George Friedman's Thoughts: War and a New Geopolitical Age

By George Friedman


It is time to end this series of philosophical ruminations and turn instead to something that is at the center of geopolitics: war. The roots of my philosophical mumblings and my thoughts on war are from two of my books. The first is from my early academic work, “The Political Philosophy of the Frankfurt School.”

The second, called “The Future of War," came later. This is the book of which I am proudest.

It is also the book that sold the fewest copies; its great moment came when the Brazilian war college adopted it as a text. I am proudest of this work because of the forecast. I wrote it in the early 1990s but envisaged a future of war that has since emerged – war waged by unmanned aircraft and hypersonic missiles and in outer space. So, I turn now to talk about the book on war in the hope that I can link the nature of enchantment to infantrymen wearing armored and powered suits.

Let me begin at the beginning.

The introduction of firearms created a new culture of weapons – what I call ballistic weapons. Once fired, the round goes where the initial explosion of energy drives it, with nothing to control it but gravity and the elements, and since it is fired through hand-eye coordination, the probability of it hitting the target is low.

The solution to this problem in war was to dramatically increase the number of weapons fired, compensating for inaccuracy with many rounds from many guns, thereby saturating the horizon and increasing the probability of killing the enemy. All weapons until around 1965 were ballistic; rifles, tanks, howitzers and the like grew into a vast enterprise, centered on the industrial plant that produced them.

The solution to this, in World War II, was to mass bombers, saturating a city with bombs to destroy a single factory. Bombing was so inaccurate that the probability of any bomb load hitting a factory was near zero. This kind of war required many ballistic weapons, many soldiers to use the weapons, many factories to produce them, and many bombers to destroy the factories.

Nuclear weapons grew out of this logic. Massed bombers dropping ballistic weapons were inefficient. One ballistic missile with a nuclear weapon could increase the probability of destroying a factory to near certain. The inaccuracy of pre-nuclear weapons had created total war, and the intercontinental ballistic missile solved the problem of inaccuracy by increasing the size of the explosion.

Between 1967 and 1973 three minor events signaled the end of the ballistic era. In 1967, a Soviet team fired Styx missiles at the Israeli destroyer INS Eilat, sinking it. In 1972, American aircraft used laser-guided bombs to destroy the Thanh Hoa bridge in Vietnam, which had survived conventional air attacks since 1965. In 1973, a brigade of Israeli tanks driving south, parallel to the Suez Canal, was obliterated by a hail of rockets fired by Egyptian special forces.

The three events were linked. In each case, the attackers used projectiles whose trajectory could be changed after firing. The Styx missiles used in the attack on the Eilat were guided internally by a radar seeker that homed in on the ship, maneuvering as needed.

The Thanh Hoa bridge was attacked by a small number of aircraft firing Bullpup missiles, which the air crew could guide to the target using a television system that fixed on the bridge.

The Israeli tanks were destroyed by AT-3 Sagger missiles (note that these are NATO, not Russian, designation).

The missile trailed a wire back to a control system that allowed the shooter to guide the missile to the target. In all cases the probability of any missile hitting the target was about 50 percent, vastly higher than with ballistic weapons.

This changed the mathematics of war. It’s said that in World War I it took 10,000 rounds to kill one man. I don’t know how they counted that but it was a lot. The number of projectiles that had to be fired to hit a ship, a bridge or a tank plummeted to one or two.

This meant that traditional weapons – tanks, aircraft and ships – were not likely to survive on the battlefield in a war of equals, at least not without fiendishly expensive and doubtful defenses. The cost of defending yourself from a weapon soared while the cost of attacking plunged.

During Desert Storm, an American cruise missile could be fired from a ship off shore at a building on land and hit the second window in, on the third floor. This is not a theoretical example, and it exemplifies how the calculation of war had changed.

Rather than firing large numbers of inaccurate weapons firing, committing massive collateral damage, combatants could fire a much smaller number of weapons to destroy a target without having to saturate the surrounding areas. These precision-guided munitions, as they were called, shifted the structure of warfare.

But precision-guided munitions have one critical requirement: intelligence. You can hit a window on a building in Baghdad if you want to, but you have to know which window you want to hit; in some cases, as with the Tomahawk, which is guided by pictures of the terrain and target, you needed to get the pictures of the target first. The challenge of firing non-ballistic weapons at a target a thousand miles away was partly a technical problem but mostly an intelligence problema.

Collecting the intelligence with the requisite level of detail was not easy. Figuring out where a specific individual was in Baghdad, for example, required a combination of humans on the ground, technology to track a huge number of phone calls, and aerial surveillance, which might spook the target.

Intelligence was always at the heart of war, but now it had become the enabler of tactical combat. Fighting the Iraqis in 1991 was relatively easy. But fighting a more sophisticated enemy required more sophisticated technology.

The United States had the National Security Agency for electronic intelligence, the National Reconnaissance Office for satellite imagery and the Central Intelligence Agency for human intelligence. But the evolution of warfare put a heavy burden on them.

The traditional forms of intelligence did not always provide the data needed to launch a precision-guided missile. There were ships for intercepting data and submarines for tapping into underwater lines, but the speed of tactical warfare with PGMs outstripped their capabilities.

The emergence of an alternative to ballistic warfare demanded a different source of intelligence. As with Desert Storm, no one knew they were going to war until after it began. Building intelligence capabilities when war is a surprise means that you have to develop intelligence on a global scale with a high degree of geographic specificity on call. And it had to combine imagery, electronic surveillance and the ability to move data from sensor to shooter.

The microchip was invented for ICBMs and fighter planes and has become the center of new technology. Satellites that had looked for static missile launchers now need to be far more flexible and dynamic.

Computers’ data flows – the internet – were essential to tell the launcher where to fire. Technologies that were emerging were force-grown by the Department of Defense, much like the microchip. Space-based sensors had to take digital photos long before Apple put that technology into the phone. And space became far more important for electronic and visual capabilities.

The emergence of precision-guided munitions drove war’s center of gravity into space. Other causes came later, but space became indispensable for managing PGMs, and any serious war has to begin there. If the U.S. and China ever go to war, the Chinese will need to fire PGMs at American ships, and therefore the Americans must blind them before they can do that by destroying China’s space-based system.

Just as the ballistic era required a vast support network to function, the PGM era needs a far smaller but much more sophisticated system to sustain it. Those systems do much more than define targets for PGM, but that is a core mission.

I can’t overemphasize the importance of the 1967-73 incidents. They opened not only a new age in war but also required a new technological platform. But the most important change was the requirement that wars begin in space, in space-based Pearl Harbors. And I suppose that is enough of a link to enchantment. 

Transcript of the Fiscal Monitor Press Briefing


Vitor Gaspar, Director, Fiscal Affairs Department
Cathy Pattillo, Assistant Director, Fiscal Affairs Department
Paolo Mauro, Deputy Director, Fiscal Affairs Department
Keiko Utsunomiya, Senior Communications Officer


Ms. UTSUNOMIYA: Good morning, everyone. Welcome to the press conference on the Fiscal Monitor. This is Keiko Utsunomiya from IMF's Media Relations Office. With me today is Mr. Vitor Gaspar, the Director of the Fiscal Affairs Department; Mr. Paolo Mauro, the Deputy Director of the Fiscal Affairs Department; and Ms. Cathy Pattillo, who is the Assistant Director of the Fiscal Affairs Department. We will have Mr. Gaspar giving brief opening remarks, and then we will take questions from you, from the floor and online.

Mr. GASPAR: That is a lot, Keiko.

Thank you all for coming to this press conference and for your interest in fiscal policy issues around the world today.

Fiscal policy is at the center of economic policy debates today. In fact, fiscal policy plays a central role in, for example, managing the synchronized slowdown in the global economy, preparing for downside risks, contributing to financial stability, financing the 2030 Sustainable Development Goals, and, finally, in addressing climate change, which is the topic of the Fiscal Monitor this time.

Major economies should be prepared for coordinated action in case of a downturn. Moreover, inflation and inflation expectations are drifting below target, and interest rates are negative in many advanced economies. Hence, the time is now for countries with budgetary room to use it to support aggregate demand.

In most other economies, however, monetary policy is not constrained. Public debt and interest‑to‑tax ratios are high and rising. Therefore, we advise policymakers to follow prudent fiscal policies, anchored by a medium‑term framework. Otherwise, as often happened in the past, complacency, fueled by low interest rates, will lead to over‑borrowing, followed by investors' panic and financial markets' disruptions.

Sovereign bond yields are negative across the maturity spectrum in most advanced economies. We are now deep into zero or negative territory. Further decreases in policy interest rates are limited.

This contrasts with the situation just before the global financial crisis. In emerging markets and low‑income developing countries, public debt ratios are high and rising. The cost of servicing debt is also increasing, unlike advanced economies, where low interest rates have compensated for high debt levels.

