Vítor Gaspar, former Portuguese minister of Finance, is now the IMF’s Fiscal Affairs Department director and was interviewed by ECO about the 2016 Fiscal Monitor, IMF’s economic and financial survey.
In his first face-to-face interview since joining the IMF, Vítor Gaspar refrained from commenting about Portugal, because IMF’s employees must not speak of their countries of origin.
Vítor Gaspar mentions countries with a quick debt accumulation are more likely to face a financial crisis and if public debt is large, they sustain a deeper and more prolonged recession, having weak nominal growth as the main reason for the increase of debt in European economies.
Also in this interview, Vítor Gaspar mentions China – an important country for Portugal because of the investments made in Portuguese companies such as Fidelidade and EDP. He says the Chinese authorities, although still limited, are working towards solving the problem of the non-financial corporate debt: “The deleveraging of non-financial corporate debt in China is, in our opinion, a very important problem, one that is urgent and requires a comprehensive strategy”.
The IMF’s recommendation stated by Vítor Gaspar in the below transcribed interview, can be summarized as: countries without fiscal space should apply growth-friendly policies such as investment and, concerning revenue, indirect taxation, while at the same time expenditure policies are enforced to prevent the inequalities inherent to that type of taxation. The issue being discussed is fiscal policies; is how Germany can and should increase public investment; it is the Fund’s stand concerning Greek debt; and the profile of fiscal policies in countries with high public debts, a group that includes Portugal, even though Vítor Gaspar never directly mentions it.
Concerning Europe, the IMF considers there are countries in which recovery is being held back by the banking situation, without mentioning which countries. Are they Germany, Italy and Portugal?
I believe you are being a little biased in interpreting the Fiscal Monitor. What to me is most relevant about the Euro Zone and that distinguishes it, for example, from the United States, is the growth difference in nominal product. It is a two digits difference and, consequently, the effect it has on indebtedness ratio is essential. That is why there is so much emphasis given to nominal growth. The IMF recommends the Euro Zone and, generally, the world should combine of monetary, fiscal and structural policies in order to simultaneously affect demand and aggregate supply, supporting economic activity in the short-term and boosting potential output in the medium and long-term.
But the Fiscal Monitor identifies issues in the Euro Zone banking sector…
The Fiscal Monitor is not the original producer of such evidence; it is a documented phenomenon in the “Global Financial Stability Report”, brought forward on the same day. It shows that in a significant amount of banks, both in the Euro Zone and in the United States, a cyclical recovery will not be sufficient on its own to assure a medium-term healthy profitability. Those banks face some challenges in terms of a business model, given the new realities in the market and regulations.
The Fiscal Monitor highlights that, when public intervention is needed, the fiscal policy has a role to play, in a comprehensive and prompt strategy to solve the problem.
Namely by injecting money to banks?
Only as a last resort. Injecting public money into banks should only be put into consideration if all other possibilities of getting capital through private investment have been exhausted. If there is a public intervention, the Fiscal Monitor clarifies the planning of the intervention as extremely important. This means the intervention must be conditioned to a process of restructuring, to improve taxpayers’ risk and control the effects of incentive on management and private sector. Adequate instruments must support interventions. For example, if public support is needed to deleverage the non-financial private sector, we identify that explicit subsidies are greater than fiscal incentives.
We also regard issues such as the time of intervention: it is crucial that, once identified, the intervention is put in place as soon as possible. And last, but not least, it is essential to fit this into a regulations and supervision scheme that allows the financial system to be stable in the future.
All of this is recommended in the Fiscal Monitor through detailed documentation of six cases including Japan, Thailand, South Korea, the United States, Finland and Iceland, being the last three examples of successful interventions.
What is the role played by fiscal policies, if there is fiscal space… let us start from there: what does it mean to have fiscal space?
There is fiscal space when it is possible to increase expenditure or reduce revenue without negatively affecting public finances or the Treasury’s access to the debt market.
Which European countries have fiscal space? Germany?
