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Remarks by Dr Kamau Thugge, Governor of the Central Bank of Kenya, at the Launch of the Chora Plan Financial Literacy Campaign, Nairobi, 11 June 2024.
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Kamau Thugge: Launch of the Chora Plan Financial Literacy Campaign Remarks by Dr Kamau Thugge, Governor of the Central Bank of Kenya, at the Launch of the Chora Plan Financial Literacy Campaign, Nairobi, 11 June 2024. *** Mr. John Gachora, Chairman, Kenya Bankers Association (KBA) Mr. Raymond Molenje, Acting Chief Executive Officer (CEO), KBA; CEOs herepresent; Distinguished Guests; Ladies and Gentlemen: Good Morning! I am pleased to be here at the launch of the Chora Plan Financial Literacy Campaign. Let me express my gratitude to the Kenya Bankers Association (KBA) for the invite and organizing this launch event. I note that the campaign themed Claim Your Financial Freedom is designed to empower individuals and businesses in the economy with knowledge and skills necessary to make informed financial decisions on banking, insurance and pension services. I am also informed that today's launch will pave the way for a month-long sensitization drive focusing on building a saving culture and financial planning. This will in turn enhance the financial health of businesses and households. Before delving into the theme of today, let me briefly set the context in which we meet this morning. Globally, growth has continued to recover, while inflation has moderated but has continued to be sticky downward in advanced economies. This generally positive global outlook is subject to downside risks, mainly from a potential escalation of geopolitical tensions and if interest rates remain higher for longer to fight the sticky inflation rates in advanced economies. Domestically, we have experienced relative macroeconomic stability this year with inflation oscillating at around 5.0 percent in April and May, which is the mid point target range of the Central Bank of Kenya (CBK). The foreign exchange market has also stabilized, and the shilling is one of the best (if not the best) perfoming currencies this year vis-Ã -vis the major currencies. On the growth front, the recently released Economic Survey 2024, shows that the Kenyan economy recorded strong growth in 2023 of 5.6 percent, driven by the rebound of the agriculture sector and robust performance of the services sector including the finance and insurance sector. While the recent flooding in parts of the country, caused considerable damage to lives and livelihoods, the economy is expected to remain strong in 2024. This will be supported by the resilient services sector, continued robust performance of agriculture and implementation of government reforms targeting priority sectors under the BETA. 1/3 BIS - Central bankers' speeches Turning back to our theme for today, the finance and insurance sector continues to be one of the key services sector driving Kenya's economic growth. But much more can be done to expand the sector and further catalyse our country's growth. As you can appreciate, the finance and insurance sector is indeed the engine of the economy given its pivotal role in financing all the other sectors, and therefore, financial inclusion is critical for sustained and inclusive economic growth. In this context, I am glad to note that access to financial services has expanded three fold from 26 percent in 2006 to 83 percent in 2021, based on the 2021 FinAccess Household Survey (the Survey). We are currently in the process of updating the FinAccess Survey and look forward to the updated results later this year. The FinAccess Survey of 2021 revealed that while progress had been made on the financial access dimension with 83 percent of adults accessing financial services, much more remained to be done on the usage, quality and impact/welfare dimensions. This morning, I will focus on the impact/welfare component which refers to financial health. Ultimately financial services and products have to impact on the livelihoods of those using them, thus the criticality of financial health. The 2021 Survey employed a framework of financial health constructed from a composite index of three main life goals:Ability to manage day-to-day needs. Ability to cope with shocks. Ability to invest in future goals. The aim of the Survey was to determine the outcome of financial inclusion in terms of the resilience of the Kenyan population and its potential for growth. The results of the Survey indicated that the financial health of respondents deteriorated to 17.1 percent in 2021, compared to 21.7 percent in 2019, and 39% in 2016. This implies that only 17.1 percent of the respondents could adequately and comfortably meet their day-to-day needs, cope with shocks and had the ability to invest in future goals like saving for old age. The main driver of this deterioration was the inability to cope with shocks and challenges in managing their day-to-day needs. This deterioration was amplified by the COVID-19 pandemic that was at its height in 2020/2021. The timing of this financial literacy campaign that you are about to launch today, is therefore apt as we seek to enhance the financial health of our citizentry and businesses. Allow me therefore to highlight three broad areas that we can reflect on as we launch this campaign. First, is customer centricity. I am pleased with the participation of a diverse set of financial sector players including banks, insurance companies, microfinance banks, mortgage refinance companies and payment service providers. It is imperative that the products and services we provide cater for the needs of customers. In particular, they should cater for their day-to-day needs, enable them to cope with shocks and provide them with the ability to invest in future goals. These will entail financial products and services ranging from transaction and savings accounts, micro-credit, micro-insurance 2/3 BIS - Central bankers' speeches to micro-pensions. My challenge therefore is to financial institutions to truly reflect on whether their products and services meet the financial health needs particularly of Kenyans at the bottom of the pyramid. Second is confidence by customers in financial services. There continues to be a high number of complaints from consumers on the high cost of financial services, unsatisfactory customer services, poor customer experience and lack of transparency and disclosure. This coupled with the growing fraud incidences with increased digitalization are eroding confidence in the financial sector. It is imperative that financial service providers rationalize their costs, enhance customer service and experience and scale up transparency and dislosure of their terms and conditions. Additionally, raising awareness amongst customers on emerging forms of fraud including social engineering and identity theft is imperative. Third is sustainability of initiatives such as the one we are launching this morning. Often times, campaigns such as this last for a given duration of time, and thereafter become dormant. Subsequently, the impact of such measures is not discernible in the medium to long term. I am pleased to note that today we have stakeholders from the financial services sector, consumer organizations and persons with disabilities. I trust that the partnerships forged today will lead to a more sustainable partnership beyond the one month duration of the campaign. The Central Bank would be keen to engage with the stakeholders here today on how we can create a sustainable framework to co-ordinate financial literacy efforts on an ongoing basis. As I draw to a close, let me reiterate that this campaign is an important plank in Kenya's quest to build on the financial health of its citizentry. Let us build on this to move forward the financial inclusion frontier as a pathway to shared prosperity for all Kenyans. Thank You! 3/3 BIS - Central bankers' speeches
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Acceptance speech by Dr Kamau Thugge, Governor of the Central Bank of Kenya, at the African Bankers Awards 2024, Nairobi, 28 May 2024.
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Kamau Thugge: Acceptance speech - African Bankers Awards 2024 Acceptance speech by Dr Kamau Thugge, Governor of the Central Bank of Kenya, at the African Bankers Awards 2024, Nairobi, 28 May 2024. *** As prepared for delivery Excellencies Distinguished Guests Ladies and Gentlemen Good evening. I am very pleased to join you on this auspicious occasion of the African Banker Awards, 2024. I greatly appreciate the invitation to this important event, and I am humbled and honoured to be awarded the African Central Bank Governor of the Year Award. The Award reflects the efforts of the Board, Monetary Policy Committee, the Management, and staff of the Central Bank of Kenya (CBK), to whom I am grateful. Tonight's recognition affirms Kenya's sound macroeconomic policies, for which I thank His Excellency the President, Dr. William Samoei Ruto, for providing overall leadership. I also greatly appreciate the institutions we have walked the journey with including the National Treasury, the President's Council of Economic Advisors, my banking sector colleagues, and our development partners. When I was appointed CBK Governor in June 2023, the Kenyan economy was reeling from shocks such as a surge in global energy and food prices, and climate factors that were exerting upward pressure on food prices. Currencies in emerging and developing economies were on a free fall, due to the monetary policy tightening in advanced economies. Capping all this, was our dysfunctional interbank foreign exchange market, with low liquidity and significant foreign payments backlog, which led to low investor confidence, especially for foreign investors. As a result of these shocks, our overall inflation rose sharply to peak at 9.6 percent in October 2022, and remained elevated at around 8.0 percent through May 2023. The shilling also depreciated rapidly, exerting upward pressure on domestic prices, and contributing to a significant increase in the Kenya shilling value of foreign currency denominated debt and debt service. My priority, therefore, was to address the inflationary pressures and the rapid depreciation of the Kenya Shilling. I convened my first Monetary Policy Committee (MPC) Meeting on June 26, 2023, one week after my appointment as CBK Governor, and The Committee agreed to raise the Central Bank Rate (CBR) by 100 basis pointsthe highest single rate increase since July 2015. This was followed by another sharp rate increase in December 2023 of 200 basis points, and a further 50 basis points in February 2024, thereby raising the CBR cumulatively by 350 basis points to 13.00 percent. This tight monetary policy stance continues to anchor inflationary expectations and addressing any residual exchange rate pressures. 1/3 BIS - Central bankers' speeches In addition to tightening monetary policy to anchor macroeconomic stability, we immediately embarked on several other key reforms including: (i) Introducing a new monetary policy framework based on inflation targeting in order to enhance monetary policy transmission. (ii) Introducing the Kenya Foreign Exchange code for commercial banks, aimed at strengthening and promoting the integrity and effective functioning of the wholesale foreign exchange (FX) market. (iii) Introducing the Electronic Matching Systems (EMS) in the interbank forex market in August 2023 to promote a transparent and accountable price discovery mechanism and ensure visibility to all market participants; and (iv) Unifying the parallel exchange rates whereby the CBK was quoting a different exchange rate from that quoted by commercial banks. We now have a single rate which is based on actual transactions in the interbank forex market. The CBK has also introduced a state of the art Financial Market Infrastructure, the Dhow Central Securities Depository (DhowCSD), which was launched by His Excellency President William Ruto, on September 11, 2023. The system has transformed Kenya's financial markets through enhanced operational efficiency and expansion of digital access, market deepening for broader financial inclusion, and improved monetary policy operations. It has improved domestic and foreign investor access to the Kenyan capital market, by providing a simple, secure and efficient process for Diaspora Kenyans to invest in government securities, wherever they maybe globally. The DhowCSD platform has been named the winner of "Central Banking's Payments and Market Infrastructure Initiative Award", by Central Banking Publications. The award recognizes the critical role DhowCSD has played in improving the financial markets infrastructure in Kenya. In line with the Government's focus on "Hustlers" and ensuring no-one is left behind, the CBK intends to leverage the DhowCSD to introduce a retail bond for low-income investors, known as M-Akiba. We expect low-income investors to invest as low as US$ 5 in government securities through M-Akiba-thereby democratizing investing in Government Securities. Turning to financial stability, Kenya's banking sector remains sound and stable, with adequate capital and liquidity buffers. Taking cognizance of the existential threat of climate change and working together with our development partners including the International Monetary Fund and the European Investment Bank, we have embarked on our vision of greening the banking sector. Towards this end we have issued the draft Kenya Green Finance Taxonomy (KGFT) for public consultation. The KGFT will serve as a reference for Kenya's transition to being a green economy. On the payments system front, Kenya has continued to be a global leader in digital financial services with an elaborate ecosystem. This has greatly expanded access to financial services in Kenya from 26 percent in 2006 to 83 percent in 2021. The Kenyan economy has also become more cash lite due to the advent of mobile money payments, with currency in circulation as percentage of GDP standing at 2.1 percent in 2/3 BIS - Central bankers' speeches 2023, way below other countries. In the past year have licensed additional Payment Service Providers (PSPs) and Digital Credit Providers (DCPs) to provide additional choice and access to Kenyans. On cross border payments, the CBK continues to support the East African Payments System (EAPS) and the Pan-African Payments and Settlement System (PAPSS). Accordingly, CBK signed an Agreement with Afreximbank to enable Kenyan financial institutions to join PAPSS, which will enable them to participate in the continental payment system to spur intra-Africa trade. Overall, the various measures I have highlighted tonight have contributed significantly to restoring macroeconomic stability. Overall inflation rate eased to CBK's target of 5.0 percent in April 2024 compared to 8.0 percent in May 2023. This is the lowest overall inflation since October 2020, 43 months ago. In addition, the Shilling has appreciated by 17% against the U.S. dollar since the beginning of 2024, making it the best performing currency globally, against major currencies. The appreciation has led to huge savings in debt service and reduced debt stock in Kenya shillings-our shilling denominated debt declined by around 6 percent of GDP within a period of weeks. As I conclude, CBK will continue to build on these gains and reforms to safeguard macroeconomic and financial stability and support the Government's economic growth objective. With improved investor confidence and sustained macro-stability, we expect the economy to remain strong in 2024, with growth projected at about 5.7 percent, supported by agriculture, resilience of the services sector, and implementation of Government measures to boost economic activity across priority sectors in line with the Bottom-up Economic Transformation Agenda (BETA). This projected growth is well above the global average of 3.2% and that of SSA at 3.8%. On this note Ladies and Gentlemen, and with humility and profound gratitude, I accept this award. Thank You. 3/3 BIS - Central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the opening of the meeting of the National Bank of Ukraine with stakeholders, Kiev, 16 January 2019.
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Yakiv Smolii: The National Bank of Ukraine's key achievements in 2018 and action plan for 2019 Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the opening of the meeting of the National Bank of Ukraine with stakeholders, Kiev, 16 January 2019. * * * Dear Colleagues, I am pleased to welcome you, our partners and clients, those for whom we work, those whom we regulate, and those with whom we cooperate, here in the National Bank of Ukraine. Our policy is built on dialogue, which lays the foundation of our success as a central bank. Low and stable inflation, reliable, transparent, and sound banking system, developed financial markets, an investment climate that favors economic growth and widens the international horizon – all of these are our objectives. That is why it is important for us not only to be heard, but also to receive feedback from our stakeholders. Today, we will summarize the economic and financial results of 2018, share the NBU’s action plan for 2019, determine the main challenges for the Ukrainian economy, and discuss the development potential of the economy and the financial system. The year 2018 was marked by a recovery of macrofinancial stability to the level seen before the annexation of Crimea and the Donbas conflict. Last year was a year of many peaks and records. In 2018, the economy of Ukraine demonstrated the most rapid growth in the past seven years. Real GDP grew 2.8% over three quarters and the full-year economic growth was 3.4% according to the NBU forecast. Despite having exceeded the NBU target, year-end inflation returned to the downward trend and has declined to a single-digit value for the first time over five years, coming in at 9.8%. As a result, today we see: lower underlying inflationary pressures on the economy of Ukraine a more comfortable business environment and an increase in household savings inflation gradually approaching our medium-term target of 5%. This is primarily the result of the NBU’s tight monetary policy. The gradual increase in the key policy rate began in October 2017 prompted by heightened inflation risks. In 2018, we raised the key policy rate four times, by a total of 3.5 pp to the current level of 18.0% per annum, in order to bring inflation down to the target over the medium term. This pushed up deposit interest rates, thus making savings more attractive. Thanks to the tight monetary policy as well as the benign global price environment for Ukrainian exports in the first half of the year, and the record harvest of grain crops in the second half of 2018, the hryvnia strengthened by 1.4% over the year. This is the sign of stabilization in the foreign exchange market of Ukraine. At the same time, Ukrainians now trust the NBU’s ability to smooth out excessive market fluctuations. This is proven by the fact that even Russian aggression in the Kerch Strait and the imposition of the 1/3 BIS central bankers' speeches martial law have not caused any major panic on the foreign exchange market. We highlighted developments on the foreing exchange market and continued to be active in the market, thus preventing panic among market participants and households. The stronger hryvnia allowed the NBU to increase international reserves throughout the year by purchasing foreign currency on the interbank market. External financing became another source: Ukraine received a new program of cooperation with the IMF, which lays the groundwork for further strengthening of macrofinancial stability. As a result, USD 2.4 billion was added to the reserves by international partners (the IMF, the EU and the World Bank). The resulting amount of international reserves is the highest in five years, at USD 20.8 billion. The last time we saw such figures was in the fall of 2013. The financial sector is showing good performance as well. The banking system is not only resilient, capitalized, and transparent, but also profitable – for the first time in five years. Consumer confidence in the banking system is on the rise. Hryvnia household deposits increased 15% last year. Banks are finally doing more lending, with hryvnia household loans up 31% last year. In addition, we can currently talk about a certain recovery in corporate lending. Our priorities in achieving these results were identified by the NBU’s Medium-Term Strategy. Approved and unveiled in the spring of 2018, the Strategy identifies seven key goals of the NBU: 1. Low and stable inflation. 2. Stable, transparent, and effective banking system. 3. Resumption of lending. 4. Effective regulation of the financial sector. 5. Free flow of capital. 6. Financial inclusion. 7. Modern, open, independent, and effective central bank. The NBU’s activities aimed at achieving these goals were what made possible the comforting highs and record-high figures of 2018. We will continue to work to ensure price and financial stability as a foundation for sustainable economic growth. We begin the year 2019 with a revolutionary currency liberalization the likes of which Ukraine has never seen. In less than a month, the Law On Currency and Currency Operations and our new currency regulation will go into effect, significantly easing currency transactions for households and businesses. The new legislation is going to actually work in practice rather than remaining just words on paper. But with extended freedom comes extended responsibility. The more liberal the conditions that financial market participants, businesses, and households enjoy, the more attention we at the NBU have to pay to financial stability. 2/3 BIS central bankers' speeches Thus, we should devote the current year to the next important step without which no financial stability is possible within either the banking sector or the entire financial system. And by this I mean the “split,” which is something that stands to shape the future of the nonbank financial sector. It is not for nothing that the planned adoption of the bill on the “split” by the Rada has become one of the structural milestones in the new program of cooperation between Ukraine and the IMF as a prerequisite for strengthening the financial sector. The new law will bring the nonbank financial market in alignment with European standards, enhance the quality of financial companies’ operation, protect financial service consumers, and encourage the arrival of new international players in this market by creating the right conditions. In addition, 2019 should become an important year for a further recovery in lending. Despite the progress made over the past two years, banks have yet to become fully operational, especially as regards working with large corporate borrowers and making mortgage loans to households. A more active recovery in lending is currently impeded by the high level of nonperforming loans. The market is waiting for the Verkhovna Rada to consider and adopt a bill on asset resolution activities that has been prepared by the EBRD. The new law will pave the way for the operation of asset resolution companies and ensure the creation of an adequate competitive environment in Ukraine’s secondary market for loans. In addition, significant institutional risks are still there, and the reform of the judiciary is still pending implementation. Completion of the reform would ensure the strict observance of laws and protection of creditor rights. It goes without saying that we cannot, on our own, travel all the way to a sustainable economy and a developed and stable financial system. Doing so requires that the NBU operate in conjunction with you: banks, businesses, government agencies, the expert community, and the media. We can now talk about the challenges that lie ahead and how we can best meet them – in a joint effort. I wish you an interesting and fruitful discussion! 3/3 BIS central bankers' speeches
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Speech by Ms Kateryna Rozhkova, Acting Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kiev, 31 January 2019.
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Kateryna Rozhkova: National Bank of Ukraine press briefing – monetary policy statement Speech by Ms Kateryna Rozhkova, Acting Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kiev, 31 January 2019. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to keep its key policy rate at 18.0% per annum. The rate was maintained at the same level in order to drive inflation down to the target of 5% in 2020. First, let us summarize the inflation development in 2018: Last year, consumer price inflation declined to a five-year low of 9.8% (versus 13.7% in 2017). The reversal of the trend after the rise in inflation in 2017 is primarily due to the NBU’s tight monetary policy. The series of interest rate hikes that started in October 2017 increased the attractiveness of saving. Moreover, the tight monetary conditions were among reasons for the strengthening of the hryvnia. High global prices for exported goods, a record harvest of grain crops, and a substantial amount of remittances also contributed to the stronger hryvnia. In addition to monetary factors, an increase in the domestic food supply and lower global prices for food products dampened inflationary pressures. Despite having decelerated, inflation was, as expected, above the central bank’s target range of 6% +/-2 pp at the end of 2018. The deviation from the target was largely due to factors over which monetary policy has only a limited effect: higher administered prices wage-driven growth in production costs crude oil prices rising throughout most of the year a narrowed supply of vegetables due to unfavorable weather. Consumer demand, fueled by higher wages, was also an important inflation driver. Real wages grew by 12.5% yoy in 2018. Uncertainty as to whether or not cooperation with the International Monetary Fund would resume and high external risks also weighed on economic sentiment throughout most of the year. The NBU deliberately chose a more lengthy path to bringing inflation to the target in order to minimize the loss of economic growth. Being able to balance the need to drive inflation to the target, and the need to support economic growth, shows the flexibility of the inflation-targeting regime. How will inflation behave in the coming years and when will it meet the NBU target? Inflation will continue to decline gradually. As before, we expect inflation to decline to 6.3% at year-end 2019 and reach 5.0% at the end of 2020. That said, inflation will already be in the target range of 5% +/- 1 pp in early 2020, as planned. The disinflation will primarily be due to the tight monetary policy. Inflation will be also 1/3 BIS central bankers' speeches curbed by: prudent fiscal policy driven by the repayment of large volumes of public debt in 2019–2020; slower wage growth, as domestic wages converge with wages in neighboring countries and migration moderates; relatively low exchange rate volatility resulting in low imported inflation; a decrease in energy prices in the global markets; weak growth in raw food prices. These factors will make core inflation decline to 5% in 2019, down from 8.7% in 2018, and to a level below 4% in 2020–2021. At the same time, the further planned increases in administered prices, which are required to bring them to market levels, will impact consumer price inflation. The NBU has also performed scheduled revisions of other macroeconomic forecasts Last year, the Ukrainian economy grew more rapidly than in any of the past seven years – by 3.3% according to our latest estimates. However, real GDP growth will slow to 2.5% this year, as predicted. The slowdown will be driven by the tight monetary policy necessary to bring inflation down to the target level and by the conservative fiscal policy intended to finance significant public debt repayments this year. In addition, the grain harvest is expected to decline from the record levels that made agriculture the primary driver of economic growth. Another factor will be a gradual deceleration of growth in the global economy and trade, including due to protectionist measures. Private consumption will remain a key driver of growth as real household income – wages, pensions, and remittances from abroad – continues to grow. Although investment activity will slow down, it will remain an important driver of demand for investment imports. As a result, even given a revival in export-oriented industrial production and record grain exports, imports will grow faster than exports in real terms. Consequently, the contribution of net exports will remain negative, although smaller than before. Next year, real economy growth will start to accelerate , hitting 2.9% in 2020 and 3.7% in 2021. The growth will mainly be propelled by a gradual easing in monetary policy, which will bolster domestic demand, and a pick-up in investment activity, as uncertainty about the political situation diminishes. After widening to 3.6% of GDP in 2018, the current account deficit will range between 3% and 4% of GDP in 2019 and 2020. In 2019, the deficit will narrow to 3.1% of GDP, due to the 2018 bumper corn harvest and a drop in energy prices. In 2020–2021, the current account deficit will widen slightly, on the back of a decrease in gas transit, a poorer grain harvest, and a rise in investment imports after the elections. A widening in the trade deficit will be offset by greater private remittances, supported by the higher incomes of labor migrants. A key assumption of the macroeconomic forecast is that Ukraine will continue to cooperate with the IMF and enjoy relatively favorable access to the international capital markets. 2/3 BIS central bankers' speeches At the same time, reasonably high interest rates will contribute to the inflow of debt capital, which, together with continued inflows of foreign direct investment, will finance the current account deficit. External official borrowing and the government’s placement of Eurobonds will make it possible to repay external public debt, the repayments of which will peak in 2019–2020. This will improve the expectations of economic agents and promote macrofinancial stability. As a result, international reserves will hover around USD 21 billion in 2019 and 2020. The usual increase in uncertainty during presidential and parliamentary elections poses the main risk to the said macroeconomic forecast, including Ukraine’s ability to meet its inflation target in 2020. This, in turn, could affect inflation expectations. External risks are also important. These include: a more significant slowdown in the global economy, including in the economies of Ukraine’s main trading partners; a drop in the global prices of the commodities exported by Ukraine; persistently strong labor migration and the resulting pressures on wages; geopolitical risks, such as an escalation of the Azov Sea conflict, which could cut export earnings; uncertainty over the volume of gas transit through Ukraine starting in 2020, as pipelines bypassing the country are being built to deliver gas to Europe. Why did the Board decide to leave the key policy rate unchanged? Taking into account the updated macroeconomic forecast and the above risks, the NBU Board deems it necessary to maintain the existing reasonably tight monetary conditions in order to ensure that inflation returns to its target range in Q1 2020. What will the NBU’s monetary policy stance be in future? Any further changes to the key policy rate will depend on inflation developments, as well as on whether or not risks to price stability materialize. The Board sees reasons for launching a monetary easing cycle, as risks of inflation decrease steadily, and inflation returns to its target, along the trajectory outlined in the central bank’s new macroeconomic forecast. However, if underlying inflationary pressures rise and risks that inflation may not return to its target increase, the NBU could raise the key policy rate. A new detailed macroeconomic forecast will be published in the Inflation Report on 7 February. A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 11 February. The next meeting of the NBU Board on monetary policy issues will be held on 14 March. Thank you for your time! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 14 March 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing – monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 14 March 2019. * * * Dear colleagues, Please be informed that the NBU Board has decided to maintain its key policy rate at 18% per annum. We believe that the tight monetary conditions continue to be an important prerequisite for gradually reducing inflation to the 5% target in 2020. What inflation developments followed the last key policy rate decision? Inflation continued to decelerate in the early months of 2019, effectively staying on the trajectory the NBU predicted in its January 2019 Inflation Report. By the end of February, inflation had declined to 8.8% yoy, with core inflation down to 7.8% yoy, indicating that the underlying inflationary pressure is easing off as anticipated. The NBU’s tight monetary policy contributed to the lower inflation, including by being one of the reasons for the strengthening of the hryvnia. Other factors that made the hryvnia stronger: favorable global prices for Ukrainian exports, in particular, agricultural and metals exports, and stable exports earnings the approaching deadline for annual tax payments to the state budget, which encouraged businesses to sell foreign currency more actively weak growth in imports of goods, and low volumes of repatriated foreign currency dividends net sales of foreign currency by households. The excess of FX supply over demand in the interbank market enabled the NBU to buy foreign currency to replenish international reserves without throwing the exchange rate off the course determined by market forces. The NBU has made USD 625 million in net FX purchases since the year started. Favorable FX market conditions were another factor that helped keep international reserves above USD 20 billion despite sizable public debt repayments. The stronger hryvnia affected the prices of imported goods and goods that have a substantial import content. In addition, the consistency of the monetary policy, which aims to tackle inflation, and the FX market conditions contributed to the gradual improvement of inflation expectations. This raises interest rates in real terms and thus ensures tight monetary conditions necessary to reduce inflation. What will be the future trajectory of inflation? In 2019, in line with the January forecast, inflation will decelerate to 6.3%, and return to its target range of 5% ± 1 pp early next year. This forecast still holds, despite new factors emerging since the NBU Board last met to discuss monetary policy. 1/2 BIS central bankers' speeches On the one hand, increases in social payments, as well as the monetization of utility subsidies are planned for the coming months. Although the effects of these individual factors are insignificant, their combined impact on inflation expectations could be substantial, on the back of greater uncertainty arising from presidential and parliamentary elections. On the other hand, a more noticeable strengthening in the hryvnia exchange rate than is envisaged in the current forecast, is helping curb inflation. That said, the risks to inflation decreasing mentioned by the NBU in its January macroeconomic forecast continue to persist. What will the NBU’s monetary policy stance be in future? After balancing the need to bring inflation back to its target against the risks that could prevent inflation from decreasing, the NBU Board has decided to leave the key policy rate unchanged, at 18.0% per annum. Although leaving the key policy rate unchanged, the NBU Board said that it could cut it in the future. How soon the NBU will adopt an easing cycle will depend on how steadily risks of inflation decrease and inflation expectations improve. Looking ahead, any changes to the key policy rate will be based on the NBU’s updated macroeconomic forecast that will be published in April. A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 25 March 2019. The next meeting of the NBU Board on monetary policy issues will be held on 25 April 2019. Thank you for your time! 2/2 BIS central bankers' speeches
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Opening speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the fourth Annual Research Conference "Central Bank Communications: From Mystery to Transparency", hosted by the National Bank of Ukraine in collaboration with the National Bank of Poland, Kyiv, 23 May 2019.