Some countries are vulnerable to exchange and interest rate shocks. In China, the largest emerging market economy, we expect the economic slowdown and fiscal stimulus to widen the deficit. We recommend that fiscal policy helps dampen the negative impact on growth from trade disputes and that it supports the long‑term rebalancing of the Chinese economy.

Fiscal policy has an important role to play in the development agendas of many countries, which need to substantially raise spending to meet the Sustainable Development Goals by 2030, particularly low‑income developing economies. The spending must be framed in the context of a comprehensive growth and development strategy. Building tax capacity is necessary to enable the state to deliver on its functions for inclusive and sustainable development. Efficiency in spending is a crucial aspect of good governance. It is also necessary to ensure complementarities between public finance, private investment, and Official Development Assistance.

Let me now turn your attention to the Fiscal Monitor on climate change. By simply looking at me, you can notice a very important thing. I am holding a leaflet. Why is it that I am holding a leaflet?

Because the Fiscal Monitor is now fully digital. It is fully paperless. And so, it contributes to limiting global warming.

It is important to realize that current pledges under the Paris Agreement are not enough. They will limit global warming to three degrees Celsius. This is well above the safe level. To limit global warming to two degrees Celsius or less, the level deemed safe by scientists, fiscal policy must be mobilized, and governments and Finance Ministers need to take further substantial action.

How much more? Each country would have to take measures that are as ambitious as our carbon tax implemented now and rising to $75 per ton by 2030. Countries may choose to take other options. We discuss various possible combinations of measures in the Monitor. Nevertheless, the $75 carbon tax provides one measure of the degree of ambition which is required to deliver on the Paris goals.

What would this entail? If the carbon tax of $75 per ton were implemented globally, China and India would account for almost 70 percent of CO2 reductions among G20 economies, compared with a no‑action scenario. This reflects the dominant role of coal in the production of energy in China and India.

The carbon tax would lead to higher prices for consumers. For retail electricity, for example, price increases would vary from 2 percent in France to 89 percent in South Africa. The average increase would be 45 percent. The differences largely reflect the role of coal in generating energy in each country. The goal is to reshape the tax system and fiscal policy more generally to discourage emissions. It is crucial that the additional revenues from carbon taxation are used appropriately to reduce burdens and make the reform more politically acceptable. The Fiscal Monitor presents several options involving, for example, labor tax cuts, payments to households, and public investment. And for a further discussion, please do not forget to consult the Fiscal Monitor.

To wrap up, fiscal policy is at the center of the economic policy debate today. In fact, fiscal policy plays a central role in, for example, managing the synchronized slowdown in the global economy, preparing for downside risks, contributing to financial stability, financing the 2030 Sustainable Development Goals, and, finally, in addressing climate change.

My colleagues and I will be happy to answer your questions. Thank you.

Ms. UTSUNOMIYA: Thank you, Vitor.

We will now take questions from the floor. Please identify your name and your affiliation first, please.

QUESTION: Thank you very much. I am from Japan.

Mr. Gaspar, I am not going to ask you about climate change because I think the debt is the more important issue. I think the debt‑to‑global GDP is more than 220 percent. Do you have any update about the figures?

The second question would be, for the government, a low interest environment is better because they have cheaper service costs, but do you think the central banks will have a challenging moment in terms of their independence? I will not give you an example because it is obvious. Some countries are facing a very harsh attack on their central banks. Do you think it is going to happen in other countries as well? Thank you very much.

Mr. GASPAR: Thank you for your very good two questions. The Managing Director, whom you indirectly quoted, did refer to the fact that we do have preliminary estimates of the global debt for 2018. And the headline number is above 226 percent of global GDP. And that corresponds to a small increase, relative to 2017, when the value was 225, but a much more expressive increase, relative to what prevailed before the start of the global financial crisis. So, debt levels in the world have continued to increase.

In order to get the details that we have in our global debt database, you will have to stay tuned for the presentation of the complete results from the database that is scheduled for December. We will be updating the global debt database yearly.

At this point in time, we already have some preliminary estimates. Specifically, we have the aggregates for the world, for the G20, for the G20 advanced, and for the G20 emerging markets. And that will give you already a good picture of debt trends around the world. For example, you will see that, for the G20 emerging markets, the number in 2007 was still below 100 percent of these countries' GDP, with 99.8. And according to our preliminary estimates for 2018, we have now a number which is 190.1, so almost a doubling in percentage of GDP in only slightly more than 10 years.

We also have the breakdown between public debt and nonfinancial private sector debt. And what you see is that, while the nonfinancial private sector debt has been flat or mostly flat during this period, public debts have accumulated quite substantially for all country groups that I referred to. And I believe that our COM department is in a position to provide you with a table, with the numbers that I am quoting from in real time. So, you can get it right away.

I believe that these numbers are very relevant from a policy viewpoint, as you were pointing to. On the one hand, because one has to be aware of high levels of public debt. As I said in my introductory remarks, for most countries around the world, where interest rates are positive and significant, where debt levels are rising, and interest payments are increasing as well, it is very important to conduct fiscal policy in a prudent way and in the context of a medium‑ to long‑term fiscal framework to guarantee that public finances are kept sound.

There is a link with a theme of the GFSR, which has to do with the accumulation of nonfinancial corporate debt. And debt, we have shown in the Fiscal Monitor some years ago, is a source of fiscal risks. In order for countries to be able to manage appropriately fiscal crises, it is important to have accumulated fiscal buffers.

I will not comment on your second question, on central bank independence. But I have already said that the simple fact that interest rates are low is not a good reason for complacency when it comes to public debt. Public finance risks still have to be managed. And many times, in the past, risks associated with the accumulation of public debt have been underestimated, and that has led to sharp reactions in the markets and disruptive adjustment processes in many countries.

QUESTION: Hi. I am from India.

Mr. Gaspar, in your comments, you mentioned about India and China, with respect to the carbon tax that can be imposed to reduce the carbon dioxide emissions. You also said that, in effect, this would lead to the end customer seeing an increase in the tariffs that they would end up paying for this power.

With respect to India, there are some structural issues with the pay the power sector is structured in the country which does not allow, say, a pass‑through of tariffs to the end customer. There are also issues with respect to the distribution of power across the country.

You are advocating a higher carbon tax in your comments, but how would that play out? And if not that, if you could throw some light on what other measures could be taken to sort of reduce the carbon dioxide emissions

Mr. MAURO: Maybe I can take that question.

You raised the question of India, China. These are major players by now. Obviously, they have grown spectacularly over the past two to three decades. So, they are really key players not just in the global economy; but, also, they are key players in the fight against climate change. Indeed, it is important that one recognizes where they are coming from, to think about how we can make progress.

I think the first thing that I will say is that, in the Fiscal Monitor, we suggest that one way of increasing global ambition in the fight against climate change is exactly to try to have an agreement among the key players ‑‑ and you have seen that chart that identifies India, China, the United States, and others. An agreement starting with the countries that have the largest emissions would be a way of kick‑starting more ambition in the Paris process. Of course, there was a conference in 2015. There is going to be another conference in 2020. As Vitor pointed out, a lot more ambition is needed.

I think it is also important to think about the implications of climate change for the individual countries. India, in particular, is very vulnerable to climate change, both because a lot of its population is in coastal areas, with cities on the coast. It has a very important agricultural sector. It’s very exposed to extreme weather events.

The other thing to note is that a lot of people are dying today because of local air pollution. There are some estimates, in the area of 400,000 to 500,000 people per year die because of local air pollution.

This is from respiratory diseases, heart disease, stroke, and so on. The World Health Organization documents these facts. So, there is an incentive for these countries to make a transition away from coal and away from other polluting fossil fuels, toward green energy, not just for the next 20, 30 years but also immediately. It is immediately relevant to save lives. We have some numbers on the number of lives that will be saved in the report. I will just say that 90 percent of these deaths that I mentioned are from the coal sector. So that is something that, clearly, has to be looked at.

In the case of India, in particular, I will note that coal is actually not especially cheap there. It is as cheap as it is in other emerging economies. We have seen in other countries that solar, wind has now become as cheap as coal. The trick there is to increase scale. The more solar panels we produce, the more economies of scale, the cheaper it becomes. And both India and China have very clever, very experienced engineers who can certainly work on that transition. So, I am really hopeful that a change can be made.

In terms of the policies, we go through the policies in the report. There is carbon taxation, but there is also emissions trading, permits systems. There are feebate. There are regulations. So, there are a whole range of measures that can be taken. In the case of India, I think about the excise tax on coal which already exists; and if one were to scale that up, that would be a very good starting point. But, of course, one has to do a package of measures. It is not just a matter of introducing one measure.

One can introduce a tax, take the revenue from there, and redeploy the revenues to transfers. And we know that, in India, those are very much used already. Public works programs, the clean‑up of mines, building new hospitals. There is a whole range of ways in which those resources can be redeployed to have a package of measures that is both economically efficient and politically and socially fair.