Germany is a particularly good example of a case where the IMF explicitly points to the existence of fiscal space in the article IV. Germany’s financial space is estimated to be of circa 2% GDP, in the medium-term. This is a very important value that enabled Germany to close its public investment gap. The IMF considers that moving forward in that direction would be good for Germany. On the one hand, there would be a short-term support to economic activity. On the other hand, because investment is being made in high turnover infrastructures (and German’s interest rates are extremely low in the long-turn), there would be a positive turnover for the medium and long-term German economy potential. This would be very beneficial for the euro economy dynamics.
Are there other countries who have fiscal space?
There are other countries like Norway, Sweden and Switzerland; in the Euro Zone, there is the Netherlands. But European rulings are somewhat flexible when it comes to exceptional happenings, such as the immigration crisis or structural reform measures… In any case, flexibility is justified by the turnover they have. This means the fiscal margin can solve short-term issues that are a priority and can reinforce medium and long-term growth potential, contributing to an enhancement of debt sustainability. That is the logic behind the flexibility elements.
When the IMF regards the fiscal space of any Euro Zone economy also considers the compliance with European fiscal rulings and, in the German case, also the national fiscal rules.
We are aware you cannot comment on Portugal, but let us mention Greece. Should the Greek debt be restructured or is that a taboo in any circumstance?
We should start off by wondering how fiscal policies can be conducted in a country where there is no fiscal space and where, on the contrary, a fiscal consolidation path must be followed. Countries without fiscal space should apply growth-friendly policies. These are policies that use the type of expenditure or revenue to change their priorities, in a way that affects economic growth. It is appropriate to reinforce public investments in infrastructures, concerning expenditure; about public expenditure, in many countries the investment in human capital and in health systems can have a very significant turnover. Besides, fiscal policies can help raise some blockages in the execution of structural policies with significant redistributive effects.
Concerning revenue, it can be changed in order to decrease the taxation with more serious effects on medium and long-term growth, which are taxes on production factors, capital and labor.
And how about increasing indirect taxation? But that impacts equality negatively…
Exactly. Regressive indirect taxation must be compensated through the progressive increase in direct taxes or through expense programmes meant for the impoverish population. The empirical evidence brought forward by the IMF suggests the expense programmes can be highly effective in stopping inequality.
Is the restructuring of the Greek debt a solution?
IMF’s stand has always been clear on that matter. The strategy of adjustment in Greece should be based on the adjustment policies – that must be firmly directed by Greek authorities. The IMF also believes Greece needs a debt relief in order to assure that, by the end of the programme, debt sustainability is assured according to gross financing requirements.
The Fund has recently developed some work on the best policies’ profile to break the cycle of weak growth, inflation and close to zero policy interest rate and large debt. Can you identify what policy would be the most adequate?
The main issue we see is whether or not, right now, there can be enough maneuver margins to effectively address the negative impact on world economy. We thought it was relevant because there is a lot being said in the press about the limits of monetary policies, as well as other issues about fiscal space and difficulties in executing the structural reform and financial policies programmes. There is the false perception that there is no space in economical politics to face a shock. We consider it is possible to answer effectively to a negative shock on the world economy by means of a comprehensive approach that takes into account monetary, fiscal, structural and financial policies and their mutual influence.
Secondly, consistency throughout time is very important for the fiscal policies – because public debt is high, there must be a strategy that assures debts’ sustainability in the long-term and that also assures there are no issues accessing the bond market, especially when, by the end of that process, the monetary policy is once again normal. And in order to achieve monetary policies it is important to assure the credibility of inflation goals. Finally, we defend policies should be internationally coordinated. Every country is different and those differences should be taken into consideration.
If there is a negative shock on the world economy, our position is that policies’ deciders have the right mechanisms to address that situation.
You were once minister of Finance: do you believe that is viable, and not just a message of hope?
The international coordination was successful between 2009 and 2010. That’s how deeper consequences of the financial crisis were avoided. That success is the reason we believe if there is any similar situation, the ability to intervene will be at least as effective as it was then.
Even though that solution has created a new problem: public debt internalizing private debt…
If we analyze the evolution of public debt, the contribution of the deficit was of just around 25%; private sector responsibilities accounted for another 25%. The remaining amount came from dynamic macro-economic factors, such as the differential between product growth rate and interest rate. Since interest rates have plummeted in the meantime, the most significant factor was, as I have previously mentioned, nominal growth rate.