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Yakiv Smolii: Opening speech "Central Bank Communications: From Mystery to Transparency" Opening speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the fourth Annual Research Conference "Central Bank Communications: From Mystery to Transparency", hosted by the National Bank of Ukraine in collaboration with the National Bank of Poland, Kyiv, 23 May 2019. * * * Dear participants, I take tremendous pleasure in opening the fourth Annual Research Conference, which the National Bank of Ukraine is hosting in collaboration with Narodowy Bank Polski. Representatives of the central banking community from over 30 countries are gathered here today. That includes Europe, North America, Latin America, Asia, and Africa. I am glad to see more international participants this year than in the past years. We are all different. We have different economic models. We face different problems and have different ways of resolving them: Advanced economies are busy fixing the problem of negative interest rates and their normalization. Emerging markets are worried about a potential capital outflow affecting their currencies. Exporter countries are concerned that the global economy is cooling off. Importer countries are keeping a close eye on commodity prices. But what brings us all together is the need to answer one question: how to make ourselves heard in a world overwhelmed with information? What is more, how are independent central banks supposed to survive in a world of post-truth, where emotions draw more attention than facts and where populism spreads like a virus? Gone are the days when central banks could afford to be closed technocratic institutions that spoke in numbers and vague terms. In this day and age, central banking is, first and foremost, about transparency, openness, and accountability. In the years to come, central banks will have to be client-oriented and capable of maintaining direct dialogue with the public. That is why not only central bankers have gathered in Kyiv today. Among those present here today are journalists, analysts, financial market players, academicians, government officials, and representatives of international institutions. All of them are clients of central banks. Last year, we developed and made public the first-ever medium-term Strategy of the National Bank of Ukraine. To us, this is a milestone document since it identifies seven strategic goals that the NBU as an institution will have to meet in the next few years. Thus, the medium-term Strategy gives the public a simple outline of what the NBU expects to achieve. However, this is not the Strategy’s only feature. Also for the first time ever, we have changed the philosophy of our relationship with individuals and institutions as clients with which we interact and for which we work every day. Paraphrasing what President Kennedy said in his inauguration speech over 60 years ago, I would say, “ask not what your stakeholders can do for your central bank – ask what your central bank can do for its stakeholders.” 1/3 BIS central bankers' speeches The need to be client-oriented sets a new and, let’s be frank, a high bar for the ability of central banks to build and maintain dialogue. It goes without saying that central banks use communications as an important policy tool. But it is important to remember that transparency must be effective. It must help central bank pursue its mandate, which consists in ensuring price and financial stability. During these two days, we will discuss this aspect of central bank transparency on more than one occasion. But it’s time for us to admit that this passive, one-way communication, when central banks used to make everybody listen with bated breath to whatever scanty and vague words they had to offer, no longer works. Ultimately, this approach undermines the effectiveness of central bank policy. “If you don’t understand us, it’s your problem” is the rhetoric that is outdated and obsolete. Today, if you – our clients – have difficulty understanding us, it’s our problem. Institutions that make themselves heard and understood are the only ones that get public trust. Institutions that have public trust are the only ones that receive support and commitment. Institutions that have public support are the only ones that can withstand the pressure of populism, fake news, manipulations, and attempts to turn these institutions into instruments for certain business interests that run counter to the interests of the people. Under these circumstances, the central bank should transform taking the corporate sector as an example and begin to finally listen to clients and seek two-way communication. When communicating with clients, the central bank should take an individual approach to every client, choosing words that are intelligible and important and ones that interest the client. At the same time, the central bank must choose communication platforms that are suitable for every party. Long story short, the need to be client-oriented compels banks to transition to targeted communications. We at the NBU have been moving in that direction for five years running. The groundwork for greater transparency was laid in 2015, when the NBU gained true institutional independence and the mandate to pursue price and financial stability. As with every central bank, we started out with a classic toolkit: banks, experts, and the media with which we communicated through press releases, press briefings, meetings, and interviews. However, the financial and economic crises, which prompted the NBU to develop more rapidly, compelled us to take our communications to a higher level of transparency. Yes, strangely enough, it took a crisis to inspire that change! With a large-scale cleanup of the banking system underway, peaking inflation, noticeable depreciation of the hryvnia, international reserves at an all-time low, and the prospect of significant repayments on public debt looming ahead, Ukraine was going through a severe economic crisis. Add to this the fact that public confidence in government institutions was at its lowest, government communications were in tatters, the media market was underwater, and the expert community was stagnating. Any institution would opt to become even more closed in those circumstances. But we made an opposite decision. We adopted the new culture and values that are built around responsibility to the public. We decided that breaking the silence was the only way to fight back the endless attacks by oligarch bankers, manipulations by politicians, and a downpour of fake news. Since then, we have strived to explain our actions to the public every step of the way. We have expanded our audience to include businesses, nonbank financial institutions, academia, students, and – most important – the general public. We commit to be accountable before the people for our actions and our words. We clearly declare the opportunities and challenges Ukraine faces. We not only communicate with clients through our official website and the media, but also gradually learn to be the media, communicating directly with the public on five social media. We 2/3 BIS central bankers' speeches counter fake news with fact-checking and are not afraid to speak up when we see a storm approaching that threatens to engulf the country. Over time, we came to a conclusion that, when choosing with whom to communicate, central banks must also address the questions of what, how, and where to say. And so, we realized which direction we should take as evolved. This led us to adopt another milestone document last year, which will keep us from abandoning our chosen course. I am talking about the NBU’s updated Communication Strategy. Once introduced, the Communication Strategy will rebuild trust to the regulator, maximize the influence of the NBU’s policy on the behavior of target audiences, and reduce economic uncertainty through provision of information required to make informed decisions. The Central Banking Awards 2019 for Transparency, which the NBU’s team had an honor to receive, recognizes our progress in moving in the right direction. The fact that the international community placed the NBU on a par with the central banks of Sweden, Canada, Czech Republic, Ireland, and Israel is undoubtedly a recognition of our achievements. But the road ahead is long and winding. The world is changing by the day, and central banks must keep abreast with it. The difficult time that the global economy in general and Ukraine in particular are going through is the best time for change. Now that central banks have found themselves outside their comfort zones is the best time for change. The NBU is ready to evolve alongside you. I hope that this conference will give us a boost and inspire us as we evolve together. But before I give the floor to our honorable speakers, let me take the NBU one step closer to a future that is more transparent. Let me open my personal Twitter account and send my first tweet as we speak! On second thought, let’s do it together! Here comes my first tweet! Thank you for your attention! I wish you many interesting speeches and live discussions in the following two days! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 25 April 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 25 April 2019. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 17.5% per annum. Inflation has been on a steady decline towards the 5% target, allowing the NBU to launch a cycle of key policy rate cuts. At the same time, the NBU Board sees risks that may hinder the plans to lower the rate. What inflation developments followed the last key policy rate decision? In March 2019, consumer price inflation continued to slow and reached 8.6%, in line with the NBU’s latest forecast. Core inflation declined even faster than expected – to 7.6%. This is evidence that underlying inflationary pressure continued to ease in early 2019. The decline in inflation was supported by the NBU’s tight monetary policy, which was one of the reasons for the strengthening of the hryvnia. That, in turn, impacted the prices of imported goods and goods with a significant import share in their production costs Despite the electoral events, conditions in Ukraine’s financial market remain benign, while inflation expectations of households, businesses, banks, and financial analysts continue to improve. In addition to monetary factors, an increase in the domestic supply of some food products, and lower global food prices also dampened inflationary pressures. What will be the future trajectory of inflation? We expect that inflation will continue to decline gradually. More specifically, it will decrease to 6.3% by the end of 2019 and to 5.0% by the end of 2020. As projected before, inflation will enter the target range of 5% ± 1 pp in early 2020. The slowdown in inflation was driven by the following factors: first and foremost, tight monetary conditions and restrained fiscal policy second, wage growth decelerated, as it approached the rates of wage growth of neighboring countries and labor migration from Ukraine declined in intensity third, the hryvnia appreciated in Q1 2019, holding down the future growth in prices for nonfood products fourth, global prices for natural gas declined, which will be reflected in price changes in the domestic market fifth, the supply of both domestic and imported food products increased. These factors will also contribute to the continued slowdown of core inflation to 5.0% this year and 3.7% in the subsequent year. The expected increase in some tariffs to the market levels and higher excise taxes on alcoholic 1/3 BIS central bankers' speeches and tobacco products will restrain the decline in inflation. The NBU has also performed scheduled revisions of other macroeconomic forecasts Economic growth will slow in 2019 to rebound in 2020. As well as in January, the NBU forecasts a slowdown in economic growth to 2.5%. This will be due to a slowdown in the global economy and trade, restrained fiscal policy resulting from the need to repay large volumes of public debt, and tight monetary conditions required to bring inflation to its target. Moreover, the harvest of grains and oil crops is expected to be lower compared to the bumper crop of 2018. Private consumption will remain the main driver of economic growth. However, its growth will decelerate due to a slower growth in real household income – wages, pensions, and remittances from abroad. Investment demand will be limited by political uncertainty in the year of presidential and parliamentary elections. Growth in real GDP will accelerate to 2.9% in 2020 and 3.7% in 2021. The growth will be propelled by a gradual easing of monetary policy, which will bolster domestic demand, and spur investment activity as the election cycle is over. Economic growth will be restrained by decreased volumes of natural gas transit to Europe as a result of the construction of bypass pipelines. In 2019, the current account deficit is projected to stay at the previous year’s level, at 3.3% of GDP, due to various factors. Proceeds from the sales of last year’s record harvest of corn and the effect of favorable trade conditions will be offset, as the economies of Ukraine’s main trading partners cool. The cooling will negatively affect exports and remittances from labor migrants. In future, the current account deficit will widen slightly, to 4% of GDP in 2021, as a result of a decrease in natural gas transit and weak demand from Ukraine’s main trading partners caused by stronger investment demand on the domestic markets. The continued fulfillment of Ukraine’s obligations under the current cooperation program with the International Monetary Fund remains the basic assumption of the macroeconomic forecast. This will allow Ukraine to attract other official financing, improve the conditions of access to the international capital markets, and support the active interest of nonresidents in hryvniadenominated domestic government bonds. These borrowings will make it possible for the government to repay external public debt, the repayments of which will peak in 2019 – 2020. Inflows of debt capital and investments to the private sector will continue as well. As a result, international reserves will hover around USD 21 to 22 billion during this and the subsequent years. The usual increase in uncertainty during presidential and parliamentary elections poses the main internal risk to the said macroeconomic forecast, including Ukraine’s ability to meet its inflation target in 2020. The NBU will consider this risk in its monetary decisions mainly due to its impact on the financial market and inflation expectations. The following external risks are also important: 2/3 BIS central bankers' speeches the global recession and lower raw commodity prices stronger geopolitical tensions, particularly due to the uncertainty around Brexit uncertainty over the volume of gas transit through Ukraine starting in 2020, as pipelines bypassing the country are being built to deliver gas to Europe an escalation of the military conflict and new trade restrictions introduced by Russia. Taking into account the updated macroeconomic forecast and the said assessment of risks, the NBU Board decided to decrease the key policy rate to 17.5% per annum. What will be the NBU’s monetary policy stance in future? As it initiates an easing cycle, the NBU Board points out that its further steps will depend on whether or not inflation risks materialize and whether or not inflation expectations improve. However, despite there being macroeconomic preconditions for starting a cycle of key policy rate cuts, this process might be impeded by the materialization of risks to financial stability (that were mentioned in the statement of the Financial Stability Council last week), and to the central bank`s independence. The NBU will closely monitor developments in Ukraine and, if the above risks materialize, will respond by deploying monetary tools. A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 3 May 2019. A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 6 May 2019. The next meeting of the NBU Board on monetary policy issues will be held on 6 June 2019. I thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Financial Inclusion Forum, Kyiv, 12 June 2019.
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Yakiv Smolii: Financial Inclusion Forum - opening speech Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Financial Inclusion Forum, Kyiv, 12 June 2019. * * * Dear ladies and gentlemen, participants of the second international Financial Inclusion Forum. Today, the slogan Leaving No One Behind unites us all. Why this particular slogan, you may ask. First, as a UN member country, Ukraine shares and supports the Global Sustainable Development Goals. We apply the principle Leaving No One Behind. Second, if we explain the meaning of the term “financial inclusion” in one word, this word would be accessibility. Technical accessibility and price accessibility. At present, over one third of people all over the world still have no access to financial services. Our mutual goal is to reduce the share of Ukrainians in this huge number. I will not be mistaken if I confidently say that all present here are aware of the fact – financial inclusion offers broader opportunities for people. Access to loans advances business and access to insurance creates a safety cushion. For the least secured social groups, an access to high quality financial services means safety today and social mobility tomorrow. Numerous studies, particularly by such respected international institutions as the World Bank and the International Monetary Fund, have proved a strong connection between financial inclusion and financial stability. At the macroeconomic level this translates into the country’s capacity to tackle crises. At a personal level, it gives Ukrainians a chance to be prepared for rapid changes and unexpected developments that have permeated the life of our country for the past two decades. Ladies and gentlemen, It should be noted that financial inclusion is not only about an increase in the number of consumers of financial services, or their sales, so to say. It is about social responsibility – transparency and clarity of products to their consumers. Protection of consumers is important because it is the prerequisite for the safe use of loans. It is impossible for anybody to benefit from the full potential of financial services without financial literacy. This is where the NBU sees great opportunities for everybody gathered here. Anyone has a purpose and anyone can play a role: commercial sector can develop new technologies and offer progressive solutions 1/2 BIS central bankers' speeches nongovernmental organizations can ensure control and enhance communal capacity in an informal way while we at the public sector will continue creating conditions for the increased well-being of Ukrainians. What are our plans? First. The NBU will improve the quality of regulation and lay the grounds for strengthening the financial sector. Our foremost task, as we see it, is enhancing protection of rights of financial services consumers. I will be honest with you – at the NBU we truly hoped that Ukraine would get a real protection system guaranteed by laws. But the parliament decided otherwise. However, this is not an excuse to abandon people with their problems with banks and nonbank financial institutions. Today, I am very happy to inform you of the following: The NBU assumes responsibility for protection of rights of financial services consumers and establishes a special unit in charge of these issues. First of all, it will enable regulation of the information disclosure system that will deal with information on financial products and services. Information transparency is at the core of trust in the financial services and safeguards higher prosperity of the public. We will continue our work on people’s complaints, but from now on it will be more systematic. The chain “complaint – response – changes in regulations” will become shorter and more efficient. This will help reduce the number of misunderstandings between financial institutions and their customers, improve their information awareness, and teach the financial market to address their customers’ questions and comments. Second. The NBU has assumed the leadership and developed a vision for the future strategy of financial literacy. Why does the central bank need it, considering that we are not part of the education system? Our goal is to prepare young people for life in the real world full of challenges and rapid changes. Today, we encourage everybody present to join in common work based on our vision. I hope in a year we will be able to sum up our first results. Ladies and gentlemen, I am confident that many of you have joined the Forum with brilliant ideas of how to make financial services more accessible for Ukrainians. So, let’s get to work! 2/2 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on optimization of the denominations of banknotes and coins of hryvnia, Kyiv, 25 June 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - changes in the denominations of banknotes and coins of hryvnia Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on optimization of the denominations of banknotes and coins of hryvnia, Kyiv, 25 June 2019. * * * Dear colleagues, Today, we are holding meetings in many Ukrainian cities, Kyiv, Dnipro, Odesa, Kharkiv, Lviv and Khmelnytskyi, to present to the public the changes in the denominations of banknotes and coins of hryvnia that aim to harmonize cash circulation. Despite the fact, that cashless settlements are gaining more popularity in Ukraine, cash remains the most used means of payment. Our domestic currency, it’s banknotes and coins, is something that everyone of us, regardless of their location, profession or age, deals with on a daily basis. Therefore, it is of outmost importance for us that hryvnia in any material form remains high-quality, secure, and stable, and that payments in hryvnia are convenient. Already this year we’ll take two important steps: first, 1, 2, and 5 kopiika coins will cease to be means of payment in Ukraine and will be withdrawn from circulation. Also 25 kopiikas, that is still used for payments, will be gradually withdrawn second, a new 1,000 hryvnia banknote will be introduced. In three years, after complete withdrawal of the above coins and the introduction of the new banknote, the number of hryvnia denominations will reduce from 17 to 12. A total of 6 coin denominations and 6 banknote denominations will remain. This will streamline existing hryvnia denominations. 11–13 currency denominations are the most common in the leading countries of various parts of the world, from the US to Canada, the UK to the Czech Republic, Denmark, Switzerland and Australia. Why are we introducing changes to the currency denominations? I can give you three main reasons backing these decisions: customer convenience, economic feasibility, and saving costs for the state and business. Let me add some details. The first reason is customer convenience. The changes we present today will reduce the average number of coins per Ukrainian almost by half, and the number of banknotes by almost a third. Consequently, cash settlements and savings will be streamlined. The second reason is economic feasibility. Considering the growth of income and prices, Ukrainians essentially have no need for low-denomination coins, instead there is demand for a banknote with a denomination higher than 500. The structure of cash in circulation has also changed. At present, 500 hryvnia banknotes account for over 55%, and 200 hryvnia banknotes account for one third. Considering global experience, the 50% threshold is indicative of the need for a higher denomination. 1/2 BIS central bankers' speeches Thus, a new 1,000 hryvnia banknote is long overdue. The third reason is saving costs for the state and business. The costs of the state and cash circulation participants on producing, processing, transporting, and storing banknotes and coins will be reduced. Thus, when and how will these decisions be implemented? The 1, 2, and 5 kopiika coins will cease to be means of payment in Ukraine from 1 October 2019. From that time onwards, these coins will no longer be accepted for cash payments for goods and services, and the NBU will commence the withdrawal of these coins from cash circulation. At the same time, the public will be able to exchange these coins without limitation and free of charge for coins and banknotes of other denominations during the next three years. Furthermore, we intend to gradually withdraw 25 kopiika coins. Unlike 1, 2, and 5 kopiikas, 25 kopiikas will for now remain in cash circulation. You can use them to pay for goods and services. But these coins, if received by banks, will not be returned into circulation. With time, their number in circulation will decrease. The new banknote denomination (UAH 1,000) will be put into circulation on 25 October 2019. And now I present to you the new highest denomination banknote. (Pause, the governor takes the tube in his hands) According to the procedure for disclosing classified information, I have to open this tube and show you an uncut sheet of the new banknotes. (Opens the tube, demonstrates the banknote sheet and gives one minute for filming) As you can see, the design of the new banknote is similar to the designs of the upgraded 20, 100 and 500 hryvnia banknotes. The front of the banknote features a portrait of Volodymyr Vernadskyi. The building of the Presidium of the National Academy of Sciences of Ukraine is at the back of the banknote. The new banknote incorporates top-notch design and security technologies. The novelties announced today bring us forward to the completion of the current series of banknotes and coins. Meanwhile we are also preparing to develop the design of the next generation of more modern hryvnia banknotes. Thank you for your attention! Now I would like to give the floor to my colleagues who will give you a detailed description of the security features and design of the new 1000 hryvnia banknote. 2/2 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 18 July 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 18 July 2019. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 17.0% per annum effective 19 July 2019. The NBU continues the cycle of monetary policy easing as inflation is declining towards the target of 5%. What inflation developments followed the last monetary policy meeting? In June, annual inflation came in at 9.0%. Thus, inflation approached the trajectory of the NBU’s April forecast after temporary factors caused a deviation from the target in previous months. Core inflation slowed somewhat in Q2, also being close to the forecast. The tight monetary policy was the main factor that restrained the underlying inflationary pressure. In particular, due to the hryvnia appreciation and an improvement in expectations of households, businesses, banks, and financial analysts. At the same time, inflation remained relatively high. Robust consumer demand, higher production costs, and further growth in administered prices put pressure on prices. What will be the future trajectory of inflation? The NBU reiterates its forecast that inflation will decline to 6.3% as of the end of 2019, return to the target range in early 2020, and reach the medium-term target of 5% at the end of 2020. The tight monetary conditions will continue to be the disinflation driver. Despite the fact that the key policy rate is reduced gradually, its real value will remain high on the back of improved inflation expectations. High real interest rates will make hryvnia financial instruments more attractive for investors, which will support the exchange rate of the hryvnia. Moreover, such monetary policy stance will limit the pressure from consumer demand. Other factors contributing to slower inflation will include: a prudent fiscal policy the slowdown in wage growth relatively low energy prices in the global markets ample supply of domestic and foreign food products. The NBU has also performed scheduled revisions of other macroeconomic forecasts The NBU has revised its economic growth forecast to 3% in 2019 (from 2.5%) and 3.2% in 2020 (from 2.9%) amid stronger domestic demand, better terms of trade, and larger harvest of grain crops. Domestic demand will remain the main driver of economic growth over the coming years. Private 1/3 BIS central bankers' speeches consumption growth will decelerate, albeit remaining high owing to an increase in real household income – wages, pensions, and remittances from abroad. Capital investment will continue to grow rapidly, which will also provide significant support to the economy. Economic growth will be dampened by a weak global economic activity and decrease in gas transit to European countries starting in 2020, due to the construction of bypassing gas pipelines. The 2019–2021 current account deficit will remain acceptable. In 2019, the deficit will narrow to 2.6% of GDP, thanks to the bumper grain harvest, a drop in energy prices, and a decline in dividend repatriation. In future, the current account deficit will widen slightly, driven by the decrease in gas transit, less favorable terms of trade, and stronger consumer and investment demand. Further cooperation with the International Monetary Fund remains the basic assumption of the macroeconomic forecast. This will allow Ukraine to attract other official financing, improve the conditions of access to the international capital markets, and support the interest of investors in Ukrainian assets. These borrowings will make it possible for the government to finance large payments on the external public debt. In addition, the private sector will get an opportunity to attract foreign investment. As a result, international reserves will reach USD 23 billion in 2021. The main internal risk to the above scenario is a further strengthening of threats to macrofinancial stability. Court rulings, legislative initiatives, or other steps that invalidate previous achievements, and delays in implementing key reforms may increase the vulnerability of Ukraine’s economy and pose an obstacle to further cooperation with the IMF. That could affect exchange-rate and inflation expectations and make it harder for Ukraine to access international capital markets in order to repay a heavy debt load in the coming years. The following risks also remain important: a suspension of Russian gas transit through Ukraine starting in 2020 an escalation of trade wars and rising geopolitical tensions an escalation of the military conflict, and the imposition of new trade restrictions by Russia. Considering the revised macroeconomic outlook and the balance of risks that threaten to worsen it, the NBU Board has decided to cut the key policy rate to 17.0%. The NBU has also decided, from today onward, to start publishing the forecasts of its key policy rate as part of the quarterly revisions of the macroeconomic outlook. Publishing interest rate projections marks an evolutionary improvement in the transparency of monetary policy conducted by inflation-targeting central banks. The NBU expects that the publication of the key policy rate forecast will improve the understanding of the NBU’s monetary policy by all stakeholders. This information will be useful to businesses, analysts, investors, and households. It may inform their investment decisions, business development plans, savings decisions, etc. The key policy rate forecast will shape the expectations of financial market participants, enabling the NBU to strengthen the impact of the key policy rate on the value of financial resources and, 2/3 BIS central bankers' speeches hence, on inflation. The publication of the key policy rate forecast will make everyone better off. It should be noted that the forecast imposes no obligations on the NBU, and thus the actual key policy rate may differ from the forecast if macroeconomic conditions change. What will be the NBU’s monetary policy stance in future? The NBU’s baseline scenario envisages the key policy rate to decrease further, to 8% over the coming years, provided that inflation steadily declines to the 5% target. This has been made possible by the years long, consistent, systemic policy of the reformed NBU, which ensured the reduction of inflation to a single-digit figure and which will continue to be the main driver of inflation-reducing efforts in the years to come. The largest decrease is expected over 2020, along with inflation returning to the target range and inflation expectations improving. If existing inflation risks, both internal and external, materialize, the key policy rate could decline to 8% more slowly. At the same time, higher demand for hryvnia government bonds from nonresidents and the subsequent strengthening of hryvnia will allow reducing the key policy rate at a faster pace than envisaged in the baseline scenario. As usual, a new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 25 July 2019. A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 29 July 2019. The next meeting of the NBU Board on monetary policy issues will be held on 5 September 2019. Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 24 October 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 24 October 2019. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 15.5% per annum effective 25 October 2019. The NBU continues the cycle of monetary policy easing as inflation is steadily declining towards the target of 5%. What price developments followed the last monetary policy meeting? In September, consumer inflation declined to 7.5% yoy, below the NBU’s July forecast. Inflation continued to slow in October according to the NBU’s preliminary estimates based on online analysis of prices. The steady disinflation has been driven by a gradual easing of underlying pressures on prices. That was reflected in a rapid slowdown of core inflation. The tight monetary policy was one of the reasons behind the strengthening of the hryvnia and improvement in inflation expectations. With a time lag, that produces a major impact on prices, offsetting the effect of the sustained consumer demand and worse harvest of some vegetables, which push prices upwards. What will be the future trajectory of inflation? Same as before, the NBU expects inflation to decline to 6.3% as of the year-end. On the one hand, core inflation will slow more than expected, while fuel prices will remain below last year’s levels due to the stronger hryvnia. On the other hand, smaller supply of some vegetables will push prices upwards. However, these factors will offset each other, which leaves this year’s inflation forecast unchanged. Inflation will meet the target range of 5%+/-1 pp in early 2020 and reach the medium-term target of 5% at the end of 2020. As in 2019, tight monetary conditions will curb price growth. Despite the fact that the key policy rate is reduced gradually, its real value will remain high on the back of improved inflation expectations. Relatively high real interest rates will keep hryvnia financial instruments attractive for investors and thus support the exchange rate of the national currency. As a result, the more favorable FX market will neutralize the pressure domestic demand has on prices, which will be somewhat higher according to the new forecast. Other factors behind the gradual disinflation will include: a prudent fiscal policy relatively low energy prices on the global markets an increase in food supply driven by higher productivity in agriculture. The NBU has also performed scheduled revisions of other macroeconomic forecasts 1/3 BIS central bankers' speeches The NBU has revised its economic growth forecast upwards, to 3.5% in 2019–2020 and 4% in 2021. The revision was driven by the sustained domestic demand, higher productivity in agriculture, and improved consumer sentiment. In the meantime, slower growth in the global economy and worsened terms of trade will weigh on economic growth in 2020. The 2019–2021 current account deficit will remain acceptable. In particular, it will narrow to 2.9% of GDP this year despite the stronger hryvnia. That will be driven by an improvement in the terms of trade and the rich grain harvest. Conversely, the current account deficit will widen slightly in the years to come, as a result of a decrease in gas transit and less favorable global commodity prices. In particular, the NBU expects somewhat lower iron ore prices and higher energy prices. What does the realization of the said macroeconomic forecast depend on? Further cooperation with the International Monetary Fund remains the basic assumption of the macroeconomic forecast. The current NBU forecast assumes a new IMF cooperation program will be approved by the end of 2019. This will allow Ukraine to attract other official financing, improve the conditions of access to the international capital markets, and support the interest of investors in Ukrainian assets. As a result, notwithstanding large external debt repayments, international reserves will range at around USD 23–24 billion in the coming years, which is sufficient to cover three months of future imports. The NBU currently sees two key risks to the above macroeconomic forecast, and in particular to inflation decreasing to its target in 2020. The first risk is a delay in signing a new program with the IMF. The second risk is about increasing threats to macrofinancial stability, mainly due to Ukrainian court rulings. If materialized, these risks could worsen exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets in order to repay a heavy debt load in the coming years. The following risks also remain important: a complete halt of the transit of Russian gas through Ukraine intensified trade tensions and more turbulent global financial markets an escalation of the military conflict and new trade restrictions introduced by Russia. Why, given the said risks, did the NBU cut the key policy rate by 1 pp? Although still existing, these risks have neither worsened nor improved since the last monetary policy decision was made. This means that the balance of risks has remained unchanged since early September. However, there has been a change in economic conditions – underlying inflationary pressures are declining more quickly than the NBU anticipated. This has made it possible to ease monetary policy somewhat more quickly this year than envisaged in the previous macroeconomic forecast. As a result, the Board has cut the key policy rate by 1 pp, to 15.5%. 2/3 BIS central bankers' speeches What will the NBU’s monetary policy stance be in future? The NBU’s forecast scenario envisages that the key policy rate will be cut further, to 8% as of the end of 2021, provided that inflation steadily declines to its 5% target. As before, the largest decrease in the key policy rate is expected to take place in 2020, along with inflation returning to its target range and inflation expectations improving. However, the actual pace at which the key policy rate is cut to 8%, together with any actual actions taken to achieve this goal, will depend on many factors. If the above inflation risks, both internal and external, materialize, the key policy rate could decline to 8% more slowly. That said, the key policy rate could be cut further, to 8%, much more quickly. These cuts will greatly depend on whether or not key internal reforms are sped up. These reforms are those that are envisaged in the memorandum of understanding signed by the Ukrainian government and the NBU, and the judicial reform required to establish the rule of law in Ukraine. Thank you for listening! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 5 September 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 5 September 2019. * * * Dear colleagues, The Board of the National Bank of Ukraine has decided to cut the key policy rate to 16.5% per annum, effective 6 September 2019. The NBU is continuing the cycle of monetary policy easing, as it expects inflation to decline to the target of 5%. What inflation developments followed the last monetary policy meeting? Despite seasonal decrease of prices in July, inflation in annual terms was higher than our forecast and made 9.1% The NBUestimates inflation to have declined in August, although still remaining above the forecast level. The deviation was mostly driven by temporary factors related to food supply, in particular the supply of vegetables. Meanwhile, core inflation was 7.4% was in line with the NBU’s forecast. The tight monetary policy continued to hold back the underlying pressures on prices, in particular through the exchange rate channel. The appreciation of the hryvnia had the strongest impact on prices of fuel and some food products. However, disinflation was restrained by the greater consumer demand and the rise in real wages by almost 10% over the year. What are the future inflation developments? The NBU reiterates its forecast that inflation will meet the 5% medium-term target at the end of next year. Macroeconomic factors in place since the previous monetary policy meeting of the NBU Board have not changed the balance of risks to the forecast. On the one hand, according to the NBU’s estimates, a strengthening in the exchange rate will help curb inflation in the next few months. The hryvnia appreciation was driven by fundamental market factors, such as: favorable global commodity prices good harvest of grain crops continued growth in IT services exports a stronger investor confidence in the Ukrainian economy the simplified access to the domestic government securities market for investors. That reduced the amount of repatriated dividends and spurred demand for domestic government bonds. Although the impact of foreign capital inflows on the domestic government bond market weakened substantially over past weeks, the foreign exchange market has remained in balance. The current drop in global oil and gas prices will be translated to domestic prices, with a certain time lag. On the other hand, the rapidly rising domestic demand and strong wage growth will push prices upward. The more rapid GDP growth seen in Q2 2019 (to 4.6% yoy) was mainly driven 1/2 BIS central bankers' speeches by a pick-up in domestic consumption amid a faster improvement in consumer sentiment. The preliminary estimates of July economic activity showed that sustained domestic demand had persisted. Internal political risks to reducing inflation to its target decreased after the new convocation parliament started to operate and a new government was formed. This makes it possible to intensify negotiations on a new cooperation program with the International Monetary Fund. At the same time, there are still threats to financial stability arising from current court proceedings related to the decisions taken by the state to improve the health of the banking sector. External risks are also important. These include: a suspension of Russian gas transit through Ukraine starting in 2020 increased trade tensions and more turbulent global financial markets an escalation of the military conflict and new trade restrictions introduced by Russia. What is the NBU’s current view of the future monetary policy stance? The NBU will continue the cycle of monetary policy easing, provided inflation is steadily declining to its 5% target. How quickly the key policy rate is reduced to its neutral level of 8% will depend on both internal and external risks. If structural reforms speed up, the NBU could cut the key policy rate more quickly. Another important condition is inflation decreasing steadily to its target. Conversely, if inflation risks materialize, in particular through persistent demand pressure, the easing of monetary policy will be more gradual. A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 16 September 2019. The next meeting of the NBU Board on monetary policy issues will be held on 24 October 2019. Thank you for listening! 2/2 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 30 January 2020.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 30 January 2020. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 11% per annum effective 31 January 2020. The NBU will continue to ease its monetary policy with the aim of maintaining inflation at the target level of 5% and supporting steady economic growth. What price developments followed the last monetary policy meeting? In 2019 consumer inflation declined to a six-year low of 4.1%. The NBU thus achieved its inflation target of 5% ±1 pp, which was declared in 2015, earlier than expected. The central bank’s monetary policy proved to be effective, being politically unbiased and relying on macroeconomic modelling and professional judgement. The NBU has confirmed its ability to set and achieve its goals. The strengthening of the hryvnia was the key factor driving the rapid disinflation seen late last year. The currency appreciation offset the effects of robust consumer demand. How will consumer prices change further on? According to the NBU’s estimates, inflation continues to slow. It will be below the 5% ±1 pp target range starting in January and throughout most of the year. However, inflation will accelerate in Q4 to 4.8% at year-end 2020.Therefore, it will return to the target range at the end of the year. This will be due to several factors. First, the last year’s appreciation of the hryvnia will continue to be reflected in prices of imported goods and products with a large share of imported inputs. Second, continued relatively low global energy prices will curb the rise in domestic fuel prices. Third, in the absence of supply shocks, food price inflation will be insignificant owing to expected higher yields of fruit and vegetables. At the same time, administered prices will grow somewhat faster than last year, mainly as excise taxes on tobacco products continue to converge with European levels. Driven by the monetary policy easing, inflation in 2021–2022 will remain within the medium-term target of 5% ±1 pp. The further steady, low pace of inflation will also be due to the following factors: a prudent fiscal policy relatively low energy prices on the global markets higher productivity of the Ukrainian economy. What will be the overall state of the economy? 1/3 BIS central bankers' speeches This year economic growth will accelerate to 3.5%, up from 3.3% in 2019, and will reach around 4% in the following years. The monetary policy easing will contribute to the faster economic growth. High private consumption and investment will remain the main economic growth drivers. At the same time, the contribution of net exports to GDP will remain negative on the back of the real sector’s considerable need for investment imports. Real household income will grow at a fast pace, which will further narrow the wage gap with neighboring countries and thus make Ukrainians more interested in working in Ukraine rather than abroad. The 2020–2022 current account deficit will remain acceptable The deficit narrowed to 0.7% of GDP in 2019. An important factor behind the decrease in the deficit was the compensation received by Naftogaz of Ukraine from Russian Gazprom under a ruling of the Stockholm Arbitration Court. However, apart from that, the current account deficit shrank due to the decreased trade deficit in goods, steady growth in services exports, and smaller amounts of repatriated dividends. The current account deficit will range from 3% to 4% in 2020–2022. In particular, the wider deficit will be caused by large volumes of investment imports and decreased proceeds from natural gas transit. However, this will be offset by greater capital inflows to the private sector amid an improvement in the investment climate. What does the implementation of the forecast depend on? Further cooperation with the International Monetary Fund remains the basic assumption of the macroeconomic forecast. The NBU expects that a new cooperation program with the IMF will be signed in the coming months, after the Ukrainian parliament approves the required draft laws. The new cooperation program, official borrowing and nonresidents’ sustained interest in domestic Treasury bonds and bills will sustain the rise in international reserves every year, despite Ukraine going through a period of peak external public debt payments. International reserves will exceed USD 29 billion in 2020, and will continue to rise in the coming years. In this light, the NBU believes any delay in entering into a new cooperation agreement with the IMF to be the key risk to its forecasts. Risks to macrofinancial stability also persist. These risks could mainly arise from Ukrainian court rulings on the responsibility and liability of the former owners of insolvent banks to the state. If materialized, these risks could worsen exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets in order to repay the heavy debt load of the coming years. There are other significant risks. They include: the continued cooling of the global economy and a further deterioration in terms of trade an escalation of the military conflict in eastern Ukraine and new trade restrictions introduced by Russia a drop in the harvest of grain, fruit and vegetable crops in Ukraine in the wake of unfavorable weather the higher volatility of global food prices, driven by global climate change a decrease in foreign capital inflows. Why did the NBU decide to cut the key policy rate by as much as 2.5 pp? The balance of risks has practically remained unchanged since the previous monetary policy 2/3 BIS central bankers' speeches meeting, while inflation has slowed down to its target of 5% ± 1 pp even faster than the NBU expected. Under such conditions, the NBU has decided to cut the key policy rate by as much as 2.5 pp. This is another step towards creating favorable conditions for reviving lending to the real sector and speeding up economic growth. What will the NBU’s monetary policy stance be in future? In light of the more rapid improvement in Ukraine’s macroeconomic conditions, the NBU has now somewhat more ambitious plans compared to when it published its October forecast. If the inflation rate stabilizes in its target range of 5% ± 1 pp, the key policy rate could be reduced to 7% by late 2020. The NBU estimates the new neutral level of the key policy rate to be precisely at 7%. The most pronounced cuts in the key policy rate are expected to take place in H1 of the current year. This will lead to further decreases in loan rates for businesses and households, thus stimulating business activity. This is our baseline scenario. If the above inflation risks materialize, the key policy rate could be decreased more slowly. Conversely, faster implementation of reforms, coupled with significant investment inflows, could enable the NBU to cut the key policy rate at a quicker pace. Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 12 December 2019.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 12 December 2019. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 13.5% per annum effective 13 December 2019. The NBU speeds up the monetary policy easing, as the rapid appreciation of the hryvnia makes inflationary pressures decline faster than expected. What inflation developments followed the last monetary policy meeting? In November, consumer inflation slowed to 5.1% yoy, exceeding our expectations. In such a way, the NBU attained the medium-term target of 5%, which was set in 2015. The steady disinflation has been driven by a gradual easing of underlying pressures on prices, reflected in a slowdown of core inflation, and by lower energy prices. Inflation slowed markedly due to both the strengthening of the hryvnia and an improvement in inflation expectations. The above factors neutralized the pressure on prices from robust consumer demand and worse harvest of some vegetables. I would like to emphasize the reasons for the hryvnia appreciation, which has given rise to much speculation. In October–November, the excess supply of foreign currency was mainly driven by proceeds from Ukrainian exports, in particular thanks to a record harvest of grain and oil crops, and selling foreign currency coming from borrowings of state-owned companies. In particular, agriculture and metals industry provided 70% of foreign currency supply on the interbank market in November. Contrary to the common belief, the continued foreign investment in hryvnia government bonds did not have a major impact on the foreign exchange market, unlike in the past months. At the same time, the NBU actively purchased excess foreign currency to increase international reserves. Net foreign exchange interventions have totaled more than USD 5.5 billion since the start of 2019. (Corrected) Besides, our purchases of foreign currency much exceed the inflows from nonresidents. The nonresident portfolio grew by around USD 4 billion this year. Thus, net purchases exceeded this amount by more than one and a half billion dollars. This indicates that these are not only nonresidents who create the excess supply of foreign currency. What are the future inflation developments? The stronger hryvnia made inflation decline towards the 5% target faster than envisaged in the latest macroeconomic forecast. For that reason, in January, we will revise and publish the new macroeconomic forecast, including the future inflation trajectory. There is a cause for optimism. Reaching the staff-level agreement on the new cooperation program with the International Monetary Fund is an important milestone in the progress of structural reforms in Ukraine as well as in maintaining macrofinancial stability and steady economic growth. 1/3 BIS central bankers' speeches At the same time, other risks that the NBU took into consideration when making its previous monetary policy decision remain in place. In particular, the risk of rising threats to macrofinancial stability persists because of court rulings and pressure on the NBU. If materialized, these risks could worsen exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets at a time when debt repayments are peaking. The following external risks remain relevant: a complete halt of the transit of Russian gas through Ukraine intensified trade tensions and more turbulent global financial markets an escalation of the military conflict and new trade restrictions introduced by Russia. Therefore, macroeconomic conditions that are more conducive to lower inflation, continued cooperation with the IMF, and the practically unchanged balance of risks have enabled the NBU to ease monetary policy more quickly. The NBU believes that more active cuts in the key policy rate will not prevent it from maintaining inflation close to its 5% target, while at the same time promoting economic growth. Favorable macroeconomic conditions have given the NBU the green light to take a number of other steps together with key policy rate cuts. First, the NBU intends to purchase more foreign currency to replenish international reserves. With that in mind, the central bank will increase the amount of its planned interventions in the interbank market to purchase foreign currency from USD 30 to USD 50 million per day for the remainder of the current year and Q1 2020. Second, the NBU has changed its approach to reserve requirements for banks. From March 2020, the NBU will introduce differing reserve ratios for different currencies. For hryvnia reserves, this ratio will be decreased to zero. For FX reserves, this ratio will be raised to 10%. The NBU believes that this will not only contribute to the lower dollarization of deposits but will also helpdecrease loan rates for households and businesses more quickly. Third, the NBU continues to liberalize the FX market. The e-limit on households’ investment abroad will be increased by two times – to EUR 100,000 per year. The Board approved all of the three decisions today at the monetary policy meeting. More information about these decisions will be made public today on the central bank’s website. What will the NBU’s monetary policy stance be in future? The macroeconomic forecast that the NBU published in October envisages that the key policy rate will be cut further, to 8%. A revised macroeconomic forecast will be made public in January 2020. Among other things, the forecast will take into account the impact of consumer demand and FX market conditions on future inflation. In addition, the NBU will continue to monitor what progress is achieved in implementing key 2/3 BIS central bankers' speeches domestic reforms. These reforms are those that are envisaged in the memorandum of understanding signed by the Ukrainian government and the NBU, and the judicial reform required to establish the rule of law in Ukraine. The next meeting of the NBU Board on monetary policy issues will be held on 30 January 2020. Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the opening of the meeting of the National Bank of Ukraine with stakeholders, Kyiv, 16 January 2020.