So, I will stop at that point, but this is a very, very good beginning of a conversation.
 
QUESTION: I was wondering if the IMF is concerned that some administrations nowadays deny climate change as a big issue or, in some cases, as any issue at all and if that could impact the discussion about carbon pricing and what message the Fund would send to these administrations.

Mr. MAURO: Well, I think everybody has to play their part. And it is important that one thinks about ways of coming to an agreement, both domestically and internationally on how we make that transition.

I have mentioned already that, in the domestic arena, there are ways of having packages that dissuade people and firms from using coal and other polluting fossil fuels, reduce the use of energy. And at the same time, we can support those communities that are mostly impacted by the transition. For example, governments can take some revenues and redeploy them to support coal mining communities, cut other taxes, provide transfers to the lower‑income segments of the population. So, there are ways of helping the domestic process.

Internationally, again, I think a good way of starting the process is to have the big players talk amongst themselves. If some countries are reluctant to come to the table, there are proposals out there in the public debate. Right now, there is a lot of discussion about border tax adjustments. There are some countries or groups of countries that say, well, if I introduce a carbon tax and you do not introduce a carbon tax, then I am going to impose an adjustment on the taxation of imports from your country so that businesses compete on an equal footing within my economy. So, there are ways for the international community to come together, and we are very hopeful that this process can get started.

QUESTION: Hello, Paolo, Cathy, Vitor, and Keiko. I work in the state television in Cameroon. I have two questions.

Cameroon does not have a strong culture of monitoring economic growth alongside its financial policies. Now, the question I want to know is: What do you do to encourage governments like mine to continue monitoring its fiscal policies? And if this can ultimately help sustain growth? Because, since the 80s, we have the feeling that all indicators are down.

When we also talk about sustainable development growth, can efficient fiscal policies help us to attain this ultimately, given the fact that the SDGs ‑‑ most countries could not make it?

Ms. PATTILLO: Thank you. Your question focuses on the need for strong fiscal policy and strong institutions then that can help your country and other developing countries then achieve their Sustainable Development Goals. It is something that we have been working very much now with countries on.

The first thing I would point out is that, for countries to achieve their development goals, they really need to have full ownership of the development strategy, of their development strategy. And that could include then setting these development goals as part of government objectives. And that would speak to your point about the importance of monitoring. Only if you include objectives then in your policy do you have then an incentive then to monitor progress towards them.

At the heart of achieving these development goals is strong and sustainable inclusive growth. And there, there is really a need for financing, and that is both on the public side and the private side. We have done work on looking at the costing then for countries to achieve their Sustainable Development Goals. And the estimates are around 15 percent of GDP, higher in sub‑Saharan Africa because of the younger populations and the need for a lot of education spending. So, to make that complementarity work between the public financing and the private, you really need comprehensive governance reforms, a strengthening of the business environment. There are a lot of things that could help. In sub‑Saharan Africa, there is the G20 Compact with Africa that could be a catalyst.

And then back to fiscal. Really, at the heart is the imperative of raising the capacity for domestic revenues, for domestic tax. And that goes hand in hand then with building the capacity of the government overall. And that means then broadening the tax base, enhancing tax administration. I know these are priorities, particularly in Cameroon, where increasing non‑oil revenue is a priority then of the government.

In addition to the tax side, also, there is a real need to strengthen public financial management, transparency, accountability, the composition of the budget. These are all, again, steps that are going to help with the monitoring then of these development objectives that the government has. And, of course, then cooperation across all stakeholders ‑‑ donors, private sector, governments, us ‑‑ is important.

Mr. GASPAR: Telegraphically from me. I want to add two things very briefly.

One, I will call your attention to slide No. 4 of my presentation, where the results from the costing exercise that Cathy referred to are presented and displayed in a way which I find visually very appealing. Look it up and see if it works for you.

The other thing, I want to amplify something that Cathy said, which is the following:

When we are talking about a country like Cameroon, where, indeed, the tax‑to‑GDP ratio is very low, it is important, it is crucial, it is decisive to build up tax capacity in order to enable the state to fully play its role in sustainable inclusive growth. This is just a repetition, but I believe it is an important repetition.

QUESTION: I am from the China media group. As we know, for fighting climate change, the Chinese Government already took a lot of measures and got some good results. So, from your view, what can China do to fight against climate change further? And what is your assessment of China's fiscal policy? Thank you.

Mr. MAURO: Well, I think that, like other countries, China has made a very important start and has some commitments that were taken in 2015 in Paris. We have the numbers in the Monitor. I think, like for many other countries, the issue is just stepping up, doing more. And I am sorry that we always ask for more; but I think in this case, it is truly needed. China is really a key global player. It can really lead the way.

As you saw in the exercise that we did, not surprisingly being the second ‑‑ or one of the two largest economies globally, China has a huge role in this endeavor. Again, we have this example. If there was an increase globally of the carbon tax to $75 per ton by 2030, then more than half of the reduction in emissions would come from China. And that tells us that it is so important to have leadership from China, together with other major players. We are hoping that there can be an agreement among the countries with the largest emissions at this point.

So great work. And we all need to do more.

Ms. UTSUNOMIYA: The assessment of fiscal policies in China. That was your second question.
Mr. GASPAR: On the Chinese fiscal policy, I also interpret your question as focusing on fiscal for climate change. I covered that in my initial remarks by saying that we at the Fund believe that fiscal relaxation, which was followed by China in the recent months is appropriate to smooth the impact from trade disputes. We very much welcome the rebalancing of fiscal policy ‑‑ better said ‑‑ the contribution that fiscal policy makes to the rebalancing of the economic growth model of China, especially where, by increasing the purchasing power of consumers, it fosters the move from exports to domestic demand and from investment to consumption, which is part of the transition of the growth model in China. So, we are basically saying, in a nutshell, that we do see that fiscal policy can play a role in stabilizing the growth path of the Chinese economy in the short run; but it should, at the same time, contribute to a sustainable, inclusive growth model for China. And that implies that fiscal policy should be contributing to the transformation of the Chinese economy and society.

QUESTION: Good morning. I will speak in French.

[Through interpreter]

Good morning, everyone. I am from Tunisia. And coming back to our continent after Cameroon, I heard Cathy talk about the concretization of fiscal measures, in particular, and about how to improve the fiscal capacity of emerging economies.

Today, the case of Tunisia is that we have been having problems since 2011, since the Arab Spring. And we were wondering, what can we do in concrete terms to reduce debt, in particular, public debt in Tunisia, which is going to reach 89 percent of GDP, with a budget deficit of more than 5 percent versus 9 percent, which was expected for 2019. So how can you help Tunisia deal with all of these difficulties?

Mr. MAURO: ‑‑ that is on the debt. And I am going to try to say a few words about the developments in the debt, in the deficit, as you mentioned, and also to give a sense of what we see as the main fiscal priorities. And, of course, the Fund is supporting Tunisia through an Extended Fund Facility (EFF). So, certainly, we are very close to that discussion of policies.

You pointed out the high debt. Indeed, the key priority is to stabilize it and to gradually reduce it. We are not at 80 percent this year. We are a little lower. The forecast for end‑2019 is 74 or 75 percent of GDP. Personally, for the purpose of this discussion, I do not focus so much on the changes from year to year in Tunisia because so much of the debt is in foreign currency; and, therefore, changes in the dinar have a big impact on the debt‑to‑GDP ratio. But I focus on the deficit. And I note that the deficit, which used to be almost 6 percent in 2017, is projected to be 4.4 percent of GDP for this year.

So, there is a decline, and that is in the right direction. The objective is to make sure that, as you started from, we let the debt‑to‑GDP ratio gradually decline over time, in the next few years.
The way that the improvement in the deficit, the reduction in the deficit has occurred has been to reduce the wage bill in the public sector, to reduce some subsidies very gradually, and revenue mobilization, in particular.

Going forward, the challenge is to continue reducing the deficit while increasing social spending and increasing infrastructure. We also look at a potential continuation of the process of pension reform. That is important. And the state‑owned enterprises are another priority to make sure that there are no fiscal risks coming from that area. So those would be the broad priorities for the country.

QUESTION: Thank you for taking my question. My name is Simon from Today News Africa Washington, DC.

First, in sub‑Saharan Africa, could you throw more light on the fiscal policy situation or recommendations on some of the big countries: Nigeria, South Africa, Ghana, Ethiopia?

And finally, climate change is one of the biggest issues facing Africa right now. We see the situation around the Lake Chad Basin, where we have 60 million people at risk of starvation. What recommendations do you have for fighting climate change? And what type of cooperation do you have with the African countries that say that the biggest polluters are actually in the west and Africa suffers the consequences? Thank you.

Ms. PATTILLO: Since you mentioned a number of countries, I am going to be very telegraphic then on points. And, of course, those countries are large countries and then with a lot of potential then of leadership then in the continent. So, the policies there are very important.

