Autumn statement effect on exchange rates

Wednesday 5th December 2012 

Good afternoon. The market has now stabilised after the Autumn statement by the chancellor. In this afternoons post I’m going to have a quick look at the effect of the statement, and also what is coming up in the next few days that could affect exchange rates. 

Effect of Autumn budget statement on exchange rates 

This is an easy one to sum up; there was little to no reaction at all! Sterling had been falling in the run up to the announcements anyway, and this morning was at a 1 month low against the Euro. As is often the case, the currency markets move more on rumour than actual fact, and the Pound was already vulnerable as investors braced for grim tidings from the UK's finance minister in his half-yearly budget statement. This is how GBP/EUR has moved today:

The market has already been anticipating a difficult Autumn Statement and this was for the most part already priced in to rates. Earlier this morning, the pound barely reacted to a survey showing Britain's service sector grew at its slowest pace in almost 2 years. The PMI number was below forecasts, but still just above the magic 50 level, which signals growth, which is probably the reason we saw hardly any movement. 

You can see in the chart above the market was already at its lowest before the speech, and the Pound/Euro rate actually recovered by around 0.3% just before Mr Osborne starting speaking. During the speech we saw basically no movement at all, as there were no surprise announcements. 

You can read a quick guide here as to what the statement contained from the BBC. The only real thing of interest was the scrapping of a planned 3p rise in fuel duty. Also of interest to the currency markets were the growth forecasts which are now predicted to be -0.1% in 2012, down from 0.8% predicted in the Budget. Forecasts for next few years are: 1.2% in 2013, 2% in 2014, 2.3% 2015, 2.7% in 2016 and 2.8% in 2017.

Quantitative Easing announcement tomorrow

Lowered growth forecasts could open the way to more quantitative easing by the Bank of England QE is generally perceived as negative for a currency. But if the fiscal austerity programme is relaxed too much that could also be negative as it would bring the UK's triple-A rating into question. 

The next announcement on QE is tomorrow lunchtime, when the Bank of England will announce whether or not they will increase the measures. We will also see the Bank of England and European Central Bank announce their latest decisions on interest rates. 

I don’t’ expect any surprises on either QE or interest rates. In the run up to Christmas it’s highly unlikely that there will be any changes, but depending on how economic figures are in the next few weeks, we may see more QE in the early part of next year.

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Source | Foreign Exchange Rate Forecasts | http://foremostcurrencygroup.blogspot.com/2012/12/autumn-statement-effect-on-exchange.html

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

Statement by the IMF Mission in Bosnia and Herzegovina

An International Monetary Fund (IMF) mission, led by Costas Christou, held discussions with the authorities of Bosnia and Herzegovina (BiH) during May 16–29, 2012 on the 2012 Article IV consultation and on a possible new program that could be supported by the Fund. At the conclusion of the visit, Mr. Christou made the following statement:

“After successfully weathering the initial effects of the global financial crisis, BiH’s economy is facing renewed pressures. The recovery, which started in 2010, has weakened amid signs that the euro zone crisis is negatively affecting BiH’s exports and capital inflows. Domestic demand remains subdued, held back by fiscal restraint, stagnant wages and slow credit growth. With the softness in the economy, inflation has been trending lower. We see no output growth in 2012 and the prospects beyond 2012 remain clouded by ongoing uncertainty in the euro zone and BiH’s own vulnerabilities.

“On the positive side, continued fiscal restraint helped contain the general government deficit within 3 percent of GDP in 2011, down from 4.2 percent of GDP in 2010. However, this was achieved in part through temporary measures, as national policy coordination weakened and progress on structural fiscal reforms slowed. Public finances are expected to remain under pressure in 2012 as the economy weakens.

“We welcome the prospect of adoption of the 2012 budget of the Institutions of BiH. This will remove an element of uncertainty in budget planning, allowing the Entities to revise their budgets and base them on more realistic tax revenue and financing assumptions. In the current environment, ongoing expenditure restraint is critical to safeguard the stability of public finances at all government levels. We encourage the governments to move beyond one-off savings measures and step up reforms of public sector wages and employment, war-related benefits, and the pension and health systems.

“The banking system has been weathering the impact of the global financial crisis well. The sector as a whole returned to profitability in 2011 and banks have continued to build their capital buffers through capital injections and profit retention. Household deposits have grown strongly. However, nonperforming loans, which rose again slightly in the first quarter of 2012 after signs of stabilizing, act as a drag on credit growth. This is affecting particularly credit to the private sector, which is being crowded out by large government financing needs that are being met increasingly through bank borrowing.

