end of the government’s term). However, attaining this goal would require measures beyond those already identified, as, under current policies and macroeconomic assumptions, we forecast the CG deficit to stay above 1½ percent of GDP by 2015.

13. The mission endorses the authorities’ 2012 and 2013 fiscal stances. The budget for 2012 provides for virtually full operation of automatic stabilizers, leading to an increase in the headline deficit, thereby supporting domestic demand. This is desirable because the outlook for near-term growth is weak and activity appears below potential. On the other hand, the long-term fiscal sustainability gap is estimated at about 4½ percent of GDP, owing to the impact of population aging on public expenditures. Thus, the mission concurs that a broadly neutral 2012 fiscal policy is appropriate, avoiding pro-cyclical withdrawal of support to the economy while preventing damage to long-term sustainability prospects. Similar considerations suggest that the authorities’ planned moderate structural tightening for 2013 is adequate too, provided economic activity rebounds as projected. Given the unusual downside risks surrounding the recovery, the authorities should nevertheless stand ready to loosen budget policy if growth underperforms considerably.

14. The mission also supports the medium-term consolidation goal. Over this longer horizon too, fiscal policy must balance the conflicting objectives of supporting growth and making progress toward closing the sustainability gap. Hence, the mission recommends a gradual structural adjustment, of about ½ percent of GDP per annum, which is broadly consistent with the authorities’ 2015 goal for the CG, eliminates the sustainability gap in 10 years, and allows for steady reduction and eventual disappearance of the output gap by 2017.

15. But we stress that such consolidation should be implemented flexibly to avoid harming growth. If growth falters significantly below potential, automatic stabilizers should be allowed to operate fully and further structural consolidation delayed until a recovery has taken firm hold. It may also be preferable to substitute part of the headline tightening with structural measures that significantly improve fiscal sustainability but only modestly impact activity, such as increasing the retirement age and boosting productivity in public service provision. The need for immediate fiscal consolidation is also lessened by the authorities’ strong track record in budget discipline. Despite the sustainability gap and high spreads in a number of other euro area countries, financial markets still regard Finland as low risk. Hence, rollover risks are marginal. Finally, postponing additional adjustment is unlikely to contravene the EU fiscal compact, since under the baseline macro scenario the GG structural balance has a substantive margin above the ½ percent of GDP deficit threshold.

16. Measures that directly reduce the impact of aging on public expenditures or broaden the tax base should form a key plank of medium-term adjustment efforts.

• The mission notes that, with a rapidly aging population and associated increase in health care costs, priority should be given to measures aimed at restraining growth in demand for health- and long-term care. By the same token, the generosity of the social and unemployment benefits system could be further moderated, notably by additional tightening of the unemployment and disability pipelines to early retirement as well as increases in the statutory minimum and maximum retirement ages, contributing to an increase in the effective retirement age.

• With an already high revenue ratio, the mission believes there is little scope for further increases in the tax burden. Hence, revenue measures should focus on broadening the tax base, reducing, if feasible, relatively high marginal labor tax rates, and shifting from labor taxation to less distortionary consumption- and property-based taxation. In this connection, the mission supports the one percentage point increase in the standard VAT rate and the energy tax hike, but also advocates reducing the number of items on reduced VAT rates. The mission endorses the authorities’ plans to lower mortgage interest deductibility, which subsidizes home ownership and promotes indebtedness by households, potentially heightening vulnerabilities of the financial system. Hiking property tax rates, which are low by international comparison, would provide municipalities with a more stable source of revenue, reducing their dependence on highly cyclical corporate taxes.

17. The mission encourages reform of the fiscal framework, especially for local governments (LG), to facilitate attainment of sustainability. Increased attention should be given to contain rapid expenditure growth in LG, for example by moving toward expenditure ceilings for municipalities and by smoothing their revenue stream with the aim of avoiding pro-cyclical spending peaks and troughs and thus strengthening long-term budget planning. Additional mergers of municipalities would pave the way for economies of scale.