On Nigeria, the priority is a comprehensive reform to durably increase non‑oil tax revenue, again, that Vitor underscored. And there are a number of reasons. Of course, this will contribute to providing then space for important spending on infrastructure and on human development spending, social spending. And for Nigeria, that is very important for a couple of reasons. One, because right now, interest payments as a share of tax are very, very high, around a third for overall and two‑thirds for the Federal Government. And that is not because interest payments are particularly high. It is because the denominator is incredibly low. Nigeria has one of the lowest tax ratios in the world. And it is not then because Nigeria does not have big development problems, development challenges. Nigeria also will have a lot of needs then for education and health spending. It has some very low indicators in that area. And with the demographic projections, Nigeria is actually projected to be, by 2050, the third most populous country in the world. So, addressing those challenges is really important.

For Ghana, similarly, the priority is sustained fiscal adjustment and transparent financing to reduce large financing needs and anchor the debt dynamics. So right now, Ghana is in the process of getting ready for the 2020 budget. And we welcome then that they are committed to the budget deficit of 5 percent. This is going to be an election year in Ghana. So, meeting that budget target in 2020 will really send a strong signal to all, including investors, of the government's commitment to fiscal discipline.

For Ethiopia, Ethiopia has challenges relating to debt sustainability, but they have just released a new homegrown economic reform program that we very much welcome. And we are looking forward to working with the authorities on that reform program that will, again, then provide the space for social spending and maintaining good quality infrastructure spending.

Finally, on South Africa. In South Africa, there is really a need to move beyond business as usual to boost growth. So, there is a need for urgent reforms to stop the decline in per capita GDP and to build jobs. There is also a need to overhaul the power utility ESCOM. And there, really a gradual but sizable consolidation is needed to stabilize debt at lower levels. This would reduce financing costs. In South Africa, the public debt has doubled over the last decade, and it is set to increase over the next 20 years or so on business as usual. So, this gradual fiscal consolidation should really prioritize growth‑friendly and inclusive measures.

Mr. MAURO: Maybe I could complement from the perspective of climate change.

As you correctly pointed out, the African continent is very exposed to the effects of climate change. On the other hand, it is not yet a contributor. When you look at some of the numbers in the Fiscal Monitor, the emissions are not really coming much from Africa. That may be the case later on in this century but not yet.

There are a few instances ‑‑ Cathy mentioned the case of South Africa. You will remember the number that Vitor gave. An 89 percent increase in electricity prices in South Africa, if we were to have a large carbon tax ‑‑ well, again, part of the reason is that there is a lot of coal used in South Africa.

So, yes, everybody has to do their part. There are some countries that can contribute to reducing carbon emissions significantly. But I do not think at the global level, this is where the real action is going to take place.

That said, there are important decisions to be made today for which kinds of infrastructure are the continent going to choose. And decisions that are made today will have implications for decades to come. So, it is important that as African countries choose the mix of infrastructure projects, they choose green types of energy. And in the transportation area, again, they can maybe choose rail, as opposed to roads. But I think it is not sort of crucial at this moment.

The other aspect I would like to draw your attention to is, there is an annex in the Fiscal Monitor that looks at the revenues from natural resources. And you will notice, when you go through that annex, that global prices of oil, gas, and so on, have major implications for whether some African countries are going to be able to develop new fields. So, the future revenues are impacted by the developments of global prices which, in turn, are related to whether there is a big change in how we use power globally. So, there are implications, again, for African countries that are important.

Ms. UTSUNOMIYA: You get the last question.

QUESTION: Vitor Gaspar, allow me to do a question about Brazil as far as fiscal numbers, if you will allow me.

According to the statistical annex from the Fiscal Monitor, the primary surplus of Brazil is just going to [wrap] in 2023, not 2022, as was estimated in April.

Also, that kind of stabilization of the public debt, growth of the public debt in 2022, even though the net public debt increases, even though in a slower way. What are the factors? What are the assumptions behind those numbers? For instance, the social security reform, what are the variables behind that? Thanks so much.

Mr. GASPAR: I would be quite happy to engage with you bilaterally on the details. At this point in time, we are slightly over time already, so details are not in the order of the day but let me give you a general answer.

I think that when we look at Brazil right now, there are a number of very promising developments.

You have been following economic evolution in Brazil very closely for many years. In how many of those years could you say inflation is coming significantly below target? That is a very promising development in Brazil, and it does have ‑‑ potentially, at least ‑‑ far‑reaching fiscal implications in terms of public debt management and other important variables.

The other aspect is that I believe ‑‑ you will correct me if I am wrong ‑‑ that every time that we had a press conference like this one, you would ask me about social security reform in Brazil, and the prospects would be always uncertain.

As you well know, at this point in time, it does look like the social security reform in Brazil is in train to pass. If you look at the quality of public finances in Brazil, that is a very important contribution. And as in other countries ‑‑ and Cathy referred to that repeatedly ‑‑ the structure of the budget makes a tremendous difference for sustainable inclusive growth, and that is the case in Brazil as well. But in the case of the path for the deficit, the primary deficit and public debt, the spending ceiling in the constitution is the driving force. The social security reform that you referred to is very important for the composition of the spending and the other factors that I referred to.

Let's pursue this conversation bilaterally.

Ms. UTSUNOMIYA: Thank you very much for your participation. This will conclude today's Fiscal Monitor press conference. Thank you and see you next time.
IMF Communications Department

China Grapples With Stagflation

The latest round of monetary stimulus from Beijing has stoked inflation without much helping industry

By Nathaniel Taplin

Data due Friday is expected to show that China’s economy slowed in the third quarter. Photo: wang zhao/Agence France-Presse/Getty Images 


Lending binges in China used to produce lots of new houses, factories and growth. These days they mostly produce higher prices for food and housing—and more debt.

On Frday China will report its third-quarter economic growth, which is broadly expected to be slower than the second quarter’s 6.2% increase.

But nominal growth—which includes changes in prices—is likely to be roughly flat, and could even accelerate.

This is starting to shape up as a significant problem and has become a major constraint on monetary policy.


Idiosyncratic factors are at play, particularly the African swine fever outbreak that has decimated the hog population in China.

But the broad picture is clear: Beijing has been very conservative with its most recent round of stimulus starting in 2018, compared with previous rounds in 2012 and 2015, but even a modest jolt has been enough to push housing and food prices sharply higher.

Debt and equity finance outstanding expanded by 10.8% in September, the same rate as in August and down modestly from 11% in June, figures released Tuesday showed.

Meanwhile, consumer price inflation is running at its hottest in nearly six years, housing prices are up close to 10% on the year, and food-price inflation is running at 11%. Industry and employment have yet to find a bottom.

The contours of the dilemma were visible even in June, before pork prices had yet reached dizzying levels.

Second-quarter headline growth came in at 6.2%, down from the first quarter’s 6.4%. But nominal growth actually accelerated for the first time since late 2017.



Unfortunately, not only is credit pumping up prices without much helping real activity, it is also pumping up prices in the wrong places.

Nominal growth accelerated in agriculture and services—likely thanks to food and real estate—but slowed in manufacturing.

Skyrocketing home and food prices are a problem for both social stability and real consumer spending.

But falling prices for factory goods make grinding down China’s massive debt burden, which is concentrated in industry, harder to deal with.
This conundrum is a big reason why Beijing has relied so heavily on infrastructure bond issuance as a way to prop up credit growth this time around.

In theory, more infrastructure funding should help boost prices for industrial products without further pumping up housing prices.


The problem is that China already has very good infrastructure for its income level.

And heavy infrastructure bond issuance—officials are considering pulling forward part of next year’s quota into the fourth quarter, according to Barclays—also risks crowding out already weak private-sector borrowing.

This all amounts to a serious challenge to China’s growth model—and another reason why even a limited stand-down on trade tensions would be very welcome in Beijing right now.

China’s monetary policy makers are running out of road.

China’s Spenders Are Saving. That’s a Problem for Everyone.

Chinese consumers, a $4.9 trillion force, transformed the global economy. With their own economy slowing, they are pulling back.

By Alexandra Stevenson


Younger Chinese have never experienced a prolonged economic downturn; now they worry about the future.CreditCreditLam Yik Fei for The New York Times


ZHENGZHOU, China — Forty years after China began its near-miraculous run as the world’s most powerful economic growth engine, its people are experiencing something new and unsettling: a feeling that the best times may be behind them.

The Chinese economy is slowing, and the cost of living is rising. The trade war with the United States shows no sign of ending. Wage growth is sluggish. More young people are chasing fewer job prospects.

Chinese consumers, who have become more cautious over the past year, are now staging a broad retreat. They are buying fewer cars, smartphones and appliances. They are going to the movies less and taking fewer trips abroad. They would rather stick their money in the bank.

For China’s young people, who have never experienced a prolonged slump in their lives, the shift is especially stark. China has seen slowdowns before, but its consumers kept spending through most of those downturns.

