• Economy & Finance

Macroeconomic and Monetary Policies in the Mediterranean. Management in a Context of Uncertainty

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Foreword

From the Barcelona Process to the Union for the Mediterranean, regional cooperation has been strengthened between the EU and its southern Mediterranean partners. Over the last few years, a period of economic and financial crisis has led to a process of reassessment and change in fiscal, financial and monetary policies in Europe as well as in its neighbouring countries. There is a broad consensus that structural reforms are needed and that more importance should be given to the private sector, to SME financing and to the promotion of south-south economic cooperation and investment. It has become clear that macroeconomic stability and sound monetary and fiscal policies are necessary to achieve long-term inclusive growth and welfare. Thus, in today’s context of uncertainty, reinforcing political, economic and financial regional cooperation is needed more than ever.

Overview Of The Macroeconomic And Financial Situation In The Mediterranean

Strengthening Economic Ties In The Mediterranean

Andreu Mas-Colell. Minister of Economy and Knowledge, Government of Catalonia

We, the people of Barcelona, Catalonia and Spain, look at ourselves as we have always done: as a connecting corridor between Europe and the Mediterranean. This conference fits very well into this perspective, and we are genuinely pleased to host it. First and foremost, it is clear that strong economic performance of the Mediterranean area in a context of political, financial and macroeconomic stability would open endless opportunities for all of us; thus we must work towards it. To that end, we must facilitate the bilateral transfer of experiences among countries in the Northern and Southern Mediterranean in order to enhance mutual understanding. It is no secret that in the Northern Mediterranean and Southern Europe we have been facing and continue to face important challenges. We have been concerned about sluggish macroeconomic performance, financial instability and the sustainability of public finance; nevertheless, we are overcoming these difficulties and learning experiences along the way that we can transmit to interested parties. In the case of Spain, I must say that we also have good news.

On the 26th October, a week ago, the European Banking Authority (EBA) announced the result of the latest stress test of the Spanish banking system, which performed very well, and I take this opportunity to congratulate the Governor for those results, and the intense work of the bank in playing its central role in this. The Spanish banking system is now in a position to foster the growth of the economy and to participate in interesting projects like today’s conference in the context of the Mediterranean region. The European Central Bank has been doing an excellent job in providing stability and aiming to secure the recovery of the European economy. From our vantage point in Southern Europe, we are calling for the Bank’s voice to be heard through its policy in Europe, most in need of balanced austerity and growth-oriented policies, and for it to strengthen its leadership towards this end. This will prove mutually beneficial to Spain, Europe and the Mediterranean.

Interdependence And Financial Reform In The Mediterranean

Luis María Linde de Castro. Governor, Bank of Spain

The Bank of Spain decided to support the European Institute of the Mediterranean in this event for several reasons. Firstly, the certitude that more must be done to strengthen the relationship and interdependence between Mediterranean countries. The potential benefits of such an enhanced relationship are great and obviously far from fully exploited. Historically, Spain has always had a great interest in the design and implementation of European Union Mediterranean policy. The Barcelona Process and the fact that Barcelona hosts the Permanent Secretariat of the Union for the Mediterranean made this especially clear. We will have the honour to have among us this afternoon Mr Fathallah Sijilmassi, its secretary general. There are no doubts about the importance that the EU, Spain, and in particular Catalonia, attribute to their relations with our Mediterranean neighbours.

Likewise, there is evidence that in practice links and relations between civil societies and private sectors of the Mediterranean countries have been moving forward at a faster pace than in the national framework, moving ahead of the curve. Foreign trade and tourism services, flows of immigrants to the European Union from Southern and Eastern Mediterranean countries with the corresponding flows of remittances and the fact that the region is an important destination for foreign direct investment from the European Union testify to the growing multifaceted and mostly private character of economic relations between our countries. In this regard, we consider this conference a very good opportunity for central banks and other institutions linked to the financial sector to enlarge and reinforce the dialogue between the two Mediterranean shores. Secondly, there is a common sense of urgency on both sides of the Mediterranean of the need to adapt the existing political, institutional and economic frameworks to the changing conditions and challenges of our countries. Indeed, the EU and the European area are still confronted with the consequences of the global financial crisis and what was called the European sovereign debt crisis. This long period of crisis has led to a process of reassessment and change in fiscal, financial and monetary policies in Europe and in the common traditional design under which we are functioning.

Yet there is also a broad consensus that this alone will not be enough and that structural reforms are needed in different fields such as, to mention just three major programmes, labour market, competency relations and pension reforms. International comparisons also show that in many Southern and Eastern Mediterranean countries the business climate is essential to the effective functioning of the private sector for its capacity to compete. Increased transparency and more homogenous implementation of the regulations that affect the private sector in aspects such as the creation of new companies, foreign trade, tax payment, and the labour market, appear to be of paramount importance. In fact, most analysts and international organisations agree that in order to achieve higher, sustainable and more inclusive economic growth the payment of a more appropriate amount by the private sector is an essential element of the needed reform agenda. Within this context, there are certainly challenges for central banks. It is also important to consider the ever-increasing worldwide interconnections of financial conditions and the new importance of financial stability for central bankers. In other areas of economic policy, we must also acknowledge that the implementation of some fiscal policies is necessary. This is a field in which common lessons can be learnt from different experiences in EU and Mediterranean countries. We can see that in many of them fiscal policy has to integrate consolidation reforms in order to preserve fiscal sustainability with some flexibility in the short term to support internal demand and maintain some standards of social protection. Overall, I want to bring to the fore the benefits of sharing wide-ranging experiences in the fields of monetary, financial and fiscal policies between countries on both sides of the Mediterranean.

Economic Development And Intercultural Dialogue In The Mediterranean

Sénen Florensa. Executive President, European Institute of the Mediterranean

We are very satisfied to host this high-level conference today, on the occasion of the European Institute of the Mediterranean’s 25th anniversary. The uniqueness of the event is greatly emphasised by the pertinence of the location, the Palau de Pedralbes, host of most Euro-Mediterranean activities and events since 1995. Ever since the 1st Euro-Mediterranean Ministerial Conference was held in 1995, Mediterranean countries and European Union members have been committed to working with the values and principles established in the Barcelona Declaration, namely to work together to build an area of peace and stability, shared economic progress, and cultural dialogue and understanding among the peoples of the countries around the Mediterranean.

Guided by the Barcelona Declaration, the “Barcelona Process” was launched and has since expanded and evolved in two different directions: on the bilateral track, through the launching of the European Neighbourhood Policy that enables countries wishing to do so the possibility of a higher degree of integration into the European economy; and on the multilateral track, with the creation of the Union for the Mediterranean launched in 2008, aimed at reinforcing the multilateral aspects of the Euro-Mediterranean Partnership, which was first established in 1995 on these very premises. Admittedly, great efforts aimed at improving the world’s economies have being made. Yet, it is clear to us all today that they have fallen short of our target, as the title of the conference seeks to point out. Overall, economic success has been achieved; yet it has been done in varying degrees. Following the liberalisation of the economic fields under the guidance of national plans of action and financial institutions in the 80s, 90s and early 2000s, under agreement with the European Union, countries that were willing to do so have in different degrees undergone a process of modernisation of their economic institutions, educational training or many other aspects. However, seen from today, we call it a context of uncertainty as there have not been enough reforms. There are exceptions, namely countries that show a relevant degree of economic success.

That is obvious in cases such as Tunisia, which registered an average growth of 5% to 6% per year; and Egypt, which before the revolution had varying degrees of economic success, though it did not meet the expectations of the population. We are now facing a period with very great expectations again on the part of the population and we have to walk a very thin line trying to provide the necessary macroeconomic stability to the countries. As we have seen from the previous experience, this has to be done with the necessary social policies and modernisation of the institutions, as required by the population and citizens. This is a very delicate balance. Central bankers and experts on microeconomic policies and monetary policy know very well how difficult this is. We must not turn to easier policies that yield great benefits in the short term but place us in an economically unsustainable situation in the longer term. These are all challenges we have to confront. In some countries the situation is much worse but there is room for hope as all citizens are ready to contribute. For instance, we just received good news about the progress made in Tunisia. This is an example that hopefully will be followed by the countries of the region at different speeds and in different ways. In order to achieve this, we need young people’s enthusiasm and the backing of citizens. We also need the return of sound macroeconomic and fiscal policies. These are all necessary elements to constitute a sound basis not only for some kind of economic success, which we had before but proved insufficient, but also for the social and political success that all countries had.

Financial Institutions And Financial Markets In Southern And Eastern Mediterranean Countries: A Regional Overview

Overview Of The Challenges Of The Financial Sector

Frank Moss. Director General, International and European Relations, European Central Bank

I would like to highlight three reasons for participating in this conference. First and foremost, as central bankers, we all take a keen interest in financial sectors. Most importantly, we keep a close watch on the banking sector owing to the transmission of our monetary policy, and lately given the non-standard monetary policy that all major central banks and the financial markets more generally have been taking. Second, as representative of the Central Bank of the Euro area, I would like to say that the north side of the Mediterranean is well covered by European area countries, starting with the country hosting the event, but also six other Mediterranean countries. Third, as head of the international department of the European Central Bank, we are concerned about Southern and Eastern Mediterranean countries.

Accordingly, we have been organising high-level events, including seminars, with governors of central banks of the entire region following up on the Barcelona Process. Let me present five evaluation points on the financial sector: Firstly, it is not devoid of complexity to make general statements about the financial sectors and the evolution of the sector in the region of the Southern and Eastern Mediterranean given the diversity of the countries’ circumstances. As we all know from experience in the European area, even aggregate figures can give an extremely misleading picture. Secondly, in many cases the financial sector in the region is overwhelmingly dominated by the banking sector. This sector has been decelerating lately and its contribution to economic growth has not been as hoped, even though it was relatively less affected by the global financial crisis for some idiosyncratic reasons. Thirdly, and in connection with the second point, the banking sector in the region risks being involved in a vicious circle. This was especially evident in the sovereign debt crisis of the euro area that combined low growth leading to problems in the balance sheets of the banking sector and the risk that the fiscal accounts in the country worsened with high dependence on the government.

The fourth element is that the low growth registered in the Southern and Eastern Mediterranean inevitably creates a full-size unemployment problem, especially ubiquitous in the case of the young people given the demographic situation in the region. Moreover, this low growth hampers financial inclusion and subsequently the further development of the financial sector in the countries. And the fifth point of evaluation is that to make the banking sector thrive a series of structural policy changes are needed. These policies are very important in the sense that they correspond to the ones that would prove favourable to the economy at large; that is, to generate more growth. “The optimal policy mix” is the relationship between monetary policy and fiscal policy, on the one hand, and structural reform, on the other. At the same time, if you carry out structural reform in one sector but the macroeconomic environment is not conducive then you get into even more problems.

The three of them have to work in the same direction to ensure the economy works well. This is basically what Turkey embarked on in the second stage and I think this is something a lot can be said about. Now, five policy conclusions I want to highlight: First and foremost, there is an urgent need to improve the framework conditions of the banking sector in the region: namely, on the one hand, legal aspects such as contract enforcements, property contracts and alike; and, on the other, financial market infrastructure developments, that is, information on investment products offered and credit quality, among others. Second, I would stress the importance of opening up the banking sector to competition, both domestically – by reducing the role of the government in the financial sector –, and externally. This is an area where countries across Europe face similar challenges, as it would provide a channel to increase cooperation and shared results: sharing experience, knowledge and capacities and ultimately propelling countries into a predominant position. The third recommendation is that a special focus be put on financing SMEs as major generators of employment and sources of economic growth, especially in the Southern and Eastern Mediterranean countries. In relation to that point, I want to refer to investment projects: how can they best be handled by the government and the private sector, and what is the financing stream attached to it.

I think that came out as a big issue and I would say it has also been a big topic of discussion in the G20 this year. We will have the G20 Summit next month and there will be a big block on investment and, more specifically, investment in infrastructure of SME financing and the like. I think that is a global issue beyond the agenda and not just of importance for the region. The fourth recommendation is that the banking sector can only perform successfully, increase its profitability, and reduce its non-performing loan (NPL) in a context of macroeconomic stability and growth. My last recommendation is that there is a need to widen the savings pool and the investment opportunities in the region. This will require, on the one hand, bigger financial inclusion and, on the other, the possibility of bigger regional integration. Interestingly enough, if you look at the potential that Islamic finances provide, I think it could fit in both respects. I would also like to emphasise the need for neighbouring countries in the region to cooperate with each other, as a source of reciprocated learning. For instance, the case of Lebanon, which is a tremendous example of a resilient economy, notwithstanding the massive shocks the country has been undergoing unfortunately quite regularly.

However, the financial system and private sector have coped with that and we have some very nice indications as to why this was possible. Finally, there is a need to push forward the normalisation of monetary policy. In some regions it will take longer than in others, so what is important is that in the meantime we avoid creating additional problems by means of creating additional risk. We do want to encourage risk taking but that, in turn, can create financial stability problems. We know that the cycle is very different there and this is something we have to look at, as the ECB is certainly doing. Monetary policy is not the magic solution for all the problems that all policy-makers have to deal with in their work. I think that it is very important that each one knows his/her particular role and if that becomes unclear, we will be running into a trouble again. This, in turn, will also be bad for the credibility of central banks. Indeed, central banks came out of the crisis with larger missions. It is important that those larger missions come with additional instruments. If you have a great number of objectives but no additional instruments, you are going to run into problems of credibility sooner or later. It becomes harder when dealing with objectives that are mutually interdependent, such as between price and financial stability. In those cases, it is important that responsibilities are clearly delineated: who does what and under which circumstances. In this respect, we are still in a process of learning.

Macroeconomic Management In Transition: The Case Of Egypt

Ahmed Galal. Former Minister of Finance, Egypt

The title of the conference suggests two ideas to me. One is “macroeconomic management” and the other one is “times of uncertainty”. I would like to elaborate on these two ideas and illustrate them through the story of Egypt and its macroeconomic management in transition. Having worked for the Government of Egypt for eight very long months I know more about this country than about any other. Let me start by telling you the end of the story: Egypt is navigating its political and economic transition reasonably well, despite detours, setbacks, and other unpleasant things. Nevertheless, I am optimistic about its future. I think there is strong evidence to believe in a brighter future in Egypt. Besides, the combination of Tunisia and Egypt will provide other Mediterranean countries with reasonable examples to follow.

What is happening in Syria, Libya and maybe Yemen is quite saddening, but hopefully the good developments will outweigh the bad. One has to understand the problem in order to act: without a prompt diagnosis of the problems one is bound to blunder. In the case of Egypt, I will examine how we saw the Egyptian economic problems in July 2013. Next I will analyse the options we had and discuss the measures we decided to implement. Last but not least, I want to explain why you should be interested in the case of Egypt. So how did we perceive the problem? All too often, whenever international missions come to Cairo, Shakespeare was right, beauty is in the eye of the beholder: it depends on who is coming. If it is people who care about macroeconomic stability, it is macroeconomic stability they point out; if it is people who care about poverty, it is poverty they indicate; if it is people who care about the private sector, it is the private sector they designate. So everyone looks at the problem from one particular angle, depending on where they come from.

The interim government I was part of in 2013 identified three major problems that hinder the Egyptian economy: macroeconomic instability or imbalances; sluggish economic growth combined with high unemployment, and the population’s perception of extreme poverty and inequalities. Any government that wanted to tackle the country’s problems at that time could not afford to overlook any of these key issues. So a holistic approach proved the only successful formula, one concerned with macroeconomic stability, activating the economy, as well as poverty and social demands. We were facing a difficult situation in a time when the economy’s state was critical, but aspirations on the street were incredibly high. The gap was just too big to bridge between what people wanted and what we could afford to do with a faltering economy and scarce resources. As an interim government, we had to act immediately and prepare the ground for the future.

The question was how to carry out this twofold task of acting on the spot and paving the way for future governments. Essentially we had two options. The first one was to say the situation was so bad that the only solution was to concern ourselves with macro stability followed by austerity measures. Hopefully, this would be the first step towards launching structural reforms, such as social justice issues or pensions. This option was on the table from January 2011 until June 2013. We thought that was a disastrous option for the following domestic reasons: the economy was growing at only 2% and it was operating essentially at half of its capacity, unemployment was rising at around 13%, too many resources were unexploited and the workforce was not operating at full capacity. So by bringing some macroeconomic stability through austerity measures we would also have sacrificed growth, increased unemployment, and probably pushed people onto the streets in larger numbers. As a result, this government would only have lasted two weeks. This was the formula we implemented.

The two options were radically dissimilar and successive governments for two and a half years had actually been pursuing the first one. This is why we decided to follow a completely different strategy. The next big challenge was to find an injection of funds. We were lucky enough to have a deposit in the central bank sitting there for 15 or 20 years of 9 billion dollars. The dollars were spent but the Egyptian pounds remained in a deposit. This money was put together into a stimulus package; therefore we were not printing money. Doubts came afterwards so we had another stimulus package. All in all we had two stimulus packages, adding up to about 3% of GDP. This is really significant: at the end of the day what we had pledged as a government was that the growth rate would be slightly higher by the end of the fiscal year and the budget deficit would also be lower. The money we received was partly intended to reduce the public debt or overdraft at the Central Bank and simultaneously invest in infrastructure in order to activate the economy in the short term and help the private sector in the medium term.

It was a win-win situation: we were achieving a shortterm objective and a longer-term perspective as well. Simultaneously, we introduced quite a few reforms to bring about fiscal balances, some results on the revenue side, value added tax and real estate tax, at least to prepare the ground for both. We also had a full plan for phasing out the energy subsidy that was eating a quarter of the budget. Moreover, we spent on social areas, such as meals for students in school, to mention only one. The idea was to try to balance all three objectives. In June 2013, the picture looked more positive than it had been before: the budget deficit was down from 14% of GDP to 10% of GDP, economic growth in the first quarter of the year had only been 2% and 1.2 or 1.5 and in the last quarter it reached 3.5%, hence the formula did work. I think we were fortunate to gather the necessary support to achieve that impossible trinity trying to combine different things that look conflicting at first but eventually married well. With respect to stimulus packages, I would like to point out that, as a recommendation to other countries, their configuration and target are vital factors to be considered. It is not good enough to say one will follow the Keynesian model; one needs to worry about the package’s structure.

In the case of Egypt, two similar packages went into public investment and infrastructure. We could have been the most popular government on earth by spending it on making people happy but we would have made everybody cry afterwards. That would not have been very responsible either so it is important to worry about the composition of the stimulus package. On this issue, I want to highlight one last point that I think is relevant to other countries. That is the nature of the relation between the ministry of finance and central banks. During that period, in Egypt, there was a very reasonable level of coordination between these two institutions. Nevertheless, there are instances when coordination between fiscal and monetary policies can be useful. As an example, throughout Egypt’s transition period the Central Bank cut interest rates on three occasions, one and a half percentage points altogether. That decision was consistent with the whole idea of stimulating the economy, and not worrying about inflation as much as one would under normal circumstances when the economy is heating and one is fully utilising one’s capacity. Let me go even further than that and argue, as our friends in the Massachusetts Institute of Technology (MIT) would say, that the difference between countries that fail and those that succeed is the nature of their political institutions. We never hear that it is the health of the financial sector or competition in the financial sector that determines the final outcome. Take, for instance, the case of South Korea and North Korea. The difference in the outcome between these two countries is their political institutions because population would have a voice and would force politicians into taking policy decisions that are in the interests of most people.

