Abstract
In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
This supplement provides an update on key developments that occurred after the staff report was finalized. These developments do not affect the thrust of the staff appraisal.
1. The Office for Budget Responsibility (OBR) published its first Fiscal Sustainability Report (FSR) on July 13. The report makes long-term fiscal projections assuming implementation of the government’s consolidation plan through FY15/16 and unchanged policies thereafter.
In this central scenario, the OBR projects that population aging and associated increases in pension and healthcare spending will slowly reduce the primary balance and increase public sector net debt to 107 percent of GDP by FY60/61.
However, the central scenario assumes that healthcare spending per elderly individual grows with per capita GDP. If instead annual healthcare spending growth is 1 percentage point faster (historically, healthcare spending per elderly has been 1–2 percentage points faster than per capita GDP growth), the FSR projects that the primary deficit would be more than 5 percent of GDP higher than in the central scenario by FY60/61.
These projections highlight that substantial fiscal consolidation after FY15/16 will be necessary to ensure fiscal sustainability over the long run. However, the UK is not unique in this regard—its long-run fiscal challenge from population aging is similar to that of many European economies.1 The large planned fiscal consolidation over the next 5 years also greatly reduces the total amount of consolidation required in the long run.
UK: Long-run Fiscal Projections under the OBR’s Central Scenario
(Percent of GDP)
Citation: IMF Staff Country Reports 2011, 220; 10.5089/9781462337538.002.A003
Source: OBR.At the same time as the FSR, the Treasury released Whole of Government Accounts for FY09/10, which for the first time presented the public-sector financial position on the basis of commercial accounting standards, including future liabilities arising from public-service pensions. This release does not fundamentally affect IMF staff’s view of the fiscal situation, but it is a step forward for fiscal transparency.
2. All four UK banks included in the European Banking Authority (EBA) stress tests passed. The stress test results show that each of the four banks—Lloyds Banking Group (LBG), Barclays, Royal Bank of Scotland (RBS), and HSBC—would maintain core tier 1 ratios of at least 5 percent (the minimum level set by the EBA) under a stressed scenario of low GDP growth over two years, falling property prices, rising unemployment, and moderate haircuts on trading book holdings of peripheral European sovereign bonds.2 The results are broadly in line with those of the FSAP stress tests for these banks.3
EBA Stress Tests 2011
(Percent)
Citation: IMF Staff Country Reports 2011, 220; 10.5089/9781462337538.002.A003
Source: European Banking Authority.1/ Standard Chartered was excluded from the exercise due to its limited European exposure. Actual core tier 1 capital ratios in the EBA analysis differ slightly from those reported in the staff report and FSSA due to minor definitional differences.Total Exposure to Greece, Ireland, Portugal, Spain, and Italy
(Percent of end-2010 core tier 1 capital) 1/
Citation: IMF Staff Country Reports 2011, 220; 10.5089/9781462337538.002.A003
Source: European Banking Authority.1/ LBG did not disclose any lending exposure outside of the UK and US.3. On July 20, the EU Commission adopted a proposal to implement the Basel III agreements through new EU-wide legislation. The package includes regulation and a directive (“CRD4”), both of which are subject to approval through the EU Council and Parliament—a process that will likely take at least six months. The proposal falls short of IMF staff recommendations (see paragraph 50 of the staff report) and hence is a disappointment. Specifically:
The common standards are too weak. The Commission suggests a common standard (maximum harmonization) set at the level of Basel III minimum requirements. Moreover, the Commission has softened the definition of core tier 1 capital relative to the Basel III recommendations in some areas. In contrast, staff has called for common standards that exceed the Basel III minima, given prevailing balance sheet uncertainties and the lack of EU-wide resolution arrangements and a fully unified fiscal backstop.
More flexibility is needed for macroprudential policies. National authorities can only set system-wide higher capital requirements on loans secured by real estate or using the Basel III countercyclical capital buffer, although they have more freedom with regard to individual banks. National authorities are likely to need more flexibility to use a range of macroprudential tools, given the uncertainty surrounding the tools required for effective macroprudential policy and future macroprudential risks.
Furthermore, the Commission proposal lacks a firm commitment to implement the leverage ratio or net stable funding ratio in 2018, as was agreed under Basel III.
It will be important to strengthen the legislation as it is finalized, including by creating stronger common standards and ensuring sufficient flexibility for macroprudential policies.
See Sustainability Report 2009 (European Commission, 2009).
The EBA adverse scenario of a slight contraction in the first year and small positive growth in the second is roughly equivalent to the mild adverse scenario in the FSAP stress test, which entails approximately a one standard deviation shock to real GDP growth over the first two years of a five-year stress horizon. The FSAP also conducted stress tests under two additional adverse scenarios (a two standard deviation shock to real GDP growth and prolonged slow growth).
In addition to the EBA four, the other major UK banks in the FSAP solvency stress test sample include Standard Chartered, Santander UK, and Nationwide. All major UK banks exceeded the Basel III and Financial Service Authority hurdle rates in these scenarios. FSAP assumptions include haircuts to bank debt and sovereign debt holdings in both the banking and trading books. The FSAP also includes liquidity stress tests of the major UK banks, building societies, and foreign investment banks.