Structural reform and other

18. With the looming decline of working age cohorts due to aging, policies should encourage greater labor force participation and productivity to enhance growth. Apart from increasing the minimum and maximum statutory retirement ages, the mission recommends that labor market policies and benefits be adjusted so that activation takes place earlier. Moreover, we note the OECD recommendation that public R&D expenditures be refocused on basic research rather than direct support to business R&D. The mission also points out that tuition fees and more reliance on loans rather than grants for students would likely improve the cost effectiveness of higher education. Additionally, the large productivity differential between manufacturing and services should be reduced by opening the service sector to more competition. Similarly, opening the health care sector to competition could improve efficiency and help contain the buildup of aging pressures.

The mission is grateful for the high quality and openness of the discussions and for the cooperation and hospitality received from the Finnish authorities and private sector.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/finland2012-article-iv-consultation.html

2012 Article IV Consultation with Japan Concluding Statement of the IMF Mission

The Japanese economy has shown remarkable resilience and adaptability in the aftermath of the Great East Japan earthquake and is now experiencing a recovery. Risks, however, have shifted decidedly to the downside, with the turmoil in Europe intensifying and other advanced and key emerging market economies showing signs of slowing. Moreover, to address the longstanding challenges of high public debt, low growth, and deflation, Japan needs to move forcefully on many fronts to take advantage of synergies among policies. The immediate priority is passage of the current tax and social security reform, which would bolster confidence and help create a more conducive environment for monetary easing. It would also help maintain financial sector stability, given increased fiscal and financial sector linkages. An exit from deflation and accelerated structural reforms would raise growth and support fiscal adjustment. This statement summarizes the findings of the Article IV consultation and the recent Financial Sector Assessment Program (FSAP) Update.

I. Outlook and Risks

1. Despite the devastation of the earthquake and tsunami, the impact on growth proved to be shortlived. Real GDP declined by ¾ percent in 2011 but grew at an annualized rate of 4¾ percent in the first quarter of 2012. Moreover, the financial sector has remained stable and the current account has continued to record a sizeable surplus.

2. Looking ahead, reconstruction will drive the recovery.Growth is expected to reach about 2 percent in 2012 supported by public reconstruction spending of around 1½ percent of GDP and a recovery in consumer demand (text table). A weak external environment, especially in Europe, is likely to dampen demand for exports and weigh on business sentiment. For 2013, real GDP growth is projected to slow slightly to 1¾ percent as reconstruction winds down. While headline inflation has risen modestly, IMF staff expect inflation to remain around zero in the next two years, under current policies, as a result of the still wide output gap and declining commodity prices.

3. Risks to the outlook have shifted decidedly to the downside. An escalation of the European turmoil or a sharper-than-expected slowing of the Chinese economy would hurt Japanese exports and growth. Moreover, an intensification of the flight to safety in financial markets could lead to exchange rate volatility, further appreciate the yen and depress equity prices and business and consumer confidence. With the complete closure of all nuclear plants, an unusually hot summer could disrupt economic activity. This risk would be mitigated, however, by the extent of conservation efforts already being taken. On the upside, a faster than expected recovery in Japanese consumer and business sentiment would lift domestic demand, while a reopening of some nuclear power plants would limit the disruption in economic activity.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/2012-article-iv-consultation-with-japan.html

Statement at the Conclusion of the 2012 Article IV Consultation Mission to Korea

An International Monetary Fund (IMF) mission, led by Mr. Hoe Ee Khor, visited Seoul during May 30 – June 12 to conduct the 2012 Article IV consultation discussions. At the conclusion of the mission, the team issued the following statement:

“After a strong rebound in 2010, the Korean economy moderated in 2011 and into 2012 in line with global developments. Reflecting the weakening global economic outlook, Korea’s growth is likely to be weaker than the 3.5 percent in our baseline forecast and we expect growth for this year to be reduced by about ¼ percentage point. Activity in the second half of 2012 is expected to expand at a moderate pace supported by Korea’s competitive export sector and the recently concluded EU and US free-trade agreements. On the domestic side, facilities investment is expected to recover, while consumption should be boosted by stronger wage growth.