That is why whenever we have to make a choice between putting forward a vote on the constitution and phasing out an energy subsidy, I would go for the vote on constitution ahead of the energy-subsidy reform. This example underpins the importance of politics and makes me optimistic about what is going on in Tunisia and Egypt. Last but not least, why would anyone care about Egypt? I would argue that the spirit of that story could inspire other countries. If we turn to the case of the US financial crisis of 2008, which of the two following measures was implemented: was it the austerity or the stimulus programme? If the USA implemented the latter, why would they then deny it to other countries? I cannot see the reason. Every time a country is facing a problem, not necessarily the one of Egypt, there are mainly two broad choices. Personally, I am an advocate of the stimulus programme. Regarding macroeconomic stability, it is clear to us all that it is a precondition for a healthy banking sector. I would argue that it is a necessary but not sufficient condition. Having macroeconomic stability does not necessarily mean the incentives and institutional arrangements and regulations, level of competition and banking versus non-banking financial institutions: you have to worry about both, not just macroeconomic stability. Concerning the relation between the macro and micro levels, they need to go hand in hand to make things happen.

In that context, I can only think of something I complained about, which is that we had fiscal stimulus and most of it was in public investment and the capacity to select, implement and oversee projects, to make sure that the money was spent wisely and it was done on time. This has been a source of frustration. We are recommending that central banks strengthen their implementation capacity but we are not telling them how. It remains to be seen what will happen on the ground. It is easier said than done. On the idea of coordination between monetary and fiscal, it is a kind of a love-hate relationship. I do not think they should necessarily work concurrently, in full coordination all the time under all conditions because sometimes the central bank will fully accommodate fiscal policies and it can lead to very destabilising results. It is almost like a marriage: in the morning life is good but in the afternoon the kids are causing problems. You need to work on it all the time. What is good at one point may not be good at another. The Lebanese story is a very interesting one. This is one case where the banking sector is accommodating fiscal deficit.

This may have been the right thing because the consequences would have been too negative but at the same time it might have allowed the finance to relax too much and not undertake the necessary surgeries. On the issue of regional integration I would like to approach the case of Spain. It is part of the EU and, in turn, the EU has a relationship with the Mediterranean south. I wonder whether that is a healthy relationship and whether that is the right formula. Indeed, that is a topic for extensive discussion. We hear too often that the EU is concerned about accession countries, member countries, association countries and our neighbouring countries. The word “neighbour” is actually keeping a distance, so language does make a difference. What the EU is doing concerning the Southern Mediterranean countries is certainly an important question and I do not think we have a very good answer. I would like to make a final comment on SMEs. I would assume that people are rational. Banks or financing institutions typically find it easier and more profitable, and transaction costs are lower when they lend to large entities. Why would they go out of their way to lend to SMEs if they can make money without having to work hard? Somebody has to subsidise somebody. Let me conclude by saying that although I am not a politician – I am an economist by training – I happen to believe that politics is something that cannot be ignored. Nowadays, we are making recommendations not as politicians but as economists, yet we must bear in mind that everything has to be related to a context at a certain point in time within a political framework.

Challenges And Prospects In The Southern And Eastern Mediterranean Countries’ Financial Systems

Daniela Gressani. Deputy Director of the Middle East and Central Asia Department, International Monetary Fund

I would like to analyse the challenges and prospects that the financial system of the Southern and Eastern Mediterranean countries is facing in the context of global and regional development. I will take a narrow definition of Southern and Eastern Mediterranean countries. Hence, I am going to cover the countries stretching from Morocco to Lebanon, excluding Israel and Turkey, because I am no expert on them and they represent very different cases from the rest of the countries in the region given their closer relationship with the European Union.

I am going to make a case that against the backdrop of mediocre prospects, to use the terminology that the IMF has used in the recent World Economic Outlook, the financial sector in these countries has a very important role to play to help revive growth. Firstly, I will try to point out some of the policies that can help in the short term. Next, I will elaborate on the need for more competition in the financial system, a reduced role and a clear mandate for the public banks – which are a big presence in the financial systems in these countries –, and the development of more non-bank, non-traditional financial institutions and instruments. Afterwards, I will focus on Islamic finance. This particular case works as an important reference of the economy as a whole and it is also an important model for SMEs. Lastly, I will comment on the fact that what is needed is a better business environment because of the difficulty that represents for the financial sector alone to revive growth deprived of a demand from good bankable projects on the other side of the equation. The IMF has recently released our world’s updated macroeconomic forecast in which growth is referred to as mediocre because it has again fallen short of our expectations, and we have revised our forecast down.

In other words, six years after the crisis, recovery is still fragile, uneven and with uncertainties in the global outlook. These uncertainties have translated this week into financial market volatility, including stock markets and foreign exchanges. This is our short-term projection. Moreover, we have to take into consideration political risks that may make economic recovery harder, namely the geopolitical risks between Russia and Ukraine, on the one hand, and our own geopolitical risks in the Middle East, on the other. Moreover, there is the risk of secular stagnation in the advanced economy added to the risk that emerging countries may not be able to sustain and recover growth if policy-making is complicated or delayed and does not address structural constraints. Finally, there are some risks, albeit not critical, in this part of the world in multinational market volatility and increasing funding costs for emerging markets as big central banks normalise their monetary policy. These forecasts notwithstanding, the IMF has foreseen that growth will rebound to a certain degree next year. Consequently, there is, for the countries of this region, the balance that these global risks could have important implications for oil prices, which have already been falling over the last few weeks.

As we all know, oil prices are of great importance in the region. As much as they are relevant for Algeria, which is the oil and gas exporter in this group, they are also important for the other regional countries that are all oil importers. A high price for oil would be good for trade and fiscal balance but bad for other things like remittances, foreign direct investment and bilateral aid. So what does this mean for the Southern and Eastern Mediterranean? We are also concerned that growth prospects will be mediocre. As it turns out, we expect them to remain modest in 2014 and to pick up modestly in 2015, but in the region there are also a number of risks. Even if our mediocre forecast turns out to be good, growth rates forecast in the region are simply not enough to deliver on what matters most, which is producing enough growth to reduce unemployment, which represents the first challenge and also has important implications for the northern shores of the Mediterranean. Therefore, in spite of accelerated reforms, some progress achieved in these countries in reigning in fiscal and current account deficits, and some courageous reforms in reducing inequitable energy subsidies, we are still going to navigate a difficult environment in a situation where GDP ratios are high for most countries and where international reserves are in many countries still thin. All things considered, there have not yet been enough improvements to relax.

What then are the implications of these prospects of a modest recovery for the financial sector? On the one hand, we can expect subdued credit growth; on the other, we must ask the financial sector to play a bigger role in helping to revive growth in these countries. In that sense, the question is: what are the financial sector trends in the region that we should reflect on? As I already said, most of these countries have bank-dominated financial systems. Most surprisingly, In this group of countries, there is Algeria at one extreme, where 86% of the banking system assets are in the public banks, and Lebanon at the other extreme, where there are no public banks. As a result, there is lack of competition and very high concentration, both on the assets and loans side. To put this in context, in the region, the top five banks hold an excess of 50% of total banking system assets. This figure is very large and unusual in other emerging economies. The other side of the coin is that the system is moderately stable, in aggregate solvency, with high capital asset ratios – although not as high as they should be given the uncertainties in the region. One possibility is that they are overstated because there is a large share of public sector debt on the balance sheets of the banks. Banks are also modestly profitable, but again there are fragilities.

Tunisia is one of the banking sectors we should be more concerned about as there are six banks that do not yet meet the minimum capital threshold. The other fact we need to keep in mind is that the system is characterised by a significant level of credit risk, and non-performing loans have been coming down in most countries, although they remain high. In some countries, non-performing loans may be understated because requirements are not sharp enough. Moreover, there is high exposure to government securities in the banks of some of these countries. That is especially the case of Egypt and Lebanon. Also, in relation to the issue of promoting competition, some participants argue that one of the most important aspects is the competition between the capital market and the banking institutions. Thus, if in the managing institutions that enter the capital market there was a very strong banking capitalisation, the competition would be unfair. Moving to another point, the most interesting thing in terms of the relationship between the financial sector and what it can do to growth is arguably the paradox that financial intermediation is high in the region and at the same time access is low.

This is not new and it has been going on for some time but it does have implications for how we think about the whole financial sector to revive growth in the region. Personally, I think that we should aim to strengthen resilience and development as we deal with this limited competition and high concentration; strengthen weak financial infrastructure and improve the insolvency framework; develop new and more suitable financial instruments for SMEs; and, at the macro level, reduce the crowding out of the private sector by public debt. We need to look at what is going to make financial sector reform successful in terms of stimulating growth in other parts of the economy. I would like to go back to the role private sector reform needs to play to complement what can be achieved by reforming the financial sector, given the paradox of high intermediation and low access, and the characteristics of the banking sectors in the region. In conclusion, I would like to stress the four main points stated at the beginning of my presentation: Firstly, the need to do more to promote competition – and there is a a whole set of things that could be done –; secondly, the need to reduce the role of government banks and to clarify their mandate. Certainly, public banks have a role to play but it needs to be clearly defined and put at the service of public interest. Thirdly, the need to look at new instruments of non-bank finance, a system to serve the SMEs; and lastly the need to look outside the financial sector at complementary policies that can magnify whatever progress can be made on the financial sector.

The Importance Of Financing Smes In Southern And Eastern Mediterranean Economies

Sarah Stölting. Economist, European Investment Bank

I would like to develop the financing of SMEs in the Southern and Eastern Mediterranean countries. The main reason for doing so is because of the importance I attribute to the dilemma we currently face in the region; namely, how to fight high unemployment coupled with low economic growth. With the current trends of high unemployment and relatively high population growth, we will soon have new entrants into the labour market in the region, so there is an urgent need for a jump-start in growth coming from the private sector. Basically, we need young innovative entrepreneurs and for them to be able to realise their ideas, and to do so they need to have access to finance. First, an overview of the region. On the one hand, the banking sector is relatively large. As an illustration, total assets (TA)/GDP ratio in Southern and Eastern Mediterranean countries is on average over 100 percent, which is in excess when compared to the asset-to-GDP ratio in the BRIC countries (Brazil, Russia, India and China). On the other hand, financial intermediation is relatively weak. There are several key points that explain the weakness of intermediation in the region.

Firstly, there is the investor protection that hinders banks’ intermediation. Next, there is a problem with the information environment. Normally, credit bureaus are usually there to mitigate information asymmetries. This region offers both public registries and private credit bureaus but their scope is limited; as a result, it is difficult for lenders to screen potential borrowers. This characteristic also hampers intermediation because if you think about the big corporate customers the banking sector usually serves, it is much easier to gather information about them. This is also because banks have longstanding relationships with these customers and there is less of a problem with information asymmetry. In contrast, collecting information about SMEs presents a bigger challenge and banks often have not had previous contact with them. As for SMEs, the problem they sometimes face is that they do not know how to properly apply for a loan, so it is difficult for them to put together the financial statements they need. In this sense, there is also scope to introduce policies to help the SME to know how to approach the banks, to have a more complete dossier and increase the chances of obtaining a loan. There is also the need for meta financing, which involves the entrepreneurs that do not really qualify for normal SME lending from banks and are too large for microcredit institutions. This is another rather forgotten segment.

These financial aspects also need to be addressed. In addition, there is no dedicated business unit for SME lending. Very often the credit facility is the same one for large customers, which could be problematic because of the need for a distinctive approach for SMEs. This means that large loans to big corporates are much more profitable for banks because if the assessment procedure is the same then the cost of SME loans will be higher and it will be of less interest for banks to start developing in this direction. If there was increased competition in those markets, it would eventually lead to banks developing better units for SME lending; therefore, this market segment would become more interesting and would also lead to increased SME lending. To sum up, I think that reforms are urgently needed in this region in order to address these specific issues, specifically, SME lending and meta financing. The EIB, on the one hand, has its own habitual instrument of extending credit lines to banks in the region, which are used for on-lending to SMEs; on the other hand, it provides long-term financing. The hope is that this is also passed on to the SME client, so that they can have access to slightly longer financing. Simultaneously, we are also trying, through slightly more innovative projects, to deal with the matter of financing very small entrepreneurs and innovative young new enterprises. For instance, we have a new project in Tunisia where we will extend a loan to relatively small second-tier banking. Another example is that of the partnership agreement signed between EIB and an association called Réseau Entreprendre.

This association is basically an organisation that helps young or small firms, often in start-up phase, to obtain some kind of financing but they also provide coaching so the idea is to provide liquidity to the bank and at the same time to help expand their business to these small firms that also receive coaching from this association. This and some other technical assistance would help the bank to learn how to assess those clients. We hope we can expand this field for a specific bank in Tunisia in the first instance and eventually other countries will follow, so they learn that this can be a profitable segment if it is approached efficiently. Otherwise, the EIB is also involved in microfinance, so we also provide financing to micro financing institutions. To illustrate this, we have a loan that will soon come up for a Jordanian microfinance institution that is active in micro insurance.

Dealing With The Crisis: The Experience Of Egypt

Abdallah El Ebiary. Managing Director, Qalaa Holdings, Egypt

We live in very interesting times and we also live in a very interesting region. The changes of the past five or six years have been remarkable. If you live in our part of the world, you will see that we started with a global financial crisis in 2008, and it took us two to three years to recover from it. If you live more closely in the Middle East region, then you know we went through a geopolitical storm that we are still working ourselves out of. How we will come out of it is still uncertain. Some have positive hopes, some are still worried, and undeniably it is still a very turbulent time. All of a sudden the environment changes and you need to change your business model, your policies and your outlook, and overall you need to change the way you do business in order to be able to survive. If you keep doing what you have hitherto been doing you will ultimately fail.

I worked for a private equity company that used to be called Citadel Capital, and we started off by looking at projects in the Middle East, North Africa and East Africa. We raised funds from the Gulf and Europe. These were incremental fund flows that would predominantly come into Egypt. We used this money and invested it in Egypt and East Africa. We went to the banking sector in each of these markets individually where we were holding projects and raised money at the local level. So we were consumers of capital on the equity, the banking and the DFI sides. Indeed, we were doing very well. Then the environment changed. All of a sudden, with the global financial crisis there was no debt availability and equity investors were no longer willing to provide fund flows to these regions that had been experiencing very good growth rates simply because they were facing problems in their home markets. Growth rates are still very difficult; everybody wants to protect their home market first before being able to invest in other countries. Things became fairly difficult and consequently we changed our business model.

We said we could not look at temporary capital. We cannot look at capital that is coming in for a specific project of three to five or even seven years. What we needed to look for was permanent capital. So we listed our company in Egypt, and we started raising permanent financing for permanent projects. Projects were taking longer to complete, receiving debt was becoming much more challenging and banks started to see risk differently. The three to six months needed for an approval process of a single project turned to six to twelve months, bearing in mind that, should any political issue arise, the banks would discontinue their financing. This added to the long process of reassessment. If you are doing any sort of project that requires permanent capital coming in, any one of these breaks actually hinders it, even sets it back and brings it closer to failure than to success. Therefore, you will all agree on the potential benefits of SME financing. Nevertheless, we cannot ignore the fact that we are already struggling to finance large and medium corporates, let alone small enterprises and micro loans. I am not saying we should not develop all the systems; what I am saying is that we should first focus on large corporates. Moving on, once we have changed our model, the question is: how do policies matter to us? We, as economists, are the ultimate consumers of macroeconomic and monetary policies. Today, there is a renewed interest in the region that attracts large numbers of investors. We have not experienced it in the last four or five years. Over the past two or three months all the investors have been looking back at the region, especially the areas that have experienced more stability. I have been spending a lot of time talking to investors who want to come to Egypt and East Africa.

They see this area as more of a relative safe haven compared to the other countries in the region. They are looking at attractive growth rates and people are excited to talk about it again. However, they have some concerns. These are as follows: firstly, we need to consider the foreign exchange risk: are we going to devalue the currency? Is it going to be a managed devaluation? Secondly, we need to pay attention to the energy policy, which is very important and reflects on your balance of payments and on foreign exchange policies as well: are we going to change it? Thirdly, we need to address the repatriation of currency. So far, we have allowed some repatriation and there have been some setbacks: will these continue or not? These are questions for which the answers, at the end of the day, dictate whether we have fund flows or not, and the ability to fund businesses and do new business or we have to wait until the tides change and the policies become more stable and investors become more confident. That is on the investor’s side. On the banking side, people have legal lending limits, among other things, that tie down the ability to do funding for new projects. So how did we deal with it? We learned that we have to go to the Development Finance Agencies. These are great institutions that potentially take longer to get involved in any given project. However, they never stop moving. We are the ultimate consumers of these policies, we do not control them but they have the biggest impact on our businesses. While that is very important, there is also another challenge ahead of the private sector; in particular, the ability of the governments to execute projects.

I am not talking about willingness. I think there is a big disconnection in our part of the world between willingness, on the one hand, and ability, on the other. Governments and ministers at the high level understand the need to develop projects for new investments, especially greenfield investments, and the need to create employment opportunities for the private sector to be vibrant and lead the economy. However, translating that into a reality, being able to execute projects, is very challenging now. I think this will remain the challenge over the coming few years. Once we solve it, and we answer some macroeconomic questions investors have and manage to attract more competition in the banking sector, the private sector will do extremely well. Finally, I would like to include an observation on SMEs: one of the most vibrant businesses is the microfinance business. We had to get commercial banks to come in, alongside our equity, in order to be able to be under their regulatory umbrella framework. All of a sudden, a regulation changed and now we are able to extend loans to more people. As a result, this business is thriving. For instance, you want to build a platform or a company without the regulatory framework being properly set down; that is like taking a shortcut solution to get the business moving. But once the regulatory framework is there, this business can take off with the prospect of creating many jobs. As a conclusion, focus on your SMEs, and on microfinance loans: these offer the highest returns, but they need the policies to accompany them.

Implications Of The Global Financial Crisis In Lebanon

Khater Abi Habib. Chairman, Kafalat, Lebanon

I have a very polarised view of things but it is very illustrative. Coming from Lebanon and therefore the Levantine part of the Southern Mediterranean, one could easily say that we should forget about things until later because our part of the world is so stressed militarily, geographically and politically that things are extremely uncertain. No one can guess how things will develop, with two countries that are blowing themselves apart. We do not know what shape they will have and they have an incredible effect on all around them. I participate as a representative of Lebanon, where the current situation is very extreme and it has a huge impact on our internal politics. We do not have a president, our parliament meets very irregularly, and there is almost no public policy. Our exporters have problems because our biggest traditional markets are the Gulf, Iraq and Syria.

Moreover, insurance rates are straight through the roof: there is danger in every shipment sent and there are delays in time, as everything has to be rerouted. Domestically, as I said, things are very difficult to manage because of the fragility of the political situation. We even have certain kinds of military insecurity, such as fighting. Moving to the other side of the coin, in spite of all the negative prospects, I still think that something can be done. Our Central Bank moves on its own because it has that ability to do so within our legal system. We used to be a very private sector-based country but the Central Bank has recently tightened up on capital adequacy, on risk calculation and so on. Our banks are very highly capitalised so that it is being tightened, and that is as it should be. Our banks have been exposed to the government to a great extent. Then they have been pushed to retain their profits to capitalise more and our ratios are far beyond what the Bank for International Settlements is asking for the coming years.