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Yakiv Smolii: Strategy of Ukrainian financial sector development until 2025 Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the opening of the meeting of the National Bank of Ukraine with stakeholders, Kyiv, 16 January 2020. * * * Dear Mr Prime Minister, dear guests, I am pleased to open the Third annual meeting of the National Bank of Ukraine with clients and partners. These events are how we make the NBU more transparent and accountable to the public, and its policy more comprehensible. Stakeholder meetings enable a comparison between what was planned and what has actually been achieved. However, today’s event goes beyond summarizing the central bank’s performance and unveiling plans for 2020. The highlight of our meeting today is the Strategy of Ukrainian Financial Sector Development until 2025. In less than half an hour, the Minister of Finance and the heads of the National Securities and Stock Market Commission, the National Financial Services Commission, and the Deposit Guarantee Fund will join me in signing this milestone document. My colleagues and I have worked on the Strategy for almost six months. We have spent hundreds of hours studying the experience of other countries, negotiating with regulators, planning, and consulting with financial sector participants. And to be honest, we are satisfied with what we have accomplished, because we did it in the spirit of maximum cooperation and transparency. We believe that this is the only way to keep our plans realistic and to make them materialize. We are convinced that this is the only way to take the Strategy beyond being words on paper and to make it into a full-blown vision of the future. By signing the Strategy, my fellow signatories and I commit to making this vision a reality. We possess the necessary and, most important, successful experience to make it happen. The past five years have been marked by the Comprehensive Program of Ukrainian Financial Sector Development Until 2020. For Ukraine, that document was the first of its kind. Like the new Strategy, it was the fruit of joint efforts by financial regulators, resulting in many bold decisions being made in that period. But let me be specific. To evaluate the results of that effort, we tracked how the actions outlined in the Comprehensive Program were being performed. We found that almost two thirds of those actions had been taken. Not all of them were brought to their conclusion, of course. Some of them were planned to last beyond 2020 and are still being realized. Some of those actions were delayed for reasons outside of our control. But we are not abandoning those plans. We will pursue them until they become reality. With that in mind, we have included those actions into the Strategy of Ukrainian Financial Sector Development until 2025. Strategy 2025 is thus a natural continuation of reforms that were launched earlier. Could we have done a better job implementing the previous program? As I look back, I am inclined to say yes. But if you take into account the conditions in which we were making those radical changes to the financial market, perhaps you can see that we did a decent job. 1/4 BIS central bankers' speeches Be reminded that we were having a triple crisis on our hands, the kind that economists call a perfect storm. Ukraine was simultaneously fighting a war, going through a financial crunch, and teetering on the brink of default. That makes me certain that we can take pride in what we have accomplished together. The list of our accomplishments is far from short. Let me mention what the NBU has achieved: The NBU has strengthened its institutional independence and become a technocratic institution that makes decisions based on analysis and facts. The NBU has undergone an unprecedented internal transformation, virtually setting an example for other central banks in many areas. We are now at a point where not only do we seek technical assistance from other central banks, but also we consult and assist our colleagues. The NBU has changed its monetary policy and is now targeting inflation rather than the exchange rate. By the way, the NBU has floated the exchange rate so that it now reflects market reality and is no longer maintained manually by burning through international reserves. The NBU has revitalized the banking sector. The banks currently in the market are solvent, profitable, and ready to take on potential economic shocks. Which means these banks are safe for clients. The NBU has liberalized its currency regime – and thus revolutionized the industry – by replacing obsolete currency laws that dated back to the 1990s. The NBU has significantly increased the responsibility of bank owners and management. With new laws in place, no one can lead a bank to bankruptcy without facing criminal charges. This is a necessary dose of discipline and responsibility that all civilized markets have, as now does the NBU. The NBU has significantly improved the corporate governance of state-owned banks. They are now required to have independent supervisory boards or else face the consequences of breaking the law. The NBU has adopted risk-based supervision and strengthened its financial monitoring function. This enables the central bank to respond to emergencies proactively, as opposed to putting out the quote-unquote fires after they break out. As a matter of fact, the list of our accomplishments goes on and on, for which I would like to thank all of the NBU’s employees and our international partners and experts who helped us make these results possible. My gratitude goes out above all to the IMF, both for providing the financing and for sharing knowledge and expertise. I also am thankful to the European Union, the European Bank for Reconstruction and Development, the World Bank, the United States Agency for International Development, and central banks from around the globe. Going back to the 2025 Strategy. I’m really glad that the NBU, the government, and other regulators share the vision of how to enhance the quality of financial services, and how to make them more easily accessible, more secure, and more convenient for Ukrainians. We think along the same lines. And this is half the battle. A famous fable talks about a swan, a crayfish and a pike that pulled a cart in different directions. This is not the case with us. We see the implementation of the 2025 Strategy as a way to having a civilized, transparent and effective financial sector. With that in mind, we have drawn up an understandable and clear action plan for the next five years. To prevent there being any surprises, we’ve decided to put our 2/4 BIS central bankers' speeches cards on the table and reveal our plans for the next five years. What do we really want to achieve? We have five goals. First. Promote sustainable economic growth in Ukraine. We want to deliver all of the required conditions for economic growth. This will make many Ukrainian residents confident about their future. Second. Delivering macrofinancial stability. In effect, we’ll continue to be involved in efforts to ensure the stable and reliable operation of the financial system, including the banking system. And to ensure that the financial system is prepared to deal with external or internal shocks. This is one of the main preconditions for sustainable economic growth that I have already mentioned. It’s because the financial system is like the blood circulatory system of the state: if it malfunctions, it causes problems for other parts of the body of the state. And we definitely don’t want to see that happen. Third. We will make the entire financial system, not just banks, but other financial institutions as well, more reliable and technologically advanced. All customers must be confident that they will get high-quality services. And know for sure that they won’t be cheated. This will only happen when standards and requirements for service providers are transparent, understandable and the same for all. A regulator that has zero tolerance of the non-market behavior of financial institutions will be watching over companies. I can guarantee that. What is more, financial services will be available online from all devices, be it a laptop, a smartphone, or an iPad. People will be able to get the services they need. In this regard, Ukraine will be on a par with countries where financial services and fintech are developing rapidly. Fourth. We want Ukrainian financial services to be fully in line with European standards. This will instill more confidence in clients. And this is Ukraine’s direct commitment under the EU-Ukraine Association Agreement. We are gradually discharging our obligations in order to enable Ukraine to integrate into the EU’s financial environment. And finally, the fifth goal. We are seeking to enhance trust in the financial market. There are many reasons why Ukrainian sometimes take a cautious approach to financial services, and may not be always prepared to be the clients of banks, insurance companies, and pension funds. The main culprits are the financial crises Ukrainians had to go through, which may have led to a negative experience or even financial losses. Our task is to minimize negative experiences and to ensure reliable protection of the rights of financial services consumers. And not just by words, but by deeds. This will be the financial system’s contribution to restoring confidence in the state. We hope that by 2025 we’ll be able to: generally increase the ease of doing business in Ukraine and attracting foreign investment make financial services reliable and transparent, while decreasing the cost of cashless payments provide remote access to such services and more. Overall, it’s not an exaggeration to say that the 2025 Strategy is a synonym for the continued development of the financial sector and the entire Ukrainian economy. If you go through the strategy, you will see that the roadmap for specific changes we want to implement accounts for 3/4 BIS central bankers' speeches more than half of the document. And we have already started. The NBU, for example, has as usual drawn up an action plan for the current year and reported on its 2019 results. The action plan is based on two documents – the strategy for financial sector development until 2025 and the central bank’s medium term strategy. The action plan has already been posted on the NBU’s official website, and the participants in this meeting also have it on paper. To wrap up, I’d like to say that we’ll definitely succeed, if we, every day, take the specified steps and remember why we’re doing that. We have a guest of honor today, to whom I will now turn over the floor. Please welcome the Prime Minister of Ukraine Oleksii Honcharuk. 4/4 BIS central bankers' speeches
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Report by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, to Verkhovna Rada of Ukraine (Parliament of Ukraine), Kyiv, 13 May 2020.
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Report to Verkhovna Rada of Ukraine by NBU Governor Yakiv Smolii 13 May 2020 12:16 Dear Chairman, dear parliamentarians! Thank you for the opportunity to tell you how the NBU is helping the Ukrainian economy overcome the consequences of the coronavirus pandemic. Spoiler: successfully. The corona crisis is the first crisis in the history of Ukraine with none of the following: bankruptcy of banks spike in inflation catastrophic decline in international reserves long lines near ATMs. Unlike in previous crises, the banking system today is not a burden for the economy, but rather its lifeline. We are not saving the banking system – the banking system is saving the economy. All of this is the result of quick and effective actions by the NBU in response to the pandemic and quarantine measures. In doing so, we are keeping abreast with central banks in other emerging markets and the world’s leading economies. Personally, it is very important for me that Ukrainians have noticed and appreciated our efforts. Public confidence in the NBU has more than doubled during the tense March–April period, according to data compiled by Razumkov Center. So, what exactly have we done to counter the crisis? Our actions have been aimed at achieving four goals. The first has been to protect everyone’s health: people who actively use financial services and those who deal only with cash. The second goal has been to ensure the high-quality and uninterrupted operation of the financial system during the lockdown. The third goal has been to support the economy with available financial resources in this difficult time. The fourth has been to create conditions in which the economy will quickly return to growth after the quarantine has ended. And now, with two months of the quarantine behind us, I can say with confidence: we have succeeded! What is more, we did it without introducing any painful restrictions! We reacted very quickly. Already on March 12, we lowered the key policy rate to support the economy as it made its way through the pandemic and quarantine. In April, we continued to reduce the key policy rate. Overall, the key policy rate decreased from 11% to 8% in a matter of two months. This is the lowest key policy rate in the history of Ukraine. The key policy rate is not words on paper, but a real tool the NBU uses to impact the cost of loans. We have introduced new tools to support the economy. First of all, it is long-term financing for banks for a period of 1 to 5 years. In the first such auction, which took place last week, the NBU granted 11 banks UAH 2.4 billion in loans maturing in 1.5 to 5 years. We also signed a currency swap agreement with the EBRD for USD 0.5 billion. Under this deal, we will receive dollars from the international organization to replenish our international reserves. In return, the EBRD will receive hryvnias, which it will use to lend to Ukrainian companies that have suffered losses from the pandemic and lockdown. We have thus created conditions in which businesses can receive funds at affordable rates not only for short-term needs, but also for large-scale business projects that require long-term investments. For example, infrastructure projects such as road construction are important for the state and for job creation. And what about the people? For the public, our efforts to cut the key policy rate and curb inflation are already working today so that a 10% mortgage rate can become a reality tomorrow. At the same time, we have simplified access to financing for banks: We have increased the frequency of tenders. We have extended the term of NBU loans to banks from 30 to 90 days. And we have already granted UAH 7 billion of these 3-month refinancing loans. We have expanded the list of collateral that banks can provide to take out loans from the NBU. We will now accept not only government bonds, but also municipal and governmentguaranteed corporate bonds. The banking system is highly liquid today, with about UAH 200 billion in liquidity. However, if any bank feels the need for funds, it can now get loans from the NBU even faster and easier than before. In addition, in order to free up the funds of banks to support the economy, we have postponed the formation of capital buffers and recommended that banks refrain from paying dividends. Also in March, we have implemented a system of anti-crisis measures that offers five key solutions to ensure that the financial system operates in an uninterrupted manner. The first solution is concerned with loans. We have introduced “credit vacations” – special grace period for servicing loans for those who have so far paid faithfully on a loan, but faced financial difficulties due to the quarantine. The result is that banks give borrowers the opportunity to make payments on consumer loans after the quarantine without penalties or late payment fees. Most banks are already providing the opportunity to restructure loans to make it easier for customers to service debt after the lockdown has ended. The second solution applies to deposits. We have prohibited banks from imposing any restrictions on withdrawals. We have bet on the reliability of banks and the confidence of depositors in them, and we have been right. The result is that deposits remain in the banking system. In the first weeks of the quarantine, the outflow of funds was insignificant – much smaller than in the first days of the 2008 and 2014 crises. However, household deposits rebounded very quickly. In the last two weeks of April, hryvnia household deposits were actually at their highest since early March. The third solution has to do with how the banking system operates. We initially worked diligently with banks to maintain the availability of financial services despite the quarantine, while ensuring that financial service consumers remain in good health. We gave recommendations about which branches should remain open and how banks should work “on the ground.” In order for banks to focus all resources on priorities now, we have postponed stress tests and onsite bank inspections until after the crisis. The result is that banks continue to provide uninterrupted customer services in full. All central offices of banks and 77% of branches across the country are open. Banks have enough funds to meet customer needs. More than 96% of ATMs are working. They are supplied with cash on a regular basis. The fourth solution deals with foreign currency. In March, the NBU registered heightened anxiety in the FX market and entered the market regularly to sell USD 2.2 billion to smooth out the fluctuations. As a result, panic buying in the FX market subsided in April. Net FX supply is now even higher than in February, before the pandemic outbreak started in Ukraine. Thus, the hryvnia appreciated slightly, and the NBU returned to moderate purchases of foreign currency to replenish international reserves. We also quickly resolved the issue of cash FX deficit due to stalled air transportation. The NBU ensured that the supply of dollar and euro cash to Ukraine would continue, and made weekly transactions to exchange cash for noncash currency. Therefore, the NBU provided banks with over USD 550 million and EUR 42 million and fully met their needs in foreign currency cash. Today banks have no problems with foreign currency cash in their vaults. The fifth solution is related to payments. The NBU has recommended the public to resort to remote banking as much as possible. The NBU canceled fees for SEP services to make cashless payments cheaper. Payment cards that expire during the quarantine can be renewed. Safe cash payments are also a priority for the NBU. The coronavirus does not spread quickly through cash, but we decided to be cautious here. The banknotes coming from the market are transferred to the NBU’s vaults for a “sanitizing quarantine.” Banks are receiving banknotes that were stored in NBU vaults before the pandemic hit Ukraine. We have enough cash to support the economy. What’s next? The Ukrainian economy entered the COVID-19 crisis in a much better state than in 2008 and 2014 crises, with moderate inflation, an effective floating-rate policy and currency liberalization, a low deficit of the current account, sizeable international reserves, a prudent fiscal policy, and a reformed banking sector, which used to be a catalyst in previous crises. These results were achieved thanks to previous years’ reforms, the NBU’s quick and effective actions, and an anti-crisis fiscal policy, and will ensure that the Ukrainian economy will contract by no more than 5% in 2020. In Q3, once the quarantine is fully lifted, business activity will start recovering and unemployment will gradually decline. In the coming years, we again expect growth of 4%. To stimulate the economy, we will probably be able to cut the key policy rate further during the current year. Through prudent monetary policy, we have ensured price stability for several years running, in line with our mandate as a central bank. In other words, inflation has been low and stable and will remain within the target range of 5% +/- 1 pp. Ukraine definitely needs large amounts of government spending to curb the coronavirus and to support the economy, like many other countries. However, the medicine should not be more harmful than the disease itself. Let me remind you of some facts from Ukrainian history. Uncontrollable printing of money to finance government spending has always had a catastrophic effect on the economy. We can make everybody a millionaire, but the millions will be of no value. The right way is to complete talks with the IMF and receive low-cost financing for the budget from official donors. The NBU has only one legal option to help the government directly with “ready-to-use cash.” It is to transfer the NBU’s profits to the budget, which has already been done. In April, the NBU transferred a total UAH 42.7 billion of its 2019 profits in one batch, which is UAH 2 billion more than was planned when the state budget was being drafted. This way, the NBU ensured that the state would receive almost half of the budget revenues planned for April. I am often asked whether the NBU is too optimistic We are cautiously optimistic about our future, but let’s be real: uncertainty is now higher than ever. Our macroeconomic projections assume that the quarantine will end as soon as Q2, and that it will not be reintroduced. But what if we are wrong? What if the world gets hit by a second wave of the pandemic? What if we have to return to quarantine restrictions over and over again? No one in the world can give straight answers to these questions. Therefore, we at the NBU are prepared to respond quickly and effectively to new challenges. The regulator is monitoring the situation, assessing risks, and checking the feasibility of its forecasts. The NBU’s toolkit has been and will be efficient even under a continued quarantine. I mean the key policy rate, financial support to the economy through banks, massive international reserves, banking sector regulatory instruments. Moreover, today any person in Ukraine can address the NBU with a request to protect their rights if they have been violated by a bank. In the near future, we will have even more options to ensure financial stability after the NBU has stepped in as a regulator of nonbank financial institutions on 1 July. Price and financial stability in the country are crucial for a healthy economy today and will remain so tomorrow and the day after. Therefore, the NBU has done its utmost and will put in every effort to preserve financial stability. However, this is our common responsibility. The financial system is not operating on an economic island. The more favorable the economic environment, the more institutionally strong the country, the more protected the rights of creditors and investors, the more the financial system can be the engine of economic growth. The question everyone here has to ask himself or herself is not where to get the money from. Instead ask yourself how fast we can make the reforms. At the end of the day, whether the Ukrainian economy falls by 5% or by less is in the hands of all of us! Thank you.
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Opening speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Annual Research Conference "Labor Market and Monetary Policy", organized by the National Bank of Ukraine and the National Bank of Poland, online, 28 May 2020.
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Yakiv Smolii: Labor market and monetary policy Opening speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Annual Research Conference "Labor Market and Monetary Policy", organized by the National Bank of Ukraine and the National Bank of Poland, online, 28 May 2020. * * * Ladies and Gentlemen, Welcome to the Annual Research Conference of the National Bank of Ukraine and Narodowy Bank Polski. Today’s event is special. First, it is the fifth anniversary conference. Second, it is held online for the first time. Third, we will discuss a very sensitive topic that is especially important for the world today as it suffers from the coronavirus crisis: the labor market and monetary policy. Although the event is remote, speakers and participants from around thirty countries have gathered in this virtual room. Indeed, the topic of this year’s conference is relevant for any country. Many countries have managed to rein in inflation and attain low levels of unemployment over past decades. However, economic inequality, population aging, migration, and numerous other aspects continue to threaten economic development and long-term macroeconomic stability of the world. Let’s look at the key labor market trends that shape the global economy today. Demographic trends go first. The development of the healthcare system allows people to live longer. However, with insufficiently high birth rates, this leads to a gradual population aging. As a result, increased pressure is put on the social security system and on employees and state budgets in the case of pension systems where mandatory contributions are made to the general pension fund. With globalization, labor market liberalization, and conflicts in a number of countries, the world has faced greater migration from lower-income countries to the countries where incomes are higher. According to the International Organization for Migration, there are currently 272 million migrants in the world. The labor migrants account for two thirds of this number. On the one hand, the global economy benefits from economic migration. Labor migrants’ host countries cover their needs in labor force, attract younger workers, and experience an increase in productivity and entrepreneurial spirit, a trait that is more typical of labor migrants than of those who stay home. In turn, migrants’ home countries receive short-term dividends in the form of remittances, which are rather stable compared to other financial inflows. On the other hand, international migration has a flip side: the shortage of labor force in migrants’ home countries, opposite pressures on wages in host and home countries, and increased burden for the social security and healthcare systems – not to mention the social and political consequences. Another upside of international migration is that it helps reduce global economic inequality. According to the World Bank, inequality between all people in the world has declined since 1990. However, the benefits of economic growth within countries are still distributed very unevenly. According to the World Bank, since 2008, economic inequality within countries has largely stopped rising due to the fact that in most countries, along with economic growth, incomes of the less well-off 40% of the population have increased. However, these 40% of the population still 1/4 BIS central bankers' speeches receive less than 25% of total income of the total population. Thus, despite fairly positive trends, inequality within countries is still even higher than 25 years ago. The corona crisis in most cases has only made things worse The Great Lockdown, as some have already named this crisis, will lead to a sharp decline in economic growth. The global economy will lose 3% of real GDP this year, according to the IMF. A partial recovery will take place next year, but GDP will still be below pre-virus levels. But this is only possible if the pandemic eases and quarantine measures are gradually relaxed this year, which is highly uncertain. The coronavirus has hit the labor market the hardest. Due to the corona crisis global working hours in the second quarter may decrease by 10.5 per cent compared to the last precrisis quarter. This is equivalent to 305 million full-time jobs. In addition, it could jeopardize 1.6 billion people working in the informal economy, which is about half of the global workforce. These are rather appalling data from the International Labor Organization. The coronavirus does not seem to discriminate between the rich and the poor, or between whitecollar and blue-collar workers. However, the actual economic fallout from the pandemic is very unevenly distributed. In today’s world, the poorer the people, the simpler and lower-paid the jobs they hold, and the more that they rely on their jobs as the sole source of income, the more that they suffer. Previous pandemics and crises have only exacerbated inequality, and the corona crisis is unlikely to be an exception, according to a recent study by a group of economists from the Center for Economic Policy Research. Incidentally, we will have the opportunity to hear one of these researchers tomorrow. The current crisis could even lead to a more significant increase in economic inequality than its predecessors, as it is more pervasive and profound than previous crises. Unfortunately, Ukraine is all too familiar with many of these problems We expect that unemployment in Ukraine will peak at 11.5% in Q2 2020 due to the corona crisis, compared to 8.2% last year. As the gradual easing of quarantine measures that has started in May continues and the economy recovers, unemployment will also decline in H2 2020, but will remain higher than last year. The job losses that hit Ukrainians as businesses closed down have not only complicated job search efforts by increasing the workload per vacancy, but also have shown that there will be no easy solution to the labor migration problem in Ukraine. Some Ukrainians working abroad did not even return home for the quarantine, as they in particular feared the prospect of becoming jobless in Ukraine. They chose remaining abroad and being temporarily unemployed over coming home and struggling to find any work at all after the lockdown is lifted. And those who did return are now forced to compete against “local” laid-off workers for jobs that rarely pay as much as these migrants earned in other countries. For this reason, migrant workers have been leaving Ukraine again in search of better pay since quarantine restrictions were partially relaxed. Demand for Ukrainian workers in Poland, for example, has not disappeared. However, most of the problems in the Ukrainian labor market are not related to COVID-19. First, one of the systemic problems of the Ukrainian economy has for years been the mismatch between job seeker skills and employer requirements. Late last year, a third of companies cited labor shortages as being one of the key factors limiting production, according to business surveys. This partially explains why unemployment in 2019 was quite high despite significant demand for labor from businesses. Not the least role in this is played by the fact that the Ukrainian education system does not keep 2/4 BIS central bankers' speeches up with the changes in the modern labor market, which are taking place under pressure of globalization and technological progress. As a result, according to the State Statistics Service, in Ukraine about a third of employees with higher education worked in a profession that does not require such. This is one of the highest rates in Europe. • Second, low productivity. Despite having grown over the past 15 years, productivity is still low. Ukraine is below the top one hundred countries in an ILO ranking of countries by productivity. In 2019, labor productivity in Ukraine was lower not only compared to EU member states, but also relative to several former Soviet countries. • Third, population decline and aging. Ukraine ranks 12th in the world in terms of population decline, according to World Bank data. Overall, Ukraine has 11 pensioners per 10 employees. As a result, the Pension Fund needs constant additional contributions from the state budget. This diverts public funds from being spent on investment and education, and weighs on potential GDP growth. The high workload on employed individuals further increases the already elevated levels of informal employment. In 2019, one in five workers in Ukraine was employed informally. According to the ILO forecast, by 2024, the burden on the working population by dependent people will increase compared to 2019 even more – by 6%. • Fourth, labor migration, as I have mentioned already. There are no exact data on the number of Ukrainians working abroad. However, according to various estimates, it is about 3 million people. Some of them are seasonal workers. Last year, an average of approximately 2.5 million of our citizens were abroad at a given point in time, according to NBU estimates. For us, this presents a double challenge. Not only does labor migration affect the quantity and quality of labor resources and labor productivity in Ukraine, but also it makes our economy heavily dependent on remittances. Ukraine ranks 12th globally in terms of total incoming remittances and is in the top 15 countries by the remittances to GDP ratio (not counting island states). • Fifth, low labor force participation. In particular, the labor force participation of women in Ukraine is insufficient compared to Europe. While the labor force participation of men in the population aged 15 and older is 65%, that of women is 49%. This is due to difficulties with accessing childcare services, and the low availability of part-time employment. In its turn, low labor force participation puts a drag on potential GDP growth. How can monetary policy help in such cases? A dual mandate whereby a central bank pursues both price stability and full employment is not particularly commonplace in today’s world. The Reserve Bank of Australia and the U.S. Federal Reserve have pursued dual mandates since post-war times, as has the Reserve Bank of New Zealand since a year ago. However, making monetary policy decisions that take labor markets into account does not require a dual mandate. In fact, the effectiveness of monetary policy depends on a deep understanding by central banks of the mechanisms governing labor markets. After all, it has been proven that there is a close link between wage growth and inflation. And labor migration in many 3/4 BIS central bankers' speeches countries has a significant impact on inflation – both through labor supply and wages and through remittances and the exchange rate. For example, the rise in labor migration from Ukraine in 2016–2019, in particular to Poland, was one of the key factors fueling the rapid increase in wages. This has led to the growth in production costs and thus in prices, especially those for services. In addition, when productivity is low, high wages make domestic producers less competitive, which in turn restrains economic growth. Have we considered this in conducting our monetary policy? We certainly have. Moreover, we, the central banks, even under the standard “single” mandate for the inflation target, care about macroeconomic stability, economic growth, and hence the unemployment rate. The task of a central bank is to strike a balance between keeping inflation at the target level and promoting economic growth. And as the current crisis has shown, it is possible and necessary to contribute to the achievement of goals at the same time. However, given the circumstances, it is necessary to act decisively and unconventionally. In recent months, we have seen developed countries with near-zero interest rates resort to nontraditional monetary policy instruments. Meanwhile, emerging economies that still have room for monetary easing are relying on standard tools. For instance, we at the NBU have done a lot to support the economy during the corona crisis and to strengthen its ability to quickly get back on its feet when it’s over. We have slashed the key policy rate from 11% to 8% in just the past two months and are not ruling out the possibility of further cuts. We have expanded the list of bank liquidity support tools and facilitated access to these tools. We have introduced long-term refinancing for banks for a period of 1 to 5 years and an interest rate swap with banks, and made a currency swap deal with the EBRD so that it can provide hryvnia loans to Ukrainian companies. We have thus created conditions in which businesses can access funding at affordable rates, not only for short-term needs, but also for large-scale business projects that require long-term investments. We have taken steps to ensure that financial stability does not become another source of problems for the economy. However, the power of central banks has its limits. Can we do anything about the differences in people’s perceptions of economic recovery? No, I don’t think we can. I think we should leave this up to national governments. In times such as these, central governments ought to prioritize fiscal incentives, including targeted measures to maintain consumption levels for those who have lost part or all of their income to the quarantine. Like other central bankers, we in Ukraine can only provide a favorable monetary environment and ease financial market conditions. But this is a good question to ask, and the corona crisis has given it special relevance. We will have two days to discuss, in particular, how monetary policy affects economic inequality and whether economic inequality should be among a central bank’s goals. And as we talk about it, we should find the answer to the most fundamental question: is the dual mandate of central banks justified, or is it more appropriate to focus on inflation? Thank you for your attention. I wish you fresh ideas and interesting discussions! 4/4 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 23 April 2020.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 23 April 2020. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 8% per annum. The continued monetary easing aims to support the economy during the period of pandemic and quarantine. What inflation developments followed the last monetary policy meeting? In March–April, inflation remained even lower than the NBU had expected, despite the temporary price growth in the first weeks of the quarantine. Last month, inflation declined to 2.3%. Price growth was restrained by three major factors. First, lower global energy prices. Second, residual effects of last year’s appreciation of the hryvnia. Third, a larger supply of raw foods. These factors outweighed the effect from the weakening of the domestic currency in March and the panic buying of some goods in the first weeks of the quarantine. According to preliminary data from NBU online monitoring, inflation remains low in April, at less than 3%. High demand for essential goods waned quickly. As a result, prices for most food products and medicines, which had grown in the first weeks of the quarantine, have declined in recent weeks. The foreign exchange market also calmed. In March, with foreign currency supply on the interbank market remaining almost unchanged, a spike in demand put a depreciation pressure on the hryvnia. However, in April not only did demand drop below the level of supply, but also the net supply of foreign currency is now even higher than it was in February, before the epidemic and quarantine began in Ukraine. Therefore, the hryvnia strengthened somewhat this month, and the NBU can cautiously resume purchases of excess foreign currency from the market in order to replenish the international reserves. How will inflation behave in the future? In 2020, inflation will remain within the target range of 5% +/- 1 pp. Price growth will accelerate moderately in the coming months, to reach 6% at the end of 2020. Fiscal and monetary policy measures that are aimed to support businesses and households will partially offset the decline in consumer demand. However, consumer demand will remain subdued for long after the quarantine ends. This will keep inflation from growing above the target level this year. Inflation will also be contained by declining global energy prices, which will continue to influence domestic fuel prices. 1/4 BIS central bankers' speeches At the same time, the increase in inflation compared with the current level will be primarily driven by a pass through from the recent depreciation of the hryvnia. In Q1 2021, inflation will temporarily deviate from the target range against a low comparison base. Afterwards, it will decrease and stabilize at the medium-term target of 5%. This level will be achieved thanks to the NBU’s prudent monetary policy and a more restrained fiscal policy after the pandemic ends and economic activity recovers. What will be the overall state of the Ukrainian economy? The economy of Ukraine will contract by 5% in 2020 in the wake of the global crisis and the quarantine imposed to overcome the pandemic. The adverse impact of the pandemic on the Ukrainian economy is expected to be relatively short-term, but strong. The quarantine has already affected business activity, consumption, and employment. A decrease in global demand has also limited export opportunities for Ukraine. According to NBU estimates, the effect of these factors will be the most pronounced in Q2 2020. However, a gradual lifting of quarantine restrictions will allow the economy to recover quickly in H2 2020. Loose fiscal and monetary policies will contribute to the economic recovery. An increase in budgetary spending by the government to overcome the crisis, along with the NBU’s actions to support the banking system, will mitigate the negative impact the pandemic has on the economy. The economy will resume growth at round 4% in the following years. Overall, the pandemic has a mixed impact on macroeconomic indicators: for some of them it is negative, while being even positive for other. In particular, the NBU revised the current account deficit for 2020 downwards. This year, the deficit will be 1.7% of GDP, although projected at 3.2% in the January macroeconomic forecast. Imports of goods to Ukraine will decrease more than exports. Amid the quarantine and lower global prices, Ukraine will reduce its purchases of energy and the majority of nonessential goods. The pandemic will affect Ukrainian exports less, as demand for food products remains strong. At the same time, the decline in remittances from labor migrants will be more than offset by Ukrainians spending less on foreign travel. The current account deficit will widen again once economic activity rebounds globally and in Ukraine. There are also several reasons for this. Next year, Ukraine is expected to see a drop in gas transit revenues, as well as pent-up demand for consumer goods from households and for investment imports from businesses. Despite that, the current account deficit will remain acceptable, at 3% to 4% of GDP, as envisaged in the NBU’s January forecast. What does the realization of this forecast depend on? Continued cooperation with the IMF remains the key assumption of this macroeconomic forecast. Ukraine is close to having a new aid program approved by the IMF Executive Board. The NBU’s revised forecast envisages that Ukraine will receive the first tranche of about USD 2 billion in Q2. First, this will cover the state budget deficit, which has increased to 7.5% of GDP. This will enable Ukraine to confidently pass through the period of peaking debt repayments, and finance measures to support businesses and households at a time when business activity is slowing down, employment and tax revenues are falling, and foreign investors are leaving 2/4 BIS central bankers' speeches emerging markets. Second, financing from the IMF and other official international partners will help maintain Ukraine’s international reserves at USD 27 to 29 billion this year and in the coming years. In this light, signing a new aid program with the IMF is the main prerequisite for maintaining macro-financial stability in Ukraine during the global crisis. Therefore, the absence of a program with the IMF remains the main risk to this forecast. Another important risk to the outlined macroeconomic forecast could arise from a longerlasting novel coronavirus pandemic and, consequently, longer-lasting quarantine measures being required to overcome the outbreak. This will have a direct influence on how quickly the global and Ukrainian economies recover. Other risks also remain significant. They include: an escalation of the military conflict in eastern Ukraine a drop in the harvest of grain, fruit and vegetable crops in Ukraine in the wake of unfavorable weather the higher volatility of global food prices, driven by global climate change and the risk of stronger protectionist measures. Why did the NBU decide to cut the key policy rate by 2 pp? Like most countries, Ukraine has found itself in a situation in which the economy needs significant support because of weaker business activity and falling consumption and employment. Moderate inflation pressures leave room for that. Other central banks are actively cutting their key policy rates and providing additional monetary stimulus. These countries are also trying to find the reasonable boundary beyond which productive stimulus to the economy becomes an excessive desire to flood the economy with money, which could undermine macrofinancial stability. In view of the above, the NBU continued to ease monetary policy, by cutting the key policy rate by 2 pp, to 8%. Together with other measures taken by the NBU, this will provide the economy with the impetus required to provide support for households and businesses in these difficult times, and to ensure that business activity picks up quickly once the quarantine is lifted. At the same time, these measures will not threaten macrofinancial stability in Ukraine. How does the NBU intend to change the key policy rate in future? The central bank plans to cut its key policy further, to 7% in the current year. In deciding how quickly the key policy rate can be decreased to that level, the NBU will take into account: how talks with the IMF progress how the coronavirus pandemic develops and how quickly quarantine measures are lifted what anti-crisis measures other governments and central banks adopt. The NBU leaves open the possibility of a greater easing in monetary policy this year if a fall in consumer demand due to quarantine measures and weaker business activity put stronger downward pressure on inflation than is currently expected. Before we proceed to the questions and answers session, I have an announcement to 3/4 BIS central bankers' speeches make. Over the last month, the NBU has been actively developing a set of tools to support the economy. These tools will enable the NBU to provide banks with greater access to financing, which they could use for lending to the real economy. This should increase the stimulus provided by the cut in the key policy rate. The NBU seeks to enable banks to help the economy get back on track for growth once the quarantine is lifted. All of these measures will be introduced gradually in April–June. First, starting next week, the NBU plans toextend the term of the refinancing loans that are granted through weekly tenders, from 30 to 90 days. Second, the central bank intends to expand its list of eligible collateral that banks can use to obtain financing using standard liquidity support instruments. The NBU is looking into the possibility of incorporating government-guaranteed corporate bonds and municipal bonds into the pool of eligible collateral. Third, the central bank is finalizing an interest rate swap tool banks can rely on to minimize interest rate risk. The tool is expected to become available in Q2. The NBU will launchlong-term refinancing loans with terms of up to five years. These loans will be issued at a floating interest rate and secured with the same collateral as loans that are granted through tenders. The NBU is currently finalizing technical preparations for the introduction of this tool, and plans to hold the first auction on granting long-term refinancing loans as early as the first half of May. This tool will serve as an additional guarantee for maintaining sufficient liquidity in the banking system if the sentiment of financial market participants deteriorates due to the spread of the coronavirus infection. The NBU also expects that banks will be able to use this refinancing tool to support the economy through lending more actively to projects that require long-term investment, such as infrastructure projects. This will help restore business activity and reduce unemployment. Thank you for your attention! 4/4 BIS central bankers' speeches
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Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 12 March 2020.