Now young people have more reasons to be worried. Job prospects for recent college graduates have worsened over the past year, according to data from the job search website Zhaopin.com, and graduates seeking jobs outnumber openings. Many of those openings are low-paying service-sector jobs.

“For young people in their 20s, it’s the first real economic downturn that they’ve been through and they are experiencing as young adults,” said Andrew Polk, founder of Trivium, a consulting firm in Beijing.

“They are now starting to think maybe this inexorable increase in economic growth is not so inexorable,” Mr. Polk said.

Wang Junda works on a short-term contract at a complex in Zhengzhou where Apple phones are made. A fresh-faced 27-year-old, he has been a driver for Didi, China’s version of the ride-hailing company Uber, and is working toward getting a truck driver’s license in hopes of being able to make more money. Still, he worries that he will never make enough.

“Whatever you earn is never enough to match your spending,” Mr. Wang said.

The retreat of Chinese consumers — a powerful force generating $4.9 trillion in economic activity a year — will have global repercussions. Their appetite for homes, cars and iPhones transformed the world, powering global growth and making fortunes for companies like Apple and General Electric.

It also poses an immediate challenge to China’s leadership, which draws its legitimacy from the wealth and confidence of the Chinese people.

George Gao and Mengjie Wu are considering postponing their wedding — and forgoing a Tiffany ring in favor of something less expensive. Credit Yuyang Liu for The New York Times


The new unease can be found across China, from the glittering business capitals of Shanghai and Shenzhen to more working-class places like Zhengzhou, an industrial metropolis of 10 million in the country’s interior.

At a downtown Zhengzhou mall, Wang Li watched as a few desultory shoppers wandered by. She was among a dozen bored shopkeepers sitting on lawn chairs and stools, watching shows on their smartphones while waiting for customers.

“Nothing is good. It’s not just this one type of business,” said Ms. Wang, whose shop sells towels, water bottles and keepsake mugs. “Every kind of business is not doing so great.”

There are still indications of strength. Headline retail sales figures have slowed significantly but are still growing at a pace that other countries would envy. Some sales drops, like those of smartphones, are due in part to the natural maturing of the Chinese market.

Still, signs of a slowdown abound. The 100 biggest retailers in China have seen their sales decline sharply in recent months, according to Capital Economics. Sales of instant noodles, seen as an indicator because newly affluent Chinese would rather eat out or order in, are rising after declining for several years.
“The bad news is that all indicators of consumer spending are still softening, and the underlying trend is probably somewhat worse than the headline data indicate,” said Ernan Cui, a consumer analyst at the research firm Gavekal Dragonomics.

The slowdown is coming just as the cost of living is rising. Young people have been priced out of the housing market in affluent places like Beijing and Shanghai. More people have mortgages and credit cards, however, expanding their spending prowess while adding to their debts.

The 100 biggest retailers in China have seen their sales decline sharply in recent months.

The 100 biggest retailers in China have seen their sales decline sharply in recent months. Credit Lam Yik Fei for The New York Times


Mengjie Wu, a Shanghai resident and technology company employee, worries about the price of basic food staples, like meat, and medicine for her mother, which must be imported from the United States. She has a mortgage and loans to pay off. Now she and her fiancé are considering putting off the ultimate act of consumption: a wedding.

“We haven’t decided if we will do it yet, because it is not a small cost,” said Ms. Wu, 30, whose dreams included a Tiffany ring and a ceremony in Bali, the Indonesian resort spot. “We won’t do it soon.”

China’s leaders are moving to get them spending again. The central government pushed out new measures in August, including discounts on big-ticket appliances.

In past years, those shoppers were part of a seemingly unstoppable growth engine. China’s opening to the outside world in the late 1970s connected global companies with one billion people eager to leave grinding poverty behind. As China’s economy developed, a new consumer culture emerged, powered by hundreds of millions of spenders. Spending by households now accounts for nearly 40 percent of China’s roughly $13 trillion in annual economic activity.


Shoppers at a new Costco, the American warehouse retailer, in the Shanghai area. They are being drawn to the store in part by lower food prices.
Shoppers at a new Costco, the American warehouse retailer, in the Shanghai area. They are being drawn to the store in part by lower food prices.CreditYuyang Liu for The New York Times


They have become an essential part of the global economy as well. Chinese consumers alone accounted for one-seventh of the world’s growth over the past decade, according to the Boston Consulting Group. General Motors and its Chinese partners sell more cars in China than they do in the United States.

Now growing numbers of people in China are reluctant to spend. A survey by China’s central bank showed rising numbers of urban residents would rather deposit their money in a bank than spend or invest it.

As income growth slows, households are making fewer discretionary purchases and choosing to save more. Sectors like automobiles and smartphones are shrinking as fewer people buy these items for the first time. E-commerce is still booming, but growth in online spending has more than halved over the past four years, the Boston Consulting Group found.

The trade war has raised costs for American-grown food, part of an overall surge in food prices. A devastating pig disease has led to soaring pork prices. In online forums, Chinese shoppers are calling for “fruit freedom” and “pork freedom.”

Costco customers seemed to be sticking to basic purchases recently.
Costco customers seemed to be sticking to basic purchases recently. Credit Yuyang Liu for The New York Times


A desire for deals drove Chinese shoppers to the country’s first Costco, the American discount warehouse retailer, when it opened near Shanghai in August.

Ms. Wu, the technology company employee, recently looked for a better deal on some of the food she buys each month.

She and her fiancé spend nearly all of their monthly paychecks — about $5,600 before taxes — to pay off loans and their mortgage, she said. But the small amount of money they spend on groceries, roughly $300, has risen by a tenth since the start of the year.

As hundreds of shoppers around them pushed large shopping carts that were mostly empty except for basics like eggs, milk and meat, Ms. Wu thought about the Tiffany ring she had been dreaming of. Now, that purchase is up to her fiancé, she said.

“The cost for the Tiffany’s ring is much more expensive,” she said, “so I will give him the choice to buy any brand.


Cao Li contributed reporting.

Alexandra Stevenson is a business correspondent based in Hong Kong, covering Chinese corporate giants, the changing landscape for multinational companies and China’s growing economic and financial influence in Asia.

viernes, octubre 18, 2019

THE IMF AFTER ARGENTINA / PROJECT SYNDICATE

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The IMF After Argentina

It’s high time to ask how to refocus the International Monetary Fund’s mandate for dealing with emerging-market debt crises. How can the IMF be effective in helping countries regain access to private credit markets when any attempt to close unsustainable budget deficits is labeled austerity?

Kenneth Rogoff

rogoff186_Carol SmiljanNurPhoto via Getty Images_argentinemoneywallet


CAMBRIDGE – In case you blinked, the Argentine government built up a pile of debt out of almost nothing with surprising speed, and then proceeded to default on it almost as quickly.

Compared to the country’s slow-motion 2002 default, the latest crisis feels like 60-second Shakespeare. But in both cases, default was inevitable, because the country’s mix of debt, deficits, and monetary policy was unsustainable, and the political class was unable to make the necessary adjustments in time.

And in both cases, loans from the International Monetary Fund seemed only to postpone the inevitable, and, worse, to exacerbate the ultimate collapse. So, after the second debacle in Argentina in less than a generation, it’s high time to ask how to refocus the IMF’s mandate for dealing with emerging-market debt crises.

How can the IMF be effective in helping countries regain access to private credit markets when any attempt to close unsustainable budget deficits is labeled austerity? The only answer is to increase substantially the resources of international aid agencies (the IMF is a lender). Unfortunately, there seems little appetite for that.

Why was the IMF willing to pour resources into a situation that – at least with the benefit of hindsight – could be resolved only through stronger fiscal adjustment (more austerity), a debt default, more foreign aid, or a mixture of all three?

The IMF’s difficulty in saying no to Argentina partly reflects an acrimonious history stemming from the failed loans from the late 1990s through 2001. It was also hard for the Fund to resist funding a big program in a world where countries can borrow at ultra-low interest rates from private markets. (China, too, has become a major source of funding in emerging markets, which might sound good in the abstract, but the lack of transparency makes Chinese loans fertile ground for corruption.)

But IMF staff know very well that countries with a history of serial default, such as Argentina and Venezuela, ride a slippery slope in debt markets. When Miguel Savastano, Carmen Reinhart, and I studied this phenomenon many years ago, we called it “debt intolerance.”

There is a case to be made that by pushing the IMF to go easy in its loan program, US President Donald Trump’s administration made Argentina’s latest economic calamity worse. After all, Argentine President Mauricio Macri’s father was a business partner and friend of Trump. But, whatever the truth of that argument, the Fund’s ever-weaker bargaining position probably has deeper roots.

Political support for necessary loan conditionality has been eroded by repeated attacks from the left, which does not accept that the IMF does not have scope to give outright grants. But while NGOs might cheer if the IMF were to convert its loans to grants, pretty soon the Fund’s coffers would be bare.