We surpassed that a long time ago. At the same time, the Central Bank in Lebanon is carrying out easing measures, given the fact that banks ought to have certain ratios of liquidity placed within the Central Bank in Lebanon. Banks are afterwards allowed to use it for certain economic activities, including supporting SMEs and the innovation sector, among others. The Central Bank, knowing that our equity financing part of the country is weak, has issued a caveat directed at the banks by which they are entitled to enter the equity market through a system of separation where they can use 3 percent of their equity, of which they have very high ratios, to participate through venture capital funds. Furthermore, banks can use this percentage to finance from start-ups to fully-fledged companies, which can then expand into the world markets, especially in the field of the knowledge economy – our country happens to have a high level of tertiary education, as evidenced by the existence of ancient universities and the high number of Lebanese people who receive higher education in centres throughout the world. Now we have to focus on what can be done. The private sector is already doing it on its own. People are finding different ways to export and we are re-concentrating our markets.

There are huge Lebanese populations in Africa, so our firms are establishing in that continent. Also, we have migrations in Latin American. These are examples of the lines of export. We are actually expanding into European and American markets in flourishing sectors. We are aware of the fact that our greatest export is our population and it is temporarily moving into different directions, from the Gulf and Iraq further into Africa or again into the financial sector, which then becomes an area for exportation. Our part of the world is dangerous, not just risky, but even danger can be dealt with. We had a 15-year war once but 90% of our banking sector – we used to have 97 banks – survived the relaunch very well. Our banks are now passing through very difficult times and the other countries in the region are in different zones of risk. As a matter of fact, we have to remain prudent in the fields of macroeconomics, banking and finance; but, at the same time, we have to become adventurous in other areas such as SMEs, which, if well supported, can find new markets. All in all, my purpose was to present a positive picture of Lebanon’s situation against the general unoptimistic world panorama.

The Role Of The Central Bank In Present Times

Monetary Policy Measures Adopted By Central Banks Following The Economic Crises

Luis María Linde. Governor, Bank of Spain

I would like to tackle the role of central banks in the present time. I shall briefly be discussing the role of the central banks in a post-crisis time, the monetary policies currently being implemented both by advanced and emerging-market economies, and I shall also be referring to an important interrelated issue, which is the new focus on financial stability. Before the crisis, the prevailing consensus between advanced economies was that, in the monetary policy, macroeconomic stability was guaranteed by price stability with regulatory and micro-prudential supervisory policy action. That objective could be translated into an implicit or explicit goal in terms of inflation target. An independent central bank principally aimed to safeguard price stability using the short-term interest rate as the main instrument of control. In the aftermath of the crisis, central banks in advanced economies have resorted to non-conventional monetary policy measures, as policy rates reached the zero level, in order to provide further stimulus to their recovery.

These measures have mainly consisted of asset purchases by central banks and forward guidance about the future in the strands of monetary policy in order to manage our expectations. These new tools were essentially set up at the height of the crisis to dispel the risk of the area potentially breaking up, thus supporting their ultimate goal of safeguarding price stability. The application of non-conventional monetary policies has set off a growing debate about the effectiveness and the risks of these strategies in the recovery phase. Additionally, the dominant existing consensus before the crisis that monetary policy should only react to asset price shocks if they affect inflation prospects is no longer acceptable. It is now widely accepted that a more cautious response by central banks to asset price bubbles known as «leaning against the wind» may be preferable, in case that other policy, namely, macro-prudential tools, in principle more appropriate to address financial stability issues, proved to be ineffective. We may be heading towards a future in which central bankers will have to optimise the use of different policy tools to achieve multiple objectives. The crisis has had many consequences, but I would like to point out two obvious consequences: the first one affects central banks.

The idea that we have to establish our duty in connection with price stability alone is not enough. The crisis shows very clearly that we have to deal with many other things; maybe the macro-prudential focus is necessary. In March 2003 the Bank for International Settlements (BIS) issued the first statement that inflation targeting alone was not enough because of what was happening. Facts have proved in three or four years that the BIS approach was quite correct. The second consequence is that the Basel II Accord proved to be unsatisfactory – the outcome of the Basel Committee on Banking Supervision’s work to secure international convergence on revision of supervisory regulations governing the capital adequacy of internationally active banks. Jaime Caruana, former director of the BIS, called it «the regulation tsunami». The feeling seems to be that the financial system is flooded with too many new initiatives being implemented in a short time, concentrated around the Basel II Accord, but also the Financial Stability Board in the form of new ratios, the leverage ratio, the liquidity ratio in the medium term as well as many new ideas that are building a new framework for regulation of banks. I think we are all taking part in this regulation tsunami in one way or another.

We all have to accept this new framework, which is more severe than before. Another lesson to be drawn from the crisis is the growing importance of the spill over effects, as illustrated by the impact that non-conventional monetary policies carried out by advanced policies had on emerging-market economies, as well as the prospects of exit from such policies. Central banks in emerging countries have often been faced with policy dilemmas between safeguarding financial stability, coping with capital flows, attaining their monetary policy objectives and managing the interest rates. Southern Mediterranean countries have traditionally relied on fixed and intermediate exchange rates as a nominal anchor for monetary policy. Most of these countries also maintain control of the capital movements and have intervened heavily in foreign exchange markets. While these regimes have provided them with substantial benefits in terms of macroeconomic stability, in recent years they have faced additional challenges stemming both from domestic and external sources, calling for a more independent monetary policy. In this respect, while flexible exchange rates may facilitate external adjustment and a more independent monetary policy, they require another anchor, normally in the form of an inflation target.

There has been a general trend towards adopting inflation- targeting regimes in emerging markets, and some countries in the region have either adopted it, like Turkey, or have announced their intention to do so, like Egypt, Morocco or Tunisia. But adopting inflation-targeting regimes is very demanding in economic and technical aspects and, institutionally, it requires a large degree of central banking independence. In any case, adopting an inflation target is not the panacea, and the soundness of other economic policies and a rigorous financial supervision are essential to maintain economic and financial stability. Moreover, it is important to highlight that the inflation targets in emerging markets have usually been concerned about exchange rate developments. They have also significantly increased their international resources and implemented macro-prudential measures to stem financial excesses, including capital controls. These elements have been very useful to preserve financial stability during the crisis. Indeed, the inflation-target framework is subject to reconsideration in the aftermath of the global financial crisis, and central banks have been called to rethink their exclusive focus on inflation and the failure to adequately account for financial sector risk. Only now do these countries have to weigh the advantages and disadvantages of fixed against flexible exchange rates, depending on the structure and diversification of their economy, their degree of openness and financial development, their flexibility of labour, private markets and other institutional aspects.

The other area of profound changes in central banking worldwide is financial stability. Prior to the onset of the crisis, most central banks and supervisory authorities limited themselves to predominantly a micro-financial approach, focusing mainly on the soundness of individual institutions combined with a benign negligence of the systemic risk. As mentioned before, this was also partly a consequence of combinathe conviction that price stability by itself guaranteed macroeconomic stability. The global financial crisis has put an end to this perception and there is now already a broad agreement on the need to pursue macro-prudential policies to ensure the stability of the financial system as a whole. In addition, there has also been a reinforcement of the traditional areas of banking regulation and supervision, with a clear focus on strengthening of capital requirements, both in size and quality, and also paying attention to new elements such as leverage liquidity ratios. And, finally, establishing sound frameworks for financial crisis management and resolution. The panorama of monetary policy implementation is not homogenous in our countries. We have different degrees of financial development and of effectiveness of the monetary policy transmission mechanisms. What is perhaps harmonised or more harmonised is the fact that we are in a permanent revision of our instruments and our implementation.

This applies not only to southern countries but also more to northern countries and indeed to the ECB as the central bank of the European Union’s Euro system. In this view we have an on-going discussion about unconventional measures, the exact orientation of the forward guidance, which kind of easing, the use of the balance sheet, etc. In the Southern Mediterranean region, strengthening the stability of the financial system is also a main concern. While central banks have a clear role in promoting financial development, international integration and expanding access to finance of the population, they should remain vigilant of financial stability risks, especially those stemming from the historically large stock of non-performing loans. As in other parts of the world, there is also a margin for improvement in the spheres of macro-prudential policies, micro-prudential regulation and supervision, and crisis management and resolution. Central banks and supervisors in the region should move towards the adoption and implementation of international standards, which will also likely prove quite demanding in institutional terms.

A comment on the role of central banks in the European Union in the context of the existence of the European Central Bank. Firstly, the ECB is a very unique and complex artefact, from almost any point of view. It is a very complex machine. It is unique because it is the only central bank not of just one state but of a number of nations and sovereign states and this makes a big difference, in contrast with any other central bank in the world, such as the Federal Reserve, the Bank of England or the Bank of Japan. Secondly, the role and participation of national central banks in the governance of the ECB consists of governors of the central banks being members of the Governing Council and every governor has a vote. Sometimes you can find unexpected alliances or combinations and sometimes you find totally expected combinations. External observers of the ECB consider that the decisions of a small country or small economy cannot be the same as the decisions of a big economy or a big country. This idea is sensible but sometimes this is not the case. Sometimes unexpected things happen and there are results that one would have anticipated with difficulty because of the opposition of some countries.

This refers to the Governing Council but there are a number of committees. Nobody can control this whole set of committees and working groups. The participation of a central bank is at the level of the Governing Council but also at the level of the committees. I insist that sometimes, regardless of the importance of the central bank, there are alliances and combinations. Things are not as clear-cut as one might think from outside this artefact. I would like to end by quoting Hyman Minksy, an American economist who died in the mid-1990s and who was the author of the financial instability hypothesis. He said in the early 1990s that the role of central banks against financial instability was going to grow and become the central piece of the new mechanism. He also referred to macro-prudential and not inflation concerns as the duties of central banks. The events during and after the crisis have proved that he was right in his ideas and his forecast of the future situation. The panorama for central banks has changed in the last ten years in that we see them not only as very important pieces in economic policies but also as having new and larger duties than we thought ten years ago.

Turkey’s Central Bank Use Of The Two-rate Corridor And Reserve Requirements Ratio

Turalay Kenç. Deputy Governor, Central Bank of Turkey

Basically, in central banking there are three conceptual problems: the first one is the difference between price stability or macroeconomic stability and financial stability. The second one is the division between aggregate-demand management policies and liquidity-management policies of central banks. The third one, especially relevant for emerging-market economies, is the separation between local currency-liquidity management and foreign currency-liquidity management. Let me present an overview of the recent actions of Turkey’s Central Bank. Central banks have evolved quite drastically since the 1923 Economic Congress in Izmir, which laid down the principles of the new Turkish economy.

The first principle focused on the discouragement of speculative lending by commercial banks. The second one was the desire to meet the credit of business. And the third one was the preference of a focus on credit over a focus on monetary aggregates. In other words, the Economic Congress in 1923 was organised with two objectives: the composition of credit and the preference of leverage level over monetary aggregate, price stability or any other monetary policy mechanism. These two points have proved to be essential to the Turkish economy. The very important composition of credit directed to productive businesses or speculative businesses has recently been complemented by the implementation of macro-prudential measures to change the composition of bank loans, from consumption to business loans. Simultaneously, leverage levels continue to be considered essential elements of a sound monetary policy, as much as price stability. Turkey has an intermediate target in terms of bank loan growth rate: it was considered that 15% was sustainable. It is remarkable that the Economic Congress’ principles in 1923 came to the same conclusion.

Let me comment on the issue of how to separate macroeconomic stability from financial stability. Empirical evidence suggested that macro-stability could not solely rely on regulation. Its effectiveness is limited because of its inability to be used in a very countercyclical way, whereas macro-prudential measures can. As a result, Turkey’s macroeconomic stability rests on a combination of regulation with macro-prudential measures. The history of central banks shows that they have used macro-prudential policies, especially advanced country central banks such as the Central Bank of France and the Bank of England. The other central banks, especially the Bundesbank, also had recourse to macro-prudential measures in the 1950s, 60s and 70s when they had constraints on the policy rate. It is not simply the policy used by the emerging economies’ central banks; it is more general than that. As an illustrative example, we introduced what is called the unorthodox monetary policy in late 2010. It was regarded as unorthodox monetary policy ignorant of the fact that the Bundesbank had implemented exactly the same policy in the early 1970s On that occasion, the German Central Bank cut the policy rate to deal with the excess of the capital inflow problem and raised the reserve requirement ratios on both local currency deposits and foreign currency deposits.

This might now seem quite obvious for any central bank that faces similar problems. The second problem to be addressed is how to separate aggregate-demand management from liquid-demand management. From time to time it becomes quite important, principally for emerging market economies, especially during excessive global liquidity or excessive capital flows and volatile counter flows. The Central Bank of Norway and the Central Bank of Romania have used this policy for many years. It has become a quite important tool to deal with the adverse capital flows. At the same time, reserve requirement ratios have been extensively used by emerging-market central banks, but Turkey has used them in a very different way from other central banks. The Central Bank of Turkey related reserve requirement ratios to leverage, to reserve accumulation and even to core liabilities. This is an achievable project provided that a clever reserve requirement ratio is set up. The third problem, which is of great importance for emerging-market countries, is the separation of local currency-liquidity management from foreign currency-liquidity management. Again, the Central Bank of Turkey used reserve requirement ratios to separate those two liquidity managements. So there are reserve requirement ratios on Turkish deposits. A facility was introduced into the financial system so that banks could pay their liabilities in foreign currency and gold as well as Turkish lira. That enabled Turkey to separate foreign currency-liquidity management from local currency-liquidity management.

There are two sets of requirements applicable to banks and applicable to their liabilities. Banks have deposits in Turkish lira and deposits in foreign currencies; therefore we have requirements on those liabilities. We have reached more or less the same level – 10% –, the average of those two. But it varies with respect to several dimensions. The first important dimension is maturity: so the longer the maturity the lower the reserve requirement ratio. The other dimension is the leverage level: the higher the banks’ leverage issues the higher the reserve requirement ratios. So we use those reserve requirement ratios more than one might think. If a country faces excessive capital inflows and the banking sector starts accumulating non-core liabilities rather than core liabilities to finance excessive credit growth, you will agree that there is a need to find a way of discouraging non-core-liability accumulation but core-liability accumulation and then encouraging core liabilities. In that regard, Turkey recently introduced a mechanism by which banks are going to pay interests on reserves but that is going to be related to the capacity of the banking sector to improve the core liabilities and reduce non-core liabilities.

This is quite useful because we are entering an episode of global liquidity, so encouraging core liabilities but discouraging noncore liabilities is going to be quite a good idea. At the same time, the facility provided to Turkish banks is not going to drastically change their choice between core liabilities and non-core liabilities. Yet, it provides a very strong signal that the country is going to do something along these lines. We have a precedent in the case of the Central Bank of Korea that introduced regulation on these non-core liabilities and aimed to correlate these core liabilities Policy coordination is a key issue in international finance. We are just talking about policy cooperation but we need more than that. In the absence of policy coordination and policy cooperation we have to be very creative as an emerging economy central bank. Certain things are quite understandable. On the advanced economies side, you have quantitative easing. So the best you can do is to introduce similar measures to be counterbalancing. Quantitative tightening is what we have been doing: introducing reserve requirement ratios, similar instruments and the like. Basically, what they do is quantitative tightening as opposed to quantitative easing of the advanced central banks. We complicated things at the beginning but that was understandable, as we did not have a financial stability committee when we started in a complicated monetary policy.

That was established a couple of years ago and now we can focus on monetary policy, which is easy to communicate. But at the same time, I would like to point out that inflation targeting requires communication but the rest does not require much of that because it is a quantitative rather than a qualitative measure to do. They do not have forward guidance as opposed to inflation targeting. But it is quite clear that when facing excess of capital inflows and volatile capital inflows what you get is a significant wedge between required interest rates for your own country and the market interest rates. So you have to fill that gap using macro-prudential measures. This is what we have been doing because otherwise the gap is huge. It is not ideal but it is necessary to do something. To recapitulate, recently Turkey has introduced many macro-prudential measures along with regulation, focusing on separating local currency liquidity from foreign currency liquidity, by introducing a mechanism to pay interests in order to encourage core liabilities but discouraging non-core liabilities, and also separating aggregate-demand management from overall liquidity management. To do so, Turkey has resorted to the two-rate corridor policy, especially during excessive global liquidity or excessive capital flows and volatile counterflows. All in all, Turkey has done something quite unique.

Morocco’s Central Bank Monetary Policy: Introducing The Inflation Target

Mohamed Taamouti. Director of Economics and International Relations Department at the Bank Al-Maghrib, the Central Bank of Morocco

I would like to present the key points of the actions taken by the Central Bank of Morocco in the aftermath of the crisis but I will begin with an overview of the international economic situation. As the global financial and economic system remained under severe stress, central banks were requested to intervene both in advanced and emerging market economies, given the fact that buffers were limited for other authorities. Their intervention was successful in alleviating the vulnerabilities and perhaps avoiding the worst-case scenario. As a result, central banks emerged from this era strengthened and conferred with enlarged missions. We normally hear that the mission of central banks is to safeguard financial stability but monetary policy alone cannot solve the problems; we need other policies, we need mixed policies, we need structural reforms. Economies are now being threatened by a deflation that can turn into a serious monetary problem. As a rule, central banks know better how to deal with inflation rather than deflation.

The one modern example of this is the Bank of Japan. At the same time, currently, global economies are heading for normalisation of monetary policy although there are still many uncertainties ahead as we are not sure what the consequences will be. It is therefore very important to lower the expectations about what we can expect from central banks in general. Following these remarks, I will now focus on the case of Morocco and its Central Bank. The Central Bank of Morocco operates under the statutes of 2006, which sets inflation stability as its core mission and provides a high degree of independence in the formulation and implementation of the monetary policy. The board members are mainly independent and some of them come from the private sector. The corollary of this is transparency. How is the bank working, formulating and implementing its monetary policy? In fact, Morocco has set up an implicit, rather than explicit, inflation target as a monetary policy framework. It is implicit in the way that our main mission is price stability. This can be seen through the way the Central Bank works.

There is an analytical framework based on monetary and real national and international pillars of the economy. The Bank then guides its policy based on the assessment of inflationary pressures. We have announced that we are targeting an inflation rate that should be around 2 or 3%. So we have maybe not one target but an interval. Therefore, the level is in line with our price-stability objectives. We also have a survey on inflation expectations and in general when we announce forecasts in our survey the results show that people are expecting us to reach that inflation target. This, of course, leads us to the previous question about credibility, which is also important because central banks are asking for more independence. If you want to have credibility with more independence you have to be transparent in your decisions: this is what we are trying to do at the Moroccan Central Bank: we announce our forecasts and we explain our decisions.

For instance, in the last meeting of the board in September we announced that inflation was very low and that the forecast of inflation was low too; therefore, the economy was not really recovering. Everyone was expecting the Central Bank to move forward and so we did. It is important to remember that the Central Bank is undertaking this task within a global economic context. The Moroccan economy can be qualified as open or following a process of openness. Since the early 1980s, Moroccan authorities engaged in an economic liberalisation process that went hand in hand with the growth of international alliances. Morocco has concluded many free-trade agreements, it has an advanced status within the EU and other agreements are underway. It should also be taken into account that capital account restrictions apply only to residents, whereas transactions are free for non-residents. The capital account restrictions have allowed authorities to keep a pegged exchange rate regime.