“We also initiated discussions on a program that could be supported by the Fund. The authorities expressed commitment to a program that would provide a policy framework for macroeconomic stability, support renewed efforts to advance the unfinished reform agenda, and help BiH meet its external financing needs. The mission is prepared to return to BiH to continue program negotiations in the coming weeks. In the meantime, the authorities have committed to develop a clear common economic strategy, agree on the policy objectives, and identify steps for implementation of much-needed reforms.”

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-by-imf-mission-in-bosnia-and.html

Statement by IMF Mission to Ukraine

A team from the International Monetary Fund visited Kiev during May 21–28, 2012 to hold discussions for the 2012 Article IV consultation. The team met with Prime Minister Azarov, National Bank of Ukraine Governor Arbuzov, Minister of Finance Kolobov, other senior officials, and representatives from the private sector and civil society. At the conclusion of the visit, the mission chief Mr. Chris Jarvis issued the following statement:

“The government and the National Bank of Ukraine have made progress in their efforts to support economic stability. We welcome the government’s recent pension reform and the new customs code. The public is benefiting from lower inflation supported by the NBU’s monetary policy. Progress has been made in deregulation and simplifying the tax laws.

“To ensure sustainable growth and reduce financial risks, Ukraine still needs to resolve a range of important issues and deal with external and internal challenges.

“Economic growth is expected to slow this year, hurt by weaker demand for Ukraine’s exports. We project that annual growth will be 3 percent. Inflation is projected at around 7 percent for the year. We expect the current account deficit to widen to 6½ percent of GDP on current policies, though if policies are tightened the deficit could be lower.

“Ukraine has considerable external financing needs that leave it vulnerable to changes in investor sentiment. Persuading investors to support Ukraine requires policies consistent with economic stability and steady progress in implementing a reform agenda in key reform areas.

“Strengthening the fiscal position is a key government objective. The supplementary budget has increased wage and pension expenditures, and targets higher revenue collection to finance this. In order to meet the government’s 1.8 percent of GDP deficit target new measures will be needed. These could include raising tax rates for high earners, ending tax exemptions, or reducing expenditures.

“The government has set an ambitious goal to achieve energy independence. Raising gas and heating tariffs for households is an essential component of any strategy to achieve this. We recommend significant upfront tariff increases and regular increases thereafter as part of a time-bound plan to eliminate subsidies. We also recommend giving more money to the poorest households to offset their increased costs. Raising prices will lower Naftogaz’s deficit, reduce imports, and free up resources for investment in domestic production and energy efficiency.

“The monetary policy stance should continue to focus on maintaining price stability. The current monetary stance is appropriate given heightened external risks. We continue to believe greater exchange rate flexibility can better serve Ukraine in adapting to changing economic circumstances and can provide a buffer for external shocks.

“The financial sector needs to be strengthened further to help revive lending and support economic growth. The banking system appears well capitalized, but further reforms are necessary to reinforce bank balance sheets, including measures to help reduce large non-performing loans.

“We recommend ambitious reforms to improve living standards and help realize Ukraine’s economic potential. These should include building stronger public institutions and creating a better and more predictable business climate to support investment and growth.”

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

Statement at the Conclusion of an IMF Mission to Sudan

An International Monetary Fund (IMF) mission visited Sudan during May 13–25, 2012, to conduct the 2012 Article IV Consultation. At the conclusion of the visit, the mission chief Mr. Edward Gemayel issued the following statement:

“The IMF team met with Minister of Finance Ali Mahmood Abdulrasool, Minister of Oil Awad AlJaaz, Minister of Mining Kamal Abdelateef, State Minister of Finance Megdi Yasin, Deputy Governor of the Central Bank Badreddin Mahmood Abbas, Under Secretary of Ministry of Finance Yousif AlHussein, members of parliament, representatives of the private sector, civil society organizations, the diplomatic community, and development partners.

“The mission discussed the appropriate policies to address the economic challenges faced by Sudan as a result of South Sudan’s secession. The mission’s preliminary assessment is that economic conditions in Sudan deteriorated in 2011. Economic growth is estimated to have slowed down to 2.7 percent, end-year inflation reached 19 percent, the overall fiscal deficit was about 4 percent of GDP, and the current account registered a surplus of 2 percent of GDP. Preliminary information for 2012 indicates that economic conditions have not improved.

