22 May 2013

IMF: United Kingdom—2013 Article IV Consultation Concluding Statement of the Mission

The UK is still a long way from a strong and sustainable recovery, and the prospect remains for weak growth. Given ongoing domestic deleveraging pressures and weak external demand, activity is expected to pick up only gradually. (Includes link to George Osborne's opening remarks.)

The key risk is that persistent slow growth could permanently damage medium-term growth prospects—this could arise if private sector deleveraging is larger than expected, credit conditions fail to improve, external demand does not pick up, and the drag from fiscal consolidation is greater than anticipated. In addition, despite recent market calm, growth in the euro area is likely to be weak, and the re-emergence of market tensions cannot be ruled out, with the potential for continued spillovers to the UK from depressed exports, higher bank losses and funding costs, and reduced confidence.

Financial sector repair has advanced, but banks are still not restored to healthy functionality. On the positive side, funding is more assured and regulatory capital ratios continue to edge up. However, the share of non-performing assets across some major banks remains at elevated levels, and underlying profitability is weak. Moreover, there are concerns pertaining to lender forbearance, under-provisioning for risky assets and conduct costs, and aggressive use of risk-weights.

A clear strategy is needed for the two government-intervened banks, with a view to returning them to private ownership. Together, RBS and LBG account for two-fifths of the stock of UK net private sector lending. The banks have made progress in repairing their balance sheets and improving profitability. But challenges remain, as evident by the recent failure to divest surplus business lines, and the still-low market-to-book value for RBS. The approaching completion of the banks’ original EC-approved restructuring plans provides an opportunity to elaborate a clear way forward. Any strategy should seek to return the banks to private hands in a way that maximises the value for taxpayers, strengthens confidence and competition in the sector, and minimises outward spillovers. In this context, if a sovereign backstop is required to meet a capital shortfall, it should be provided, as this would have a high multiplier.

While adhering to the medium-term framework, the government has shown welcome flexibility in its fiscal programme. The government has accommodated a slowdown in the pace of structural consolidation, notably in the context of weakening potential growth; allowed automatic stabilisers to operate freely; and public sector net debt is forecast to fall in 2017-18, two years later than set out in the Supplementary Debt Target. Furthermore, several measures to support growth have been introduced, such as increases in personal tax allowances and reductions to corporate tax rates. The government has also used its balance sheet to provide support through the use of guarantees. But planned fiscal tightening will be a drag on growth. Discretionary measures for this fiscal year amount to £10 billion. These will pose headwinds to growth, as expected, coming on top of domestic deleveraging and a weak external outlook, notably at a time when resources in the economy are underutilised.

Within the context of the medium-term fiscal framework, several growth-enhancing initiatives could be considered now to offset the drag from consolidation and bolster the recovery.

• Bringing forward planned capital investment where possible, which would help catalyse private investment and spur much-needed growth. Alongside this, well-designed public guarantees could be used to facilitate private investment.
• Further modifying the composition of consolidation to boost growth. This could include growth-friendly measures, such as reducing marginal effective corporate tax rates to bring investment forward, and introducing tax allowances for raising equity. To offset the budgetary impact of these measures over the medium term, the government could undertake a reform of property taxes and consider broadening the VAT base.
• The 2013 Budget announced a new scheme, Help To Buy, aimed at boosting activity in the housing market. This measure may temporarily help boost confidence in the housing market, but there is a risk that, in the absence of an adequate supply response, the result would ultimately be mostly house price increases that would work against the aim of boosting access to housing. To mitigate this risk and engineer a supply response, the government should consider fiscal disincentives for holding land without development.

Full press release

IMF-Article IV opening remarks by the Chancellor of the Exchequer, Rt Hon George Osborne MP © Crown copyright

© International Monetary Fund