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Yakiv Smolii: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 12 March 2020. * * * Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to cut the key policy rate to 10% per annum effective 13 March 2020. The NBU continues its monetary policy easing, as predicted, in order to bring inflation back to its target range of 5% +/- 1 pp and to support economic growth in Ukraine amid a cooling global economy. What inflation developments followed the last monetary policy meeting? In the first months of the year, inflationary pressures waned faster than we had expected. Consumer inflation slowed down to 3.2% yoy in January and to 2.4% yoy in February, which was faster than foreseen in the forecast trajectory. As a result, inflation is currently below the NBU’s medium-term target of 5% that is the level optimal for the development of the Ukrainian economy. A number of factors stand behind the faster disinflation. First, last year’s strengthening of the hryvnia impacted prices of goods, especially those which are imported. Second, supply of some raw foods increased. Third, global energy prices dropped. These factors offset the effect of robust consumer demand, which was bolstered by the lasting growth in real household income. Growth in real wages accelerated to 12.5% in January, and growth rates of retail turnover continues to exceed 12%. What are the future inflation developments? In January the NBU forecast inflation at 4.8% as of the end of 2020, but this forecast may be reviewed in April depending on further developments. So far, the global spread of the novel coronavirus has had a limited or neutral impact on the economy of Ukraine. Ukraine’s exports continue to rise. Further increases in physical volumes of exports have more than offset certain declines in prices for some of the goods the country exports. At the same time, import prices (especially energy prices) are declining even faster than export prices. The price environment on the crude oil market has been favorable for Ukraine even disregarding the latest developments. In February, crude oil prices declined by 10%–15% yoy on average, European prices for natural gas fell by 50%, and metals prices dropped by 11%–12%. Prices for grains and iron ore remained almost unchanged. Uncertainty over the spread of the novel coronavirus, and stronger turbulence on financial and commodity markets saw the Ukrainian FX market respond with deteriorated sentiment and 1/3 BIS central bankers' speeches increased nervousness. This has led to a sizeable increase in demand for foreign currency, which exceeded the supply, starting last week. The NBU has been active on the interbank foreign exchange market since last week in order to smooth out large fluctuations of the exchange rate. This week alone, net FX sales by the NBU reached USD 700 million, and the central bank is ready to conduct more FX interventions if necessary. Despite the fact that the psychological factor is the only reason for the FX market turmoil, it poses a risk of a deterioration in inflation expectations, which can later affect consumer prices. Although so far the global spread of the novel coronavirus has had little effect on economic growth and inflation in Ukraine, the NBU will most probably have to revise its macroeconomic forecasts in April. After all, the following consequences of the spread of the coronavirus have not yet impacted economic activity and inflation in Ukraine: the downward pressure on prices and a cooling of the global economy monetary policy easing by central banks of the leading economies and Ukraine’s trading partners in response to these processes measures taken by governments to prevent the spread of COVID-19. Apart from the drop in global prices caused by the coronavirus, disinflation in Ukraine will be driven by the recent rise in competition between crude oil producers. This will keep energy prices at record lows, which will also impact prices for Ukrainian exports. Overall, the effect of all these factors on economic growth and inflation in Ukraine will be mixed, adding to the uncertainty. What other factors did the NBU consider when making its monetary policy decision today? The NBU Board continued to rely on the key assumption that cooperation with the IMF will continue. Signing a new agreement with the IMF will make the Ukrainian economy less vulnerable in a time of turbulent global markets and during a period of heavy public debt repayments. Investors’ perception of Ukraine will also depend on Ukrainian court rulings on the responsibility and liabilities to the state of the former owners of insolvent banks. The risk arising from the global spread of the novel coronavirus could, if realized, drive the global economy into a recession and cause a significant slowdown in the Ukrainian economy. A dramatic decline in global demand and investors’ revaluation of risks related to developing economies could negatively affect Ukraine’s external trade and make it more difficult for Ukraine to obtain financing. There are other significant risks. They include: an escalation of the military conflict in eastern Ukraine and new trade restrictions being introduced by Russia a drop in the harvest of grain, fruit and vegetable crops in Ukraine in the wake of unfavorable weather the higher volatility of global food prices, driven by global climate change. Therefore, the NBU Board made its key policy rate decision when inflationary pressures were decreasing faster than expected, and the economy needed further support. 2/3 BIS central bankers' speeches In view of the above, the NBU Board continued its monetary policy easing cycle by cutting the key policy rate by 1 pp, to 10%, as envisaged by the central bank’s January forecast. What matters to the NBU the most is that the cut will provide the necessary impetus to the economy, while also not preventing the central bank from achieving its inflation target, which is its priority. What will the NBU’s monetary policy stance be in future? As before, the NBU plans to decrease its key policy rate to 7% by the end of the current year. In deciding on the pace of key policy rate cuts to that level, the NBU will closely monitor: the spread of the coronavirus around the world and in Ukraine, and its impact on the domestic and global economy the response of governments and central banks to these developments any progress achieved in negotiating a new aid agreement with the IMF, which will shape the expectations of financial market participants, and determine the prices of Ukrainian assets. If there are favorable developments, and if the new Ukrainian government speeds up reform, the NBU will be able to ease its monetary policy more quickly. Conversely, if the above risks materialize, the NBU will respond quickly by deploying the monetary policy tools it has at its disposal. Thank you for your attention! 3/3 BIS central bankers' speeches
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Resignation speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Verkhovna Rada of Ukraine (Parliament), Kyiv, 3 July 2020.
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Yakiv Smolii: Resignation speech Resignation speech by Mr Yakiv Smolii, Governor of the National Bank of Ukraine, at the Verkhovna Rada of Ukraine (Parliament), Kyiv, 3 July 2020. * * * Dear Members of Parliament, As the NBU has long been under systematic political pressure, I have made a difficult but necessary decision to resign. For months, the central bank has been pressurized to make decisions that are economically unsound, that focus on short-term, easy “victories,” and that could take a tremendous toll on the Ukrainian economy and people in the long run. As governor, I have been safeguarding the NBU’s institutional capacity for more than two years. Together with the members of the NBU Board, we have been a shield that has protected our technocratic and apolitical institution from the influence of political forces. Over the past year, this shield has come under unrelenting pressure to give in. That includes pressure in courts, paid rallies at Instytutska Street and near the Board members’ homes, information attacks based on manipulation and lies, unfounded political assessments of the NBU’s policy and of my actions as governor, and use of the NBU Council to incite a corporate conflict within the central bank. All these have been links in the same chain. This has also hampered the efficient operation of the central bank, as it does not operate out of an island. Despite attempts by some to equate the NBU’s independence with the desire to distance itself from other public authorities, the NBU does not actually work in isolation. Neither do the economy and financial markets, which depend not only on the NBU’s policies, but also on the ability of all public institutions to find common ground. We at the NBU have also been striving to find it. However, pressure is the antithesis of effective dialogue. A conversation in which one party speaks professionally of economics and finance while the other is concerned solely with political gain is doomed to fail. Does my resignation imply that the NBU has lost its independence? Not at all. My resignation comes as a protest. It is a signal and a warning that a red line is about to be crossed. As I step down as governor, I seek to warn politicians against further attempts to undermine the institutional foundations of the Ukrainian central bank. At this very moment, the NBU Board and several thousand top-of-the-line professionals continue to work at the NBU to promote the macroeconomic and financial stability of Ukraine and the institutional capacity of its central bank. However, it is crucial that their work goes on uninterrupted. It is imperative that the president, government, and political forces finally begin to work effectively with the central bank. After all, the NBU has made tremendous efforts to speed up the development of the economy and financial markets and to advance the welfare of all Ukrainians, and can do a lot more if not interfered with. Let me focus only on what has been accomplished during my term as governor since March 2018. We have finally curbed inflation. Every year, we broke our own records in terms of bringing inflation closer to a level that is optimal for the economy. In 2018, inflation stood at 9.8%. In 2019, it was down to 4.1%. Through its consistent monetary policy, the NBU has 1/4 BIS central bankers' speeches achieved an inflation target of 5% ± 1 pp sooner than expected, and inflation has since remained low. Our ability to be consistent in maintaining price stability in the face of political cycles was widely recognized by the international community last year, when the NBU received the GlobalMarkets award. For the first time since Ukraine gained independence, the key policy rate has been reduced to 6%. Two years ago, when the Parliament appointed me to lead the NBU, the key policy rate stood at 17%. Today the central bank pursues a stimulating monetary policy aimed at reviving economic growth. But we have not stopped there. We have introduced completely new tools to support the economy. Those include refinancing loans for banks for up to five years, an interest rate swap for banks, and an FX swap facility with international institutions. We have made single-digit loan rates a reality. Yes, it will be some time before low inflation and the low key policy rate have their full impact on the cost of debt. But it will definitely happen. Of course, if creditors’ rights were better protected, it would happen sooner, but this is beyond the NBU’s purview. We have strictly adhered to a market-driven, flexible exchange rate regime, while at the same time ensuring that the hryvnia is stable. Moreover, we have worked to develop the FX market. As a result, today the exchange rate is set transparently on leading international platforms, where all players participate anonymously. We have come under criticism for strengthening the hryvnia last year. Those criticizing us said that the NBU should have been more active in the FX market, when in fact the NBU was active enough that last year alone it added to international reserves a record USD 8 billion, having purchased it in the FX market. Yes, if we had bought more dollars, we would not have heard complaints from exporters. But we would have heard complaints from importers and, most important, from ordinary people who earn and spend hryvnias. Therefore, we kept the balance and, as befits a central bank, pursued a neutral policy, rather than playing into the hands of individual market participants. Another category in which the NBU set a new record every year is international reserves. This time we hit a new high. While I was in office, Ukraine’s financial safety cushion increased by USD 10 billion, from USD 18 to USD 28 billion. Last year, Ukraine was popular among international investors. Although this provided good financial support to the government, this was used to criticize the central bank. At the same time, our critics ignored the fact that international reserves grew, not least due to foreign exchange inflows from nonresidents. This enabled us to overcome, reasonably painlessly and quickly, the FX market turbulence in March caused by the coronavirus pandemic. In 2019, the NBU embarked on a large-scale liberalization of the FX market.This was a truly revolutionary event, for which Ukrainian businesses and households had been waiting for a quarter of a century. The NBU has already lifted about 40 FX restrictions, which had for years hampered business development and investment inflows, while also limiting the rights of Ukrainians to freely engage in FX transactions. The banking system is healthy, highly liquid, and profitable. Since November 2018, not a single bank has been removed from the market. The general public knows who owns each and every bank. This is reviving confidence in the banking sector. This is evidenced by deposit growth – since the start of 2018 hryvnia household deposits have risen by one-andhalf times. Moreover, thanks to years of continuous preparation of the banks for potential problems, the banking system entered the coronavirus crisis stronger than ever. It is now an outpost of financial stability and a lifesaver for the economy. 2/4 BIS central bankers' speeches Cashless payments are gradually becoming commonplace in Ukraine. Thanks to the numerous initiatives the NBU launched while I was in office, the share of cashless payments among all transactions involving payment cards increased from 39% to 55%. The NBU has become even more transparent and open. The NBU’s current policy is based on a dialogue with banks and nonbank financial institutions, businesses, the expert community, the international community, the media, and our other partners and clients. The NBU’s achievements were recognized by the international professional financial community through a prestigious award from the Central Banking Awards, in the category of transparency. All these achievements could easily be reversed. It is much easier to take a step back than the steps forward that it took us years to make. I call on you not to let this happen! Let the NBU retain the achievements of previous reforms and go on to new ones. The NBU has a lot of work ahead of it. Don’t forget that the coronavirus crisis is continuing. We need to maintain financial stability and help Ukraine get back on the track to economic growth, without provoking a spike in prices. We need to successfully complete what we started. This includes completing FX liberalization, while not undermining macrofinancial stability with hasty decisions. We have to make the market of nonbank financial services, over which the NBU became a regulator just the day before yesterday, healthy, transparent, customer-oriented and confidence-inspiring. We have to protect the rights of consumers of financial services and enhance financial literacy. The NBU received a mandate for this at the beginning of the current year. We have to make financial services more accessible, and create conducive conditions for the development of innovations in the financial sector. All of that, and many other things, are envisaged by the NBU’s Strategy for the Development of the Financial Sector until 2025. This requires five years of work, if not more. Finally, I would like to thank all NBU employees and all our partners and clients who followed the path of reforms with us. These are financial market participants, businesses, and the expert and scientific communities. Our discussions gave rise to the proper decisions, while your support inspired us to keep going. I thank all of the NBU’s like-minded people – MPs and colleagues in other government institutions who united with the NBU to promote reform. I’d also like to thank the NBU’s international partners and colleagues from other central banks for your support that went beyond financial assistance. First of all, you gave us knowledge and faith in ourselves. I’d also like to thank journalists who tirelessly helped the NBU become more transparent and easier to understand. I’m infinitely grateful to the whole NBU team for providing support. All of the NBU’s achievements are our joint achievements. I thank all Ukrainians who trust in the professional ability of the NBU. Confidence in a central bank is the best recognition of its achievements. I’m proud that the NBU has this confidence. I leave the NBU as an integrated institution that has a strategic vision, well-established processes, a strong professional team, and a good reputation among the world’s leading central banks and the international community. 3/4 BIS central bankers' speeches I’m leaving with my head held high. And I leave the NBU under your responsibility. 4/4 BIS central bankers' speeches
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Closing remarks by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, to the NBU's online workshop on inflation targeting in emerging economies, 26 November 2021.