The Moroccan Dirham is pegged to basket, which is composed of 80% euro and 20% dollar. Of course this may seem impossible: you cannot have a pegged exchange rate regime and a free capital account for non-residents. Nevertheless, Morocco gets some autonomy, some buffers, because the capital account is free for non-residents but there is a kind of imperfect substitution between domestic capital market and international capital market. Maybe one of the reasons is that the domestic capital market is not deep enough for international investors. So we have a margin to do something to target inflation. Globally, the final result, in terms of price stability, is good; over the last 10 to 15 years the inflation rate in Morocco has been around 1.7. There is no inflation problem in the country. How do we deal with the crisis? In Morocco there is no financial integration. Instead there is an economic integration. The direct consequence of this is that our financial system, namely our banking system, was preserved from the crisis but not our economy.

Our economy is linked to the international global economy, especially to the Eurozone, through four main channels: exports, tourism, remittances, and foreign direct investments. If we look at the time horizon since 2000, there are two main phases: from 2000 to 2007, we had a period of excess liquidity but since the crisis, since 2008, there has been a shortage in liquidity, which is explained mainly by the fall in international reserves. And this is how our banking system was affected by the crisis. How is the Central Bank dealing with this situation? Firstly, we significantly increased the weekly liquidity injections in the banking system. We more than doubled them. For instance, in 2012-2013, we doubled the volume of injections. Secondly, we lowered the required reserve ratio many times; it went from 15% in 2008 to 2% now.

Thirdly, we lowered the policy interest rate, the key rate, from 3.25 in 2009 to 2.75 currently. Of course, there was a lot of pressure to lower the policy interest rate but there was also a lot of uncertainty in Morocco because with the crisis the twin deficits deteriorated significantly and the government was announcing that there would be a reform of the subsidy system and no one knows when exactly that reform will be put in place. We did not want to lower the key rate rapidly because we were expecting the government to move on the subsidy reform and the consequence of this is of course that high levels of prices have been registered. This is what happened in September 2013 but fortunately there was a combination of many factors that meant that the final result was no important increasing inflation. The SMEs are the most vulnerable segment of the economy, especially in a time of crisis and for this reason the Central Bank of Morocco pays a lot of attention to this sector of enterprises. There are some examples of mechanisms put in place to give incentives to banks to ease access to credit for this category of enterprises. One of the conditions to bear in mind is that political stability is fundamental. Without political stability there is nothing we can do. In the case of Morocco it is easier for us to do business with Sub-Saharan Africa and with Europe than with the Maghreb. In 2012, we extended the eligible collateral for central bank funding to securities that offer credit to SMEs; they do not need to have reserve banks as collateral; you can provide as a collateral credit securities that represent credit to the SMEs. In December 2013, we put in place a mechanism similar to the one put in place by the Bank of England, which is funding for landing. We started providing liquidity for one year to banks and they pledged to give money to SMEs, especially SMEs in the industrial sector or SMEs that export their production.

These are some examples and the result of this is that you cannot change the economy only with monetary policies. Despite these measures, the bank credit is still evolving and there is a long-term phase. But with the focus on SMEs, the share of credit given to them in the total credit is 35%, which is very high compared to the levels we have in the region. To further help SMEs, the Central Bank is also setting up an observatory to collect data on our SMEs and their problems, especially those related to financing. The Central Bank also organised four regional outreach campaigns. We went to all the regions of Morocco to meet small SMEs to ask about their problems, to explain what we are doing for them because sometimes there is also an asymmetry of information: small enterprises in the far regions of Morocco are not always aware of the possibilities offered to them in terms of funding. In addition to that, the Central Bank has started a foundation for financial inclusion to ease access to financing. As previously addressed, the credit is still running under its long-term objective and we will simply ask banks if the demand is not met. We are significantly impacted by what is happening in the Eurozone and the credit is running at + 4-5% but without these measures we would be in negative areas, as is the case in the Eurozone.

This is how we are dealing with the transition. What are we planning for the future? We are working to make our implicit inflation target explicit; we are working to move towards a monetary regime that is inflation targeting. A very important aspect is that we are improving our technical capacity in terms of modelling and forecasting. We are also working with the government on moving towards more flexibility in the exchange rate regime. Of course there are mini-requirements for these mini-prerequisites before moving. We were not very far from achieving it years ago but with the crisis now we have more things to do before arriving there. But it is an important objective in Morocco because with this openness policy, with the Casablanca financial city as a regional hub in Morocco, it is more appropriate to have a more flexible exchange rate regime. And, of course, like many central banks we are changing our status and we will have new missions and one of them is financial stability. But inside the Central Bank we have already been working on that: we have a committee that works on this financial stability and we released our first financial stability report in July 2014. That is the overall situation of how the Central Bank of Morocco is dealing with the crisis and how it is looking forward to the future.

Challenges Of Monetary Policy In Advanced Economies In A Post-crisis Context

Pilar L’Hotellerie-Fallois. Associate Director-General, International Affairs, Bank of Spain

The global financial crisis and the great depression that followed have put into question the paradigm built around monetary policy management in previous decades. According to this paradigm, monetary policy should be conducted by an independent central bank that plays a main role in safeguarding price stability with the short-term interest rate. The economic and financial upheaval provoked by the global financial crisis has forced central banks in the main advanced economies to operate outside this comfort zone and adopt bold measures faced with thoroughly new situations. I will review the actions taken by the main advanced economies’ central banks – the FED, Bank of England, European Central Bank (ECB), the Bank of Japan – in the aftermath of the crisis and then I will refer briefly to the risks around the process of normalisation of monetary policy in the main advanced economies. Finally, I will make some considerations on the extent to which we can expect some of these changes to be permanent features in the future of central bank activities. It has been more than six years since Lehman Brothers went bankrupt, in September 2008; official interest rates in the main advanced economies continue to be close to zero and there are still numerous unconventional measures in place.

These measures have differed to a certain extent, depending on the different circumstances under which the central banks operate and the specific targets, but they all have general common denominators. In the case of the Eurozone, it has to be taken into account anyway that the crisis has been more protracted and compounded by specific factors, which has resulted in a longer cyclical downturn and some more delayed timing of monetary policy measures. In the early stages of the crisis, central banks adopted a series of measures to support liquidity. These included the expansion and change of maturities, the standard lines of liquidity provision and extension, the widening of collateral assets, the extension of the access to liquidity facilities to a broader range of institutions and the setting up of new liquidity facilities, sometimes temporary, including bilateral currency swaps. As lenders of last resort, central banks try to avoid liquidity shortages that could result in insolvency crises in the banking industry. In the case of the ECB, the progressive tailoring, the progressive adaptation of the refinancing operations to the liquidity needs of European banks, testifies to the enormous effort made on this score.

The extraordinary provision of liquidity was accompanied by a reduction in official interest rates in order to support activity. Already in late 2008 and early 2009, policy rates had reached in many cases almost 0% or were at least at historically very low levels. Once the major central banks had reached the zero lower bound for interest rates they had no other option but to resort to unconventional measures in order to address the still very weak economic situation in their countries. So then central banks began to purchase financial assets, expanding the size of their balance sheets, the so-called quantitative easing programmes. According to the portfolio balance, the higher demand of assets by the central bank increases prices and reduces the years of these assets, reducing the price of risk. This pushes the demand for riskier assets. In general, the financing costs of the economy are reduced and a positive wealth effect takes place, encouraging spending and nominal demands. The asset purchase programmes by major central banks have differed in the type of assets they have acquired, the maturity and the duration.

As a result of these differences, the composition in the total amount of the balance sheet of individual central banks has differed over time. In the cases of the US Federal Reserve and the Bank of England, the size of the balance sheets has reached 28% and 27% of GDP, respectively, reflecting huge portfolios of assets held to maturity, treasuries, and in the case of the FED, also MBSs. The Bank of Japan is also rapidly expanding its balance sheet through the purchases of Japanese government bonds, not with the aim of reducing interest rates, which are already very low, but with the aim of aggressively expanding the monetary base and I think last night the Bank of Japan increased the objective of purchases of Japanese government bonds in order to increase the monetary base more rapidly. Finally, in the case of the ECB, asset purchases have been less important quantitatively although, in October 2014, the ECB started to purchase cover bonds and will shortly start buying asset-backed securities. Central banks have also adopted forward guidance on future monetary policy to economic agents as a means of reinforcing the loosening of the monetary stance. Forward guidance is transmitted to the economy through different channels. The most important one is the flattening of the yield curve since the announcement of expected official interest rates pacts affect the long-term interest rates. Forward guidance also reduces the uncertainty about future interest rates and, by affecting inflation expectations upwards, it is also able to reduce real interest rates.

The nature of the commitment conveyed by forward guidance has evolved from signalling and an openended period of time for monetary expansion to setting specific dates for the exit and finally conditioning the exit on achieving certain thresholds for certain economic variables. The contingent strategy adopted by the Federal Reserve and the Bank of England has proved to be challenging in terms of communication and both central banks have recently reintroduced qualitative elements in their forward guidance strategies in order to highlight that official rates could remain low even when the benchmark for these variables has been reached. The ECB has also used the management of future expectations but for an indefinite period of time and with variable rewarding. In terms of what the main central banks have done with prices, it is clear that the set of unconventional measures has managed to dispel some of the risks of financial stability that were more acute in the aftermath of the crisis aimed at counteracting deflationary pressures, to restore the operation of certain financial markets and, ultimately, to support, in a very important way, economic recovery. Looking ahead, the expected path of monetary policy is increasingly diverging across advanced economies due to cyclical divergences in the strength of the recovery.

The decision taken in October 2014 by the Federal Reserve and the Bank of Japan clearly assesses these different paths they are going to take. Japan and the Euro area, which are still growing at very low rates – around 1% –, comprise the first block of countries where no increases in official rates expectaare being considered in the near future. The United States and the United Kingdom make up the second bloc of countries expected to grow around 3% more or less in 2015. In the case of the United States and the United Kingdom, an extension of unconventional expansionary measures has already reached a situation of negative returns. In fact, the Federal Reserve was in the process of monetary normalisation in 2014 and has already brought the monthly volume of asset purchases to zero in this last meeting. In addition, the first hike in official interest rates is expected in 2015, both in the case of the United States and the United Kingdom, acknowledging the process in the recovery of these two economies. For the moment, the normalisation is taking place in an environment of relative calm in financial markets despite some bouts of volatility. One of the challenges ahead will be reshaping central banks’ balance sheets in terms of size, composition and average maturity. In addition, it will be very important to adequately communicate the steps to the markets in order to avoid episodes of volatility like the Taper Tantrum in May 2013.

There are also possibly more substantial risks than the ones that could be attached to a scenario of abrupt adjustment of interest rates, exchange rates and capital flows. This scenario could arise in a situation like the one I mentioned before in which there are widening cyclical divergences among advanced economies. For example, while the Bank of Japan is increasing the quantitative easing, the United States applies growing unconventional measures. This could have spill over effects and potential disorderly reactions in financial markets. This is not the baseline scenario but we should be aware of it. Before turning to the future of monetary policy, I will provide some comments on spill over effects on emerging markets. The evidence shows that both unconventional monetary policies in advanced economies and the normalisation of such policies can have substantial spill over effects on emerging markets. Although higher growth in advanced economies is obviously good, the financial volatility attached to drastic expansions and retractions of international liquidity can raise difficult policy dilemmas and trade-offs in emerging market economy central banks for their financial stability. These challenges can only be reduced by establishing a clear communication on the part of advanced economy central banks and through policies that ensure more sustainable growth in emerging-market economies.

Although the provision of liquidity between central banks through swap lines may operate under certain circumstances, other types of monetary coordination seems nowadays far away from a realistic policy set. Are unconventional measures exceptional and bound to disappear when new norms arise or are some of these changes going to stay here in the lines of central banks in the future? The principle that price stability is the best contribution that monetary policy can make to social welfare has not been challenged and remain valid. It seems clear that the crisis, though, will have implications for how monetary policy will be carried out in the future. It is now widely accepted that price stability is not enough to guarantee macroeconomic stability but that financial stability is also needed. A feature that will most likely characterise monetary policy in the post-crisis period is that central banks will play an even bigger role. In the aftermath of the crisis, central banks were the lenders of last resort. Obviously, it is essential to have appropriate mechanisms to provide liquidity in the presence of possible financial panics, which was the purpose of extraordinary measures taken by central banks in 2007 and 2008. Nevertheless, there are more ordinary situations in which the role of central banks in market making and provision of liquidity will remain wider than it was before the crisis. In the second place, the use of a broad array of unconventional monetary measures following the global financial crisis has widened the set of instruments available to central banks, probably also on a permanent basis.

The effectiveness of communication to shape forward guidance and market expectations has been proved at least once official exchange rates has reached the zero lower bound. On the other hand, some unconventional instruments, such as the purchase of mortgage-backed securities, may end up also being considered among the regular set of instruments of monetary authorities, as it has been acknowledged that, in order to reach certain market segments, specific instruments may be more effective than changes in central bank interest rates. The solvency of the public sector is essential to prevent a situation of fiscal dominance, especially given the weight that public debt has achieved in the balance sheets of some central banks. And, finally, the global financial crisis has led to broad consensus on the need for macro-prudential regulation and supervision to address financial risks of a systemic nature. In addition, it has also contributed to reopening the debate on the role of monetary policy in relation to financial stability. Although there is still no general agreement about the appropriate institutional design to manage macro-prudential policy, it does seem clear that it interacts with monetary policy and that coordination between these two policies is of the essence.

The experience of the effectiveness of different institutional frameworks that has been established in recent years is still insufficient but, regardless of the operating scheme for macro-prudential policy, monetary policy decision-making should take into account the implications it has for financial stability and vice versa. The capacity of a central bank to separate itself from the objective of price stability is strongly related to the credibility of the central bank. This is not only the case in advanced economies but also in emerging market economies. For instance, in the case of Chile or Mexico, what we are seeing now is that those central banks, although they have inflation rates over the upper limit of their inflation banks, they are able to reduce interest rates and to be a little more anti-cyclical in their economies. All this is based on the credibility they had before. Finally, one important caveat is that this mutual recognition between monetary policy and financial stability should not put into jeopardy the independence of central banks in contacting monetary policy oriented to price stability.

Safeguarding Financial Stability: Indicators, Framework And Toolkit

Christian Upper. Head of the Financial Markets Section of the Monetary and Economic Department, Bank for International Settlements Representative

If there is anything we have learnt from the crisis, it is that we cannot really separate monetary stability or price stability from financial stability. One reason is that central bank actions meant to safeguard monetary stability or price stability can actually affect the risk-taking of the private sector and, through that, eventually affect financial stability. Financial stability, in turn, has massive repercussions on output. That makes price stability feel meaningless. All in all, we need to adapt central bank frameworks in order to recognise their independence. The first problem we encounter is that research on financial stability analysis is much less developed than business cyclical analysis.

There are many reasons for that. One of them is that business-cycle research basically started in the 1940s, whereas research on financial-stability indicators came up later. We can identify a well-developed set of tools, including coherence as far as it is possible in economics, to assess business cycles. In contrast, financial stability does not benefit from current models of analysis. Not only is the belated beginning in the research a problem, but also the financial stability analysis has to overcome some structural problems. First and foremost, the lack of empirical evidence; namely, the fact that there are actually not that many financial crises. Let’s take the case of research on business cycles. In the United States there are six or eight, whereas there is only one financial crisis. As much as this is a good piece of news for the world, it hinders research. Besides, crises are heterogeneous and unique: they occur for different reasons in different settings and at different times. Any financial stability analysis based on two different countries that have experienced a similar crisis is bound to fail. This is why many crisis-prediction models just do not work.

They are very good at predicting crises in sample, so past crises are very easy to predict, but future crises are more difficult to forecast and I often predict 5 of the 10 crises that happen or I do not predict any. But there is hope. Inflation tends to be preceded by a large expansion of money. At the same time, financial crises tend to be preceded by sharp rises in credit, growing more rapidly than the usual trend. And on a shorter horizon, debt service ratios are a pretty good indicator to detect it. There is a graph from some economists that actually shows the predictive power of some of these indicators. That is the analysis part, which is very difficult. What can we actually do to safeguard financial stability? Before the crisis, the only tool the German Central Bank relied on was the broad financial stability review. Our finding suggested that this is not a very effective indicator. The other tool we had at our disposal for a long time was interest rates. Although they have proved useful in managing crises, as a rule they have massive side effects on preventing crises. For instance, they may be more effective slowing sharp growth in credit, but this would be done at the expense of sending the economy into a collapse. A broad consensus has now been reached that regular financial stability assessment should instead consider macro-prudential instruments. Although these tools have been around for a long time, many emerging market central banks have had a long experience with them; they may be new for some central banks, particularly for advanced economy central banks, and are now widespread.

By way of illustration, some economist colleagues tried to find the central bank reports of 60 countries in order to find evidence of macro-prudential measures aimed at influencing housing markets and found that more than 800 of these measures had been taken. Yet there are sound reasons to believe that macro- prudential policies are not going to be the ultimate solution. The available evidence shows that they are very good at increasing the resilience of the financial system, for instance raising capital ratios or reserve ratios that help maintain a stable banking system. There is much less evidence that they reduce the financial cycle. Crisis management also poses problems, for some instruments such as capital ratios cannot be lowered in times of stress given the fact that the market implied a capital requirement that is much more binding than the regulatory capital requirement in crisis. So they are a bit asymmetric as well. Another major inconvenience is that market implied capital and regulatory capital requirements are not fully independent from each other. So in academic models you can also have five objectives or five instruments, and target them and make accommodation even if they are correlated. It sort of works out because you know how to calibrate these things. In practice, in these models you may need a capital ratio of 60% and interest rate of minus 4% and this does not work.

They are not as independent and they may not work as well as we think they do. I think interest rates are no longer in difficulty. There is still a reason to use interest rates in conjunction with others instruments to prevent financial instability. Interest rates also have the advantage that they are much harder to evade for macro-prudential instruments to work through the banking system. Now in emerging markets there are many non-financial firms borrowing money. The problem is actually much larger than you think if you look at payment data, offshore borrowing, the large numbers and the lack of effective macro-prudential tools in preventing financial instability from happening. Currently, we have analyses of these instruments that central banks can use: but how do we put it to work? The problem is that financial instability is based on a financial cycle and that has a very different frequency from a business cycle. The former moves slower than the latter. And this has an impact on public pronouncement as well as on the policy-decision debate. Since financing indicators have been warning for two years that nothing was happening, financial instability has just been dismissed as unimportant. So there is a need to look for an overall analysis that embraces different analytical perspectives. In that sense, we can borrow the ECB’s two-pillar approach based on two complementary analytical elements: the economic pillar, which looks at price developments, inflation forecast and business cycle, and the monetary pillar, which is used to crosscheck the information provided by the economic pillar with financial stability indicators.

This strategy proves to be very useful: for instance, in a situation when credit has been growing rapidly, it should be a warning that we should incline to being too tight. The two-pillar approach exists to some extent in the Bank of Japan, which has two perspectives. It is fairly flexible and could actually help combine these different frequencies and these different types of analysis. What is important is that you cover the entire financial system and something grows rapidly no matter how benign it is. This is something that needs to be looked at. It is relevant to examine the exchange rate, especially important in many emerging markets and in advanced economic markets too. Even in the last crisis, countries that most strongly committed to a floating regime, allowing the exchange rate to fluctuate in response to different shocks, intervened. That is the case of Chile, which intervened before Lehman Brothers collapse in September 2008 in order to prevent the peso from depreciating and after the collapse in 2011 again to prevent the peso from tanking. If you want floating exchange rates there may be a point in time when you think the fundamentals are so out of line with the exchange rates and not the other way round that you maybe want to do something about it. Reacting to stronger imbalances to some extent is just like factoring in financial stability analysis. It is something that happens occasionally over time and at some point you have to react.