“The mission and the authorities agree that the challenges confronting Sudan are daunting and require appropriate reforms to stabilize the economy. More work is needed to improve prospects for inclusive growth and job creation.

“To address these challenges, the mission recommends a two-pronged reform strategy: short-term emergency measures to regain control of, and stabilize, the economy, including fiscal consolidation, and in the medium-term, a comprehensive structural reform program to recalibrate the economy in line with the country’s economic and financial potential.

“The mission welcomes the government’s reform efforts. It encourages the authorities to expeditiously implement the appropriate policies to address the challenges ahead.

“The mission wishes to thank the authorities for their cooperation and constructive dialogue.”

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-at-conclusion-of-imf-mission_03.html

Statement by the IMF Mission to El Salvador

A mission from the International Monetary Fund (IMF) led by Mario Garza visited San Salvador during May 21–25 to review recent developments and the economic outlook. At the conclusion of the visit, Mr. Garza issued the following statement in San Salvador:

“The IMF team had productive meetings with President Mauricio Funes and his economic team. The authorities reiterated the government’s commitment to prudent policies that will place the public debt-to-GDP ratio on a downward path and protect social spending. They noted the importance of further strengthening El Salvador’s fiscal position through expenditure restraint and higher fiscal revenues and expressed their interest in maintaining a financial arrangement with the IMF until

2014. As part of the agreed working agenda, IMF staff will maintain a close dialogue with the authorities to assist them in achieving their fiscal consolidation objectives.”

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-by-imf-mission-to-el-salvador.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

Statement by the EC, ECB, and IMF on the Fourth Review Mission to Portugal

The program remains on track amidst continued challenges.The authorities are implementing the reform policies broadly as planned and external adjustment is proceeding faster than expected. At the same time, rising unemployment has emerged as a pressing concern. The need to combine fiscal consolidation with deleveraging private balance sheets while restoring external cost competitiveness remains a difficult balancing act. But the authorities are determined to stay the course of adjustment and reform. Broad-based political support and social consensus is a key contribution to a successful adjustment.

Growth in 2012 may hold up better than expected. The rebalancing of the economy has continued, with stronger-than-expected exports more than offsetting weaker domestic demand. GDP in 2012 is now expected to decline by 3 percent (against 3¼ percent before). Positive albeit still subdued growth is expected in 2013. However, with domestic demand weak and pressures on firms to reduce high indebtedness, unemployment has increased sharply as part of the adjustment process, and could peak at close to 16 percent in 2013. Continued tensions in the euro area represent a risk clouding the external outlook.

The ambitious 2012 fiscal deficit target remains within reach. Notwithstanding the weaker labor market and a less tax-friendly growth composition, the authorities expect to achieve the deficit target of 4.5 percent of GDP. As during the third review, new fiscal measures were not discussed, but developments warrant close monitoring to detect potential slippages in a timely manner. The strategy to prevent new and to settle existing arrears is being implemented and regional and local governments under financial stress receive additional support, on the condition of enhancing their own consolidation efforts. Reforms of state-owned enterprises and public-private partnerships are on track. Efforts to strengthen public financial management, bolster tax compliance, and streamline public administration are continuing at good pace.

Protecting the banking system and ensuring orderly deleveraging remain among the program priorities. Liquidity in the banking system continues to benefit from exceptional support from the Eurosystem. The authorities are finalizing efforts to ensure that mid-year targets for banks’ capital buffers will be met. Further progress has also been made in strengthening the banking supervision and resolution frameworks. Tight credit conditions remain a concern and a range of measures is in train to ensure that sound companies, particularly in the tradable sectors, can fund their activities.

Progress is being made on reforms to raise long-term growth. Although product market reforms could still be stepped up in some areas, the program’s structural reform agenda will create the conditions for sustainable growth in productive jobs over the medium term. Reforms are in progress as regards removing rigidities in the housing market, privatizing state companies, making the ports more competitive, and increasing the efficiency of the judicial system. Examples of reforms already legislated include the competition law, the insolvency code, and the urban lease law. Some progress has also been made in reducing the undue burden on consumers and taxpayers by increasing competition and reducing rents in the network and sheltered services sectors, including in the electricity sector. Nevertheless, more determination is needed to push through reforms that touch on sensitive political and vested interests.