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Sergiy Nikolaychuk: Inflation targeting in emerging economies Closing remarks by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, to the NBU’s online workshop on inflation targeting in emerging economies, 26 November 2021. * * * Distinguished speakers and participants, Ladies and gentlemen, I would like to thank you for joining our virtual workshop and making it possible to have this insightful event, which has exceeded my expectations. While most of us would have liked to gather in person today, I am grateful that we have been able to get together, at least online. Since early 2020, the COVID-19 pandemic has affected our lives in unprecedented ways. We have had to adapt ourselves to such irregularities and discover how to perform under these new conditions. The novelty of the pandemic crisis and considerable uncertainty around its further development have made the challenges unique in being considered from different angles. Last year, central banks (CBs) dealt with acute and persistent volatility on financial markets and together with their governments tried to address deep economic contraction. This year, CBs of emerging markets (EMs) have been facing new challenges of a multi-speed economic recovery and a simultaneous inflation spike with a high degree of uncertainty. That creates a unique environment that is calling for reshaping our models and updating analytical tools. That is why it is so important to gather for such discussions and look for the solutions in our areas of responsibility. In what follows, I would like to share several of my personal lessons from the recent developments on the sidelines of our workshop. *** My first lesson concerns a timely and decisive reaction from central banks around the globe to a financial shock and risk aversion to prevent a full-fledged financial crisis. As the financial shock hit during the first weeks of the pandemic, the central bankers were initially focused on adopting measures to restore the orderly functioning of the financial markets. That time the resilience of the EMs’ domestic financial sectors to adverse shocks, along with the liquidity provided by systemically important central banks, proved to be crucial to financial market stabilization. In contrast to a monetary policy response to previous crises when most EM CBs increased interest rates to avoid sharp exchange rate depreciations, last year they were able to cut their rates almost immediately. This reflects a higher degree of credibility gained by the central banks, as well as well-anchored inflation expectations. The credibility gained in previous years, sometimes with sizable costs, paid back and, as our speakers have said today, that cannot be underestimated. 1/3 BIS central bankers' speeches In the case of Ukraine, the central bank embarked on a series of interest rate cuts and implemented measures to provide ample liquidity, within its legal mandate to ensure the financial stability via the orderly functioning of domestic markets, as well as supporting economic recovery via lending channels. Yet, there is no universal recipe for every case. Some EM CBs have adopted unconventional monetary policy measures for the first time, embarking on government bond purchases. In some cases, it required the elimination of legal restrictions and the implementation of necessary reforms. Even though in the first phase of the crisis, the central banks had to respond swiftly to stabilize their markets and avoid worse consequences, I believe we should not have overemphasized the so-called “market-maker-of-last-resort” narrative as its utilization may destroy the credibility achieved before the crisis. Because efforts to regain the credibility may be very painful for the EMs and their CBs. *** My second lesson is that in an environment of high uncertainty, like the one associated with the inflation shocks resulting from a post-pandemic recovery, a solid macroeconomic framework, including a prudent and data-based monetary policy approach, and deep and liquid financial markets are essential. Across the world, the conduct of monetary policy faces an acute challenge nowadays. Incoming data seem to conclude that the global recovery might be halting or at least losing steam. Meanwhile, inflation has stuck to the upward trend on the back of elevated commodity prices and supply disruptions induced by the pandemic. And the narrative on the nature of inflation is switching firmly from transitory to persistent. Concerns about inflation are amplified by worries about a faster tightening of global financial conditions. Advanced economies’ CBs are now close to the end in their ultra-accommodative policies pursued for many years. If the surge in inflation is more persistent than initially assumed, the CBs will be forced to react. If they tighten their policies too fast, this may cause capital outflows from the EMs. Rising volatility will certainly affect their economies. I have heard this concern a few times during the workshop. In such an uncertain environment, it is vital that the EM CBs continue to ensure that their monetary policy decisions contribute to the orderly normalization of the financial conditions in their economies. Sure, a prudent and data-driven approach, mindful of policy tradeoffs, is necessary. In this context, a key challenge for policy makers, particularly CBs, is to respond to the crisis in a timely and decisive manner, but without affecting the resilience of both the financial markets and the economy. As it has been repeatedly mentioned today, the current inflation spike was badly forecast by CBs and markets. Given the unprecedented crisis conditions, previously estimated economic models and their coefficients are not allowing us to accurately project an economic recovery and inflation; we have to be cautious and flexible in our policy responses. For example, we must learn from the fact that we have missed the mark in some aspects of the economic recovery and inflation response. The latter has been affected by sudden changes in consumption patterns, supply-side disruptions, labor market adjustments, and non-linear effects on prices from exchange rate fluctuations. 2/3 BIS central bankers' speeches Moreover, it is extremely challenging to identify the effects of the pandemic shocks that are shortlived from those that are long-lasting. But my strong believe is that in spite of all this uncertainty, we should discuss the calibration of our monetary reaction to the inflation spike and a deterioration in inflation expectations. However, we cannot allow ourselves to ignore the need to react to the deteriorating inflation outlook. *** My third lesson is that we still do not need to fix the current monetary framework. Six years ago, the NBU instituted a flexible inflation targeting (FIT) framework as its monetary policy regime. I recall that then there were widespread misgivings in public discourse and within the NBU. The central bank was perceived as a blinkered monetary authority pursuing a narrow inflation target with little chance to succeed. Over the period of 2015–2020, inflation was slashed from 50%-60% to 5% in line with our target, which was hailed as a defining success of macroeconomic management. This outcome was due to a combination of ‘good luck’ and ‘good policy.’ Be that as it may, the monetary policy earned a credibility bonus due to the anchoring of inflation expectations, while investors and businesses reposed confidence in Ukraine’s macroeconomic stability. During that period, the NBU introduced a lot of innovations into its monetary policy framework, including setting the appropriate operational design of a monetary toolkit, streamlining its strategy of FX interventions, enhancing communications, and so on. However, the framework continues to involve. That’s why we are examining the potential of reviewing the definition of price stability, monetary policy instruments and their effects (both main effects and potential side effects), as well as our communication practices. In a long-term outlook, we are also going to assess the importance of digitalization, financial stability, globalization, and climate change from the perspective of monetary policy. Needless to say, such themes continue to be important topics for future research. Many of them have already been raised during this workshop. Another topical and important theme in economic research and central banking is the interaction between monetary policy and inequality. We are also going to pay attention to this topic. *** Let me conclude here. It is necessary to understand and learn from both the wins, or target hits, and mistakes, or target misses. Yet, even as we are seeking to move forward, we are confronted by the reality of the complex and rapidly evolving world. It is now more than ever that the CBs should turn this challenge into a new opportunity to create a more exciting future, which will be associated with price stability. With that in mind, I would like to thank you all again for being part of this event full of valuable insights. Stay safe! 3/3 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 4 March 2021.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 4 March 2021. * * * Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to raise its key policy rate to 6,5% per annum. The decision is aimed at gradually reducing inflation to the target of 5%, as the Ukrainian and global economies are recovering. How did prices change at the start of 2021? As expected, inflation accelerated in January, and deviated from the 5±1 pp target range. Inflation continued to accelerate in February according to preliminary estimates. In particular, consumer inflation exceeded the NBU’s forecast, while inflation expectations remained high. At the same time, the underlying inflationary pressure was generally in line with the central bank’s forecast trajectory in January–February. The growth in inflation in the first months of 2021 was driven by a number of factors. Among them were: higher food and fuel prices stronger inflationary pressures from trading partner countries sustained domestic consumer demand. Moreover, prices continue to be influenced by the effects of last year’s hryvnia depreciation. How will inflation behave in the future? The growth in consumer prices will peak in mid-2021. However, inflation will start to decelerate afterwards, returning to its target range in H1 2022. The global and Ukrainian economies, which are recovering rather quickly, will produce significant inflationary pressures throughout the whole of 2021. At the same time, the inflation trend will be reversed gradually as new harvest supplies come to the market, the effect of a low comparison base wanes for some products, and the NBU raises its key policy rate. Inflation will thus decelerate at the end of the year and will settle within the 5% ± 1 pp target range in H1 2022. What other factors were taken into account in the decision on the key policy rate? The primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF. The NBU expects further progress to be made in negotiations between Ukraine and the IMF. Cooperation with the fund and other international partners is essential for financing budget requirements and providing the economy with an additional impetus for growth. This will enable Ukraine to maintain its international reserves at about USD 30 billion. As before, the imposition of stricter quarantine restrictions in Ukraine and globally remains the main risk to macrofinancial stability 1/2 BIS central bankers' speeches Indeed, vaccination campaigns are already proving to be effective in some countries. However, they are being rolled out rather slowly, as a result of which the risk of tighter quarantine measures this year remains significant. In particular, some regions of Ukraine have seen a significant rise in morbidity in recent months. Therefore, the pandemic still poses the threat of a decline in business activity and a cooling of consumer and investment demand. This, in turn, could rein in inflation. Conversely, the rapid recovery of business activity, rebounding commodity markets, the lagged effect of large-scale expansionary measures, and potential pent-up demand are generating risks of higher inflation globally. Under such conditions, among other things, inflationary pressures from Ukraine’s main trading partners could increase further. There are other significant risks. They include: volatile global capital markets a more dramatic deterioration in the terms of trade an escalation of the military conflict in eastern Ukraine or on the country’s borders. Given the above balance of risks and the significant rise in underlying inflationary pressures seen in recent months, the NBU Board decided to raise the key policy rate, to 6,5%. What will the NBU’s monetary policy stance be in future? Looking ahead, the NBU stands ready to raise its key policy rate more resolutely in order to curb underlying inflationary pressures, stabilize expectations, and bring inflation back to its target. The NBU remains committed to its duty to meet the inflation target. Therefore, NBU monetary policy will continue to be aimed at preventing a spike in inflation. Thank you for your attention! 2/2 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 15 April 2021.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 15 April 2021. * * * Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to raise its key policy rate to 7.5% per annum. This step will help gradually slow down inflation in H2 2021 and return it to the 5% target already in H1 2022. How did prices change in Q1 2021? As expected, inflation deviated from the 5% ± 1 pp target range, but the deviation was greater than forecasted. In particular, consumer inflation increased to 8.5% yoy in March. On the one hand, the steeper rise in inflation was driven by temporary factors, such as: growth in global prices for some food products and energy global economic revival effects of last year’s smaller harvests. On the other hand, underlying inflationary pressures also increased. This was due to sustained growth in consumer demand, which was, among other things, fueled by higher wages. Moreover, inflation expectations remain high on the back of the rapid growth in the prices of goods consumed every day. How will prices behave in the future? The upward inflation trend will reverse in H2 2021. This will be due to several factors: new harvest supplies coming to the market the waned effect of low comparison base for some goods the effect of the increase in the NBU’s key policy rate. As a result, inflation will decline to 8% at the end of this year, return to the 5% target H1 2022, and subsequently remain there. What will be the overall state of the Ukrainian economy? The NBU estimates Ukraine’s GDP declined somewhat in Q1 2021. First, this was driven by the introduction of new quarantine restrictions, which dampened business activity. Second, last year’s smaller harvests affected the performance of agriculture, the food industry, and freight turnover. Third, increased competition in some global markets and greater trade restrictions imposed by Russia restrained the economic recovery. In addition, less favorable weather conditions in January–February weakened the performance of construction and transportation. The Ukrainian economy will return to steady growth starting in Q2. Consumer demand will remain the main growth driver. Investment demand will also rise gradually as the global economy revives and more progress is made in overcoming the pandemic. 1/3 BIS central bankers' speeches Factoring in losses to the economy caused by the tightening of quarantine restrictions, the NBU downgraded its GDP growth forecast for 2021 to 3.8%, down from 4.2%. The Ukrainian economy will grow at a pace of around 4% in 2022–2023. The current account is expected to return to a slight deficit in 2021, propelled by higher domestic demand and the gradual revival of international tourism. The current account deficit will widen noticeably in 2022 – 2023, propelled mainly by: less favorable terms of trade for exporters of agricultural and metallurgical products the expected drop in earnings from gas transit and continued growth in consumer and investment imports, fueled by the complete recovery of the global and Ukrainian economies from the coronavirus crisis. Under what conditions would this forecast be realized? The primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF. The NBU expects that Ukraine will make further progress in its talks with the IMF. Cooperation with the IMF and other international partners will enhance the government’s ability to support the economy during the crisis, while also helping Ukraine pass through the period of debt repayments that will peak in the coming autumn. This cooperation will help maintain Ukraine’s international reserves at a reasonably high level of USD 29 to 30 billion in 2021 – 2023. The key risk to the macroeconomic forecast is the imposition of stricter quarantine measures in Ukraine and globally, and the slow pace of the vaccination campaign domestically. New waves of the pandemic forced countries to once again tighten quarantine restrictions in Q1 2021. Despite the partial adaptation of businesses to the new conditions, this is slowing the recovery of business activity. The slow pace of the vaccination campaign in Ukraine, coupled with higher inflationary pressures arising from the rebounding global economy, poses an additional risk of future economic losses. There are other significant risks. They include: an escalation of the military conflict in eastern Ukraine or on the country’s borders volatile global capital markets and a dramatic deterioration in the terms of trade. Taking into account all of the above, the NBU Board decided to raise the key policy rate to 7.5%. How does the NBU intend to change the key policy rate in future? The NBU’s forecast envisages that the key policy rate will remain unchanged, at 7.5%, until the end of 2021. Given current inflationary movements, this should suffice to bring inflation back to its 5% target in H1 2022. However, if underlying inflationary pressures rise more noticeably than currently expected, and if inflation expectations worsen, there could be the need for further monetary policy tightening. The NBU stands ready to continue raising its key policy rate to a level that will bring inflation back to its 5% target in H1 2022. 2/3 BIS central bankers' speeches Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 21 October 2021.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 21 October 2021. * * * Dear colleagues, I would like to inform you that the NBU Board has decided to raise the key policy rate to 8.5% per annum. This decision comes in line with a decline in inflation to 5% at the end of next year projected in the baseline scenario of the updated macroeconomic forecast. What price developments followed the last monetary policy meeting of the NBU Board? As expected, consumer inflation ranged between 10% and 11% in the past several months, which was close to the forecast the NBU made in July. Underlying inflationary pressures also expectedly persisted, and inflation expectations remained high. At the same time, benign FX market conditions restrained price growth, keeping core inflation below the July forecast trajectory. How will prices behave going forward? The NBU expects the growth in consumer prices will peak in September–October this year. Afterwards, the inflation trend will reverse, and inflation will slow to 9.6% at the end of the year. The NBU expects inflation to decline to the 5% target at the end of 2022 and remain close to this level further on. Inflation will slow thanks to waning low base effects, FX markets remaining favorable, and this year’s large harvests. The monetary policy tightening actions taken earlier by the NBU, in particular the optimization of the monetary policy design, a complete phaseout of anti-crisis monetary measures, and raising the key policy rate, will also curb growth in consumer prices. At the same time, a faster disinflation will be restrained by energy prices remaining high longer and by sustained consumer demand. Considering the lasting effects of these pro-inflationary factors, the NBU will have to tighten the monetary conditions in 2022–2023 more than was expected in July in order to bring inflation to the target of 5%. What will be the overall state of the Ukrainian economy? The economy has been actively recovering in H2 2021. This is evidenced by high-frequency indicators of economic activity. In particular, a record harvest of early grain crops spurred growth in agriculture. Robust consumer demand supported retail trading and passenger turnovers. A pickup in investment activity, together with a favorable external price environment, contributed to a recovery in construction and industrial production. At the same time, the impact of the pandemic turned out more persistent and strong. Coupled with the consequences of the surge in natural gas prices, this led to a weaker performance of the Ukrainian economy in H1. Therefore, the NBU has downgraded its economic growth forecast for 2021, from 3.8% to 3.1%. Unfavorable conditions on the energy market and the impact of global logistic problems will limit Ukraine’s industrial output, thus curbing economic recovery next year. To this end, the NBU has 1/3 BIS central bankers' speeches revised downward its GDP growth forecast for 2022, from 4% to 3.8%. GDP is expected to grow by 4% in 2023. Over the forecast horizon, economic growth in Ukraine will be driven by: continued global economic recovery an increase in domestic demand, including investment demand the terms of trade remaining favorable for Ukrainian exporters the progress in vaccinations, which will prevent the imposition of lockdowns or other restrictions on economic activity. In 2021, the current account deficit will hit about 1% of GDP on the back of a bumper harvest and high export prices. In the coming years, the deficit will gradually widen to 3% to 4% of GDP. The deficit will be driven by some worsening in the terms of trade and more robust consumer and investment demand resulting from economic recovery. Under what conditions would this forecast be realized? The primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF. Ukraine reached staff level agreement with the IMF. This has opened the way for the first revision of the Stand-by Arrangement (SBA) by the IMF Executive Board, and for consideration of the request for the program to be continued. The implementation of the existing Stand-by Arrangement will ensure the receipt of required official financing in 2021–2022, provide better terms of external borrowing, while also supporting foreign investors’ interest in hryvnia assets. Cooperation with the IMF will help speed up economic growth, stabilize inflation at its target level, and maintain international reserves at USD 30 to USD 31 billion in the coming years. The key risks to the economy are the imposition of stricter quarantine measures in Ukraine and globally, and a longer and more pronounced than expected surge in global inflation. Higher morbidity due to the low vaccination coverage in Ukraine could lead to a stricter lockdown and, consequently, a more significant slowdown in economic activity. However, in contrast to the quarantine imposed last year, this time supply will be more affected than demand, which could increase pro-inflationary pressures. What is more, a more protracted global price surge than currently expected will put pressure on domestic prices. Other pro-inflationary risks also remain important. They include: a sharp deterioration in terms of trade, capital outflows from emerging markets and an escalation of the military conflict with Russia. What will the NBU’s monetary policy stance be in future? As set forth in the baseline scenario, with a view to bringing inflation back to its 5% target, the NBU will keep its key policy rate no lower than 8.5 % at least until Q3 2022 rather than until Q2, as was expected in July. The key policy rate will be cut more gradually in 2022 than forecast before. The key policy rate is also expected to stand at 7.5% in late 2022, as opposed to 6.5%, as predicted in the previous forecast. 2/3 BIS central bankers' speeches If the said or any other pro-inflationary risks materialize, the NBU stands ready to raise its key policy rate and deploy other monetary tools. It could decide to do so even during the December meeting. Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 9 December 2021.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 9 December 2021. * * * Dear colleagues, Please be informed that the NBU Board has decided to raise the key policy rate to 9% per annum. The decision is aimed at neutralizing the impact of additional pro-inflationary risks, improving inflation expectations, and ensuring steady disinflation toward the NBU’s target of 5%. What price dynamics followed the previous NBU Board meeting on monetary policy issues? The growth in consumer prices decelerated to 10.9% yoy in October. The NBU estimates inflation continued to decline in November. The decline was driven by: the vanished effect of the last year’s low comparison base better harvests gathered this year administrative decisions on public utility rates the strengthening of the hryvnia in previous months the impact of the NBU’s previous decisions to tighten its monetary policy. At the same time, disinflation was somewhat slower than the NBU had predicted in itsOctober forecast. The decline in inflation was restrained by: higher pressures on prices of an increasingly wider list of consumer-basket goods and services due to the rise in food and energy prices businesses’ higher expenses on logistics and wages domestic consumer demand remaining robust despite a slight deterioration in consumer confidence and the quarantine restrictions. Additional pro-inflationary risks have also materialized. First, rising geopolitical tensions are affecting prices of Ukrainian assets and FX market conditions. Second, global prices for natural gas and food exceed the NBU’s expectations and are likely to remain high in the coming months. Third, higher global inflation is prompting leading central banks to step up their monetary policy tightening. In turn, this lowers investor interest in assets of emerging markets (including Ukraine). Moreover, emerging market central banks are also actively raising their rates. For example, yesterday the central bank of Brazil hiked its rate by 150 bp, to 9.25% per annum. This means the competition for foreign capital is getting stronger among emerging markets. How will prices change further on? Inflation will continue to decline gradually until the end of this year and throughout the whole of 2022. 1/2 BIS central bankers' speeches This year’s record-high harvest and a correction in global prices will help decelerate food price inflation. Natural gas prices in Europe are also expected to go down in spring, after the heating season is over. This will also help decrease production costs in Ukraine. Underlying inflationary pressures will also gradually ease, due to, among other things, the expected slower growth in wages next year, and the sustained effect of the monetary policy tightening by the NBU. What were the other considerations behind today’s decision? A key factor behind the reduction in uncertainty was the IMF Executive Board’s approval of the first review of Ukraine’s progress in implementing the Stand-By Arrangement and the extension of this arrangement until June 2022. This factor partly offset the effect of stronger geopolitical risks on the financial markets. It is critically important that Ukraine continues to implement the structural reforms envisaged in the Stand-By Arrangement and maintains partner relations with other official lenders, with a view to making its economy less vulnerable to these and other risks. Key risks to the economy are posed by an escalation of the military conflict with Russia and a longer-than- expected global price surge In particular, considerable uncertainty over whether or not the military conflict will escalate could worsen expectations and cause investors to put off their investment decisions, which would dampen economic recovery. A related geopolitical risk arises from high gas prices persisting longer than envisaged in the forecast. The risk of an increase in global food prices also remains important. Through secondround effects, these factors could push up prices for an increasingly larger number of goods and services. A more prolonged surge in global inflation, especially in central and eastern Europe, could also put pressures on domestic prices in Ukraine. A faster-than-expected monetary response by leading central banks poses the risk of there being capital outflows from emerging markets. The economic repercussions arising from the spread of new coronavirus variants are creating a lot of uncertainty. These repercussions could increase the risk of global stagflation on the back of logistic and production problems. The NBU continues to assess the balance of risks for its baseline scenario of inflation and the key policy rate as having tilted to the upside. What will the NBU’s monetary policy stance be in future? If pro-inflationary risks continue to materialize, the NBU stands ready to raise its key policy rate at the next Board meetings on monetary policy issues. Thank you for your attention! 2/2 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 20 January 2022.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, Kyiv, 20 January 2022. * * * Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to raise its key policy rate to 10% per annum. As many of the pro-inflationary risks have materialized, tighter monetary policy is needed in order to improve inflation expectations and ensure steady disinflation toward the target of 5%. What price developments followed the last monetary policy meeting of the NBU Board? At the end of the year, consumer inflation slowed from a peak of 11% in September to 10% in December. The factors behind the decline in inflation included: record-high harvests and a correction of some global food prices the strengthening of the hryvnia in the previous months the vanished low base effect and monetary policy tightening by the NBU and administrative decisions to fix tariffs on some utility services. On the other hand, a faster disinflation was prevented by a further increase in global energy prices, which passed through to prices of goods and services, and by pressures from other production costs, including labor costs. In particular, robust consumer demand also continued to play a role, which, among other things, pushed up core inflation to 7.9% as of the end of the year. How will prices behave going forward? The NBU has downgraded its 2022 inflation forecast, from 5% to 7.7%, considering the materialization of said pro-inflationary factors. In particular, global energy prices will remain high for longer than expected. Not only will it put pressure on businesses’ production costs, but will also require at least a gradual revision of utility tariffs. Price pressures from Ukraine’s trading partner countries, in which inflation is only approaching its peak, will remain strong as well. Second-round effects from businesses’ larger raw material expenses and labor costs will also materialize further on. An increase in demand for Ukrainian labor force, both inside the country and abroad, and qualification mismatches on the labor market will impact the growth in wages more than expected. With household income rising, consumer demand will remain robust, which will restrain disinflation. On the other hand, monetary policy tightening by the NBU, a correction of global commodity prices, the influence of last year’s bumper crops, the easing of the global inflation surge, and vanishing effects of the pandemic will foster a gradual disinflation. The NBU estimates inflation will be quite volatile in 2022 due to base effects. In addition, like in many other countries, the rise in inflation in Ukraine will last longer than expected. 1/3 BIS central bankers' speeches Taking into account the strong pro-inflationary factors and the need to continue supporting the post-pandemic economic recovery, inflation is projected to return to the target range of 5%±1 pp in 2023. What will be the overall state of the Ukrainian economy? We have revised the forecast for real GDP growth in 2022 to 3.4%, down from 3.8%. The growth will be underpinned by consumer demand and still rather favorable terms of trade. Yet the potential for growth will be limited by the rather heavy fallout from the coronavirus crisis, relatively high energy prices, and shortages of certain raw materials, especially in the first half of the year. In 2023–2024, real GDP growth will accelerate to about 4% per year. This will be due to the following factors: Geopolitical conditions will stabilize during 2022. The negative impact of the pandemic will fade completely. The global economy will continue to grow. And the terms of trade will remain rather favorable. According to our forecasts, the current account deficit will widen to 3.3% of GDP in 2022 and to 3.3%–3.5% of GDP in the coming years due to the revival of domestic demand from both consumers and investors. Under what conditions would this forecast materialize? The primary assumption of the NBU Board is that Ukraine will continue to make progress on its cooperation with the IMF. IMF financing was a significant catalyst of the Ukrainian economy in 2020–2021. Cooperation with the IMF stands to be at least as important in the years ahead, especially as geopolitical tensions loom large and competition for capital between EMs and other countries intensifies amid the tighter monetary policies pursued by central banks around the globe. Key risks to the forecast are still posed by an escalation of the military conflict with Russia and a longer and more pronounced global price surge than expected earlier. The stoking of tensions in the media regarding the possibility of military aggression has decreased the value of Ukrainian assets and increased depreciation pressures. Prolonged geopolitical tensions could have a very negative impact on the expectations of households, businesses and investors, while also significantly hampering investment in the economy and making it difficult to raise external financing. If geopolitical risks increase further, the NBU will stand ready to tighten its monetary policy. The ongoing global spike in inflation, due to, among other things, persistently high energy and food prices, remains an important risk. Looking ahead, global price movements will strongly depend on how quickly leading central banks respond to inflation challenges. Any delays will push up external price pressures. Conversely, a rapid tightening of monetary policies by leading central banks poses the risk of there being more substantial capital outflows from emerging markets. The baseline scenario of the NBU’s forecast assumes that the impact of the pandemic on the Ukrainian economy will continue to decrease. That said, the emergence of new coronavirus variants, coupled with the still low vaccination rollout in Ukraine, poses the risk of additional economic losses in 2022. New pandemic outbreaks are unlikely to hit consumer demand hard, 2/3 BIS central bankers' speeches but will stifle business activity. This could increase inflationary pressures. Other pro-inflationary risks are also important. These include: a marked deterioration in terms of trade or a sharp decline in harvests after last year’s bumper ones a revival in labor migration, on the back of the gradually waning pandemic, which could increase the mismatches on the domestic labor market and push up wage costs and the need to bring utility prices to economically sound levels. What will the NBU’s monetary policy stance be in future? Under the baseline scenario of the macroeconomic forecast, the monetary policy stance will remain moderately tight over the entire forecast horizon. The key policy rate will be at least at its neutral level in 2022 and in the coming years. In addition, to shore up the interest rate channel of monetary transmission by managing the structural surplus of liquidity in the banking system, the NBU in February will raise by 2 pp the required reserve ratio for current accounts denominated in hryvnias and current accounts and term deposits in foreign currency. In March, the central bank will also consider the issue of introducing other measures to regulate the banking system’s structural liquidity surplus. The NBU will continue to intervene in the FX market to smooth out excessive market fluctuations. At the same time, the NBU decided not to carry out daily interventions to purchase foreign currency on the interbank FX market to replenish the reserves. The NBU continues to assess the balance of risks for its baseline forecast for inflation and the key policy rate as having shifted upward, especially in the medium term. In view of the above, the NBU will continue its monetary policy tightening cycle and stands ready to act decisively if pro-inflationary factors continue to materialize. Thank you for your attention! 3/3 BIS central bankers' speeches
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, 2 June 2022.