It could be part of the second pillar or a three-pillar approach, where you would have a monetary policy committee meeting. Another perspective being considered and put on the agenda, which policy-makers would have to discuss, involves how this affects the exchange rate. Is it just way out of line? Should we do something about it and how should we move the other policies in order to try to get in line with preventing these massive realignments? In conclusion, the system mentioned is much more difficult to implement than the one we had in the traditional inflation-targeting framework but I think it could actually work. It would help us keep the strengths of the inflation targeting of the pre-crisis frameworks, the focus on inflation and the reactions to perceived threats to price stability, but it would force us to take into account the trade-offs that arise, of the side effects of the policies geared towards keeping inflation down. This would mean a lot of work and could result in a better world.

Banking Union And Financial Convergence: Lessons From The Experiences Of The European Union (Eu) And The Union Of The Arab Maghreb (Uma)

The Economic And Financial Challenges To Regional Integration In The Maghreb

Jaloul Ayed. President of MED Confederation and Former Minister of Finance, Tunisia

When I was young, like many other young people in the Maghreb, we had a vivid dream that we would live in a region that would become one country. We had every reason to believe that that dream would come true and that the region would become one country. Countries in the region had many similarities: they shared the same religion, culture, language and history. Unfortunately, that dream became an illusion and sometimes even a mirage, except for a few advances in that direction, such as the creation of the Arab Maghreb Union in 1989, the decision of African Central Bank governors to adopt a single currency by 2021 and the intention of Maghreb banks in November 2007 to create one currency for the Maghreb.

Those were good intentions but they did not yield any results. Meanwhile, we looked north, towards Europe. We share geography, history, many cultural traits, and more importantly, most Maghreb countries trade mostly with Europe. Share of European trade with North African countries sometimes exceeds 80%. We were looking at Europe with admiration because the idea of a European community started long ago, at about the same time as our dream for a Maghreb community. Drawing on the European experience, first with the creation of the EU and then the launch of the Economic and Monetary Union in three stages from 1990 to 1994, the signing of the Maastricht Treaty in February 1992, and the creation of the European Monetary Institute (EMI) in 1994, which was a forerunner of the ECB, and then the creation of the ECB in 1998, we asked ourselves why there was no action in our part of the world. We had more reasons to embark on a very similar project. When we look at Europe, we can see it is a very heterogeneous space that comprises many countries with different languages and histories.

Nevertheless, European countries were determined to take the steps towards the convergence, and so they did. If we wanted to reinstate our dream of a Maghreb community we should take into account the developments the countries in the region have undergone over the last 50 or 60 years, economically and politically, which have put more distance between them. First of all, the biggest problem the region faces is a political constraint. The conflict between Algeria and Morocco is a major obstacle, while there is a humanitarian crisis in Libya. It may not be very timely but it is a dream that we have to uphold. Certainly, political stability is fundamental in creating a regional unity, but there are other aspects to be considered. The second problem the region confronts is on the macroeconomic level. In order to establish a monetary union, certain conditions need to be met, such as the degree of openness of the economy. In the case of the Maghreb, some countries are open to a higher degree than others. Morocco is the most open country, Algeria is still very much closed, with barriers to access the market, and Tunisia remains relatively closed, a little better than Algeria but certainly behind Morocco. This is a condition for which there is no uniformity. In reference to this point, Algeria is the strongest country in the region, ahead of Morocco and Tunisia.

As you all know, it is a one-product country as a hydrocarbons exporter, but it is a very rich country. Algeria is one of the top twenty countries in the world in foreign exchange reserves, which today are around 200 billion dollars or even higher. Meanwhile, Morocco and Tunisia are struggling today with a level of reserves that hardly covers four months’ worth of imports. Regarding the financial system, there are also major differences between these three countries. In Morocco, which I consider to be far more advanced than all the other countries – and I know that for a fact because I headed BMCE (Banque Marocaine du Commerce Extérieur) in Morocco –, the financial system is much more advanced, not only concerning the Maghreb countries but even in Africa as a whole. By way of illustration, in Morocco there are today two large private banks, the so-called «national champions», and one large public bank. In Morocco more than 85% of the banking system is controlled by three or four public banks: in other words, banks that are controlled by the government. In Tunisia, there is a trichotomy in the sense that there are four public banks, ailing banks for that matter. There are two private banks controlled by business groups and the rest of the banks are subsidiaries of mostly French banks.

All in all, these are some fundamental elements that should be seriously considered in a monetary and economic union. Another important factor is that in Morocco, whilst the banking sector is the important component in the system, there are active capital markets; in other words, they have developed. For instance, BMCE has initiated the creation of the repurchase agreement, also known as «repo market», so there is an interest rate market, but in other markets in Morocco they do not exist. Consequently, Morocco has a yield curve that goes up to 20 years. Meanwhile, Tunisia and Algeria have no yield curve at all. The stock exchange in Morocco represents north of 60% of GDP, whereas it does not exist in Algeria and it is very small in Tunisia, barely 30% of GDP. In this respect, the role of the central bank is vital not just in conducting monetary policies and safeguarding price stability, but also as a true agent of change in making the financial system what it is today.

We can see it in the case of Morocco, where the central bank played an amazing role. When the BMCE launched the repo market or the secondary market for security bonds, there was no regulatory framework in Morocco. The central bank, however, was informed on a daily basis of the BMCE actions and supported them. Subsequently, the regulatory framework came three years later. Another example is that of the national financial education programme initiated by the Central Bank of Morocco, which was also extremely important at a time when consumer credits were going up. It set a good example and became a source of inspiration for the rest of the countries, not only in the Maghreb but across the rest of Africa as well. In the case of Tunisia, it tried to have a microfinance industry as an integral part of the financial system in the country. The Central Bank of Morocco decided to integrate microfinance under its supervisory authority, which was an exceptionally positive action. Keeping all that in mind and going back to the case of Europe, I want to highlight the fact that banking union and convergence is also a very recent achievement even in Europe. In fact, when the Single Supervisory Mechanism was put in place that meant the end of the beginning of something very big; because how can you talk about monetary union in a continent as big as Europe, or tomorrow I hope in the Maghreb, if you don’t talk about banking union?

In fact, I know that when the current French President, Mr. Hollande, mentioned this, he had genuine economic and monetary union in mind. It was first of all a true convergence and banking union throughout Europe; second, a common management of fiscal capacity; third, a common management of the debt stock in Europe; and fourth, an alignment of the activities of the labour unions. Personally, I do not think this will happen any time soon. Yet these challenges are being tested at the moment and I think that Europe came out much stronger from the 2008 crisis, for it has triggered the launch of many mechanisms by the ECB and the monetary authorities in Europe. I believe these are all extremely inspiring examples that hopefully will lead the way for the Maghreb region and we will all see the dream come true.

The EE’s Process Towards The Banking Union: Lessons And Challenges

Fernando Vargas. Associate Director General of the Regulation and International Coordination Department, Bank of Spain

The banking union is not created in a vacuum. It is created inside a whole process of convergence inside the EU. The EU’s main objective was not exclusively to create an internal market with freedom of movement of persons, goods, services and capital, but it was also set up with a higher goal. Initially it seemed that it was enough and some people still underestimate its capacities. As the Lisbon Treaty stipulates, the EU’s main mission was to promote peace and wellbeing of the Union’s citizens; to create an area of freedom, security and justice, without internal frontiers; to create a free single market; to promote a sustainable development, scientific and technological advance; to combat social exclusion and discrimination, as well as to guarantee equality of gender and the protection of human rights, particularly those of the child; and to promote economic, social and territorial cohesion and solidarity among Member States.

This is a very important starting point because what you are trying to achieve will determine how you do it, the instruments you use and the complexity of the process behind. The milestones in this process starts in 1957 with the Treaty of Rome, in a completely different world from today. Back in that year, in relation to the notion of a country’s openness, you could do a lot of internal policies, without the problem that external influences would accelerate the process. It would be impossible to think today of slowly lifting barriers in many countries in the world because they just tumbled down. It was a long and complex process. We had to wait thirty years from that beginning before we had a European Single Market Act and another twelve years for the introduction of the Euro. Processes accelerated. After the introduction of the Euro, major progress was made in banking convergence: a European financial supervision system was created, such as the European Banking Authority. Finally, in 2012, there was the proposal for a banking union. In that direction, the single supervisor came into force on 4 November 2014, exactly one year after the coming into force of the last law. Inside the EU there are 18 countries that have a common currency and 10 others that do not. That means that anytime we deal with the subject of the banking union we are only referring to the Eurozone. But we have to put it into context.

This is part of this bigger process. It started with a decision by the EU in going beyond a single market, about the question of whether member countries wanted a federal state. Initially, countries chose to remain independent. To that end we need a number of elements to instigate this union of independent countries to fulfil the above-mentioned goals. For instance, countries that are members of the banking union have to lose sovereignty to the centre. To that end, we need institutions that are able to move this forward and decision processes that work. Another necessary element is economic convergence, in the EU in general, but especially in the Eurozone. It is very difficult if not impossible to have an EU with divergent economic situations in member countries. As regards convergence in the EU’s banking system, we have experienced two types. One is legislative convergence. Inside the EU there are directives and regulations regulating the whole banking and financial systems intended to have a single rulebook for the EU. Sensibly enough, a common market calls for the same rules for all players in that market.

You need consistency across the 18 countries. And you also have institutions, in this case the European Banking Authority (EBA), which can have secondary regulations. The second type of convergence is supervisory. In that field, there has been a lot of work through what we call colleges in banking, which is the meeting between the supervisors of a parent company of a bank and the supervisors of the subsidiaries if they are in a different country. Besides, a single supervisory mechanism has been set up, even though it is only working in some countries of the EU. Arguably, the crisis we are experiencing has been the catalyst for more union inside the EU. In 2008, ten years after the single currency, the EC issued a report saying how successful the Euro was. The only problem was that there was some divergence in the economic situation of some members of the Euro. Four years later, we were involved in the biggest sovereign risk crisis we have ever experienced and the Euro was close to bankruptcy. There was a moment when people were thinking the Euro would disappear or at least that some countries of the Eurozone would leave the Euro. This has not happened but the crisis allowed us a reassessment of what we were doing and we looked again at the institutions we were using and it allowed us a bigger convergence, also in areas in which we thought we would never coincide and one of those areas was the banking union.

Two years ago, the idea of having a single supervisor in Europe was inconceivable. On that point, the lessons and challenges that can be identified are the following: firstly, a union that goes beyond a common market is possible, even among countries with different languages, cultures and relations. It will not be devoid of difficulty and it will be a long process. It requires sufficient political will and it implies a transfer of power, some central decision mechanism and both institutional balance and balance between the centre and the independent countries that make up this union. Nevertheless, this balance is not easy to achieve due to the tension in the heart of negotiations, which can sometimes be creative and sometimes destructive. The EU is actually making some strides forwards and some others backwards. Secondly, a monetary union is also possible, with a common monetary policy and a common central bank and a common currency. It is more difficult than the union given the fact that it requires special conditions: above all, economic convergence, namely stability. In relation to these two key ideas, the European Central Bank has always championed a banking union as a prerequisite for a monetary union. However, that will not become a reality without the political will mentioned before. That, in turn, was not possible without the breakup of the crisis. In other words, the crisis allowed the banking union to happen in the EU.

One of the current challenges to bear in mind is that a banking union is not equivalent to a single supervisor. Not only does the banking union require a single supervisor but also a single resolution mechanism – both of which we will have in the near future. And probably it requires much more, maybe more convergence in fiscal policy. Maybe we need to deal with unresolved tensions and a difficult decision process we live with. The reason is very simple: who pays for problems in a bank? No government or taxpayer would be willing to pay for something they are not responsible for. This is the way history has done things. Looking back, you may think there are easier and more efficient ways to do it. But the banking union is a huge success.

The Path To Financial Cooperation After The Arab Spring In The Union Of The Arab Maghreb (Uma)

Habib Ben Yahia. Secretary-General, Union of the Arab Maghreb (UMA)

The EU is older than the UMA. The EU is 60 years old and the UMA is only 25 years old. Let me emphasise three key times in regional cooperation in the Maghreb region. The first started in 1958, during the first Conference of Maghreb Economic Ministers in Tunis, which culminated in 1964 in the establishment of the Conseil Permanent Consultatif du Maghreb (CPCM) between Algeria, Libya, Morocco and Tunisia. The second opportunity for regional cooperation appeared when Algeria, Libya, Mauritania, Morocco and Tunisia signed the foundation treaty of the Maghreb Union in Marrakech in 1989, and the third case of cooperation was opened with Europe on 4th November 1991 in Brussels. Back at the launch of the Maghreb Union, Egypt was excluded. Now I believe Egypt should join the Maghreb Union. There is a kind of connection between Egypt and North Africa, not only religiously but also in terms of population. There are tribes in North Africa spread throughout the Maghreb, Libya and Egypt. Since its foundation, the AMU has not been able to carry out its plans to develop an economic union due to a number of regional events, and political and security transnational conflicts.

The Lockerbie bombing under Libya’s leader Muammar Gaddafi triggered a big downturn in the region as well as within the UN. After the Lockerbie events, Libya remained for nine years under special UN scrutiny and was embargoed. In July 2012, the foreign ministers met in Algeria and proposed that we should focus more attention on what could be done together to face those extraterritorial challenges, including the challenges coming from our countries. The foreign ministers also dealt with the security issue coming clearly from our borders, the Sahara and the desert. We opened dialogue with 15 countries, our neighbours in Africa, and discussed our common challenges with desertification. 82% of our land is going through the process of desertification, and the UNCCD convention on desertification has projected that it might go to 90%, becoming a great menace and threat to our region. Back in 1991, I was Tunisian Minister of Foreign Affairs and one of our main concerns was to create a special atmosphere with Europe to ask for help. After 15 years of standstill following the Lockerbie bombing, dialogue with Europe was resumed in Lisbon in 2007 to promote regional cooperation and to address specific issues with the focus on migration to Europe from the Maghreb region and even from sub-Saharan Africa. Another important concern in talks has been the issue of security given the rising problems in that field.

Meanwhile, the Maghreb Union is trying to follow the EU on what can be done to create the new atmosphere to foster regional integration between the five Maghreb countries, especially in the economic field. In order to tackle common economic interests, a committee of the directors of customs administration and a committee of directors of the tax administration was set up. The director of customs administration was very active preparing the project to create the Maghreb union of customs in order to increase intra-trade, which is very weak: 3% of our trade is between Maghreb countries. Recently, the Maghreb region held a meeting with the UN Committee of Africa to address the study carried out by the World Bank concerning a plan of action that will focus on the issue of trade between the Maghreb countries, in order to increase it from 3% to 10% and afterwards to 15%. Ministers of trade of the Maghreb countries are now studying the World Bank proposals. Hopefully, by the end of this year the second meeting will be arranged in order to facilitate our concept of common trade. Minsters of finance used to hold extremely important annual meetings, although they have not attracted much publicity. Since the breakup of the Arab Spring in 2011 these meetings have been at a standstill.

A common policy between central banks is now needed, such as the Maghrebian committee on insurance and reassurance, in order to help the business community invest more. The first Maghreb meetings of businessmen, who created the Union of Maghreb Businessmen, took place in 2007 and 2008 and have been held regularly since. The last meeting was held in Marrakech on 17 and 18 February 2014. As a result of the meeting, a plan of action to increase cooperation was ratified. Indeed, these are very influential meetings. Simultaneously, in the context of challenges in the economic and financial field, the Maghreb Union of Bankers – a group of 107 banks, both private and public – met on September 2014 in Tunis and approved another plan of action to enable dialogue on possible solutions and to coordinate our action with the member countries of the EU, who are our closest allies. At the same time, the boards of governors of the central banks have worked with the IMF. Until 2015 we have had six meetings with them in Maghreb capitals; the last one took place in Mauritania. The IMF presented a lot of plans to us: preparation for Basel II, money laundering, development of the role of financial institutions in the Maghreb, the outlook and basis for economic and financial stability in the Maghreb and, finally, the management of external reserves of the Maghreb countries. All in all, there is a large spectrum of coordination that embraces the Maghreb Union, the World Bank, the IMF and the EU. Most recently, collaboration has also been strengthened between the Maghreb and the Gulf countries.

The 2014 meeting between these two blocs took place in Rabat and in Kuwait during the Arab Summit. They were intended to increase the investment of the Gulf countries in the Maghreb, an area in which Gulf countries are doing quite a fine job. In reference to the banking system, the model of the Tunisian-Libyan bank that was created in Tunisia has become a successful story. Trade before the revolution between Libya and Tunisia rose from approximately 400 million dollars to 2.6 billion dollars. Now trade between Tunisia and Algeria is also increasing, as well as trade between Tunisia and Morocco. Mauritania is a successful story too. It has quite a lot of fish, and exporting fish is quite a rewarding experience. They have iron ore and they discovered that they have gold and maybe oil too. The projection according to the last World Bank report is that Mauritania is going to increase its income per capita starting next year. On top of that, there is an important agricultural area in Mauritania. Now, both Saudi Arabia and Kuwait along with some Maghreb countries are investing in that area because overall these countries are importing a lot of cereals from abroad. On the level of macroeconomic policy convergence, it was recommended by the ministers to create the Maghreb Monetary Institute. At the moment it is still at planning stage. Moreover, the establishment of a common framework for budget discipline within the Maghreb Union was recommended.

These recommendations have been presented to the ministerial committee on economy and finance. Ministers of finance met in Marrakech and suggested a long procedure to review our relations in the financial field. Those recommendations were already adopted and now we are creating different sub-committees to discuss their implementation by the beginning of 2015. What I suggest is the creation of a hybrid fund with the foreign currency component and the local currency component. If you want to invest in Tunisia, for instance, you have to approach the pension funds, the insurance companies, to join you in your fund in order to avoid having to go through the central bank approval process because we have been having some big problems with cross-border funds, where the fund will come from Europe allowing investments from Tunisia out to Europe via companies in Europe and from Europe on to Tunisia. We finally got the approval because it goes both ways. So the hybrid fund is a temporary solution but one I would recommend you should contemplate. Perspectives of increased regional cooperation look difficult in the current times of uncertainty and challenges. Our most recent challenge is Libya. A year ago, Libya underwent revolution.

All of a sudden al Qaeda invested in this country. In spite of the civil war that is hitting the country, there are attempts to open the dialogue between the associations, two governments and the parliament. Hopefully, we can help Libya with the support of our neighbours in Europe, the USA and UN; the latter has already sent special representatives to the country. There are also some problems inherited from the past between countries left to the UN and this involves a long process. There is also the need to coordinate a youth policy in this region given the rising numbers of young people enrolling in the fight in Syria. These are times of hardship, especially after the onset of the Arab revolutions, the recently held elections and the plans to democratise our societies. Certainly, I do not think we have solved all our problems yet, but the monetary and financial integration in the Maghreb has already been launched. It is clear that this integration will depend on each country. There are differences in macroeconomic policies between countries. This is what makes the harmonisation of economic policy difficult for the time being. However, the dialogue is open and started and it is serious in the framework of the Maghreb institutions. Ministers of finance, economy, and social affairs, and hopefully the Prime Minister, will meet with the private sector representatives. An exchange of ideas is bound to bring partners much closer. They are not discussing competition, but rather how to work together in order to increase our common interest, especially in a time of crisis and challenges, when the consolidation and acceleration of the integration process becomes vital.