The surge in unemployment requires decisive policy action.Temporarily higher unemployment is part of the transition to a more export-oriented economy, but its rise has been exacerbated by Portugal’s long-standing labor market rigidities. The recent approval of the revised Labor Code should attenuate job losses. The broader structural reform agenda and rising capacity utilization in the export sector should help employment recover in the medium term. Nevertheless, further action to improve the functioning of the labor market is urgent. This includes institutional reforms that give firms more flexibility in matching labor costs and productivity. The exceptionally high unemployment, particularly among the young, also calls for more immediate measures, including active labor market policies. We also welcome the government’s initiative to consider, in the context of the budget 2013, ways to reduce social security contributions targeting specific segments of the labor force.

Overall, this review confirms that the program is making good progress amid continued strong external support. Provided that the authorities persevere with strict program implementation, the euro area member states have declared they stand ready to support Portugal until market access is regained. The efforts of the Portuguese authorities are being complemented by a strengthened EU economic policy framework and new EU initiatives to support growth and employment in Portugal, and in Europe as a whole.

The government’s program is supported by loans from the European Union amounting to €52 billion and a €26 billion Extended Fund Facility with the IMF. Approval of the conclusion of this review will allow the disbursement of €4.1 billion (€2.7 billion by the EU, and €1.4 billion by the IMF). These disbursements could take place in July subject to the approval of the IMF Executive Board and ECOFIN and EUROGROUP. The joint mission for the next program review is expected to take place in September 2012.

Source | International Monetary Fund - Blog NEWS | http://imf-news.blogspot.com/2012/06/statement-by-ec-ecb-and-imf-on-fourth.html

IMF Article IV Mission, Concluding Statement of the IMF Mission, May 29 to June 5, 2012

Much progress has been made in addressing Tuvalu’s economic challenges. The government has taken difficult decisions regarding spending, tax compliance is rising, and the new Policy Reform Matrix (PRM) process should streamline the process by which donors help the government reach its own priorities. The banking system is moving toward health, and public enterprises’ operations have shown improvement. All these steps are commendable, but a significant agenda remains to be implemented. To secure these gains and return Tuvalu to high growth, the government should build on these successes.

Economic Developments

A slow recovery is underway in Tuvalu, but there are important risks. GDP grew in 2011 for the first time since the global financial crisis, led by the private retail sector and education spending. We expect growth to rise slowly from 1.1 percent last year to 1.2 percent this year as the services sector continues to grow. Falling prices for imported goods such as clothing pulled inflation down to 0.5 percent in 2011, but the prices of domestically produced goods and services are also broadly stable. However, falling numbers of Tuvaluan seafarers, and the corresponding drop in their remittances, are hurting household incomes at a time when a strong, if weaker, Australian dollar is increasing imports. The possibility that seafarer income both does not recover and is not replaced by opportunities such as seasonal employment schemes is the biggest risk to long-term sustainable growth.

Even beyond employment, Tuvalu remains exposed to the difficult global environment.

Strong performance at the Tuvalu Trust Fund (TTF) has brought closer the point where it will begin to recapitalize the Consolidated Investment Fund (CIF). But a reversal could hurt the TTF, depriving the government of necessary support. Proceeds from licensing and joint ventures have improved the government’s revenue prospects, but further strengthening of the Australian dollar could negate these gains. On the other hand, a rapid weakening of the dollar could cause prices of imported goods to rise quickly. In the current fragile environment, this would present serious difficulties for Tuvaluan households.

Policy Discussions

Fiscal Policy and the Global Environment

The global crisis led to two linked problems in Tuvalu. First, high spending has drained the government’s assets just as the TTF was hit by poor returns. Second, falling seafarer employment hurt household incomes. Both have been aggravated by the strong Australian dollar, which reduced U.S. dollar-denominated earnings for seafarers and the government.

Now is the time to build on last year’s successful measures to bring the budget under control. Steps taken to bring down TMTS costs, and the decision to approve no new scholarships this year were difficult and commendable. Thanks to these steps, improved tax compliance by the private sector, and a large one-off Australian grant, the CIF will not be exhausted in 2012¹. But budget support next year will be tied to implementing PRM measures. Raising the TCT rate is an important step, but raising compliance among PEs – currently none of which pay TCT – will be crucial both to bring deficits down in the future and for securing budget support from donors. The next step for direct taxes is to follow through with penalties for noncompliance, including nonfinancial ones such as passport suspension. On subsidies, returning TMTS referrals to a committee of doctors should begin to bring costs down. The authorities should also continue to coordinate with donors to ensure scholarships remain at a sustainable level and bring CSOs transparently on budget. Public wage increases should also be tied more closely to inflation. Finally, new joint ventures should be signed with care, and only after verifying that market-based borrowing by NAFICOT does not endanger concessional assistance from donors.