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Speech by NBU Governor Kyrylo Shevchenko at Press Briefing on Monetary Policy Decisions 2 Jun 2022 14:10 Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to raise its key policy rate to 25% per annum. Along with other measures, a significant increase in the key policy rate will help protect households’ income and savings in hryvnia, raise the attractiveness of hryvnia assets, and ease the pressure on the foreign exchange market. This will enhance the NBU’s capability to maintain the stability of the exchange rate and restrain inflation processes during the war. Why has the NBU returned to using the key policy rate? At the start of the large-scale military attack on Ukraine, the NBU refrained from taking any key policy rate decisions. This approach was justified. Due to a strong psychological pressure caused by the war, changing the key policy rate would not be sufficient to stabilize expectations and to accumulate and maintain hryvnia assets. To this end, in the first months, the NBU aimed its monetary policy measures primarily on ensuring uninterrupted functioning of the banking system and payments in the economy. Fixing the exchange rate was supported by FX restrictions imposed to reduce demand for foreign currencies and by the NBU’s interventions to sell foreign currency in order to cover the remaining FX deficit of on the interbank market. At the same time, the gradual adaptation of Ukraine’s economy and the psychological shock giving way to the economic decision-making logics of businesses and households require changing the approach to monetary policy. Under such conditions, insufficient yields on hryvnia assets increase the threat that economy dollarization might rise and the financial system might lose respective resources. Depreciation expectations of households and businesses are not stable and are susceptible to war developments, in particular to changes on the frontline and other situational factors. As a result, the NBU has increased its interventions to sell foreign currency. Amounting to around USD 2 billion in March and April, the interventions reached USD 3.4 billion in May. In addition, the difference in the cash market exchange rate and the official one widened in May, which worsened negative effects on the economy. As a result, risks to macrofinancial stability and economic recovery have risen in the medium term, despite the sufficient international reserves. If yields on hryvnia assets do not rise significantly, international reserves will deplete rapidly on the back of the need to maintain exchange rate stability and imbalances will keep building up in the economy. What are the current price dynamics? In April, inflation accelerated to 16.4% yoy. In particular, core inflation rose by 13%. In monthly terms, prices grew by 3.1%. According to the NBU’s preliminary estimates, inflation continued to grow in May. As of now, inflation is restrained by: ▪ ▪ ▪ ▪ ▪ a certain recovery in the economic activity a gradual setting up of logistics an increase in supply from domestic producers and importers an excess of agricultural inputs and a relatively low demand for them the NBU fixing the official exchange rate and limiting its fluctuations on the interbank market, and the government imposing administrative caps on prices. The liberation of Ukraine’s northern regions (Kyiv, Chernihiv, and Sumy oblasts) and the Ukrainian army’s resistance in southern and eastern regions restrained the deterioration in inflation expectations. At the same time, the disruption of production and logistics by the war is fueling inflation. High global energy prices also remain a significant inflationary factor, putting pressure on consumer inflation, both directly and indirectly, through higher production costs. Third, Ukraine is also in part importing global inflation, which has hit a record-high. In particular, the current inflation rate in the United States and euro area countries is over 8%. How will prices behave in future? Despite the gradual recovery of the economy, the upward trend in inflation will continue over the coming three months. This could worsen inflation expectations even further, and encourage depositors to convert their hryvnia savings into FX ones. For this reason the NBU has decided to return to an active interest rate policy to prevent these negative trends. Why did the NBU raise the key policy rate significantly? After considering several scenarios, the NBU decided to raise the key policy rate by a whole of 15 pp, to 25% per annum. The NBU believes that a slight increase in the key policy rate wouldn’t have had the desired influence on the financial and economic system. The first reason for this is that the monetary transmission mechanism has only a limited effect in wartime. Second, this would have resulted in depositors taking a wait-and-see approach and, investors having weak interest in hryvnia assets. Third, to revive interest in hryvnia assets, their yields must exceed expected inflation rates. In this light, a decisive rise in the key policy rate will spur investors’ interest in hryvnia assets, while also easing pressures on international reserves and reining in inflation. The NBU has also decided to widen the interest corridor for monetary transactions with banks to revive the interbank market. More specifically, from 3 June, the interest rate on refinancing loans will equal the key policy rate plus 2 pp, while that on certificates of deposit will be the key policy rate less 2 pp. What result does the NBU expect? The NBU expects that the government and the banks will appropriately respond to the hike in the key policy rate by raising interest rates on domestic government debt securities and deposits. Sufficient yields on such assets will prevent household income and savings from being eroded by inflation, while also making hryvnia assets, including domestic government debt securities, more attractive. More attractive hryvnia savings will help decrease demand in the cash segment of the FX market. This will prevent the further accumulation of imbalances, ease pressures on Ukraine’s international reserves, and will gradually resolve the issue of multiple exchange rates. Setting market rates on domestic government debt securities will help increase demand for these assets, while also decrease the need for the NBU’s monetary financing. The re-imposition of taxes on imports should be an important step in balancing fiscal and monetary policies. On the one hand, this will secure additional revenues for the state budget, while on the other hand it will increase incentives for domestic producers and ease pressure on international reserves. What will the NBU’s monetary policy stance be in future? The NBU expects that a significant rise in the key policy rate, to 25%, will be sufficient to ease pressures on the FX market, maintain a stable exchange rate, and to stabilize inflation expectations. In future, this will lay the foundations for a monetary easing cycle. Thank you for your attention!
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Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, 21 July 2022.
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Kyrylo Shevchenko: National Bank of Ukraine press briefing monetary policy statement Speech by Mr Kyrylo Shevchenko, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, 21 July 2022. *** Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to keep the key policy rate at 25% per annum. The decision to raise the key policy rate taken in June will continue to push up market rates. Improved attractiveness of hryvnia assets, coupled with the change in the official exchange rate, will dampen demand on the FX market. This will allow maintaining sufficient international reserves and ensuring macrofinancial stability in Ukraine. How have prices changed since the onset of the war? Inflation has been accelerating but is under control. In June, the pace of growth in consumer prices was 21.5% yoy. The consequences of the war are the main reason for the rise in inflation. They include a disruption of supply chains, a decrease in supply of some goods, higher business expenses, physical destruction of production facilities and infrastructure, and temporary occupation of some territories of Ukraine. Persistently high global energy prices and record-high inflation in trading partner countries also fueled price pressures in Ukraine. On the other hand, administrative measures of the NBU and the government – namely, fixing the hryvnia exchange rate and natural gas and heating tariffs – restrained inflation. How will prices behave going forward? Inflation pressures will persist in late 2022: consumer prices will grow by more than 30% yoy. The consequences of the war and high global prices, especially energy prices, will remain the main factors. Under such conditions, the NBU will conduct tight monetary policy. It will allow maintaining inflation expectations, raising interest in hryvnia assets, and reducing pressures on international reserves. These measures will support financial stability and partially lower inflationary pressures. The NBU's baseline scenario contains a number of assumptions, including the assumptions that in 2023 logistics will recover, businesses will face lower risks, and 1/4 BIS - Central bankers' speeches harvests will increase gradually. Such developments will help improve inflation expectations and reduce inflationary pressure by partially overcoming the adverse effects of the war that restrain the recovery of supply. A decline in global inflation and the NBU's tight monetary policy will additionally foster disinflation. At the same time, persistently high energy prices will limit disinflation in Ukraine and require a review of utility tariffs. Taking into account the above and the consequences of the war, the NBU expects inflation will drop to 20.7% in 2023, and 9.4% in 2024. Inflation will return to the 5% target in 2025. What will be the overall state of the Ukrainian economy? Economic activity has been reviving in Ukraine since April 2022, particularly due to the liberation of northern oblasts and a decrease in the number of regions affected by active hostilities. In the meantime, hostilities in the east and south of the country, destruction of infrastructure in various regions, the blockade of sea ports, and weak demand in the majority of sectors are restraining the economic recovery. Losses in the agricultural sector also make a large impact. The economy will thus shrink by a third in 2022 because of the war. When the active phase of the war is over, it is expected that consumer demand will rise, technological and logistical processes will be set up, and investment activity will recover, among other things, thanks to Ukraine's European integration prospects. This will enable the Ukrainian economy to return to growth. At the same time, the large losses of production and human potential caused by the war and security risks will be a drag on economic growth. The NBU expects the Ukrainian economy will grow at the rate of around 5%–6% per year in 2023–2024. What does the materialization of the NBU's baseline scenario depend on? Ukraine's continued cooperation with its international partners will remain one of the key factors in supporting the economy during the full-scale war and contributing to its recovery after the active phase of hostilities ends. Ukraine will continue to work closely with international financial organizations in 2023, including through the launch of a new IMF program to support macroeconomic stability in the country. Ukraine's cooperation with the IMF and continued European integration will help the country implement other structural reforms. A prudent economic policy is also a necessary prerequisite for delivering macroeconomic stability and ensuring the NBU's baseline scenario materializes. Under the current conditions, it envisages: narrowing the budget deficit through prioritizing expenditures and raising revenues gradually reducing imbalances in the energy sector replacing the monetary financing of the budget with market borrowing decreasing demand for imports by imposing additional taxes discontinuing the practice of monetizing the state budget deficit. 2/4 BIS - Central bankers' speeches The key risk to the forecast is that the war in Ukraine will last longer. If materialized, this risk will delay economic recovery and the return of inflation to its target. What will the NBU's monetary policy stance be in future? According to the baseline scenario of the macroeconomic forecast, the key policy rate will remain at 25% at least until Q2 2024. If risks materialize, the NBU is prepared to continue to act decisively, if this is required to safeguard economic stability and to ensure inflationary processes remain under control. If required, the NBU stands ready to take additional measures to protect international reserves, increase monetary transmission, rein in inflationary pressures, and to maintain economic stability in the country. Today, the NBU took FX regulation decisions that will lay a solid foundation for economic recovery. Starting from 9 am on 21 July 2022, the NBU set and fixed a new official UAH/USD exchange rate of UAH 36.57 per USD 1. This step will improve the competitiveness of Ukrainian producers, converge exchange rate conditions for various groups of businesses and households, while also supporting the resilience of the economy during the war. The NBU's decision to fix the hryvnia exchange rate at UAH/USD 29.25 from the first hours of the war helped ensure the stable functioning of the financial system. Today, the fixed exchange rate remains the stabilizer of the economy. That said, the war has lasted for almost five months, during which the Ukrainian and global economies have changed significantly. Therefore, the official exchange rate of the hryvnia fixed on 24 February lost its relevance and gradually stopped being an anchor for expectations. With that in mind, the NBU has made a one-time correction in the hryvnia official exchange rate against the U.S. dollar and fixed it at a new level. The new exchange rate will become an anchor for the economy in a time of uncertainty. Keeping the exchange rate fixed will enable the NBU to maintain control over inflation dynamics and to support the uninterrupted functioning of the financial system. This is a key precondition for the stable operation of the economy, which is vital in wartime. The NBU also took some additional measures to balance supply and demand on the FX market. First, the NBU allowed the banks to sell cashless FX to individuals with the purpose of depositing it for three calendar months or more, with a monthly limit of UAH 50,000 and without the right for early termination. This will reduce the demand for cash foreign currency. 3/4 BIS - Central bankers' speeches Second, today the NBU has introduced additional measures to minimize the use of international reserves on things that are not a top priority in wartime. More specifically: Individuals will still be allowed to withdraw abroad the equivalent of UAH 50,000 from their hryvnia payment card accounts per month. However, the monthly limit on abroad FX cash withdrawals from hryvnia card accounts has been replaced with a weekly one: the equivalent of up to UAH 12,500 per seven calendar days. The monthly limit on card-based P2P transfers from Ukraine abroad, using hryvnia cards issued by Ukrainian banks, has been reduced to the equivalent of UAH 30,000 per month from UAH 100,000. A monthly limit of UAH 100,000 (in the equivalent) has been set on hryvnia cardbased payments outside of Ukraine from all of a customer's hryvnia accounts opened with a bank. Most Ukrainians staying abroad will not be affected by these restrictions. Third, the NBU has changed the algorithm for calculating the banks' open FX position limits to reduce potential demand for foreign currency. The new requirement will come into force on 1 August 2022. All of the restrictions imposed since the beginning of the war are temporary measures. That said, today they are one of the wall of the country's "financial fortress." It is keeping the economy afloat in wartime, and will contribute to the economy's more rapid recovery after the war. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Special intervention by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, at the 10th NBP Annual Flagship Conference on the Future of the European Economy (CoFEE), 21 October 2022.
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Sergiy Nikolaychuk: Ukraine's economy and the prospects for its recovery Special intervention by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, at the 10th NBP Annual Flagship Conference on the Future of the European Economy (CoFEE), 21 October 2022. *** 1. Introduction Dear colleagues, First of all, I am greatly honored to speak at this event hosted by Narodowy Bank Polski, a true friend of the National Bank of Ukraine. Today, I'm very pleased to share my view of the Ukrainian economy in these challenging times, and on how the authorities' policies, events on the battlefield, and international aid might affect Ukraine's economic prospects. Clearly, our capacity at this time to project the economic future is extremely limited. However, we must deal with this challenge, along with the many others we currently face. That is because in the near-term we need a macroeconomic framework in order to calibrate our policies for keeping the Ukrainian economy alive and on a sustainable path for the duration of the war, as well as to ensure that scarce resources are allocated efficiently. Then, for longer-term, we need a vision of the economy that we would like to build. This vision should shape our structural policies and reforms. So, let me start by briefly reviewing the economic situation and the short-term outlook, and then consider some of the policies for shaping the economic landscape in the medium-term. 2. War effects The war has affected the country in a multitude of ways, including through creating a humanitarian crisis and active migration abroad – mostly to Poland. This will influence Ukraine's demographic development and labor market conditions for many years to come. The latest estimates show that around seven million Ukrainians remain abroad, and the number of internally displaced persons is also almost seven million people A lack of money, and difficulties in finding housing and work remain the main problems of migrants – both abroad and inside Ukraine. A large share of our refugees would like to return to their homes. But in view of the continuing security risks, an increase in the 1/7 BIS - Central bankers' speeches number of people returning is currently unlikely. According to surveys, only 13% of refugees plan to return to Ukraine within the next three months. And even before these latest attacks, the estimates of the direct damage done to Ukraine's civilian infrastructure and other objects, and of general economic losses, were huge – in the scale of hundreds of billions of dollars. 3. Economic activity stance and projections Let me now show you how these losses of human and physical capital are reflected in Ukraine's GDP numbers. After declining steeply at the beginning of the war, economic activity recovered gradually in Q2–Q3 2022 with businesses adapting to new conditions and the opening of the "grain corridor," which allowed Ukraine to export grain from three of its ports. However, current logistical problems, the destruction of production facilities (in the energy sector in particular), and a decline in real household income are restraining economic recovery. As a result, the fall in GDP will be 32% in 2022. The key factor in the future recovery of the economy is the assumption in the NBU's forecast that there will be a decline in security risks from the middle of 2023. In particular, full recovery in operations at the Black Sea ports will allow there to be a significant increase in Ukrainian exports. Large-scale budgetary support will boost consumer demand, and investment in the reconstruction of the country. At the same time, huge losses of labor force and production capacity, in tandem with high global energy prices, will slow economic recovery. Under such conditions, the growth in Ukraine's GDP will be moderate in the next few years, at around 4%–5%. 4. International experience For the longer-term perspective, we as economists tend to study the past to quantify the effects of shocks and, more importantly, to outline the most effective policies for driving economic growth. For post-war recovery periods, this is a rather complicated task, as wars or indeed any military conflicts are extraordinary events, and thus always difficult to compare from a historical perspective. Still, not surprisingly, the literature provides strong evidence that the macroeconomic costs of wars are generally very large and long lasting. A recent IMF study based on the rich dataset of military conflicts starting from 1990s shows that GDP per capita is about one-third lower ten years after the onset of a conflict (Novta and Pugacheva 2020). Obviously, wars create unprecedented challenges for economies and policymakers. 2/7 BIS - Central bankers' speeches However, history provides some good examples of effective and rapid recoveries in the aftermath of wars. The famous Marshall Plan, or European Recovery Program, is always recalled when we talk about the successful switch from a wartime economy to peacetime prosperity in Western Europe after the Second World War. Indeed, the unprecedented foreign aid of about $13 billion (which is roughly $120 billion in today's dollars) was crucial in ensuring the effective recovery of the continent. This foreign aid helped considerably in rebuilding destroyed infrastructure. Reconstruction investments proved to be a driving force for short-term recovery in Europe, boosting economic activity and creating labor supply (Vonyó 2008). Nonetheless, some economists (for example Barry Eichengreen from the University of California, Berkeley) argue that the fundamental secret of Europe's success was not the financial support in itself, but institutional readiness to use these resources, and to allocate them effectively (Eichengreen 2010). There are several examples of financial support from foreign allies actually harming a recovery instead of boosting it due to a lack of such institutional readiness.1 The real secret of Europe's post-war success can be seen in the fundamental and structural changes. Resources flowed quickly and efficiently from public uses to private ones, the labor market and wages were liberalized, and price controls were lifted. Measures that helped during the war but that could potentially have harmed the economy in future were removed (Vonyó 2019). Croatia gives us another lesson in why prudent macroeconomic management and forward-looking policies are crucial for a successful recovery. With its economy almost completely paralyzed after the start of its War for Independence in early 1990s, Croatia experienced the problems that are common to all war economies: economic contraction, high inflation, depreciation, a lack of foreign financing, together with thousands of deaths and destroyed social infrastructure. Increased military expenditures and debt financing via monetary emission placed a huge burden on the economy. That forced the government to cut non-military expenditures, while the central bank started its policy of monetary stabilization. Following convincing military successes, economic reforms helped Croatia restore private consumption, stabilize its markets, and win the war economically (Schönfelder 2005). 5. Macroeconomic policies in wartime This is why it is very important to properly shape macroeconomic policies in wartime. The NBU's first steps after the Russian invasion were directed at preventing panic and disruptive behavior, ensuring the uninterrupted functioning of the banking system and payments, keeping the economy running under an unprecedented shock, and reining in inflation expectations. For this purpose, in the first day of the war, the NBU fixed the official exchange rate of hryvnia to U.S. dollar through the use of FX interventions, and by introducing tough capital controls. The exchange rate started to play the role of a nominal anchor for expectations, and went on to become the main instrument for curbing inflationary pressures and ensuring macro-financial stability in Ukraine. 3/7 BIS - Central bankers' speeches The NBU also adjusted the operational design of its monetary policy, taking a set of crisis measures to mitigate risks to financial stability. Specifically, the liquidity of the financial system was boosted significantly. Due to the strong psychological pressure caused by the war, changing the key policy rate was unlikely to stabilize expectations and maintain control over inflation. From February through May 2022, the NBU postponed key policy rate decisions, keeping the rate at 10%. In addition, in the earliest days of the war, the NBU deployed a wide range of measures to support financial institutions and borrowers, so as to stabilize the financial sector. Moreover, to ensure the uninterrupted funding of critical public expenditures, the NBU has been supporting Ukraine's state budget via purchasing government debt securities. So far, the NBU has purchased government bonds worth a total of UAH 315 billion (around $10 billion). I expect that everyone in this room understands that this mix of a massive injection of liquidity via the budget and banking system, a fixed exchange rate supported by interventions and capital controls, and a freezing of the key interest rate helps the banks, businesses and households to adjust to the new reality in the short-term, but this mix is not sustainable in the long-term. That's why we started to adjust our policies. First, the NBU started to withdraw liquidity support measures for banks. Second, at the beginning of June, the NBU raised the key policy rate considerably, to 25%, to boost the attractiveness of assets priced in the national currency, and ease pressures in the foreign exchange market. Then, as depreciation pressure remained too strong to withstand, in late-July the NBU made a one-time 25% adjustment to the official exchange rate. Relatively tight monetary conditions and this re-pegging of the exchange rate have helped weaken the pressure on Ukraine's FX reserves. Together with an acceleration of international aid inflows, this has allowed to maintain our reserves at a relatively comfortable level. All of these steps have helped us to avoid monetary destabilization so far. In September, inflation in Ukraine stood at 24.6 per cent. Other countries have had far worse inflation during or immediately after a war. Taking into account the global trend of accelerating inflation, Ukraine's inflation rate can be considered an achievement. But it is too early to relax. Ukraine has benefited from the safety margin it accumulated before the war. And as winter draws near, we need to further strengthen the effectiveness of the redistribution of domestic resources. 4/7 BIS - Central bankers' speeches The easiest way of adjustment – via inflation – would erode household savings, deepen crisis trends in the economy, and undermine social stability. Modern European history is full of lessons of the dire political consequences that can follow from unrestrained inflation. Instead, Ukraine should curtail the budget deficit by slashing non-priority expenditures and raising taxes. Besides, Ukraine should revitalize domestic borrowing by issuing government debt on market-driven terms. The purpose of this is to shift the burden of financing the deficit to postwar times. However, this process has to be structured so as to prevent public debt from continuing to rise in peacetime. And last but not least, international financial support for Ukraine should increase in order to maintain macroeconomic stability in the wartime period. 6. Reconstruction and recovery Even larger financial resources will be required for reconstruction and recovery in the years to come. Rebuilding will require financing in the hundreds of billions in dollars. Therefore, Ukraine has already started seeking to mobilize funds for the projects to come. Legal efforts are also being made to access frozen Russian assets for recovery needs. The seizure of these funds requires the development of corresponding legal procedures, and we believe that the necessary approach could soon be found. We are confident that a cornerstone of the future mobilization of international support will be to build confidence and trust in the administration of the recovery. For this reason, we seek to create a vehicle for managing assets in a transparent manner – with full accountability and the involvement of our international partners' representatives. In addition, the proper functioning of the banking system will play an important role in this process. The banking sector has shown unprecedented stability and resilience since the beginning of Russia's full-scale invasion; it remains operational and maintains the necessary liquidity. We believe that the banking system has huge potential for tackling the challenges of reconstruction. Properly capitalized and liquid, the banking system could be a powerful channel for transferring credit, for corporates as well as small- and medium-sized enterprises. That's why as the economic situation stabilizes, we will conduct asset quality reviews and stress testing of the banking system, and based on the results of these, develop and implement recapitalization plans together with the banks. 7. EU integration perspective 5/7 BIS - Central bankers' speeches In addition, it's crucially important to have a vision for Ukraine's future, and here we have very clear anchor – EU membership. In that respect, landmark steps have already been taken, including the provision by the EU of candidate member status to Ukraine. The consequences of this provision should not be underestimated, as we have seen how over the past 30 years or so the EU accession anchor has enabled successful transitions across Emerging Europe. We understand that the road to full membership could be long and uncertain, but Ukraine needs a vision of integration with the EU, which can be of benefit to it in the near term. From our point of view, access to the European single market could be a core element of support. In practical terms, it would create enormous development opportunities for Ukraine within the next few years. Indeed, the very promise of rapid access to the European single market could increase private investment into Ukraine almost immediately – particularly in those areas that have been less affected by the war. Certainly, many reforms still have to be implemented. For our part, the NBU is committed to doing everything necessary to bring our regulation of the financial sector into line with EU standards as soon as possible. In fact, in recent years, we have made significant progress in implementing the respective EU acquis, through supporting the adoption of fundamental legislation on banking regulation, insurance, and payment services. In addition, with consultancy support from the EBRD, the NBU aims to align our banking regulatory and supervisory framework with EU standards. The EBRD is also supporting our efforts to achieve equivalence with EU requirements in confidentiality and professional secrecy in the banking system. We also see joining the Single European Payments Area as an important element of our integration with the EU. The NBU has conducted a self-assessment of its compliance with the area's membership criteria, and is now identifying the optimal solution for integration with SEPA systems – taking into account the challenges that Ukraine faces at the moment. We plan to finalize preparations very soon, and initiate consideration of our case by the EU. 8. Concluding remarks In conclusion, I wish to underline the following: There has long been a debate among economists over which type of investment provides the highest yield to the wellbeing of a nation in the long run: infrastructure, education, or healthcare. For Ukraine in the nearest future the answer is obvious – it is security. Long-running full-scale war still remains the key risk to Ukraine's economic development. This is an existential challenge for us, which requires the taking of firm decisions in order to survive, as well as international support. The war continues to pose significant 6/7 BIS - Central bankers' speeches risks to Ukraine's economic development, and elevates uncertainty not just for our country, but for the whole world. International financial support is needed to deal with the humanitarian crisis, to rebuild infrastructure, and to restore and transform the Ukrainian economy. The NBU, jointly with the government, continues to make every effort to reform Ukraine's economy and financial system and to do everything in its power to contribute to Ukraine's pursuit of European integration. We believe strongly that all the efforts outlined here will ensure the Ukrainian economy continues to survive in wartime, and then recovers rapidly in peacetime. Thank you very much! Sources: Vonyó, T. (2019). Recovery and reconstruction: Europe after WWII, Commentary in the VoxEU Debate https://cepr.org/voxeu/columns/recovery-and-reconstruction-europeafter-wwii Vonyó, T. (2008). Post-war reconstruction and the Golden Age of economic growth. European Review of Economic History. Vol. 12, No. 2, pp. 221-241 https://www.jstor.org /stable/41378546 Schönfelder, B. (2005). The Impact of the War 1991 – 1995 on the Croatian Economy – A Contribution to the Analysis of War Economies. Freiberg Working Papers, No 14 https://www.econstor.eu/obitstream/10419/22512/1/schoenfelder_14_2005.pdf Eichengreen, B. (2010). Lessons from the Mashall Plan. World Bank World Development Report 2011. Background Case Note. https://web.worldbank.org/archive /website01306/web/pdf/wdr_2011_case_study_marshall_plan_1.pdf Novta, N. and E. Pugacheva (2020). The Macroeconomic Costs of Conflict. IMF Working Paper Series. WP/20/110 www.imf.org/-/media/Files/Publications/WP/2020 /English/wpiea2020110-print-pdf Finckenstein, V. (2021). How International Aid Can Do More Harm than Good: The Case of Lebanon. LSE IDEAS Strategic Update www.lse.ac.uk/ideas/Assets/Documents /updates/LSE-IDEAS-How-International-Aid-Can-Do-More-Harm-Than-Good.pdf Seth, M. (2017). South Korea's Economic Development, 1948–1996. Oxford Research Encyclopedia of Asian History https://doi.org/10.1093/acrefore/9780190277727.013.271 1 For example, Seth (2017) reviews a slow post-war recovery in South Korea despite an unprecedented foreign aid. While Finckenstein (2021) discusses how foreign aid might have been harmful for Lebanon. 