Dualist Financial System In Emerging Europe: A Post-crisis Model

Piroska Mohácsi Nagy. Director for Country Strategy and Policy, European Bank for Reconstruction and Development (EBRD)

I would like to start by commenting on Mr Jaloul Ayed’s words about his dream that he would be part of a unified country, a unified region. Maybe I can make a personal observation as a Hungarian, from an ex-communist country. We did not even dare to dream back in the 70s when we started having some recognition, or in the 80s, that we would ever be outside a communist empire and part of the EU. But here we are, so dreams do come true. Let me set out the means by which economic integration for emerging markets within the EU has been achieved. Certainly it is attainable, but it has to be done extremely carefully, even if it is done fast, looking at the regulatory environment in particular. Otherwise, it can have high costs. I want to start by examining the central European market economic model. It has been a model of very rapid convergence until the outbreak of the global financial crisis that gave way to a major readjustment of the model since. As a result, the share of investment in GDP has increased steeply, starting from 2000, while the national savings did not keep pace. So savings stayed unchanged. Therefore, the quick rise in investment that underlay and financed economic transformation in emerging Europe came from foreign savings and, particularly, foreign direct investment.

That was really the European magnet: it was a twofold process. It was a top-down process of integration and harmonisation of institutions and legal frameworks, as well as a bottom-up process of financial sector integration and trade integration, as the two had very nice positive dynamics. Meanwhile, the financial sector experienced a very intense, high-density, cross-border, integration in terms of equity. It was a one-way process. Western European money as well as ownership were taking over emerging Europe’s banks so, by the early 2000s, basically most of the banking sectors in emerging Europe were already owned by Austrian, Italian, Greek, French, German, and Belgian banks. That was a massive and swift integration process that financed investment and consumption with a very successful outcome. All in all, the model unquestionably worked for growth. Regarding emerging Europe, we can identify two conflicting situations. In the transition countries, the higher the current account deficit, the higher the growth for a long period of time. Conversely, in non-transition European countries, the lower the current account deficit, the higher the growth. That is the usual paradox for the emerging markets. In this latter case, foreign savings are not financing growth. In the case of emerging Europe, the model has worked very well and it has led a very rapid integration. However, as a result of the global financial crisis there was a collapse in investment and finance.

Domestic savings started to edge up as part of the adjustment process and the big difference closed up, so current account deficits disappeared without registering foreign financing. Consequently, the whole integration model and in turn emerging Europe were massively tested. There has been huge leveraging in parent banks from emerging Europe, not that much capital that stayed in but more liquidity. As a whole, the region registered a massive withdrawal of capital and according to most recent data it lost 10 percentage points of GDP between 2008 and 2014, which represents a large amount of money and explains why leveraging is actually hitting this region. That has been the vulnerability that came about with very strong integration. Besides, the bulk of the leveraging, two-thirds, actually happened when the Eurozone crisis hit, when the parent banks got into trouble. So the parent banks were still holding up in 2008-2009 when leveraging was not very strong and we supported that with a coordination framework between home and host country regulators. The model has been tested and it still holds very nicely for growth. It has just experienced one adaptation given the fact that foreign savings that were financing growth are no longer there in the quantity there used to be.

Subsequently, there has been an important part of rebalancing of the economic model based on much more reliance on local currency funding than in the past on parent bank funded resources. This is an additional point as there is a rebalancing in terms of ownership because it has been phenomenally good to have the foreign banks that brought in very important capital and knowhow. However, there has been a certain political economic resentment to having both banks owned by foreigners and locals that indicates that the political economy unfortunately matters and sometimes trumps economic efficiency and economic desires and thinking. So in quite a few countries, particularly Hungary but also in others, there has been a call for more domestication of many sectors of the economy, not only the banking sector, by reducing the share of foreigners, but also other sectors such as telecommunications or energy. All in all, it led to the spread of anti-foreign sentiment. Financial integration is extremely good and it has worked beautifully for emerging Europe; but political economy considerations also have to be taken into account, and that means a balanced model both for funding and also for ownership while ensuring local presence in all these sectors. An additional lesson to be drawn from this integration is that the regulatory framework, particularly in the financial sector during the boom time, did not keep pace with the very rapid micro integration. Basically, there was very limited coordination between the host countries such as Poland and Hungary, central banks and regulators and home countries.

There were lots of memos on understanding what to do. On the outbreak of the crisis there was no previous experience about how to proceed. Ad hoc coordination mechanisms had to be invented, such as the Vienna initiative, home and host regulators and banks, to manage the crisis. In this situation the banking union emerges as the solution to rescue the regulatory system. A very close integrated financial sector is now being matched hopefully by an effective supranational regulator. From the emerging Europe point of view, the banking union is a game changer, not only for the Eurozone but potentially also for Europe as a whole, thus it is a pan-European game changer. This is a very challenging situation first and foremost because the banking union only applies to participating states in the Eurozone. Granted, there are some countries in emerging Europe like Slovenia, Slovakia, Estonia, Latvia and Lithuania that will automatically be members of the banking union as members of the Eurozone, but there are big EU members who are not part of the Eurozone and can participate in the banking union through the Single Supervisory Mechanism (SSM). It would be very important to have the right conditions for these countries that are not automatically in the SSM for them to also opt in, and hopefully this will happen soon enough. We think that the ECB, which has shown wonderful leadership, may give more consideration to having more sweeteners, particularly in the form of currency swaps, which would give some assurance for non-Eurozone countries for liquidity management, should they opt into the banking union. So what does it all mean for the Southern European countries?

If we take the case of Jordan, Egypt, Tunisia and Morocco where EBRD is working, the same investment savings balance we put together for these four countries shows in the aggregate before the crisis that actually they relatively financed their own investment with domestic savings. Yet there was foreign capital inflow that was wisely used to build up reserves and strengthen the monetary framework and credibility. Meanwhile, foreign savings at the aggregate were not used to finance investment. That is changing because, as the crisis hit, savings are declining and investment too, but not as much. As a result, current account deficits have emerged. Now there is not too much saving but there is foreign financing, and as a result there has been a massive draw down of reserves. In the Mediterranean the share of foreign-owned banks remains very low, which in turn means that there is no major foreign ownership and input of capital. Therefore, there is also no major inflow of knowhow, knowledge transfer, which was so helpful in the case of emerging Europe. It has also been discussed that banking sectors are very large and financial integration is very high, while simultaneously financial penetration by any measure is extremely low.

The conclusion is the following: this region has a dualist financial system. On the one hand, there is a large banking sector that finances large corporates and large ticket items and, on the other, there is a rapid relatively unregulated and healthily growing microfinance sector. The system lacks SMEs that are cut off from finance. If compared with other countries, the share of SMEs with credit lines is appallingly small in the region. So what could financial integration really bring to the Southern and Eastern Mediterranean if the policy decision-making was really there to open up the sectors? First, opening up to more competition, to foreign capital, and to foreign banks would in turn enable knowledge transfer and an economic restructuring. Moreover, introducing an arms-length approach to enterprises, which is a major lesson from emerging Europe, would prove to be a major benefit of foreign banks. They were less politically influenced than the domestic banks when it came to allocating credits and that is really what enhanced their productivity and profitability. So policy decision-making has to allow increased competition. And, in a sense, financial integration could really be used to address the problem that some call the privileged economy, the missing middle class and the big dynamics between firms and banks. Finally, let’s consider interregional financial integration. The experience in emerging Europe has been the following: the first arrow of integration had been very clearly towards more advanced economies, again utilising foreign capital and knowledge, and only then countries built up a certain solid economic and trade structure and countries have started to trade with each other.

This happened even when the EU single market already existed, at least in terms of trading routes and also in the financial sector. So even though there were no regulatory barriers nor customs union barriers, countries within the EU started to trade and carry out FDI with each other only for a certain amount of time. I think there is some natural growing period when you have to establish your own strong economic base so you can undertake fast trading and financial integration. However, when it starts, it really accelerates. For instance, back in the early 2000s, well into transition, the trade relationship between Poland and Hungary, let alone between the former Yugoslav countries that have had a civil war, was close to zero. In a matter of 10 years, it went up to 20-25%, even within the former political and military enemies of Serbia and neighbouring countries. We may conclude that there may be a gestation period for countries to rebuild themselves and link up. Once real legal barriers have tumbled down, it certainly can add to growth and social welfare.

Key Factors And Challenges Of The European Banking Union

Chris De Noose. Managing Director, World Savings Banks Institute (WSBI)

First, I want to stress the fact that the European Banking Union, namely the supervision by the ECB, started on 4th November 2014. Therefore, the experiences presented are not conclusive. On this point, the asset quality review (AQR) and the stress test carried out yielded rather positive results for many countries, with the exception of Italy. My understanding of the European Banking Union, based on my practical knowledge, is first and foremost that it is no secret that in the very beginning not everybody was convinced of the practicalities of it: there was scepticism and also uncertainty in the EU environment. However, the clearer the idea and the legal framework of the banking union became and the better the positive aspects of the establishment of it were specifically worked towards in the preparations stage, the more stakeholders were convinced of the importance of the project. There was sometimes a fair amount of reserve as long as the mandates and responsibilities between the European Central Bank (ECB), the European Banking Authority (EBA) and the national competent authorities regarding the supervision of banks was not clearly defined.

The national competent authorities are the ones that know best the specific business models and the local banks, and this knowledge and expertise are of course fundamental in order to ensure an adapted supervision. However, when it became more precise which institutions would be in charge of which tasks and what the cooperation between those institutions would be like, the initial reserve slowly faded away. Nevertheless, there are still issues that need to be clarified, such as the complete practicality of the interaction between the ECB and the national authorities regarding the less significant banks, since a degree of harmonisation exists in the ECB supervisory manual, which describes the supervisory standards within the European Union. The second aspect is the establishment of the two first players of the banking union –for now, I will not deal with the third one, the Deposit Guarantee Schemes (DGS). These two are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). They should be guided by the principle of proportionality when adapting regulations for the banking sector. Proportionality plays a key role in building a more stable financial industry. In most cases, savings banks, for instance, have a different risk profile from those players that have a tendency to be involved in more risky practices.

It would therefore be hard to understand if smaller banks are charged in the same way as certain other banks when the banks’ contributions to mechanisms, such as the SSM and the SRM, are determined. It would be unfair not to apply these mechanisms to savings and retail banks when it comes to supervision resolution. This is why financial conversion is a sound objective, provided it does not neglect the protection of the diversity of the banking sector, which needs to be taken appropriately into account. I am convinced it is not a disadvantage for a European banking sector to be characterised by a significant degree of plurality. If the totality of the mechanisms that were created by the European legislation over recent years became too costly and if European regulations render certain activities more expensive, only a limited number of players would be able to afford the additional financial burdens and to continue offering certain services to their clients, and in particular to SMEs. This again would threaten the plurality of the banking sector in Europe. Proportionality is also a key term with regard to the so-called «Single Rulebook», which is a regulatory framework complementing the single supervisory and resolution mechanisms and aims to harmonise regulations among the Member States. Thirdly, and this is a little bit aside from the banking union, the Financial Transaction Tax (FTT) is currently widely discussed in Europe. It is not clear whether it would be an added value to our European financial framework. I rather feel a tax would distort competition between European and American banks and maybe this is a negative point for convergence, specifically taking financial transaction banks on a European level.

I believe that the future legislation, which is about to be fully operational, might bring a certain number of challenges. For instance, the upcoming commission might contribute to a higher degree of financial convergence within Europe, which seems to reinforce the philosophy of integration that underlies the banking union. Mr Jean-Claude Juncker, the current president of the European Commission, in cooperation with the new commissioners, aims to breathe life into the concept of a European capital markets union, which would apply to the 28 Member States as a single market initiative. If this is well calibrated, it can promote financial convergence in Europe but at the same time it has a certain number of drawbacks. At any rate, it is clear that the setting up of a capital markets union must not be to the detriment of the banking sector. I think that the banking union and capital markets union should be complementary. If you ask me whether the banking union system currently established in Europe could be copied to the Arab-Maghreb states, I would suggest being prudent, as I think every region has its own specificity. You cannot copy the banking union to the American banking system either, or vice versa. Before setting up a banking union, the real possibilities of creating such a union, the degree of convergence or the banking structures have to be taken into account, among other things.

The Market’s Perspective On The Need To Reach A Banking Union In Southern Mediterranean Countries

Albert Alsina. Director, Fons Mediterrània Capital F.C.R.

I want to address the subject of the impact that the current low integration prevailing in Southern Mediterranean countries has on the market. To do so I am going to take the investor’s perspective. As a private investor, I am always very pragmatic. Every time I see multi-government initiatives I always think that it is going to be difficult to achieve, given the fact that it is already hard to realize it in one country. In the financial industry we are measured by the return on capital employed. In this case, the return on time and effort employed in the short term is very little but hopefully it will be very great in the long term. I can assure you that the Maghreb is one of the least integrated regions in the world, only after North and South Korea. For instance, if I make a transaction between Morocco and Algeria, I have to do it through Spain or Luxemburg. I do not have any explanation for that little integration. It is not so different talking to a Moroccan, an Algerian, a Tunisian or an Egyptian. In fact, there are more cultural similarities between them than between a Spaniard and a German. Inverting this tendency remains a massive task to undertake in the region. The legal environment has become stronger over the last ten years, which is very important for investors.

Besides, the capital markets and stock markets are open and liberalised, which also has a very positive impact on the market. The other side of the coin is that the bond market, which is a very important tool for funding SMEs and large corporations, is very weak; it is almost non-existent, except for the cases of Turkey and Egypt, which are the most developed in that sense. There are very weak institutional local investors, pension funds and insurance companies; they do not actively invest in the local markets. As a result, there is a stock market with a larger scope where Morocco has 75 companies, Tunisia has 57, Turkey has 264 and Egypt has 230. So the market lacks depth. And that depth is linked to liquidity for investors. Then there is private equity, which is also very significant for markets. In a region where less than 3% of trade is between these countries, size is a matter of concern for banks. If we take the whole of the banking industry in just three countries, without considering Egypt, we see that the market concentration of all of them is similar to the BNP in France. Consequently, there is no large dominant bank that could play a role on a global basis. Moroccan banks have worked efficaciously in penetrating Africa, particularly sub-Saharan Africa, but it has not been sufficient. Tunisia is extremely fragmented and there are too many banks that do not allow for a competitive banking advantage in the country.

The same applies to insurance: there are more than 24 insurance companies in a country of 10 million. Algeria is dominated 96% by public banking. Accordingly, we ask ourselves how these three very different banking structures could be united. I do not have the answer but it looks very complex. This leads us to my next point: the need to have more finance in the region. As the lifeblood of the body, companies cannot work without money. But when you try to attract the investors’ money to the region, where is your local money? Where is the Algerian, the Tunisian or the Moroccan money? Today, the Central Bank plays a big role controlling local money invested outside their countries, to be reinvested in their countries, as well as regulating the foreign exchange. Our market, our segment, is mainly driven by hubs of financial excellence like Luxembourg, the UK and several other places, where the investor puts the money into a fund and then invests the fund in the region. Today, for me it is very difficult to bring an Algerian, Tunisian or Moroccan investor to invest 10 to 15 million euros in a fund, which afterwards will be reinvested in the region. So how we can overcome this technicality that would trigger much additional commercial and private money coming to the region? How can we find a way, whenever you have the quality stamp of a big financial institution like the EIB, the EBRD or World Bank to allow us to manage local money to go out of and into the region? I understand that the local regulations for pathway venture capital do not exist, and that is important for the region.

The region has not yet attracted private money to the level it should have. Private banks in the region are not equipped to finance SMEs, which represent 95% of the economy. There is the inability to prepare dossiers for SMEs: namely the lack of capacity that an entrepreneur has to prepare with a bank and to prepare a business plan. By way of illustration, the team in the bank that worked for a large financing of an airport of 150 million will be the same one working for a 3 million loan for small SMEs. As we can see, the cost of the transaction is critical and the teams are not equipped for that. Currently, financing from the banking system is mainly driven by an asset-based company or by the personal wealth and assets of the entrepreneur. All that remains a major barrier to the economic area in the region. I also want to stress that it is not only important that those companies, as SMEs, can become leaders of the local markets but also become international. This is extremely important because that will give them the extra growth that will allow more value to be generated in those companies. The Central Bank plays a big role because it will have to approve or disapprove that investment, which will take six months. The Moroccan Central Bank is one of the fastest, as well as the most flexible, in the region. But even so, the process of investing is slow, as in the financial sector time is money, and we have to be very proactive and very fast in those types of exercises. In some cases, it will be delayed for 12 months given the non-clarity of the transaction from the Central Bank perspective.

The financial institutions can play a big role in articulating a fast track for parity firms or venture capitals that are investing in the region. To conclude, I would like to present my recommendations for the banking union system. First, we should set small goals for that banking union. Second, central banks can and should play a very important role and there should be a higher number of meetings and forums in that regard. The banking system needs to modernise and adapt the internal system and processes to focus on SME financing, which is very difficult but needs to be done. And my last and third recommendation is to allow private banks to invest in regional funds by supporting SME growth and financing their needs, and also creating an informal platform for banks to start the dialogue for this banking union.

Sound Budgetary And Fiscal Policies: A Needed Tool For The Construction Of The Pillars Of The Welfare System

Strategies And Policy Reforms To Improve Social Inclusion And The Welfare System

Mukhallad al Omari. Director of Policies and Strategies Department, Ministry of Planning and International Cooperation, Jordan

The events of the last four years have brought to the forefront the need for social inclusion, a better welfare system and a new social contract. The transitions are defining moments for social welfare systems where key questions are discussed, such as the kind of policies that should be put in place to reduce poverty; how the impact of these policies can be assessed to improve them; what minimum social safety nets need to be implemented in a context of crisis and scarcity; or how to increase the revenues for the state to implement social policies through the broadening of tax fees. In the case of Jordan, in 2012, one of the new strategies implemented was the subsidy policy reform by which the government immediately started to eliminate the subsidies, especially on fuel, and tried a compensation mechanism for the people who deserve compensation, whether they are in the poor category or the vulnerability group, and even in the middle class category, to protect them because of the wider role of the middle class in the economy.

Towards Welfare-enhancing Fiscal Rules: The Case Of Lebanon

Raya Haffar El Hassan. Former Minister of Finance, Lebanon

I regard this particular panel as relevant, first of all, because it is people-centric, so it is nice to think about the human side of issues sometimes, and also because as Lebanon’s former Ministry of Finance one of the key challenges I faced was how to enhance welfare at one point while not increasing budgetary deficits and at the same time trying to maintain a sustainable fiscal position. That was a heavy toll and especially during the pressing social needs that we faced and are still facing even more profoundly than before. This has become a huge policy debate around the globe, especially after the 2008 financial crisis; and even after the worst effects of the crisis have subsided, this has been presented as a central policy debate among emerging and developing countries around the world. Policy advice for the last two decades has mainly focused on maintaining financial and monetary stability, with social issues taking a somewhat secondary role in budget discussions and formulations.

However, even the IMF has reached the conclusion that macroeconomic conditions and the environment obviously have proven not to be enough to work on the crisis or to address the huge social developmental and economic demands of countries. It is no longer unthinkable to talk about increasing public expenditures, especially social expenditures or even investment expenditures, at the expense of increasing fiscal deficits, as long as financial and monetary stability is not jeopardised. It is becoming more mainstream and more acceptable to economies, institutions and policy-makers across the economic ideological spectrum around the world, some of which had thought otherwise. Maybe four or five years ago even the title of the panel would have appeared to have underlying tones of leftist policies. But today everybody is embracing that concept and it is no longer just a certain ideological category that is thinking about the social dimensions of fiscal policy.

