|British Prime Minister David Cameron reviews a guard of honour with the Chinese Premier Wen Jiabao, Beijing, Nov 09, 2010.|
The IMF (International Monetary Fund) said in a report issued on Tuesday that
repairing UK economy will take time but the recovery is expected to continue.
Growth of 2% is forecast for 2011.
The Fund said after
a deep recession, the UK economy started growing again in late 2009
and in its
annual health check of the economy (pdf), it is expecting growth
of 1¾% in 2010, followed by 2% in 2011.
“There’s considerable uncertainty around this forecast, which
makes it very important for policymakers to be vigilant and
flexible,” IMF mission chief Ajai Chopra said.
“Encouragingly, unemployment has stabilized, but it’s still too
high. This crisis won’t be over until we start seeing significant
falls in unemployment, and that’s going to make it very important to
lay the foundations for sustainable, strong, and equitable growth.”
Very low real interest rates, the fall in sterling, and the
global recovery could provide a bigger boost to growth. But further
rapid debt reduction by households and companies, a sharp new
downturn in the housing market, or greater than expected weakness in
the euro area are all factors that could undermine the recovery now
underway, according to the report.
The UK fiscal deficit was 11% in 2009, a post-war record and one
of the highest deficits in the world. As a result, debt is rising
rapidly. The report says that after assuming office in May 2010, the
Conservative-Liberal Democrat government has moved swiftly to
announce a number of important policy initiatives to promote
confidence and sustainable growth.
The cornerstone of the government’s policies is an ambitious plan
to achieve a balanced cyclically-adjusted current budget by 2014/15
through a combination of spending cuts to reduce total government
expenditure by more than 7 percentage points of GDP over the next
six years and tax increases that include a bank levy and higher
value-added and capital gains taxes. Many of these measures will be
implemented during the government’s first year in office.
“The government has announced tough measures to ensure fiscal
sustainability and also reduce the risk of a possible costly loss of
confidence in public finances. Inevitably, the consolidation will
slow short-term growth, but this is outweighed by the longer-term
benefits,” Chopra said.
“Although consolidation is necessary, it’s important that it
be fair, which means that it will be important to protect the poor
and the vulnerable,” he added.
Restoring growth and jobs
Looking beyond the immediate future, the report says there are
many uncertainties surrounding the growth potential of the UK
economy. The financial crisis not only depressed demand, it also put
a dent in potential supply, which determines the economy’s ability
to generate growth and new jobs, the report said.
Loss of skills in the labour force due to longer-term
unemployment is one factor that could impact future growth.
Unemployment rose from 5½% to 8% as a result of the crisis. Even
though it has recently started to decline, it has already affected
the many workers who lost their jobs during the crisis. The lack of
new jobs also affect those seeking to enter the labor force for the
Further job losses are expected in the public sector as the
government starts implementing its planned budget cuts, so new jobs
will have to be created mainly in the private sector.
Flexibility is key
Given all the uncertainties surrounding the outlook, the IMF says
the government should be ready to adjust its policies if conditions
change. A key safeguard are the automatic fiscal stabilizers, which
should be allowed to operate freely in both directions, the report
said. In the unexpected but possible event that the economy
experiences a significant downturn, temporary and targeted tax cuts
should be considered, provided overall credibility of fiscal policy
“If there’s a sharp and prolonged downturn in the economy, the
pace of fiscal consolidation may need to be adapted,” Chopra
Monetary policy should also remain flexible. Asset purchases
should resume if the recovery weakens. Conversely, if inflationary
pressures continue to surprise on the upside, policy rates should be
gradually tightened, according to the report.
“The current accommodative stance of monetary policy remains
appropriate. It will help offset the shrinkage in the budget,”
“Yes, inflation is running well above the 2% target, but this
is due to a series of one-off price level shocks, such as the
increase in the VAT, which will keep inflation above target in 2011
as well. But we do expect inflation to fall below target in 2012.”
Moving to a safer financial system
The Fund says the financial sector is another key building block
for the economic recovery. The bank stress tests carried out by the
European Union in July 2010 confirmed the relatively good health of
British banks. The tests facilitated banks’ efforts to tap markets
for longer-term funding. But many banks still need to roll over or
replace large amounts of wholesale funding coming due over the next
few years, underlining the importance of ongoing efforts to
strengthen the financial system.
“The health of the U.K. banking system has improved, but it’s
going to be important to continue progress in this area to be able
to support the recovery and cope with possible future shocks. This
means that supervisors will need to maintain pressure on banks to
rebuild capital over time and to also strengthen their funding
models,” Chopra said.
Private credit remains relatively weak. UK consumers responded to
the global financial crisis by saving more of their income and
paying off debt. The gross household savings rate jumped by more
than 6 percentage points, to a peak of 7¾% in mid-2009. Consumers
have recently started to spend more of their disposable income, but
lending to households remains weak. Corporate credit is also weak,
reflecting a lower appetite for investing.
In sum, the IMF says the UK economy is on the mend. Economic
recovery is underway, unemployment has stabilized, and the health of
the financial sector has improved. But the government should be
ready to adjust its policies, should growth drop back or speed up
beyond what is currently expected.