This, too, might make some people happy, but it would be a disaster for global financial stability. Debt in many emerging markets today is at record levels, and the IMF remains the closest thing there is to a global lender of last resort. For all its limitations, the Fund has greater competency than any other organization to mitigate the costs of emerging-market debt crises, not least to the general population.

But the goal must be to prevent such crises from occurring – or recurring, as in Argentina’s case. Macri was elected in 2015 by a populace that had grown weary of the slow growth and high inflation that marked the last few years of former President Cristina Kirchner’s administration. Kirchner’s policies (and those of her husband, Néstor Kirchner, who preceded her) sharply expanded state intervention and control. Booming commodity export prices allowed the economy to continue growing, but when the cycle turned, it all fell apart.

Still, Macri inherited an economy where debt was not high (owing to the 2002 default), and the main fiscal problem was an unsustainable pension system. The normal prescription for an incoming administration would have been to take the pain of budget consolidation early on, and hope that the economy recovers well in advance of the next election. Instead, Macri decided to close the budget gap slowly, and use his political honeymoon to cut taxes and liberalize markets.

Unfortunately, after Big Bang reforms, economic conditions tend to get worse before they get better, and it appears that Macri, facing an election later this month, will not be around to see that. Things have gotten so bad that Argentina has “reprofiled” (a form of default) even domestic-currency debt (which is more common than most people realize, as Reinhart and I showed in our 2009 book). It is a sad state of affairs.

It also demands an answer to a fundamental question: How can the IMF reconcile the need for a credible regime in which emerging markets can conduct necessary borrowing with demands for more aid and less austerity?

The short answer is that the IMF cannot do it alone. The only way to square the circle is with a huge increase in aid flows. But don’t expect either a Democratic or a Republican US administration to lead the charge. In the meantime, politicians should let the IMF do its job – helping to maintain global financial stability – and not force it to back unsustainable policy regimes.


Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Folly, his new book, The Curse of Cash, was released in August 2016.

Transcript of the Press Conference of the October 2019 Global Financial Stability Report

 

Participants:

Tobias Adrian, Director, Monetary and Capital Markets Department

Fabio Natalucci, Deputy Director, Monetary and Capital Markets Department

Anna Ilyina, Division Chief, Monetary and Capital Markets Department

Evan Papageorgiou, Deputy Division Chief, Monetary and Capital Markets Department

Randa Elnagar, Senior Communications Officer, Communications Department 
 

Ms. Elnagar - Good morning. Welcome to the 2019 Annual Meetings. This is the press conference on the Global Financial Stability Report. I am Randa Elnagar from the IMF's Communications Department.

Let me start by introducing our panel: Tobias Adrian, Financial Counselor and Director of the Monetary and Capital Markets Department; Fabio Natalucci, Deputy Director of the Monetary and Capital Markets Department; Anna Ilyina, she is the Division Chief that oversees the Global Financial Stability Report in the Monetary and Capital Markets Department; and Evan Papageorgiou, Deputy Division Chief in the Monetary and Capital Markets Department.

Tobias is going to give some opening remarks, and then we are going to take your questions. Tobias.

Mr. Adrian - Good morning, ladies and gentlemen. It is a pleasure to present the new edition of the Global Financial Stability Report. Along with the report, you will be interested in the leaflet that summarizes the report's findings.

Global markets have been subjected to the twists and turns of trade tensions and have been kept off balance by continuing policy uncertainty. Against the backdrop of deteriorating business sentiment, weakening economic activity, and intensifying downside risks, many central banks have adopted an easier stance on monetary policy. About 70 percent of the world's economies, weighted by GDP, have done so.

Investors have interpreted the central bank actions as a turning point in the monetary policy cycle. The shift has been accompanied by a sharp decline in long-term yields. In some major economies, interest rates are deeply negative.

Remarkably, the amount of government and corporate bonds with negative yields has increased to about $15 trillion. Moreover, markets expect about one-fifth of government bonds will have negative yields for at least three years.

With rates staying lower for longer, financial conditions have eased, helping contain downside risks and support global growth, for now. But loose financial conditions have encouraged investors to take more risks in a quest to achieve their return targets. Valuations appear stretched in some important markets, including equity and credit markets, in both emerging and frontier, as well as advanced economies.

As a result of easier financial conditions and stretched asset valuations, vulnerabilities have continued to intensify, putting growth at risk in the medium term. Let me draw your attention in particular to our assessment of global vulnerabilities, summarized in the radar chart.

The gray shading in that chart shows where vulnerabilities now stand.

As you can see, there has been a notable increase in vulnerabilities in the section marked "Other Non-bank Financials."

Vulnerabilities among non-bank financials, which include asset managers, structured finance vehicles, and finance companies, are now elevated in 80 percent of economies, as measured by GDP.

This is similar to what we have seen at the height of the global financial crisis. The search for yield among institutional investors, such as insurance companies, asset managers, and pension funds, has led them to take on riskier and less-liquid securities.

These exposures may act as amplifiers to shocks.

In addition, corporations are taking on more debt, and their ability to service that debt is weakening. In the event of a material economic slowdown, the prospects would be sobering. Debt owed by firms unable to cover interest expenses with earnings, which we refer to as corporate debt at risk, could rise to $19 trillion in a scenario that is just half as severe as the global financial crisis.

That is almost 40 percent of total corporate debt in the eight economies that we studied, which include the United States, Japan, China, and some European countries, could be addressed in such a downside scenario.

Among emerging and frontier economies, external debt is increasing, as they attract capital flows from advanced economies, where interest rates are lower. External debt has risen to 160 percent of exports on average, up from 100 percent in 2008.

A sharp tightening of financial conditions and higher borrowing costs would make it more difficult for them to service their debts. Overall, resilience of the banking sector has improved, thanks to stricter regulations and supervision since the global financial crisis.

However, there are still pockets of weak institutions. Negative yields and flatter yield curves have reduced expectations about bank profitability, and the market capitalization of some banks has fallen to low levels.

Among banks outside the United States, US dollar funding liquidity remains a source of vulnerability that could amplify the impact of a tightening in funding conditions and could create spillovers to countries that receive cross-border dollar loans.

Policymakers need to take urgent action to mitigate financial stability risks. They should deploy and develop, as needed, new macroprudential tools for non-bank financial firms to mitigate vulnerabilities, highlighted in this report.

They should address corporate vulnerabilities with stricter supervisory and macroprudential oversight, including the creation of targeted stress-testing of banks and the development of prudential tools for highly levered firms, which can help restrain debt at risk.

They should tackle risks among institutional investors through strengthened oversight and disclosures. Emerging and frontier economies should implement prudent sovereign debt management practices and frameworks.

Greater multilateral cooperation is needed in several areas. Policymakers should complete and implement the global regulatory reform agenda. They should ensure that there is no rollback of regulatory reforms.

In addition, policymakers should foster the further development of sustainable finance, an approach to investment that takes environmental, social, and governance factors into account.

To help promote awareness of climate threats and other risks to the financial system, policymakers should encourage better corporate disclosures and adequate standardization.

To sum up, with financial conditions still easy, and with vulnerabilities building, policymakers should act now to reduce the vulnerabilities that could exacerbate the next economic downturn.


Ms. Elnagar - Thank you, Tobias. We are ready to take your questions now.

Question - Can you be a little bit more specific on what types of debt that you see as most concerning? In the 2008 financial crisis, it was subprime loans that started everything. What areas are you looking at?

Also, can you be more specific on what you would recommend policymakers do? They have taken steps to shore up the banking system. So what other steps do they need to take? More specifically, though, what can they do to address these non-bank problems?

Mr. Adrian - Absolutely. So the banking system is safer today. There is more capital and more liquidity in the banking system, and stress tests are commonly done across jurisdictions. At the same time, vulnerabilities in the non-bank financial sector are building, so there is a growth of credit intermediation in the non-bank financial sector, and corporate vulnerabilities are rising.

So what we urge policymakers to do is to contain underwriting standards for those nonfinancial corporations at the issuing stage. This could be done by a number of policy tools.
 
Ms. Ilyina - Let me elaborate a little bit on what can be done to contain corporate sector vulnerabilities.

First, just to step back and maybe comment a bit on the 19 trillion USD number.

This is our estimate of debt at risk, which we define as debt owed by nonfinancial firms with weak debt repayment capacity; that is, that do not have enough earnings to cover interest payments.

That is not necessarily debt that will default immediately, but these are firms that would be at risk of distress in a significant material economic slowdown.

So the estimate that we provide in the report is for eight major economies, including the United States, China, Japan, and several European economies, in a material downturn, which is about half of the severity of the global financial crisis.

The reason why this number is large -- and the number is, indeed, large -- is because of, I would say, three things. I would highlight three things.

First, corporate debt levels have increased in major economies over the last decade, significantly.