I may say that social spending is not important in terms of its magnitude but in terms of the outcomes it yields. From that angle, it is also important for any government to try to translate these social expenditures into specific indicators and objectives and to put them in a certain macroeconomic or medium-term fiscal framework. Otherwise there is a risk of being subjected to heavy political interference; specifically, political interests and changing political agendas. Given the budgetary constraints that most countries face, it has become extremely important to be outcome-oriented when discussing welfare. When talking about spending and fiscal policy in terms of enhancing welfare, we have to talk about the revenue side. As you all know, especially since French economist Thomas Piketty discussed in his book the increasing disparities in income and wealth in developing countries, a lot of economists are calling for increases in taxes, income tax structure, reducing tax expenditure deductions and exemptions, and so forth. More voices than before are now advocating these policies. Simultaneously, more liberal voices are now rebuffing these policies, especially in France and the US. The debate is gaining ground on the type of proper fiscal policy mix to be adopted. I think this discussion will remain in the future. This is a delicate balance that governments have to find between maintaining and enhancing the welfare of their population and maintaining a sustainable fiscal position. To a large extent, this will have to depend on the specificities, the economic and developmental conditions, of each country.

What is good for Lebanon in a crisis situation is not necessarily good for Tunisia, which is on a much more promising path. There are no standard policies or recipes for any of the Mediterranean countries. Each country is going through its own difficulties, crises, and stages of development and, therefore, it is always good for multilateral institutions and policy-makers to take into account the economic conditions of each country. Whatever policy mix policy-makers adopt, it is important not to forget the private sector role in social welfare. It is important, first of all, to delineate between the role of the private sector and the provision of social services. Beyond being just the main engine of growth in our country, the private sector can sometimes also provide a comparative advantage and fair social welfare, so this also has to be taken into account. Decision-makers must adopt an appropriate policy that does not stifle private sector growth while generating enough financial revenues to finance all the social demands of each country. In the case of Lebanon, in the early 1990s the country emerged from a long cycle of violence and faced the huge task of restoring the role of the state, enhancing social services and security, and addressing significant economic and development infrastructure needs. Provided with very limited resources, it ran large fiscal deficits to meet these huge social, fiscal and infrastructure demands. We finally succeeded in building our country and economy, while maintaining financial and monetary stability, albeit at a very high fiscal cost.

However, we failed to realise the full potential of the social benefits that were commensurate with the huge outlays that we undertook to enhance social welfare. The biggest problem was that, in times of growth, especially between 2007 and 2010, even when Lebanon had growth, it failed to balance it and create jobs, and that is shared by all sectors of society. Nowadays, though, this reality has become even direr. Policy formulation in Lebanon has become a very complex mechanism. There is no policy formulation in the sense that it can rationalise expenditure or increase efficiency of the expenditures. The last budget was ratified in 2006. It has been operating for eight years without a budget and without a Parliament that could ratify laws. Lebanon operates on a crisis basis. In addition, the political situation is very complex; the country is polarised. If we talk about social services, we need to place them in a general context. Lebanon faces an influx of one and a half million Syrian refugees versus a country of four and a half million. This is a huge social problem. I do not think any country in the world has tackled such as a burden before. Although Turkey and Jordan have accepted a lot of the refugees and have opened their borders to them, in relative terms the challenge is much harder than that of the rest of the neighbouring countries.

The problem also with regard to the influx of Syrian refugees is that they have received abundant assistance from the international community. It has not proven to be enough but has proven to be a much bigger support than that received by the Lebanese community itself. This has created a lot of social tensions within the Lebanese community because they see that they have opened their arms to receive all these Syrian refugees who have been dispersed through the Lebanese territory without refugee camps, whereas the Lebanese people have not received international assistance in that sense. I do not see how this situation can be resolved. Moreover, there are a lot political ramifications to this situation. One thing that has happened is that the host community has now become much more demanding of social services because of what they see in relation to the Syrians. The government has become more cognisant of these demands and has now started, with the help of the World Bank and other donors, to provide some sort of target assistance to the host communities who are receiving the majority of Syrian refugees. We are now using the mechanism that has been developed by the World Bank, the poverty-targeting mechanism, and hopefully this mechanism, which has been in the process of development for the last four years, is now well conceived for us to identity the people or the portion of the population that is most negatively affected by the impact of Syrian refugees to start granting them some money. Our expectations are very modest. What we want for Lebanon is to maintain a status quo. That may sound a bit defeatist but the challenges are gigantic so the best thing for us to do today is try to maintain some sort of social cohesion, social balance and monetary stability in order for us to be able to sustain the next two or three years at best. Regarding the financial entities in Lebanon, we are now almost 150% of GDP, and in normal circumstances that would have been very difficult to finance with high interest rate costs.

The reverse of the argument is that if there was not the structural relationship between the banks and the treasury our financial and monetary stability would have long been exposed. This is high exposure of the financial sector to sovereign risk, but without the structural relationship whereby the excess liquidity of the financial institutions are used to finance the high treasury needs, the Lebanese lira would probably have depreciated a long time ago. In other words, in normal circumstances that situation would have been detrimental to the growth of Lebanon, with exposure and the crowding out effect in the public sector. But in our case, with the high deterioration and the high deficit, if we did not have these financial institutions financing the high debt, our monetary situation, which is the only thing that is stable, would probably have been long gone. Arab countries have also faced the issue of inclusive and balanced growth. The uprisings over the last four years explain that the root causes were mostly of a social and economic nature. When we talk about social expenditures and social spending, we do not only talk in economic terms because it has political ramifications. So these are the risks I want to highlight: for emerging markets, when the institutional framework is not that strong and there is no real accountability, there is a risk of actually going through the back door of getting very significant fiscal dominance.

Related to that, and a separate point, given that the exploitation is so complex, this credibility is very complex and coherence is becoming an issue for the market participants to understand these various instruments. It is becoming a challenge, even in Turkey. Communication and policy become very important with the market participants because, in the end, if it is very complex this can also complicate the transition mechanism. I would like address the emerging market perspective of this increased complexity and exploitation of central banks, coupled with quantitative easing demands and the institutional quality of emerging markets, and the associated issue of central bank accountability and independence. In emerging markets, naturally, there is a demand for using all the instruments that are available in advanced countries; there is a demand for quantitative easing but the institutional credibility is not there, or not fully there, for central banks to do it in a credible way. And there is no accountability at the same time, constitutionally, only by definition of central banks. In our region we are seeing that some central banks are really going extremely far in using their balance sheet to do de facto fiscal policy. The central bank balance sheets are becoming instruments of further fiscal policy. Finally, unless the economic and social needs of these countries are addressed by the new regimes, through social structures or equitable growth or by providing the social services they need, the political stability will remain in jeopardy.

Strong And Efficient Institutions: The Way To Ensure Welfare

José Luis Escrivá. President, Independent Authority for Fiscal Responsibility (AIReF), Spain

When you examine the empirical and theoretical analysis produced over the last decades, there is overwhelming evidence that sound fiscal policies, fiscal sustainability, is certainly a precondition in order to reinforce the welfare of the population. Strong debt dynamics eventually have huge costs in terms of macroeconomic stability for the population, either in terms of inflation or defaults that imply vast problems for financing the economy or other kinds of financial disturbances, as well as severe welfare consequences. This is extremely painful and detrimental to economic growth. However, the evidence is perhaps not so clear on the level of debt when this happens. In reference to that point, even if unsustainable debt does not have imminent consequences, high debts imply passing the costs to future generations, and this is extremely unfair. On top of that, once a certain level of debt is reached the room for manoeuvre for fiscal policy in order to perform its stabilisation role is very much diminished. Thus, for quite a number of reasons sound fiscal policies are certainly essential. In spite of that, when we examined fiscal performance over the last decades, in the 1960s the deficit and strong debt dynamic was the rule. All OECD countries, except for three, have experienced fiscal deficits four years out of every five years since 1960. There are many reasons for this, and the literature again helps us to understand this propensity towards fiscal deficit. There are informational problems, such as a tendency to be overoptimistic about future growth, which eventually proved to be wrong.

The common pool theory also helps us because it shows that the beneficiaries of public services failed to interiorise the negative externality that they create for others, and this results in a high resistance to losing privileges that come from the fiscal side. Governments do not internalise the cost of debt, as this could be a problem to be re-elected. There are time inconsistency and inflationary biases when fiscal policy is overused. There is even a tendency in economic agents and also policy-makers to be impatient, and this gives rise to time-inconsistent preference. So there are many reasons that give rise to this leaning towards fiscal indiscipline. The Spanish case is a good example of these kinds of problems. In 2007 Spain had a fiscal surplus of 2 percentage points of GDP and a debt ratio of 35% of GDP. Now Spain has a debt ratio 100% of GDP and the fiscal deficit jumped from a surplus of 2% to a deficit of 11% in just two years. As the economist Charles Diplo once said, «debt problems become unnoticed until they become very clearly noticed.» There are so many liabilities that are not so apparent; growth becomes unsustainable and this creates extra revenues. There are so many reasons that explain why the debt may become unsustainable much earlier than you expect. But there are also lessons from the Spanish example. In 2007, and even in 2008 and 2009, the international organisations were recommending that Spain should embark on expansionary fiscal poli cies because they thought that the structural fiscal position in Spain was extremely sound. So that was based on these very simple structural measures, which the European Commission and the European authorities have unfortunately even reinforced after the crisis.

Nevertheless, they were giving wrong policy messages in the mid-2000s and beyond. The lesson that can be drawn from the Spanish example is that you need to go to an all-encompassing analysis looking at contingent liabilities, at sustainable growth or revenues, and move away from simple indicators that are based on estimates that can be revised dramatically. Unfortunately, the framework that is now used in Europe is relying even more than before the crisis on measurements of structural balance position. But in the case of Spain, Ireland or other countries, just the opposite is recommended. The Spanish example also makes it very clear why you should not depend on market discipline. The market has been extremely pro-cyclical. In the period of buoyancy they did not spot any problems or any weaknesses and vulnerabilities and there was an overshooting afterwards that further complicated the problems of financing when the situation was probably not as bad as they expected. Market discipline could help on some occasions but it is not the panacea by any means as an instrument to reinforce fiscal discipline. The Spanish case also shows that you should not overrun fiscal policy with many tasks. The Irish case is as dramatic as the Spanish case, and you should have instruments in place to deal with the banking crisis. You should not use fiscal public money because this actually creates huge problems afterwards. Those who took the risk primarily should assume the debt. If you want to embark on social benefits, they have to be very selective. You should not embark on universal benefits for everyone but target those who really need the subsidies. But huge subsidies that are not supported, that are not sustainable, tend to overrun fiscal policy and, at the end of the day, you simply cannot cope with the result of that. There are so many lessons to be drawn from the Spanish case.

You might believe that you have strong institutions on the fiscal front but when the heat of the crisis comes you realise that your institutions are much weaker than you expected. In the Spanish case, for instance, sub-national, regional and municipal authorities did not have their instruments in place to reinforce fiscal disciplines in the wake of such a crisis and financial turmoil. But we also saw an emergence of an informal economy that also reduced revenues at unexpected levels. In the case of Spain, the ratio of revenues to GDP declined by 6 percentage points in just three years; a fiscal gap that was created between 2008 and 2010. Revenues were gone and the problem was basically that you expected that these revenues were going to stay forever but that the structure and expenditure was very much entrenched. In the end, it has proven extremely difficult to revert. One way to try to reinforce institutions is fiscal rules. There are a growing number of countries relying on fiscal rules. In 1999 there were 7 countries and there are now 80 countries that have introduced fiscal rules in their frameworks. Fiscal rules are helpful: they are the simplest way to establish fiscal discipline when political commitment is not very strong, and are more politically accepted than something coming from the IMF because they can be self-imposed by the elected government. But at the same time it is not easy to deal with them. The stability and growth in Europe is a case in point. How do we enforce them when the rules become binding? Based on the experience in 2003 and 2004 in Germany and France, it weakened the framework a lot.

German authorities were the champions in giving rise to the stability and growth path, as they did in the 90s when the Maastricht Treaty was created. Nevertheless, the first time that Germany had to comply with the rules they declined to do so. Now we have a problem with France and Italy as well. While the rules become binding, the enforcement of the rules is not obvious. In Europe the expected mechanisms were sanctions. The sanctions that are in the Treaty have never been applied, even to Greece. The enforcement in this case came from liquidity, from support in order to finance through mechanisms outside the system. In Spain, with the Spanish regions the stability path contains a number of corrective and coercive measures that have never been applied. In contrast, when you have liquidity constraints and you need financing – this is why the IMF is so effective –, but the enforcement of the rules is by no means easy and the evidence is mixed. At the same time, the rules should be flexible enough to accommodate and foresee contingencies. This is not easy. How much flexibility? How do you measure? It is not obvious, either. Rules are prone to manipulation because they should contain projections, and forward-looking assumptions can be problematic.

The framework is not easy. In spite of that, Spain has also gone in the direction of reinforcing the rule-based framework. First, in 2011, introducing in the Spanish Constitution the balanced budget as a constitutional provision and also the dead brake, and then in 2012 with the organic law on financial stability, which actually contains a fiscal rule-base, which is more stringent than the European framework in many respects. We are also operating under this framework at a European level, after the crisis rules have been reinforced and the framework has also been strengthened. All these measures are trying to reinforce the institutional support in the system. We are now testing, both at a national and European level, the basis of this rule because debt dynamics in Europe are very worrisome. This is becoming a real necessity, quite difficult, because at the same time there is very little growth and the perception of the problems of the sustainability of the debt, with no inflation and prices that are practically flat, becomes very demanding. The Independent Authority for Fiscal Responsibility in Spain was created just a few months ago and it is part of this new institutional framework. In addition to the European framework, institutions are being created at the national level providing national ownership to the enforcement of the rules. I think it is an interesting development, although it is not an easy challenge. There are a growing number of countries introducing these institutions. The congressional budget of the United States is probably the precedent and the Netherlands is another example.

Increasingly over time these fiscal watchdogs are being introduced. These fiscal watchdogs emerge from two dimensions. On the one hand, there is a more Anglo-Saxon approach, which gave rise for instance to the congressional budget of the United States, which basically tried to avoid some of the problems in terms of over-optimism and estimates and analyses coming from their own authorities by giving this responsibility to an independent institution with a medium term of acting completely separate from the electoral cycle and providing projections and estimates. This is a more objective and positive analysis based on the provision of inputs of information for the budgetary process and analysis. On the other hand, there is another dimension underlining these new waves of institutions emerging in Europe that comes primarily from a ruled-based framework. This analysis is no longer positive; it is more normative. Basically, what these institutions are expected to do is enforce compliance with the fiscal rules and try to identify at an early stage risks of non-compliance or budgetary dynamics that may prove inconsistent with fiscal budgetary sustainability. In this respect, it is no longer about just giving positive analysis or input from the analysis of the fiscal process but must come with adjustments about what is going on and have instruments in order to try to exert pressure on the authorities.

Again, being independent, very professional and medium-term oriented should help in performing these tasks. Actually, the time we have in front of us is certainly challenging. As they are new institutions, they have no track record. So in a way you have to build your track record, your reputation, but at the same time you are already expected to perform your function. It is not obvious how to deal with it. You need to be extremely independent. Meanwhile, central banks have already ensured independence on the financial and resources side, because they are banks and they have a lot of resources. This is normally protective and in order to perform their role these institutions need to regain this. Basically, the instrument by which they exert their pressure in literature is what is called the compliance plan. For instance, in the Spanish case, the so-called AIReF institution of the Spanish government (the “Independent Authority of Fiscal Responsibility”) decides the validation of macroeconomic projections. If it does not validate the macroeconomic projections of the government at a certain point in time, the government has to either adhere to its recommendations or change the projections in the budgetary process or, if they do not agree with us, they need to say why in public.

Either you comply with the recommendations of the fiscal authority or you need to explain in public why you do not follow them. This is, at least in Spain, a new thing: it is not in our culture or in our tradition to engage in a public dialogue between an administration, an authority, and the fiscal watchdog, and this must be tested. But this is the way it should work. You have no precedent in the world where you have an independent fiscal authority institution that is binding because basically fiscal policy is the core of sovereignty and the democratic process. You may come out with recommendations on the rules, but going very far is quite difficult. So you need to exert pressure in order to meet the orientation of the fiscal policy in order to alert about early dynamics that may result in deviations. In conclusion, what we have learnt from the European crisis is that you need stronger and more effective institutions, and a rule framework that is also enforceable, although it is not obvious how to do it. It remains to be seen how the new framework works. At the same time, in addition to institutions, which are quite important, you need to increase the sense of awareness of the society and the economic agents about the huge cost of engaging in fiscal dynamics that prove to be unsustainable and create all the problems.

How to convey this message and how to convince the people about the cost of fiscal unsustainability and fiscal disorder remains a challenge in a number of European countries. In some countries, stability- oriented behaviour is very much entrenched, while in other parts of Europe this is still very far away. We should aspire to the same position on inflation. I think now my experience working at least in emerging countries is that 20 years ago it was not so obvious that persistent and volatile inflation was extremely costly for society, for welfare and for the growth of the economy. And now this is very much accepted and we can see that there are few cases in the world where they have these hyperinflations that used to be so common in the past, particularly in emerging countries. But still on the fiscal front, dynamics are very worrisome and the debate in this society has not completely interiorised how important it is to have stable and sustainable economies in our societies.

Towards A Better-Targeted Social Expenditure Policy In The Southern Mediterranean

Dirk Lenaerts. Head of Sector Macro-Financial Assistance, DG Economic and Financial Affairs, European Commission

For more than 30 years now our southern neighbours have shown weak economic growth rates when compared to other emerging markets in developing regions. It is especially disappointing if you look at it in per capita terms, which is of course partly explained by the rapid rates of demographic growth. This also means that the labour market cannot provide enough jobs, resulting in higher unemployment and migration. The economic literature generally concurs in the notion that this inequitable economic performance reflects a combination of structural deficiencies. On the fiscal policy side, in particular, there is the existence of costly and inefficient price subsidy systems, the lack of modern and well-targeted social safety nets, tax systems that yield meagre revenues and are sometimes socially regressive, and oversized states. Other structural deficiencies are shortcomings related to the labour market, the trade and investment framework, the financial sector, and an insufficient degree of economic diversification. Several of the above-mentioned structural deficiencies combined produce a socially inequitable growth model.

The state in the southern EU neighbours is relatively large: the public expenditure in percentage of GDP is quite high but often the bulk of expenditure is spent on categories that are bad in terms of either growth or equity. They go to price subsidy schemes, civil servant wages, and military spending or debt service. Accordingly, the ultimate objective of fiscal reform in the countries of this region should be to generate or to free up the resources necessary to undertake a more ambitious and better-targeted social expenditure policy, while also increasing public investment and reducing budget deficits. This requires both a policy to limit the aforesaid four types of inefficient expenditure but also tax reform in generating fiscal resources in a socially fair manner. It also requires an effort to replace inefficient price subsidy schemes with a modern and well-targeted safety net. Some people may argue that despite the soundness of structural reforms, countries in the region have other concerns, namely geopolitical problems. This should actually not always be the case: there are examples of countries – Jordan, Morocco, Tunisia and more recently also Egypt – that have undertaken quite extensive reforms, notably with respect to price subsidies. For instance, Jordan’s strategy, where they were first overcompensating and then improving the target, provides an interesting case. It increased the social acceptability but still yielded considerable fiscal savings. Once the reform has been in place for some time, the cash transfer programme can be gradually tightened in a careful and well-calibrated way, in parallel with the developments of more sophisticated databases and testing methods. Another example is a crisis instrument that is called «Macro Financial Assistance».