“The outlook is, however, subject to substantial uncertainty. The main downside risk relates to the intensification of the crisis in Europe. While the direct exposure to Europe is not high, if weaknesses there were to spill over to the United States and China, the impact on Korea can be substantial.

“The baseline for 2012 envisages the full implementation of the budget. The government’s determination to resist spending pressure in an election year and to continue to consolidate the fiscal position is commendable. However, given its fiscal strength, in the event of a significant worsening of the global economy, there is room for the government to take additional fiscal measures to support the economy, if necessary.

“We commend Korea’s longstanding commitment to fiscal prudence, which creates space for a strong fiscal response when needed. In this regard, we welcome the plan to achieve a balanced budget (excluding the social security fund balance) in 2013. Looking ahead, higher social spending, rapid population ageing, and potential costs related to geopolitical events, all suggest that integrating long-term issues more systematically into the fiscal policy framework remains an important priority.

“Korea’s intention to increase social spending is also laudable, particularly to improve the welfare of the lower income groups. Despite a significant rise over the last two decades, there is still scope for social spending to increase at a measured pace. Ideally, this spending increase should be carried out while maintaining the overall fiscal consolidation path, which could be achieved through a combination of reducing spending in some lower priority areas, and strengthening revenue performance.

“With respect to monetary policy, maintaining the policy rate at the current level is an appropriate response to global economic weakness and uncertainties. However, the monetary policy stance is still accommodative, and when growth strengthens from its current moderation, some increase in the policy rate may be needed in early 2013 to ensure that inflation remains within the target range. If the economy were to weaken significantly more than expected, the Bank of Korea still has room to cut rates as it did effectively in 2008-09.

“The external vulnerability of the Korean financial system has diminished considerably since 2008. This reflects higher international reserves relative to short-term debt, lower reliance on external funding for the banks, and the adoption of a series of macroprudential measures. International reserves are currently at a strong level and have been augmented by the bilateral swap lines with China and Japan. The exchange rate should continue to be market determined with intervention limited to smoothing excessive volatility. If the Euro area crisis intensifies, international reserves should be deployed to support foreign exchange liquidity and maintain orderly market conditions.

“Despite substantial progress in strengthening the financial system, some potential vulnerabilities remain. Korea is one of the most open economies in Asia and is highly exposed to volatile capital flows and foreign currency funding risks. We would therefore encourage the authorities to enhance its contingency planning for tail risks. The high level of household debt has been a concern for some time and the government has taken measures to address it. Recently, lending by nonbank financial institutions to households has grown rapidly and this also needs to be monitored closely with corrective actions taken if necessary.

“Korea is now an advanced industrial economy. Maintaining high potential growth will become more challenging over time and will require improved labor markets and higher productivity, especially in the services sector. Higher labor force participation rates—particularly by females—will support higher growth. Improving competition in the education and health sectors, and expediting the bank-led restructuring of small- and medium-sized enterprises will enhance service sector productivity, as will deregulation measures being implemented under the free-trade agreements with the US and EU.”

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-at-conclusion-of-2012-article_19.html

Statement at the Conclusion of the 2012 Article IV Consultation Mission to Korea

An International Monetary Fund (IMF) mission, led by Mr. Hoe Ee Khor, visited Seoul during May 30 – June 12 to conduct the 2012 Article IV consultation discussions. At the conclusion of the mission, the team issued the following statement:

“After a strong rebound in 2010, the Korean economy moderated in 2011 and into 2012 in line with global developments. Reflecting the weakening global economic outlook, Korea’s growth is likely to be weaker than the 3.5 percent in our baseline forecast and we expect growth for this year to be reduced by about ¼ percentage point. Activity in the second half of 2012 is expected to expand at a moderate pace supported by Korea’s competitive export sector and the recently concluded EU and US free-trade agreements. On the domestic side, facilities investment is expected to recover, while consumption should be boosted by stronger wage growth.

