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© 2004 International Monetary Fund
March 2004
IMF Country Report No. 04/56
United Kingdom: 2003 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the United Kingdom
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2003 Article IV consultation with the United Kingdom, the following documents have been released and are included in this package:
the staff report for the 2003 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on December 18, 2003, with the officials of the United Kingdom on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on February 13, 2004. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.
a Public Information Notice (PIN) summarizing the views of the Executive Board as expressed during its March 3, 2004 discussion of the staff report that concluded the Article IV consultation.
a statement by the Executive Director for the United Kingdom.
The document(s) listed below have been or will be separately released.
Selected Issues Paper
The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information.
To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to publicationpolicy@imf.org.
Copies of this report are available to the public from
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INTERNATIONAL MONETARY FUND
UNITED KINGDOM
Staff Report for the 2003 Article IV Consultation
Prepared by the Staff Representatives for the 2003 Article IV Consultation with the United Kingdom
Approved by Michael Deppler and John Hicklin
February 13, 2004
Article IV Consultation discussions were held in London during December 3-18, 2003. The mission comprised Messrs. Cottarelli (Head), Chadha, Escolano, Ms. Honjo, and Ms. Koeva (all EUR). Mr. Scholar, Executive Director, and Mr. Kelmanson (OED) attended the meetings. Staff met with the Chancellor of the Exchequer, the Governor of the Bank of England (BoE), the Chairman of the Financial Services Authority (FSA), other senior government officials, members of the Monetary Policy Committee (MPC) of the BoE, representatives of employers’ and employees’ organizations, and financial institutions.
At the conclusion of last year’s consultation in February 2003, Directors welcomed the growth performance of the UK economy during the slowdown, sustained by the timely easing of monetary and fiscal stances. However, they called for vigilance regarding the risks posed by high household debt and house prices. Directors also saw downside risks to the authorities’ revenue projections and called for expenditure restraint to lower over time the structural fiscal deficit and avoid inefficiency in spending. Directors welcomed the conclusions of the Financial Sector Assessment Program (FSAP) indicating the financial supervision framework was strong and banks were highly profitable and capitalized, but called for sustained vigilance of the insurance industry.
The authorities’ policies continue to be broadly in line with Director’s appraisals in earlier consultations. The macroeconomic policy and financial supervision frameworks remain at the forefront internationally and are consistent with Fund recommendations. The authorities, however, have not yet responded to the call for moderating the growth of public spending, in spite of fiscal outturns that have remained weaker than targeted.
The United Kingdom has accepted the obligations of Article VIII, Sections 2, 3, and 4. The exchange system is free of restrictions on payments and transfers for current international transactions (Appendix II).
The United Kingdom has subscribed to the Special Data Dissemination Standard, and data provision is adequate for surveillance (Appendix III).
The authorities released the mission’s concluding statement and have agreed to the publication of the staff report.
Contents
Executive Summary
I. Key Issues
II. The Discussions
A. Recent Development and Outlook
B. Calibrating Monetary Policy
C. Does the Fiscal Correction Require New Measures?
D. Assessment of the Five Tests for EMU Entry
E. Structural and Financial Sector Issues
F. Other Issues
III. Staff Appraisal
Text Boxes
1. Household Balance Sheets
2. Does the Shift from RPIX to CPI matter?
3. Asset Prices and Inflation Targeting
4. Fiscal Sustainability
5. Steps to Facilitate EMU Entry
Figures
1. The Economy Has Weathered the Global Slowdown Well
2. Financial Markets are Pricing in an Upswing
3. Household Balance Sheets are Important for Consumption
4. The Labor Market Has Remarkably Resilient During the Slowdown
5. The Housing Market Remains Robust
6. Inflation Has Remained Close to Target
7. The Monetary Policy Stance Has Been Expansionary
8. The Fiscal Balances are Deteriorating
9. Spending in Key Sectors is on the Rise
Tables
1. Selected Economic Indicators
2. Quarterly Growth Rates and Contribution to Growth
3. Balance of Payments
4. Medium-Term Scenario
5. Public Sector Budgetary Projections
Appendices
I. Basic Data
II. Fund Relations
III. Statistical Information
IV. Sustainability Exercise
Appendix Tables
A1. Public Sector Debt Sustainability Framework, 1998-2008
A2. Net Investment Position
A3. Indicators of External and Financial Vulnerability
Executive Summary
Background
After faltering in the wake of the Iraq war, economic activity has staged a strong recovery. Real GDP grew by over 2 percent in 2003, with quarterly growth rates rising above trend in the second half. The upswing reflects not only strengthening external conditions but also the continued buoyancy of domestic demand driven by expansionary monetary and fiscal policies, robust increases in house prices and rising household debt. The labor market has been resilient, with unemployment remaining near a 20-year low during the downturn. RPIX inflation remained close to its target, though CPI inflation remains some 0.6 percentage point below the new target of 2 percent. Near term prospects are for an acceleration in growth before settling down to trend rates later this year. Further out, the main risk relates to a hard landing in house prices and private consumption.
Policy Discussions
Staff and the authorities broadly agreed that against a backdrop of strengthening external demand, macroeconomic policies needed to tighten. The discussions focused on whether or not policy actions were required for the necessary fiscal consolidation and on calibrating the required tightening in monetary policy. The discussions also encompassed structural policies for raising productivity, the outlook and risks for the pension system, financial sector issues and the authorities’ assessment of readiness for EMU entry.
Fiscal consolidation. Over two-thirds of the five percentage point deterioration in the fiscal position between 2000/01 and 2003/4 is estimated by staff as structural. It reflects primarily deliberate increases in spending on public services and unexpected shortfalls in tax receipts attributable to the bursting of the global equity bubble. Staff and the authorities concurred that a gradual strengthening of the fiscal position was needed to respect the government’s fiscal rules going forward, improve fiscal fundamentals, and support monetary tightening at this cyclical juncture. The authorities saw the deficit improving sufficiently with the cyclical upswing, a rebound in revenues from the financial sector, improvements in tax collection, and rising effective tax rates from the fiscal drag. In contrast, staff saw the deficit declining only modestly over the medium term without new measures, to 2¾ percent of GDP, some 1 percentage point above the authorities’ projections. Thus, additional measures were likely to be needed. In particular, staff saw a case for moderating the government’s ambitious spending plans, as a more gradual increase in public spending would reduce the risks of inefficiencies.
Monetary tightening. There was agreement that a strategy of gradual, early interest rate increases was called for. Uncertainties as to the likely response of consumption to changes in interest rates, related to the unusually high household debt level, called for gradualism. In the staff’s view, the case for gradual—and correspondingly “early”—increases was strengthened by the risk that late and, thus, larger increases could precipitate a sharp downward adjustment in house prices.
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Public Information Notice (PIN) No. 04/15
FOR IMMEDIATE RELEASE
March 5,2004
International Monetary Fund
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Washington, D. C. 20431 USA
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