This is an emerging form of financial aid extended by the EU to its partner countries experiencing a balance of payment crisis and it will complement an IMF programme. The idea is that, first, this disbursement will happen quickly and without any conditionality − basically the previous existence of an IMF programme in the country is the only legal conditionality in that respect. Further disbursement will, however, require the implementation of some structural reforms and this has always been agreed jointly with the governments. We have been undertaking around 60 different operations in the past in the EU neighbourhood with a total amount of 8.8 billion euros. Most of these operations are loans, because countries suffering a balance of payment crisis no longer have access to the capital markets. More recently, over the last few years, around 22% of these operations have gone to the Southern Mediterranean. For example, there has been an operation with Jordan where the macro financial assistance provided consisted of a loan of 300 million euros in combination with the IMF and a number of structural reforms that have been identified related to public finance management and tax reform. This aid has, as a result, created a social safety net as well as some more specific issues related to the financial sector, trade and statistics. Another example of macro financial assistance is that of Tunisia, where a loan of 180 million is being implemented and similar reform criteria have been defined. EU policies are supportive of these reforms and this support includes growth and competitiveness.

The priority areas of cooperation, defined as central to the European Neighbourhood Policy (ENP) by each country, become bilateral action plans that are jointly set, and where economic reforms in the short and medium term have been developed. They are being monitored and progress is reported on a yearly basis. The new ENP policy has also put more focus on the more-for-more principle where partners embarking on political reforms should be offered more market access to the EU, more mobility of people and a greater share of EU support. Regarding the banking union in the Arab Maghreb Union (UMA), we are still fighting to improve trade integration between countries of the region. If we compared it to the case of Europe, we first talked about trade integration, then bank integration, followed by monetary union and the euro. It seems to me that we have to make a choice between growth and macroeconomic stability. We can have growth in the short term with macroeconomic stability but in the long term we cannot have sustainable growth with macroeconomic stability. Investors would end up losing trust in the country. I would like to conclude by saying that the EU will continue to support the Southern Mediterranean region in its efforts to modernise its economies so that they also become more socially inclusive.

Moroccan Post-crisis Welfare Model

Abdelhak Allalat. Central Director of National Accounts and responsible for coordinating the work of analysis and economic forecasts, High Commissioner for Planning, Morocco

The Moroccan experience demonstrates what the favourable framework would be for an appropriate welfare system. Budgetary and fiscal policies must create a framework favourable to the promotion of investment and the creation of economic wealth. They must enable an equitable redistribution of the fruits of growth between the different social categories and, of course, they must create a framework for sustainable domestic development. If we have these different aspects theoretically, we can say that we have a welfare system sustainable at a domestic level. This theoretical framework shows that the emerging countries in the Southern Mediterranean as a whole are subject to some constraints: complexity in terms of growth objectives through economic openness and liberalisation; improvement of the living conditions of the population; and, of course, equity objectives between the present and future generations. This must be done with limited resources in a context of a world economy full of uncertainties and in full fluctuation, which means that the equation is very difficult to resolve. Considering the case of Morocco, I would say that Morocco adopted commitments recommended in the 1st Washington Consensus on living standards or the Millennium Development Goals.

Lately, the constraints have become more severe with the recommendations of the Rio de Janeiro Conference on the preservation of the environment. We have tried to respond to these different calls through the budgetary and fiscal policies, as they were the central cores to establish a framework to meet a set of complex objectives. In terms of liberalisation and openness, fiscal policy has responded with a downward readjustment in tariffs at the level of foreign trade, which was enormous, as we have moved from 45% of customs taxes to 35% at present, globally. Morocco has tried to enhance household purchasing power and the capacity of self-finance of enterprises through downward readjustments of direct taxes. Moreover, it has tried to support the domestic demand through salary increases, whether at the level of civil servants or the private sector, and have tried to absorb the shock of the increased cost of raw materials at an international level through huge subsidies. Finally, and most importantly, it has tried to respond to the need of investors and the domestic need of the social sectors through substantial investments in the economic and social structures. All this has been done in partnership with the private sector. The social sectors have had particular importance because we were well aware that to meet the objective of equitable redistribution of the fruits of growth means that we must endow the available human resources with the capacity and skills to participate in the production process and take advantage of the distribution of added value. All this has created constraints.

Additionally, the objectives have been achieved but not at the level envisaged. The investment rate in Morocco today, which was around 20%-23% before the year 2000, amounts to almost 34%. This means that, without taking into account China, Morocco’s investment rate is among the highest in the world. Nonetheless, it is an investment that is made to a great extent in economic and social infrastructures and construction. In the second place, we have reached an economic growth that breaks with the past, but not at the level of the objectives. Therefore, it is a growth that has been reduced in relation to the past by 1.5 at an annual average but we had potential growth objectives of 7-8%. These are activities that create revenues but low-qualified mass employment. Therefore, they have created revenues for a category of population that I would call poor or modest that improves their standard of living. Thus, it is acknowledged that poverty is reduced but inequalities remain almost at the same level. This context has enabled an improvement in household consumption, with figures at an annual 4% or 5%, but this has created a constraint for the decision- makers. With the effects of the international economic and financial crisis, which has impacted on Morocco as it has had on other countries, there was a reduction of the demand. It has had an immediate impact on exports but the increase of domestic demand, whether at the level of investment or at the level of consumption, has resulted in a multiplying effect at the level of imports and, of course, a structural deficit of the trade balance.

This shows that, at present, if the fiscal policy by itself enables a response to some objectives, it cannot be sustainable in the long term without the management of development within a more global framework. That means that it must request the optimal allocation of resources in terms of investment. Industry must usually be carried out around the potentialities that exist in the southern countries, whether at the level of agriculture, mining resources or energy resources, to create what is called an iterative development. That is, if we move away from the economic and social reality in the country, it is very difficult for our capacity of competitiveness to respond to this situation at an international level. What is required at present is a global investment and management in a framework of partnership with effective involvement of the private sector. In the case of private partnership, in terms of contracts, the Moroccan experience offers many lessons in terms of social dialogue and change of management approach because the state has further disengaged and must therefore ensure a regulatory approach to the market mechanisms so that the development goals are applied in a framework of agreed sharing and management at the level of the economic actors. There are three scenarios proposed for the Moroccan economy. In 2007 we conducted a survey in Morocco at the level of the Haut Commissariat for Planning on Economic Growth and Human Development. The first scenario suggested that the Moroccan economy would be exhausted if there were no effective involvement of the development actors, notably the private sector, in this process. We identified a second scenario in which Morocco could undertake strong growth based on a priority of economic efficiency.

It was possible to enhance the intensification of the capital through technological content but it had to be accompanied by a concentration of wealth, and a slash in unemployment, poverty and inequality. Finally, the third and most favourable scenario, which forms the Morocco dynamics, was the scenario of the convergence in which there was a shared management in terms of development. We noticed in this scenario that Morocco could have a gradual growth or improvement with fewer deficits at the social level, in terms of reduction of poverty or reduction of inequality. Unfortunately, with the crisis, we have been forced to revisit that scenario. In 2010, the Moroccan government conducted another survey on economic sustainability. We stopped seeing just the macroeconomic side with an expansive budgetary policy because the state always had the will to absorb liabilities in terms of social deficit, education, health, and economic and social infrastructures. This expansive policy has created more pressure on the state budget. Among these factors, which are the consequence of this external instability, we addressed the increase in the price of raw materials and the increase in the cost of money in relation to the 1990s and 2000s. Indeed, against the backdrop of the international economic and financial crisis and the sovereign debt crisis in several countries, the cost of money began to rise. We have realised that these two aspects alone, namely the increase in the price of raw materials and in the cost of money, would increase the deficit by 80 in relation to GDP.

There was a last scenario, which we have used as a basis to clarify the choice of policy-makers, related to how the involvement of private sectors could improve the promotion of exports and local Moroccan productivity, and we could achieve a better growth with deficits that could be maintained. If we analyse the current policy in Morocco, the third scenario is the best one because we had prepared it to balance the decision-making. I think that at present there is a set of partnerships and sectorial development strategies. In each strategy there are public and private partnerships, and the private one is very present. Even with the crisis, Moroccan exports are increasing in new sectors, such as the car sector and aeronautics. What we propose at present is industrialisation: in Morocco today we have moved from industrial emergence to industrial diversification. The objective is to create an industry around some of our main sectors, such as agriculture and others. This could absorb the unemployment mainly through better qualifications, something that already exists, and this would enable a gradual share of growth.

Thus, with the reforms that are already underway at the level of compensation and pensions, there is a will to ensure the convergence of sectorial programmes and policies. I think that the third scenario, whether for 2007, 2011 or 2015, is the one currently implemented. The state by itself cannot respond to all the development issues and the participation of the private sector is needed. It is a condition sine qua non. To conclude, the mobilisation of fiscal and monetary policy for a welfare state is necessary but not enough. It must be framed within a more global approach and an agreed approach which tackles divisions in the long term. This must be agreed on and based on a framework in which the development actors could take part in the operational implementation of development programmes.

The Importance Of Sound Budgetary And Fiscal Policies To Sustain Growth

Fatih Özatay. Director, TEPAV Finance Institute, Turkey

Something unimaginable in the past happened after the collapse of Lehman Brothers. The response to job losses of most emerging markets economies was to ease their fiscal policy. For example, in G20 each emerging market economy announced various fiscal stimulus measures in late 2009. However, six of these emerging market economies had similar output losses, and job losses in the 1990s or early 2000s. 2009 was different, in the past they had to tighten fiscal and monetary policies but in late 2008 to the end of 2009 they implemented counter-cyclical policies. The main reason for that was that in the episodes of 2008-2009 these countries had room for manoeuvre as opposed to the episodes in the past. Their public debt and budgetary deficit were much lower in 2009 compared to the episodes before the crisis.

The first positive outcome of sound budgetary and fiscal policies is that you can take counter-cyclical measures when needed. So you graduate to counter-cyclical to lead. Some budgetary and fiscal policies also provide more space for automatic stabilisers, like unemployment benefits, and also give room for manoeuvring and for allocating resources to social expenditures. Some budgetary and fiscal policies remove fiscal dominance and set the stage for a sound monetary policy as well. Lax fiscal policies lead to build up of public debt and set the stage for fiscal dominance. High public debt, if widely conceived as unsustainable, leads to increased risk perception, loss of confidence and increased demand for foreign currency denominated assets in most of the emerging market economies. Under these conditions, implementing monetary policy becomes rather difficult. Suppose the Central Bank increases its growth rate to curb inflation pressures in such countries: if such a move of the Central Bank increases concerns about their sustainable debt due to possible rising public sector borrowing rates rather than decreasing inflation expectations it could backfire. It could backfire in the sense that confidence could decrease, risk perception could increase, currency could depreciate and, under such circumstances, inflation could further rise. This is one of the reasons behind fiscal austerity proposals.

Not that the pros and cons of fiscal austerity or fiscal accommodation are not independent of sustainable concerns and associated risk perceptions. In a country in which the real interest rate is very low and if there is no risk perception arising from public debt, fiscal austerity could in this short run be unnecessary. However, in a country with high risk perception arising from public debt sustainable to issues, fiscal austerity could be supported by real economic activity by increasing confidence in the short run. Some budgetary and fiscal policies are also essential for a sound and pro-growth financial sector. Financing the needs of the government should not crowd out the private sector, and highest premium and high interest rates could jeopardise financial stability as well. However, this relationship is not one way. Problems in the financial sector could become the problems of the public sector overnight. In relation to that, fiscal policy soundness cannot be analysed in isolation to the soundness of the financial sector. One example of this is the 2001 crisis in Turkey. Due to the collapse of the banking sector and the strengthening programme of the banking sector, public debt to GDP ratio jumped from 70% to 105%. This immediately led to debt and real interest rates jumped to 20% or 25% in that environment. This is why the Central Bank of Turkey at that time introduced interested inflation targeting like Morocco and only achieved it in early 2006. From the market economy perspective, this is the importance of sound budgetary and fiscal policies.

Closing Remarks

Achievements And Challenges Of The Euro-mediterranean Partnership

Senén Florensa. Executive President, European Institute of the Mediterranean

In the Euro-Mediterranean Partnership in which we have been working for the last 20 years we have tackled many different issues: how to work together towards these final goals that we are establishing, which were mainly geopolitical in the first basket of the Barcelona Process, or shared economic progress in the sense of building free trade areas and the modernisation of the economic institutions in different countries. That would be achieved through the different facilities that were established a long time ago or through civil society participation, intercultural exchanges and so on. Not much has been achieved on the kind of exercise we have conducted today: exchange and dialogue on issues such as macroeconomic stability or monetary policy. We thought there was room for that, especially because it has been clear in most of the presentations that macroeconomic stability and sound monetary policies are necessary ingredients for long-term growth and social progress.

We agreed with the Governor of the Bank of Spain that it would be good to bring together this community of people as it exists in other geographical areas. This is the normal talk among countries in the OECD but in the Euro-Mediterranean area this does not happen much. So we thought it would be good to invite people from this field from all countries in the Euro-Mediterranean area and start talking about these issues and try to help this very critical moment in which very hard and delicate choices have to be made between contradictory goals, such as choosing whether to preserve macroeconomic stability or making a greater effort in the social field. In reference to that, I refer to Mr Ahmed Galal’s words: «the necessities of the reality in the political field and the political necessities impose themselves in the end.» We need to have flexibility to keep the necessary macroeconomic stability while being able to bring about the necessary reforms in many different aspects of the economic and social institutions in different countries and to have inclusive growth and an inclusive process. The Union for the Mediterranean is somehow the voice of the conscience of Euromed policies, not only to promote certain projects in infrastructures or in other areas, but also to keep the flame of the main goals established in the final declaration of the Barcelona Conference in 1995.

The Regional Dimension Of The Euro-mediterranean Partnership: Strengthening Cooperation In The Region

Fathallah Sijilmassi. Secretary General of the Secretariat of the Union for the Mediterranean

My closing remarks will focus on the regional dimension of the Euro-Mediterranean Partnership. It is not surprising because this is the first mission of the Union for the Mediterranean: to try to promote regional cooperation and integration together with other organisations. I am doing this from my personal conviction because I always introduce myself to the world with the three Ms of identity: Moroccan, Maghrebian and Mediterranean; because I firmly believe in regional integration. Therefore, I would like to share with you some reflections on this regional dimension that is at the core of our objectives, our concerns and, of course, our identity. When we talk about the issue of regional integration, and it is often approached from different angles, we often quantify it from the angle of the volume of trade exchanges, from which a certain number of statistics and figures are produced. Notably, I can refer by means of an illustration to a survey recently conducted by the UfM, according to which if we consider the countries of the Union for the Mediterranean as an economic block, 90% of exchanges take place within the European Union, which is an intuitive result, 9% take place between the north and south of the Mediterranean, and only 1% between Southern Mediterranean countries.

All this has been quantified from the perspective of trading exchanges. In relation to the existing unanimity around the table about the need to promote investments, SMEs, exports and many other factors, the aim is to give more substance to these trade exchanges, which must normally result in exports and finally result in one of the strengths of Europe: to be able to have 90% of exchanges within this European Union and, of course, with the dynamics that are by definition gradual. We are now approaching the 20th anniversary of the Barcelona Process this November 2015. So we have the right to wonder whether we are globally on a path of convergence or divergence. If we look at the figures, they are rather cold. Obviously, the unanimous political will is, as has been affirmed and reaffirmed, the logic of convergence. The figures are a little more complicated to decipher, to put it diplomatically, and would enable us to be a little more ambitious about the next 20 years if we do not want our successors in 20 years to look at 2015 and say there has been no progress since. One way to analyse the difficulties for regional integration is the connection of all trading policies that could be implemented and all the decisions at a commercial level, such as the fact of reducing customs taxes.

Reducing customs taxes has never been and should never be conceived as an isolated element because trading exchanges, if we want them to have a result in statistical terms and have repercussions, must be linked to a certain number of parameters, particularly monetary parameters. When the new president of the European Commission announces a plan of 300 billion euros to reinvigorate investment, it is not possible to unlink this path of relaunching investment, of growth, without having this division with the south, where by definition the economies are linked with such intensity. We cannot unlink monetary policies from trading policies and, of course, it is well-known that sometimes competitiveness is often linked to monetary fluctuations, which have an impact. Consequently, you can reduce the tariffs but if you ever have actions on currency there can be diversely appreciable impacts. The same applies to competitiveness policy, and you have talked of sectorial economies in Morocco. I think it is also important to have sectorial divisions because there are sectors that are more sensitive to variables where it is important to add this political relationship. As for unemployment, I think we cannot dissociate employment and trading policies. I do not know how many parameters there are to really try to connect the complete evolution of trading economy to employment policies. I think that today we are well aware of the challenges in the region– and by saying region, I am not only referring to the Southern Mediterranean. We cannot dissociate the growth rate from the fundamental notion of territorial balance at the level of social redistribution. I think that what has happened in certain countries of the Southern Mediterranean is striking because they have taken place when the growth rate was high. In conclusion, I would like to share two points with you.

The first one is the need to be able to coordinate the actions in the Euro-Mediterranean region. All indicators exist to reinforce this trend, and you and the institutions you represent are also fundamental actors in this respect. We are now facing a paradox as many international financial institutions are focusing their support in our region, but it is important to further coordinate the action. In October 2014 I participated in a meeting chaired by Commissioner Stefan Füle of the European Commission, who brought together around him all the financial institutions of the international scene, whether international, European or from the Gulf countries. Everybody said we are doing a lot but we need to do more and this «more» is not only quantitative but also lies in this capacity to coordinate the action and try to direct it towards more tangible results in the field; in fact, to contribute an added value at the level of social balances, territorial balances, growth, competiveness and, finally, regional integration. But this also means, for everyone, and I think this is the beauty of the action in front of us, defining priorities. In early September 2014 in Tunis, a conference took place where the Tunisian government – on a multi-party basis in which everybody has signed to ensure the sustainability of the process – identified their priorities, in terms of projects, sectors and actions. I think the good approach is that of enhancing priorities in order to channel them towards all the efforts of international coordination. We should all make these priorities also regional, so that we move towards this convergence to which I referred before.

From this point of view, when we speak of coordination, we can also use all the institutions that have the capacity to mobilise networks. I think of the MED Confederation, a network of savings banks, who said they are in over liquidity and seek profitable investments to invest it. I believe the saving banks networks and the MED Confederation are extremely interesting in order to channel a certain number of actions and orient them towards concrete results in the field. The more we advance under the pressure of economic complexities, we must know how to integrate them as much as to manage them, and the title of the session includes the word «uncertainties», which I believe are structural. But when we have these complex environments, we must consolidate the conventional approach, but also favour new innovate and creative ones. Innovative actions include, first, further integration into our region of an issue widely mentioned, the notion of Public Private Partnership, for instance, by financing projects through popular participation; and, second, thinking about the potential opportunities for the region of Sub-Saharan Africa. I am very aware of the difficulties of the region but it is a region of opportunities as well as possibilities. This feeling of what is possible exists and it is up to us to reverse the reasoning and invest in a way that the figures accompany our political will and our objectives.