Total corporate sector debt in these eight major economies now stands at about 51 trillion US dollars, and that compares to about 34 trillion in 2009, so this is a significant increase.

Second, corporate vulnerabilities are already elevated in a number of major economies. In some of them, debt at risk is already at about 25 percent of total corporate debt; and, of course, in an adverse scenario, it rises fast and further.

And what is particularly notable is that, even though the shock is only half the severity of the global financial crisis, in many of those countries, debt at risk rises to the same level as we have seen during the financial crisis or even exceeds those levels.

So that tells us that there are quite a few weak nonfinancial firms in these economies that are still able to roll over debt and continue to accumulate debt because of very low interest rates.

But, of course, the concern is that in an economic downturn, these firms may come under pressure.

They may experience difficulty in servicing their debt, and would have to deleverage. And so when they deleverage, they cut back on investment and employment, and that exacerbates the recession, what we have seen during the euro area crisis.

To answer your question on what can be done, as Tobias already mentioned, it should be done through a combination of more stringent supervision, particularly of credit assessment practices and lending practices of banks, which is what supervisors, presumably, already do.

But perhaps there are some areas where more attention is needed, like in regional banks that are more exposed to small- and medium-sized firms.

And if corporate debt is viewed as reaching systemic levels, then macroprudential tools can be activated as well, including sectoral tools, such as additional risk weights or additional capital buffers on bank exposures to corporates.

If the main source of credit is not banks but, rather, non-bank financial intermediaries, then this is somewhat more complicated because there are fewer policy tools to address that.

But, again, greater, more rigorous supervision is needed, more disclosure perhaps by these financial intermediaries to allow a more comprehensive assessment of risks by both investors as well as supervisors.

Of course, there are other tools that can be considered as well; for example, some criteria on the credit quality of securities that different financial intermediaries can invest in, and so on so forth.

Let me stop here.

Question - What you have outlined seems very familiar to those of us who have been here for quite a long time: lots of risk, lots of debt, lots of vulnerability, and a lack of policy action. How close do you think we are to repeating the mistakes of 2008, when action was taken but taken too late and only after the problem had exploded?

Mr. Adrian - Thanks for the question.

We are in a better place today, from the point of view of banking regulations. Banks have more capital. There has been tremendous progress in terms of banking regulation and, to some extent, insurance regulation as well. So I do think that we have to acknowledge that overall capital and liquidity levels in the banking sector are much better, and the banks remain the core of the financial system.

Some estimates are that, depending on the country, high-quality capital is about two to three times higher than it was prior to the last financial crisis. So tremendous progress has been made there.

But we do see a build up of vulnerabilities in the non-bank financial sector and in the corporate sector, in particular, as Anna has explained. And we particularly worry about the risks in the medium term.

In the short run, say, over the next year or so, risks have been contained to some extent by the sharp easing of monetary policy that has occurred in many countries around the world.

So that easing of monetary policy has taken out some of the downside risks. But in the medium term, say, over two to three years, we worry that vulnerabilities continue to build up. And in the scenario of adverse shocks, these vulnerabilities are amplification mechanisms that can make shocks worse. So financial vulnerabilities act as amplifiers for any negative shocks.

So we do worry about the medium term, and we urge policymakers to take action today, using prudential policy tools to contain the deterioration of underwriting standards to make sure that the non-bank financial system is safe and that underwriting standards in the corporate sector do not deteriorate too much.

Ms. Elnagar - The gentleman here.

Question - Good morning. How the trade wars, they would increase those vulnerabilities and put the financial risk worldwide?

Mr. Adrian - The question was about trade tensions.

What we have seen over the past year -- really, over the past two years is that trade tensions have moved markets. And many times when the markets became more pessimistic about trade, there have been significant moves. And downside risks to economic activity have been a function of those trade tensions.

So we urge policymakers around the world to continue to work together in order to resolve those trade tensions, as that is a significant source of uncertainty, and a significant source of creation of downside risks is trade uncertainty.

Now, the trade uncertainty is interacting with the financial vulnerabilities. So financial vulnerabilities are amplification mechanisms for bad news. So when there is bad news on the trade front, then the higher the financial vulnerability, the worse the amplification. That is our thinking about financial stability. And, as we pointed out, these vulnerabilities are rising, particularly in the corporate and the non-bank financial sectors.

Mr. Papageorgiou - I just wanted to make a very quick point.

In terms of the implications of trade tensions are, obviously, very important on the real economy and, obviously, on trade; but as Tobias also mentioned, there are real implications for portfolio flows, in particular, to emerging markets. Clearly, we are very concerned about -- the whole word is very concerned about China and the US but there is also real spillovers to emerging markets.

We have seen that equity flows of the emerging markets have reacted very closely to the ebbs and flows of that trade news. And there seems to be a domino effect from the external factors on those portfolio flows, rather than country-specific fundamentals. And we think that is very important because, much like you had strong inflows during periods of calm, during calm periods, you can have a sudden reversals of those flows.

Ms. Elnagar - Thank you.

Question - Yesterday we saw rather a spectacular explosion of an open-ended Fund empire in the UK, the Woodford Funds. I just wonder what you thought about the vulnerabilities of open-ended funds, and what steps should be taken by regulators to try and address that vulnerability?

Mr. Natalucci - We have one chapter in the Global Financial Stability Report that focused on the behavior of institutional investors in this lower-for-longer environment. So the three investor types we focus are asset management, pension funds, and insurance companies.

So the open-ended funds, which is one subset of the asset management industry, what we highlight there is that in this low-for-longer environment, there is an incentive for some of these players to reach out for yield in the form of more liquid security, higher credit risk, to achieve their return targets, whether they have nominal mandates or whether because they have nominal return targets or because of investment mandates.

So the two risks we highlight there are that liquidity buffers, some of these funds have decreased, and also that the portfolio seems to be much more correlated, much more similar; and so the reason why we highlight those is that those could become an issue of financial stability concerns.

On the one hand because those are the marginal bid for some of these assets, especially credit, and so they are pushing down higher valuation for credit, and so if that demand comes away, it could have a repercussion for asset valuation but also because those could be amplifiers in the sense that if these funds come under pressure, specifically those that provide the daily liquidity and invest in more liquid assets, that once they run the box where we provide a stress-test scenario where we look at what would happen in some of these funds if there are, in fact, demands for withdrawal and liquidity, and the number in terms of shock, it is about 160 billion, which is about 1.5 percent of the assets of the Fund under the scenario.

The weakness seems to be concentrated geographically more in Europe than other jurisdictions and also more among the smaller funds than the larger funds. So the point is, those are, as Tobias mentioned, amplifiers, if there are shocks and you go to a fire sale episode, that could in fact, amplify the price moves. So the recommendations were up there, so enhanced supervision and disclosure. Specifically, for the Fund a couple examples of measures that could be considered are, one, considering very strict liquidity risk management as well as stress testing as well as stepping up efforts to address leverage and maturity and liquidity mismatch in the funds.

Ms. Elnagar - We go to the gentleman here.

Question - Thank you. The Trump administration has been warning against Chinese debt in Africa.

Do you see any risk? Can you talk generally about Africa and China in Africa, especially China loans? Thank you.

Mr. Papageorgiou - The issue of non-Paris Club creditors as we have looked into it in this Global Financial Stability Report, you know, this is one of the issues that we identify as potentially creating some instability or some vulnerabilities.

Not that the debt itself creates problems. We examine some issues that debt has to be used for productive purposes, but usually debt that is given under non-Paris Club or multilateral types of agreements, more broadly in a lot of low-income countries, particularly a lot of Sub-Saharan African countries, the issue of debt vulnerabilities is becoming more and more prescient.

It is already, as the IMF in the IMF's evaluation, is more than a dozen countries that are either in distress or in high risk of debt distress, and there the issue again of either collateralization of that debt or the type of this debt may create a more difficult way of resolving it down the line through a debt restructuring, for example.

Mr. Adrian - Let me just complement that by saying that, of course, capital flows to Sub-Saharan Africa has to be dealt with in a responsible manner, and so when we look across countries in Africa, there is a variety of approaches, and so we do see an increase in overall debt levels, and there are both costs and benefits to that.

Ms. Elnagar - OK. I will go to the gentleman with the glasses.

Question - Thank you. I see that the way of corporate debt at risk in European countries as well as Japan has decreased in the past ten years, so are these countries still a concern for you, and if yes, why? Thank you.

Ms. Ilyina - So the chart that you are referring to presents debt at risk as of 2009 and as of 2019 relative to GDP. So in some cases, if we look at debt at risk relative to total corporate debt, the share may be high; but if overall corporate debt is not large relative to GDP, those numbers that you see would be smaller. So we would worry both about the high share of firms with weak debt repayment capacity in total corporate sectors as well as the overall size of corporate debt because that tells us something about how debt is distributed across firms that have various fundamentals.