“The outlook is, however, subject to substantial uncertainty. The main downside risk relates to the intensification of the crisis in Europe. While the direct exposure to Europe is not high, if weaknesses there were to spill over to the United States and China, the impact on Korea can be substantial.

“The baseline for 2012 envisages the full implementation of the budget. The government’s determination to resist spending pressure in an election year and to continue to consolidate the fiscal position is commendable. However, given its fiscal strength, in the event of a significant worsening of the global economy, there is room for the government to take additional fiscal measures to support the economy, if necessary.

“We commend Korea’s longstanding commitment to fiscal prudence, which creates space for a strong fiscal response when needed. In this regard, we welcome the plan to achieve a balanced budget (excluding the social security fund balance) in 2013. Looking ahead, higher social spending, rapid population ageing, and potential costs related to geopolitical events, all suggest that integrating long-term issues more systematically into the fiscal policy framework remains an important priority.

“Korea’s intention to increase social spending is also laudable, particularly to improve the welfare of the lower income groups. Despite a significant rise over the last two decades, there is still scope for social spending to increase at a measured pace. Ideally, this spending increase should be carried out while maintaining the overall fiscal consolidation path, which could be achieved through a combination of reducing spending in some lower priority areas, and strengthening revenue performance.

“With respect to monetary policy, maintaining the policy rate at the current level is an appropriate response to global economic weakness and uncertainties. However, the monetary policy stance is still accommodative, and when growth strengthens from its current moderation, some increase in the policy rate may be needed in early 2013 to ensure that inflation remains within the target range. If the economy were to weaken significantly more than expected, the Bank of Korea still has room to cut rates as it did effectively in 2008-09.

“The external vulnerability of the Korean financial system has diminished considerably since 2008. This reflects higher international reserves relative to short-term debt, lower reliance on external funding for the banks, and the adoption of a series of macroprudential measures. International reserves are currently at a strong level and have been augmented by the bilateral swap lines with China and Japan. The exchange rate should continue to be market determined with intervention limited to smoothing excessive volatility. If the Euro area crisis intensifies, international reserves should be deployed to support foreign exchange liquidity and maintain orderly market conditions.

“Despite substantial progress in strengthening the financial system, some potential vulnerabilities remain. Korea is one of the most open economies in Asia and is highly exposed to volatile capital flows and foreign currency funding risks. We would therefore encourage the authorities to enhance its contingency planning for tail risks. The high level of household debt has been a concern for some time and the government has taken measures to address it. Recently, lending by nonbank financial institutions to households has grown rapidly and this also needs to be monitored closely with corrective actions taken if necessary.

“Korea is now an advanced industrial economy. Maintaining high potential growth will become more challenging over time and will require improved labor markets and higher productivity, especially in the services sector. Higher labor force participation rates—particularly by females—will support higher growth. Improving competition in the education and health sectors, and expediting the bank-led restructuring of small- and medium-sized enterprises will enhance service sector productivity, as will deregulation measures being implemented under the free-trade agreements with the US and EU.”

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-at-conclusion-of-2012-article_7228.html

Statement by the 2012 Article IV Consultation Mission to the Russian Federation

A staff team from the International Monetary Fund (IMF), headed by Mr. Antonio Spilimbergo, visited Moscow during May 31 - June 13 to hold discussions for the 2012 Article IV consultation.¹ The team met with Finance Minister Anton Siluanov, Central Bank of Russia (CBR) Governor Sergei Ignatiev, other senior officials, and representatives from the private sector, academia, and think tanks. At the conclusion of the visit, Mr. Spilimbergo issued the following statement:

“The Russian economy has recovered from the 2008-09 crisis and is now running close to its potential. High oil prices, strong wage growth, and robust consumption have supported demand. Meanwhile, the unemployment rate has fallen below 6 percent and capacity utilization in manufacturing has risen to its pre-crisis peak, suggesting that the remaining slack in the economy is small. While headline inflation slowed to 3.6 percent in May 2012, this owed mostly to a delay in administrative price increases and favorable food prices, and the IMF staff team’s measure of underlying inflation remains above 6 percent.