Going forward, expenditure should be reoriented toward supporting social goals and growth. The PRM rightly focuses on primary education and streamlining health expenditure. More support for training, for example by enrolling women and broadening the curriculum at TMTI and by determining priority areas for awarding scholarships, will improve Tuvalu’s ability to send productive workers abroad, as will taking more advantage of seasonal labor schemes in Australia and New Zealand. Cuts to capital expenditure should not postpone needed infrastructure improvements, and Outer Islands projects should be clearly prioritized and financed by the FTF’s unspent balances rather than relatively scarce government resources.

These and other ongoing efforts will also help Tuvalu deal with the challenging global environment. Smaller budget deficits will allow the government’s assets to be rebuilt while better training and more opportunities for Tuvaluan workers, in New Zealand and increasingly in Australia, will help cushion the blow of declining seafarer demand. The new objective-based asset allocation of the TTF should be implemented with a strong bias toward protecting Tuvalu’s asset holdings, both of the TTF and the TNPF, from risky conditions in global financial markets.

Supporting Private Sector Growth

Raising incomes will also depend on creating a better business environment. Some results are already visible from public enterprise reform: collections at TEC are up and TMTI is on a better footing. But further improvements are undermined by overlapping arrears with the government, which PEs cite as a reason not to pay taxes. However, improvements at the banks are encouraging, as they will grant more Tuvaluans access to credit and increase capacity to support new businesses.

Continuing to implement the PE reform agenda is key to supporting growth. Addressing tax arrears and poor customer payment culture is especially challenging in small countries. Improved accounting procedures should help sort out the net position of unpaid government supplier payments to PEs and PE tax arrears, but more important in the long run will be ensuring both parties make all payments on time and transparently. The effort to commercialize PE operations is also paying off with improved risk management at the NBT and higher collections at TEC. In the long run, this will increase the flow of dividends to the government, easing fiscal pressures, and reduce PE overdrafts at the NBT, freeing capital for lending.

The financial system has made significant strides, and progress seems likely to continue. The improved focus on credit quality and financial position of the DBT and NBT are encouraging. In particular, the DBT has begun to clean its balance sheets by writing down uncollectible loans. As the NBT’s risk monitoring capabilities improve, it should begin to do the same. On the other hand, delinquencies from small loans at the TNPF are a concern of unknown magnitude: to ensure the Fund’s continued financial health, the authorities should seek to have its actuarial viability assessed, and also amend the law to encourage retirees to take annuities rather than lump-sum withdrawals.

Government interference in the economy should also be reduced. As they return to health, the DBT and NBT should gradually be allowed to set their own rates, at least in areas, such as lending to businesses, where they are already effectively in competition. Installing a new and fully professional board at TEC to ensure the company’s independence will show that Tuvalu is serious about improved PE management. Finally, the unfortunate situation at TCS presents a very difficult problem with no easy solution. Private companies are already taking over TCS’ traditional business of supplying the Outer Islands. To facilitate this transition, the government should coordinate with businesses both in Funafuti and the Outer Islands to ensure that they have sufficient credit and freight capacity to ensure all Tuvaluans have access to retail goods.

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

Statement at the Conclusion of an IMF Staff Visit to Turkey

An International Monetary Fund (IMF) mission, headed by Ernesto Ramirez Rigo, visited Istanbul and Ankara on May 31–June 6, 2012 to discuss recent economic developments and preparations for the 2012 Article IV consultation discussions. The team met with senior officials and staff at the Treasury, Ministry of Finance, Central Bank, and Banking Regulation and Supervision Agency, as well as representatives of the business community.

The Turkish economy has been resilient to heightened stress in the Euro area and a weak recovery in most advanced economies and, although reduced, vulnerabilities remain. The tightening of macroeconomic policies since the second half of 2011 was appropriate and has contributed to slowing domestic demand. Encouragingly, the economy is decelerating toward a soft landing, thus helping redress the imbalances built over the last two years. It will be important to maintain current budget targets for 2012 and tight monetary policy to guard against external shocks and to strengthen existing policy buffers. However, global economic developments pose downside risks. Should these risks materialize, the public sector's strong balance sheet gives the authorities room for countercyclical policies.

The mission thanks the participants of the meetings for their time and candid expression of their views. It is expected that the team will return to Turkey in September for its regular Article IV consultation discussions, which the IMF conducts with its member countries on an annual basis.

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