So in several countries in the Euro Area in particular, debt at risk has declined since the Euro Area crisis because of the deleveraging efforts that have been undertaken, and that is true that in some of those cases, even in the stress scenario, debt at risk stays below the levels seen during the financial crisis.

So in that sense, that would be less of a concern, yes.

Mr. Adrian - It is a differentiated picture. So in some countries things have improved, and in others they have deteriorated, but the overall picture is one of concern.

Ms. Elnagar - The gentleman in the third row with the glasses.

Question - Thank you. My question is that China has made efforts on reforms to keep financial stability like structural deleveraging, control of local government debt, regulatory reforms, and international cooperation, so how do you evaluate the reforms and what are the vulnerabilities still remaining, and what is the reason to trigger that? Thank you.

Mr. Adrian - We welcome the efforts of the Chinese authorities to increase financial stability. As you mentioned, in a number of areas, financial regulations have been tightening, and the authorities have made an effort to deleverage some parts of the financial system, including the shadow banking system.

We do continue to urge the authorities to continue with that path of tightening financial regulations. The shadow banking system, while it has stopped growing, it continues to be large in size. We also have concerns for small- and medium-sized banks and regional banks. As you know, a number of banks have failed this year, and we continue to see some vulnerabilities in that sector.

Mr. Natalucci - In terms of vulnerabilities, the experience of the three small- and medium-sized banks over the summer in some sense highlight three global vulnerabilities that remain in the system, especially in small and medium banks in terms of reliance on outside funding on the liability side, investing in riskier asset on the asset side; and for some of these banks, the generally low level of capitalization, as well as profitability. That is one.

The second vulnerability has to do with maturity mismatch and use of leverage in the investment funds, so the shadow banking sector, so that is why the progress of deleveraging is something that we welcome.

The third one has to do with the remaining interconnectedness between the bank and non-bank sector, especially in a system that still continues to have essentially a guarantee in the system, implicit guarantees.

The point is the tradeoff here is in some sense increasing the resilience, so deleveraging the system, raising capital, raising liquidity, and on the other hand, maintaining growth and maintaining credit growth so that that can help boost the economy, that is the balance that in terms of intertemporal tradeoff we tried to highlight in the report. In terms of policy recommendation, the three banks' experience suggests there is need for crisis management framework, including resolution for banks, as well as continue to implement the asset management reform and increasing the solvency of the banking sector, especially the small and medium size.

Ms. Elnagar - I will take the gentleman in the blue shirt.

Question - In a previous answer to the question Anna was responding to where you said that probably non-bank financial institutions could take higher securities because there is limited scope for some of the other pools to control debt distress, but specifically in economies like what is coming out is that while they have been taking securities, the enforcement of the securities have been problematic, which is why the eventual recoveries of the loans have suffered considerably, and that is now turning out to be a bigger crisis within the economy so in terms of the IMF's recommendation with respect to what could be the nature of the securities and probably some of the enforcement tools that the government could introduce.

Mr. Papageorgiou - The question is about market structure, or what is exactly the question? Securities markets? OK. So obviously on India, a lot of steps have already been taken.

In terms of NPL, for example, the NPL recognition, which has accelerated in terms of recommendations related to more aggressive public sector bank (PSU Bank) disinvestment, privatization, and in general reducing the role of the public sector on the financial system. Enhancing the bank lending capacity would come on the back of that and could help reduce the fiscal contingency, if you will, from state through the PSU banks.

Question - [microphone off]. With respect to the non-banking sector what are the IMF’s recommendations?

Mr. Papageorgiou - That is obviously another channel of spillovers, but in banks and the nonbanks, you also had an NBFI default this year, a non-bank financial institution that is, default this year and a run on a COOP bank more recently. There it is a matter of stricter supervision and encouraging banks to divest or to manage their risks better.

Ms. Elnagar - Gentleman.

Question - Last time around, the financial crisis, the credit rating agencies received a lot of criticism for falsely giving investors confidence in both sovereign and corporate debt that was not warranted.

The efforts of reform are largely watered down. Does the IMF rely on those credit rating agencies at all? What is your degree of confidence in those?

Mr. Adrian - That is an excellent question. So after the financial crisis, there were initial reform efforts to change the governance of credit rating agencies, but as you point out, there have been some reforms but perhaps less than was originally envisioned, so there continue to be a number of governance issues, conflict of interest in the credit rating agency model.

Now, having said that, last time around one of the particular challenges was that there was a whole new asset class that was being rated, which was subprime mortgages, and the historical data for subprime mortgages was limited, so models were particularly deficient.

Today what we are worrying about are corporate sector vulnerabilities, and, of course, rating agencies have assessed the corporate sector for more than 100 years by now, so I would say that the model, so the analytics are probably more advanced in the corporate sector than they were in the subprime mortgage sector ten or fifteen years ago.

There is very nice work that has been done at the Fund and in other agencies that is documenting those failures of the models. It is just like the models were not good for subprime mortgages. And I think we do not see that particular problem.

So my answer is twofold. Yes, there continue to be certain governance problems with rating agencies, but in terms of the analytics, I think we are on a safer footing today. Having said that, of course, we do see that CLOs are an important buyer of corporate debt, and those are structured products. Now, CLOs fared well through the last crisis, which is one of the reasons investors continued to buy CLOs, as opposed to some CDOs, say, on mortgages. But we do observe that the quality of collateral that is entering into those CLOs is deteriorating, and that is a source of concern.

Ms. Elnagar - I will take one question online: In this context that describes vulnerabilities, what is the greatest risk in Mexico being an emerging economy linked to trade tensions between the US and China but also with high monetary policy rates.

Mr. Papageorgiou - Obviously Mexico has been directly in the forefront of the trade war and being concerned with the impact on global trade, so obviously having been exposed a lot to US manufacturing and trade would have to -- it is a very high priority for them. Our country team was recently in Mexico for the Article IV consultation, and the recommendations that came out of that visit was pursuing a more growth-friendly and inclusive fiscal policy, easing monetary policy, to the extent that inflation is in check and inflation expectations are anchored, boosting financial inclusion to strengthen the financial system, and then reinvigorating and promoting structural reforms, particularly on state-owned enterprises.

Mr. Adrian - Let me just add to that, that Mexico is, of course, an emerging market that relies on capital inflows, and trade tensions tend to make capital flows more volatile, so Mexico, along with other emerging markets, is exposed to the volatility in capital flows related to trade tensions.
Ms. Elnagar - We will go back to the room. The gentleman here.

Question - Good morning. Adrian, in your presentation, you highlighted the fact that external debt in emerging and frontier markets have been on the rise, which is the case we have seen in Nigeria; so would you recommend that frontier markets and Nigeria focus more on domestic borrowing instead of doing more external borrowing? Thank you.

Mr. Adrian - Both domestic and external debt markets are important for economic growth and economic development, and both markets should be well developed; but, of course, any borrowing has to be managed in a responsible manner. There are both costs and benefits. So borrowing can be helpful for economic growth and investment, but it can also be dangerous when negative shocks hit. So we have done a lot of work at the Fund on debt sustainability and debt management, and we have a host of recommendations of how to manage debt in a responsible manner.

Mr. Papageorgiou - Can I make a specific point on Nigeria? You mentioned local currency. Local currency borrowing could be preferred in some cases, but it is not a panacea. The guiding principle, as Tobias mentioned, is also prudent debt management. Over the summer, local currency flows have been more volatile, and Nigeria was not an exception to that. Nigeria has a large exposure to nonresident holders of domestic debt, particularly with central bank bills; and then as we understand the central bank bills, there is a lot of higher redemptions or has to deal with more rollovers of those in the coming quarters, and so managing those risks, particularly with respect to local currency debt and the behavior of nonresident investors is very important.

Ms. Elnagar - We will go to the back.

Question - Thank you. My question is about China's currency. Recently the US Treasury has designated China as a currency manipulator, and they say they are working with IMF on this regard. I am wondering is there an update on this? Has the US Treasury reached out to the IMF to discuss the issue? Thank you.

Mr. Adrian - So the IMF has an assessment of currencies, which is the External Sector Report, and the Chinese currency was not viewed to be excessively valued in either way.

Ms. Elnagar - The lady in the third row, and then we will wrap up.

Question - What are your recommendations on how to increase investment flows in Nigeria? Thank you.

Mr. Adrian - So flows of investment to Sub-Saharan Africa have been strong and are expected to reach record highs this year, so global financial conditions are favorable to countries such as Nigeria at the moment. Issuing bonds in hard currency and in domestic currency is currently possible because of the favorable global financial conditions.

Of course, it is key what countries such as Nigeria are doing with those borrowed funds, and as Evan was pointing out already, undertaking structural reforms to develop the economy is key.

Ms. Elnagar - Thank you very much for coming. We will wrap up now, and there is the Fiscal Monitor press conference after that. We will see you. Thank you for coming.
IMF Communications Department