“The outlook is for continued moderate growth and a rebound in inflation. Under unchanged policies, we project growth of about 4 percent both in 2012 and 2013. With the economy moving above potential, the supply-side factors muting prices reversing, and the exchange rate recently depreciating, inflation is projected to increase to around 6½ percent in 2012 and to remain at that level in 2013.

“The ongoing turbulence in international markets is affecting Russia mostly through oil prices. The reliance on oil exports exposes Russia to declining oil prices, especially if accompanied by large capital outflows. The increased exchange rate flexibility has been a major policy advancement and is helping the Russian economy absorb external shocks, including spillovers from international developments.

“An ambitious fiscal consolidation is needed. This would help avoid overheating in the economy and depleting the wealth of future generations. Cutting the nonoil government deficit by some 1½ percent of GDP in 2012 to 9 percent of GDP, and further by about 1½ percent of GDP per year through 2015 would limit demand pressures in the short term and lay the basis for balanced economic growth and inter-generational equity over the longer term. The immediate priorities include withdrawal of the crisis-related enterprise subsidies and reduction in tax exemptions. Looking further ahead, pension reform is indispensible for fiscal adjustment. To stabilize pension spending at its 2010 level, the retirement age should be raised for both men and women to 63 years by 2030 and 65 years by 2050, in line with increases in life expectancy. In addition, the eligibility criteria for early retirement should be tightened, combined with a strengthening of disability and welfare programs to protect the vulnerable. Other budget measures, such as better targeting of social transfers and improving the efficiency of expenditures, will also be needed.

“A fiscal anchor should be promptly reinstated. Such an anchor would guide medium-term fiscal policy, decoupling the fiscal stance from short-term variations in oil prices and ensuring intergenerational equity. While reinstatement of the nonoil deficit target would be the first-best option, an oil price-based rule, if well designed, could broadly achieve the same objectives. In this regard, however, the specific oil-price rule under discussion would leave the nonoil deficit in excess of the level consistent with intergenerational equity, and a more conservative base oil price would be appropriate. Strong political commitment to the chosen fiscal rule is important; in this respect, continuing the long-standing practice of multiple supplemental budgets during the year would undermine the rule and should be discontinued.

“Monetary policy should be aimed at securing low and stable inflation. Timely tightening of monetary policy is necessary to contain the rebound in inflation and anchor medium-term inflation expectations. At the same time, the CBR should stand ready to provide emergency liquidity as needed if global financial conditions worsen. The greater exchange rate flexibility is a welcome development in this context as, besides helping absorb external shocks, it allows monetary policy to focus squarely on inflation. For the successful adoption of inflation targeting, continued steps to strengthen monetary policy tools are necessary. In addition, further enhancing communication policies, including the publication of inflation forecasts, will be important to improve transparency and convey the rationale for CBR’s policy measures to the public. Transparency would be improved by making the repo rate formally the primary policy interest rate.

“A stronger supervisory framework is key to facilitating sound financial intermediation. The financial system is improving, but concerns remain about asset quality in the context of rapid credit growth and volatile oil prices. Russia continues to improve its financial stability analyses and macro-prudential oversight framework. In this regard, the prompt passing of legislation on consolidated supervision and connected lending and the expansion of the CBR’s powers to use professional judgment remains a top priority.

“Delivering on structural reforms will promote economic growth. Structural reforms are crucial to increase investment, diversify the economy, and raise potential growth. Russia’s accession to the WTO should be seized upon to strengthen the momentum for reforms making the business environment more predictable and rules-based. Complementary steps to reduce corruption, strengthen the rule of law, and scale back state involvement in the economy―including through transparent and decisive privatization of state owned companies―are priorities”.

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¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with its member countries, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-by-2012-article-iv.html