Poul Thomsen, Director, European Department, IMF gave a press conference on the Euro area. Growth estimates are up slightly in the short term, but there are significant structural issues across fiscal management and banking supervision and longer term growth remains mediocre.
I am going to explain to you that for Europe actually we are revising growth forecast up even for the Euro area although slightly. And the main challenge is really of a medium-term nature.
Let me start with the Euro area. The recovery is continuing after a strong start at the beginning of the year. We are now projecting growth to be 1.7 percent in 2016. That’s a slightly upward revision compared to when we were together six months ago. However, the medium-term forecast is indeed quite mediocre. We have potential growth around 1.5 percent. With that we have several important countries that even 10 years down the road will still have unemployment above pre-crisis levels, which is clearly unsatisfactory.
The reasons for the subdued outlook I think are well-understood by now, there are some long-term challenges, demographic challenges, low productivity, like in other advanced countries and there are, secondly, a number of crisis legacies. There is high structural unemployment. There is high debt, and non‑performing loans in the banking sectors.
So the picture is nuanced. The recovery is on track. The short-term outlook is indeed slightly better than when we were together six months ago, but clearly the political uncertainty in the sense of fragility has increased, Brexit, the refugee crisis, et cetera. So there clearly are downside risks that are dominating if we look beyond the near term.
What are the policy implications? For one, monetary policy, we continue to think that the ECB is doing the right thing with the accommodative monetary policy. We see that there is space to do more if needed, but clearly the scope for doing more on monetary policy is limited. Clearly, monetary policy is being overburdened.
Two, fiscal policy. The overall fiscal stance in the Euro area this year is slightly expansionary. Next year it’s set to be neutral. We think this is appropriate given where we are in the cycle. As I said, the recovery is broadly proceeding as expected.
But we do think that the distribution could be better, we think that some countries with fiscal space should use that space. And we think a number of countries with high debt should consolidate more than currently is the case.
We still have seven countries inside the Euro zone that are set to have debt above 100 percent of GDP which, of course, significantly limits fiscal space. I think it’s important to preserve broad, political support inside the Euro zone not least for the policy of the ECB. I think it’s critical that the fiscal rules are implemented as envisioned and that fiscal adjustment is not delayed during times like now when the recovery is on track.
Countries without fiscal space, as we have said before, can also improve the growth outlook by improving the composition of their budget to promote a stronger potential growth. We continue to support the so-called Juncker Initiative and the plans in this regard for an extension and enlargement are welcome.
Third, structural reforms. Unemployment in the Euro area is primarily structural and the key issue is structural reforms to boost potential growth. There are good examples of how structural reforms really have a good payoff in the Euro zone, but there are clearly also signs of adjustment fatigue and a lost reform momentum in recent years.
In that regard, we are supporting talking about policy efforts to develop outcome-based benchmarks to incentivize structural reform and I think this is some work we want to encourage. As far as the priorities, I shall not comment on the structural reforms. They are very country-specific as you know. To reduce the labor tax wedge and the labor market duality; to open up closed professions; to proceed with a single market, covering a single market in services, capital, energy and transport. But as I said, this really varies from country to country.
Fourth, we need the repair of the banking sector’s balance sheets to continue. We have the problem of non-performing loans, as you know, in a number of countries. We welcome the work that is going on inside the ECB in this regard with the high level working groups. We think it’s critical that the supervisor sets ambitious targets for reduction in NPLs over time, over time. It should not be something excessively pro-cyclical. This has to be over time, but there needs to be ambitious targets and there needs to be follow up with close monitoring and review.
There are some other issues that my colleagues in MCM have discussed with you. I shall not go into them. Clearly, the European banks have an issue with profitability and need to improve their business model but this has been discussed at length by my colleagues so I’ll just mention it. It’s a very important issue.
So let me sum up for the Euro area. Where are we? Cyclical recovery on track. Monetary policy appropriate. Fiscal policy overall appropriate with some need to redistribute, so countries who have space should use it, while all the countries with high debt should consolidate more.
There’s a lot of talk about Germany. We think that Germany has some fiscal space and should use it. We have about 0.5 percent of GDP in our recently published staff report and we see a case for using it particularly on infrastructure. And this will help, will have a positive spillover, but it is a limited spillover.
The problem with the low growth in the Euro zone is mainly a structural one, that requires structural reforms in the individual countries and we should not believe that just to get Germany to do more is going to solve the Euro zone’s growth problem. It is mainly a structural problem that requires structural reforms.
One more issue before I turn to Eastern Europe outside the Euro zone. The UK, Brexit, this is a new and unexpected development since we last met. While sterling obviously has declined sharply, there have been no major negative market reactions in part because of a very strong and appropriate policy reaction by central banks, by the Bank of England, but also announcements by the ministry of finance to stand ready with an appropriate fiscal policy response if needed.
As to GDP, we had two scenarios before the Brexit vote, a modest impact and a strong impact. We are largely in the modest impact scenario. Actually, we have revised slightly upwards our UK growth forecast because essentially of developments in Q2 data that came out a lot stronger than we had before. But we are largely in the modest impact scenario and that’s of course very good news. The main issues are, as you know, in the longer term how is this going to be handled? And it’s absolutely critical that the uncertainty in this regard is settled sooner rather than later.
Let me turn to Eastern Europe. Despite the sort of mediocre growth globally, the recovery in Eastern Europe is nearly complete. Output gaps are closing and unemployment is falling to pre-crisis levels. And that is obviously good news. It’s on the back of strong wage growth and accelerating credit growth and this is much welcome. The key challenge facing Eastern Europe is also of a medium-term nature. It is to boost potential growth.
We estimate that potential growth is about half of what it was before the crisis. To some extent, it is not surprising, in the sense that the first 25 years [of transition] clearly provided some easy catch-up gains in productivity, some low-hanging fruits, and it was always in the cards that the next 25 years, if you want, would be a bit more difficult. It’s a more difficult reform, more fundamental and institutional reforms, and this is the scaly part of the challenge.
There are also some crisis legacies, that weigh on growth but so it’s a mix of issues. The key challenge in Eastern Europe is to overcome these things that are weighing on potential growth and get potential growth back up. Without that increase in potential growth, Eastern Europe will not be able to continue the current growth rates without experiencing external imbalances.
So that’s the challenge. In terms of the macroeconomic policy mix, with inflation still low but a number of countries with a high [external] debt, we think that generally the current monetary policy stance in Eastern Europe is appropriate, but we would like to see more fiscal adjustment in a number of these countries than actually is taking place.
Now when we talk about Eastern Europe, I find it more and more difficult because in some ways the group is getting more and more heterogeneous. There are some countries that are doing very well and the other countries that are doing not so well. So the challenges they face are difficult to sort of generalize in a broad presentation like this.
Broader structural reforms, of course, are critical: measures to increase investment. And I think here the key challenge is what I alluded to before, fundamental institutional reforms that are needed to allow Eastern Europe to sort of continue to converge apace with Western Europe.