7/7 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, 20 October 2022.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy statement Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy, 20 October 2022. *** Dear colleagues, Please be informed that the Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. With exchange rate stability supported by the key policy rate and the NBU's additional measures, inflation processes will remain under control. As expected, inflation has been rising amid the full-scale war, but it remains controllable. The main reason for the rise in inflation remains the same - the consequences of the full-scale war. They include: supply chain disruptions and destruction of production facilities, which result in: reduced supply of goods and services and higher costs incurred by businesses. Additional pressure on prices came from the correction of the official UAH/USD exchange rate in July, which enhanced the resilience of the Ukrainian economy. A further rise in global inflation also influenced prices in Ukraine. Fixing utility rates and the saturation of the domestic fuel market while keeping the preferential tax regime for fuel slowed price growth. The planned reduction in budget financing by the NBU in July - October was restrained by a deterioration in inflation expectations. Inflation will reach around 30% at the end of this year, but it will slow in the next years provided that security risks subside and monetary and fiscal policies are well coordinated. This year's rise in inflation is rather moderate considering the challenges of the war in and inflation reaching its highest levels over many years in many countries. The NBU expects inflation to decline from the next year onward thanks to: a gradual setting up of logistics and production a slowdown in global inflation 1/4 BIS - Central bankers' speeches moderately tight monetary conditions prudent monetary policy of the government and refusal from monetary financing of the budget. A decline in security risks, which is the main assumption of the NBUs baseline forecast, will allow: improving inflation expectations lowering business risks reducing production costs and setting up logistics recovering the production capacity. All of this will contribute to inflation declining below 21% next year and to below 10% in 2024. A faster decrease in inflation will be restrained mainly by high energy prices, which will require to gradually bring utility tariffs to market levels. After a deep fall at the start of the war, economic activity is gradually reviving. This is supported by businesses adapting to new conditions, and the launch of the "grain corridor". On the other hand, economic recovery is restrained by logistical problems, destruction of production facilities, a decrease in real household income, and weaker performance of agriculture. As a result, GDP will fall by around 32% this year. In 2023 - 2024, the economy will recover gradually at a pace of 4% – 5% A decline in security risks from the middle of 2023 assumed by the forecast will be the key factor in the future economic recovery. Moreover, large budget support will boost consumer demand and investment in the reconstruction of the country. Significant losses of labor force and production capacity, high global energy prices, and large import needs in the period of post-war reconstruction will be a drag on economic recovery. The current account of the balance of payments will move back into deficit in the coming years. On the one hand, international financial assistance in 2023 - 2024 is expected to be large. The improvement in security assumed in the forecast will favor further growth in exports, and remittances from labor migrants will not be lower than before the war. On the other hand, the reconstruction of the country will require large volumes of imports. Moreover, migration will remain strong as security risks persist. 2/4 BIS - Central bankers' speeches Cooperation with international partners remains an important factor for reviving the economy and post-war recovery. Support by our official partners remains a critically important source for replenishing the budget. It will also enable the NBU to maintain its international reserves at a sufficient level, keep expectations under control, and to safeguard financial stability. The key assumption of the forecast is that security risks will start to decline significantly from mid-2023. The NBU has revised its key assumption of the security situation forecast. Therefore, the full unblocking of sea ports, reductions in Ukraine's risk premiums, and an increase of investment in the restoration of the country have been delayed in our forecast. If the full-scale war lasts longer than is envisaged in the baseline scenario of the current forecast, the Ukrainian economy will recover at a slower pace, while inflation will higher than currently expected. Other risks are also relevant for the forecast. When realized, most of these risks could worsen inflation dynamics and hold back economic recovery. Specifically: despite a certain easing, the risk of state finances becoming unbalanced persists on the back of possible problems with the regularity of international aid provision and the repercussions of the war russias attacks on Ukrainian energy infrastructure facilities are increasing the risk to Ukraine's ability to go through the coming winter smoothly the duration and intensity of hostilities, are increasing the risk that a large part of Ukrainians who had gone abroad, will not return, and that some more Ukrainian may decide to leave the country. there is still a risk that the "grain corridor" will cease to operate. Instead, the rapid implementation of a recovery plan for Ukraine, generating foreign investment inflows and substantial funding could accelerate economic growth to twodigit figures, and facilitate faster return of inflation to its target of 5% set by the NBU. The NBU Board has decided to keep its key policy rate at 25%. Supporting the exchange rate stability and protecting international reserves require ensuring that yields on hryvnia assets stay attractive in the long run. This is one reason why the NBU has decided to keep its key policy rate unchanged. Interest rates on hryvnia deposits continue to rise in response to the key policy rate hike in June. We certainly appreciate the Ministry of Finance's decision to increase the rates on hryvnia domestic government debt securities. First, such step has already enabled a sizeable increase in volumes of borrowing, which reduces the need of monetary financing of the budget. Second, it will provide the additional necessary impetus to other rates, which will make hryvnia assets more attractive. 3/4 BIS - Central bankers' speeches In order to stabilize exchange rate expectations and reduce pressures on international reserves, the NBU developed a new mechanism that will provide households with more options to protect their savings from the risk of exchange rate fluctuations and will help dampen demand for FX cash. Such an instrument will enhance the effect of monetary transmission, and improve resilience of the fixed official exchange rate regime. Moreover, the NBU has developed a set of potential measures for reinforcing monetary transmission and optimizing the structural surplus of hryvnia liquidity. The detailed design of these measures is being discussed as part of current consultations of the NBU and the Ministry of Finance with the International Monetary Fund. The updated forecast, like the previous one, envisages maintaining the key policy rate at a level of 25% at least until Q2 2024. If required, the NBU stands ready to raise the key policy rate above its forecast and will further deploy additional measures to protect international reserves, as well as and to maintain control over inflation. Today we are facing a perfect storm, but the NBU continues to stand strong to hold the financial frontline. We will keep taking decisions aimed at maintaining price and financial stability. This will enable Ukraine to come out of this perfect storm stronger than before. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 8 December 2022.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 8 December 2022. *** Dear colleagues, I would like to inform you that the Board of the National Bank of Ukraine has decided to keep the key policy rate at 25% per annum. The NBU has also decided to raise reserve requirements for banks. This will enhance monetary transmission, support exchange rate stability, and gradually slow inflation in 2023. Inflation continues to grow as expected, but the growth is slower than forecast by the NBU. The consequences of the war are the main reason behind this year's increase in inflation. They lead to higher production costs and shortages of some goods. In particular, an escalation of attacks against energy infrastructure of Ukraine: affects economic activity in various sectors – from metals industry to food industry, animal farming, and the services sector causes production cuts, leading to a decrease in supply of goods spurs households' demand for fuel, which creates additional pressure on energy prices. All of the above is driving an increase in prices for a wide range of goods and services, with prices for some items surging. At the same time, overall inflation dynamics remain under control, and prices are rising slightly slower than forecast by the NBU. First, the gradual tightening of monetary conditions following the key policy rate hike to 25% in June and fixing the official hryvnia exchange rate are playing a major role in stabilizing inflation expectations. Second, FX market regulation and the introduction of new savings protection instruments contributed to a narrowing of the spread between the hryvnia exchange rate on the cash market and the official exchange rate. Third, the NBU and the government are following their joint plan to cut monetary financing of the budget deficit. Coupled with the above factors, this helps ease pressures on the FX market and reduce net FX sales by the NBU. 1/4 BIS - Central bankers' speeches In addition, large inflows of financial assistance drove an increase in international reserves to almost USD 28 billion, which exceeds the pre-war level. This strengthens the NBU's capability to maintain exchange rate stability. Unchanged utility tariffs also remain important for restraining inflation. After this year's inflation surge, the growth in consumer prices will slow as of the end of next year. This should be primarily driven by security risks subsiding. Liberation of occupied territories, setting up production and logistics, and increased capability of maritime logistics will help reduce inflationary pressures. Furthermore, steady disinflation in 2023 will be facilitated by: well-coordinated fiscal and monetary policies complete cessation of monetary financing of the budget deficit next year the NBU keeping monetary conditions relatively tight. At the same time, the Ukrainian economy will continue facing limited logistics and electricity shortages in the long run. Weaker consumer demand will be able to only partially offset the effects from higher production costs. Therefore, the NBU continues to expect inflation to decelerate gradually and exceed the central bank's 5% target in 2023–2024. Under such conditions, the NBU will focus on maintaining control of inflation expectations and reining in inflation processes. Sufficient and regular inflows of international financing and cooperation with the IMF are an important precondition for the stable functioning of the economy in wartime. International financial assistance to Ukraine considerably increased in H2 2022. It is forecast to exceed USD 31 billion by the end of the year. I'd like to thank all of the international financial organizations and Ukraine's partner countries for the unprecedented support they have provided to the country as it fights for the values all civilized countries share. International financial assistance needed to finance the budget deficit and restore the economy will continue to arrive into 2023. More specifically, the European Union and the Unites States have already announced their preliminary intentions to provide Ukraine with EUR 18 billion and about USD 10 billion respectively. What is more, the NBU has made some progress in negotiating with the IMF a new monitoring program involving the IMF Executive Board. Once finalized, this program will help Ukraine obtain financing from other international donors in 2023. The NBU expects that an Extended Fund Facility will be approved for Ukraine after the monitoring program expires. 2/4 BIS - Central bankers' speeches Ukraine is also negotiating over obtaining financing from other partner countries and donors. A war and escalating attacks on the country's critical infrastructure remain the key risks for Ukraine's economic development. Overall, risks for the economy remain elevated. On the one hand, the threat that the "grain corridor" will cease operating and risks that Ukraine will not obtain enough external financing has declined. In addition, the smaller extent of the NBU's interventions to sell FX and larger international reserves have bolstered the central bank's ability to maintain a stable exchange rate and to keep price growth in check. On the other hand, the risk of continued attacks on Ukraine's critical energy infrastructure persists. The scale and duration of blackouts could be greater than the NBU envisaged in its October forecast. This could dampen economic activity and increase inflationary pressures. Other risks also remain important. They include: the risk of state finances becoming unbalanced on the back of the unpredictable nature of the war and the possible emergence of additional budgetary needs the risk of the energy sector running large quasi-fiscal deficits because of high energy prices the risk that a large part of the Ukrainians who have gone abroad will not return, and that some more Ukrainians may decide to leave Ukraine, at least during the heating season. In view of the expected price movements, persistently high inflation expectations and the upward shift of the balance of risks, the NBU Board decided to keep the key policy rate at 25%. The central bank has also increased the required reserve ratios for hryvnia and FX current accounts by 5 pp in order to strengthen monetary transmission. What is more, the NBU will allow the banks to use benchmark domestic government debt securities to meet up to 50% of their total required reserve ratios, with a view to decreasing the risk of the NBU having to return to the monetary financing of the budget deficit in 2023. The central bank will decide separately on a list of eligible securities on the basis of proposals made by the Finance Ministry. The banks must start complying with new reserve requirements from 11 January 2023, using domestic government debt securities to meet a portion of their required reserve ratios if they chose to do so. 3/4 BIS - Central bankers' speeches After assessing the effectiveness of the above measures and changes in the banking system's liquidity, the NBU will decide whether or not it should increase the required reserve ratios any further. If pro-inflationary risks materialize, the NBU stands to ready to tighten monetary conditions in order to keep the exchange rate and inflation in check. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the workshop "Inflation targeting in a world of large and persistent shocks", organised in cooperation with the Euro Area Business Cycle Network (EABCN), Kyiv, 25 November 2022.
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Andriy Pyshnyy: Inflation targeting in a world of large and persistent shocks Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the workshop "Inflation targeting in a world of large and persistent shocks", organised in cooperation with the Euro Area Business Cycle Network (EABCN), Kyiv, 25 November 2022. *** Dear colleagues, I am happy to welcome you at the workshop Inflation Targeting in a World of Large and Persistent Shocks. The NBU is hosting this year's event in cooperation with the Euro Area Business Cycle Network (EABCN). Let's hope that this workshop becomes a good tradition. The event has yet again convened leading experts, academia representatives, researchers, and skilled monetary policy practitioners. This highly professional panel will discuss challenges that central banks around the globe are or will be facing as they pursue their core mandates by ensuring price stability for sustainable economic development. Despite being country-specific, these challenges often have much in common. This is especially true for emerging markets. This is why, now more than ever, it is important that we share our experience and jointly seek solutions to key issues. Today we are aiming to answer three questions: First. How to ensure the effectiveness of inflation targeting with limited monetary policy transmission? Second. How to strike the optimal balance between fiscal and monetary policies? Third. What are the features of inflation targeting with varying credibility? Without a doubt, these are the hot topics of the day. For the first time in four decades, the world is facing risks of the simultaneous occurrence of persistently high inflation and a global economic slowdown. With elevated uncertainty following the COVID-19 pandemic and russia's invasion of Ukraine, the world has encountered a series of economic shocks that have triggered a perfect storm of conditions for an accelerated increase in inflation. Those include: demand-driven pressure caused by pent-up consumption and significant stimulus programs of central banks and governments during the COVID-19 crisis supply shocks triggered by structural breaks in production chains at the domestic and international levels energy and food price shocks that had a rapid effect on consumer prices under the conditions noted above. 1/3 BIS - Central bankers' speeches Global inflation is expected to accelerate to 8.8% in 2022 from 4.7% in 2021, according to the IMF's updated forecast. At the same time, global economic growth will decrease to 3.2% in 2022 from 6% in 2021, this forecast shows. Central banks are once again faced with the choice between achieving price stability at the expense of tighter monetary policy with temporary losses in GDP growth, and ignoring inflationary problems and long-term losses in economic development. Today's monetary policy involves difficult, and often controversial, decisions. On the one hand, central banks and governments have a common long-term goal of facilitating sustainable economic growth. On the other hand, it is precisely a central bank's mandate to pursue macroeconomic stability in the short and medium runs. This is because an excessive monetary policy response to inflation weakens economic growth and increases the risk of recession. At the same time, tolerating inflation may throw inflation expectations off balance, causing even more prolonged and painful losses to the economy in the future. From this perspective, balancing fiscal and monetary policies is a prerequisite for success. Practice shows that an excessive accumulation of fiscal imbalances and fiscal dominance lead to chronic inflation, which eats away at the economy, and to a financial crisis that eventually forces the central bank to give a strong countercyclical response. As a result, the ability of both the central bank and the government to exercise their mandates becomes very limited. To ensure macroeconomic stability and sustainable economic development, we need to start looking for this balance today. We also need to remember that in conditions of uncertainty and varying credibility of the monetary policy, central banks have to be even more active in their stabilization policies to prevent unanchoring of expectations. In addition, in terms of policy instruments, ensuring the efficiency of the transmission channel due to the accumulated structural surplus of liquidity calls for unconventional methods. Fortunately, history has many successful examples of combating persistent and excessive inflation and embarking on a path of sustainable development. Forty years ago, developed countries took the path of reducing inflation. In addition, today we have a large number of emerging markets whose experience can become key to the global stabilization of economic and inflationary processes. Ukraine has this experience too. The NBU has proved its capability to tame and curb inflation during the war. After introducing inflation targeting in 2015, the NBU managed to take inflation down from the record 60% level and stabilize it at its 5% target. Switching to the floating exchange rate and strengthening the central bank's institutional credibility and independence were the key factors in that success. Apart from global challenges, Ukraine is currently forced to deal with the fallout from the invasion, which has destroyed one-third of the economy. While responding to the war, the NBU had to deviate from its benchmark inflation targeting approach, but our fundamental principles remain unchanged. The NBU is committed to pursue its 2/3 BIS - Central bankers' speeches mandate, an effort that has made it possible to maintain macroeconomic stability and the sustainability of the financial system even as the perfect storm rages on. The NBU's first steps after February 24, 2022 were intended to prevent panic among the population and ensure the operation of the banking system and payments. The NBU imposed harsh restrictions on capital flows and fixed the exchange rate in order to anchor inflation expectations. To maintain financial stability, the NBU changed its operational design, supplied the financial system with the necessary liquidity, and took a number of steps to support the financial sector. In addition, to ensure the continuity of critical government expenditures, the NBU purchased domestic government debt securities. The central bank's rapid response enabled the banking system to survive the earliest, panic-vulnerable stage of the war. Subsequently, to overcome economic imbalances that were accumulating fast amid an unprecedented shock, the NBU launched the stabilization of its monetary policy by raising its key policy rate to 25% and weakening the official exchange rate by 25%. Coupled with revived support from international donors, this also preserved Ukraine's international reserves at a relatively convenient level. These steps have enabled the regulator to maintain macroeconomic stability. Inflation will be about 30% at the end of 2022, the NBU projects. This, of course, is much higher than our inflation target, but the experience of other countries shows that in wartime it is a rather successful outcome. The NBU pursues forward looking approach and adjusts its policy to ensure a quick and sustainable recovery after the war ends. Again, the world's post-war recovery experience shows that timely stabilization policies are what make economies thrive in peacetime. We therefore stay committed to our inflation-targeting regime and declare that we will resume it as soon as Ukraine's business activity returns to normal. After all, a low, stable, and predictable rate of inflation guarantees macroeconomic stability and is a solid foundation for the productive development of the economy. Although Ukraine is facing additional challenges today, we as policymakers face common challenges of revitalizing the transmission channel and striking a balance between fiscal and monetary policies amid varying credibility. What unites us even more is our unwavering mandate, which is to ensure price stability. I therefore expect that in the course of today's event, we will be able to share our experience, discuss current issues, and form important practical conclusions that will help us achieve our goals. I wish everyone a peaceful sky over your heads, a meaningful discussion, and informative conclusions. 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 26 January 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 26 January 2023. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep the key policy rate unchanged at 25% per annum and to continue raising required reserve ratios for banks. This will facilitate a further increase in the attractiveness of hryvnia assets, support exchange rate stability, and gradually slow inflation. Inflation has stabilized in the past months but is still high As of the end of 2022, consumer prices grew by 26.6%. At the same time, in the past three months, inflation remained almost unchanged in annual terms. The de-occupation of territories, an increase in supply of food products, and consumer demand being dampened by the energy sector destructions helped stabilize the inflationary pressure. Inflation was also restrained by unchanged utility tariffs, the fixed exchange rate of the hryvnia, and improved logistics. The NBU's measures, in particular to introduce deposit instruments to hedge the FX risk, as well as limited volumes of monetary financing of the budget, contributed to a more stable FX market at the end of 2022. At the same time, the price pressure remained strong due to consequences of the invasion, such as the destruction of enterprises and infrastructure and disruption of production and supply chains. Moreover, business costs continued to grow on the back of the energy sector destructions. Despite a stabilization, inflation expectations remained high. Inflation will decline gradually and will remain under control thanks to measures taken by the NBU and the government and the support provided by international partners The NBU forecasts inflation will slow to 18.7% in 2023, supported by monetary conditions remaining tight, global inflation declining, and consumer demand being dampened by power outages. Inflows of announced international assistance and joint efforts of the NBU and the government to revive the domestic debt market will help avoid monetary financing of the budget deficit and balance the FX market. In the next years, inflation will decelerate more rapidly thanks to subsiding security risks, proper recovery of logistics, and larger harvests. 1/3 BIS - Central bankers' speeches The economic recovery ceased due to military attacks against energy infrastructure. As security risks subside, Ukraine will return to steady economic growth in 2024–2025 The critical infrastructure destructions deepened the decline in Ukraine's GDP in Q4 2022 (to 35% yoy). Trading businesses and the services sector adapted to power outages rather quickly. This, coupled with stronger performance in Q3, led to an upward revision of estimated decline in real GDP in 2022 to 30.3%. The NBU expects growth in real GDP to be weak in 2023, at 0.3%. The deterioration of the forecast compared to the October estimates was primarily caused by consequences of the energy sector destructions and the revision of the main assumption of the duration of security risks. The forecast assumes in 2023 Ukraine will manage to avoid further significant destruction of its energy infrastructure, while businesses and authorities will take effective measures to neutralize the consequences of the damage inflicted earlier. The economy will grow in 2024–2025, driven by a decline in security risks, along with a resumption of proper operation of ports, an increase in harvests, a gradual recovery in production, an improvement in logistics, and a pick up in domestic demand, including thanks to the return of displaced persons. The loose fiscal policy will also play an important role. All of the above will push up Ukraine's real GDP by 4.1% in 2024, and in 2025 economic growth will accelerate to 6.4%. International aid, coupled with cooperation with the IMF, will finance Ukraine's substantial budget deficit, and maintain international reserves at a sufficient level. In 2022, Ukraine received over USD 32 billion in international assistance, of which over USD 14 billion was in the form of grants. This enabled the country to finance a larger portion of the consolidated budget deficit, and to increase international reserves, to USD 28.5 billion by the end of the year. Currently, reserves are sufficient to safeguard the stability of the FX market. In view of the already announced international aid and progress made in negotiations with the IMF, overall official financing in 2023 could exceed USD 38 billion. This will enable Ukraine to refrain from the monetary financing of the budget deficit in 2023, and to maintain international reserves at a sufficient level even in the face of longer-lasting high security risks. International reserves are expected to hit about USD 27 billion by the end of 2023, and will continue to rise. The key assumption of the forecast is that security risks will start to decline significantly from early 2024. A prolonged war and further destruction of critical infrastructure remain the key risks. The NBU has revised its key assumption of the security situation forecast due to fiercer fighting and escalating military attacks on the country's critical infrastructure. The baseline scenario of the new macroeconomic forecast envisages a noticeable decrease in security risks from the start of 2024. Therefore, the full unblocking of seaports and 2/3 BIS - Central bankers' speeches reductions in Ukraine's risk premiums have been delayed in the NBU's forecast. More intense hostilities and greater power shortages than expected due to air attacks could dampen economic activity more significantly, while also increasing inflationary pressures. Other risks also have a bearing on the forecast. If materialized, they could also require revisions in key macroeconomic indicators. That said the rapid implementation of the recovery plan for Ukraine, supported by the arrival of official and private financing, could markedly speed up economic growth. In order to bring inflation back to the steady decline trajectory and to maintain exchange rate and macro financial stability amid high uncertainty, the NBU Board decided to keep the key policy rate at 25%. At the same time, the NBU has raised reserve requirements for banks, as it said it would do in December. More specifically, from 11 February the banks' required reserve ratios will be raised by 5 pp for demand deposits from, and current accounts of, businesses and households; for deposits from, and current accounts of, nonresident banks; and for loans from international (other than financial) and other organizations. In particular, from 5% to 10% for hryvnia funds and from 15% to 20% for FX funds. What is more, from 11 March the banks' required reserve ratios will be raised by another 10 pp for household hryvnia and FX demand deposits and current accounts. The banks will not be allowed to use benchmark domestic government debt securities to meet these reserve requirements. The NBU expects that these measures will help decrease the liquidity surplus in the banking system. This, in turn, will encourage the banks to compete more actively for time deposits, which will push up interest rates on hryvnia assets and increase the share of time deposits. This will make the FX market more resilient to situational factors, while also enabling the NBU to ease administrative restrictions for businesses and households in future. The revised forecast envisages keeping the key policy rate at 25% at least until the end of Q1 2024. If required, the NBU stands ready to deploy other tools to avoid the monetary financing of the budget deficit, make hryvnia assets more attractive, increase the resilience of the FX market, and lay the foundations for easing administrative restrictions. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 27 April 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 27 April 2023. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. This will support the effects of previous measures to improve attractiveness of hryvnia assets, help maintain sustainability of the FX market, and form proper conditions for the continuation of steady disinflation trend and for easing FX restrictions. From the start of the year, inflation has been declining faster than expected, including thanks to the NBU's measures to support exchange rate sustainability However, the impact of the war keeps the price pressure and production costs high – in particular, due to difficulties of running business and setting up logistics during the war. Inflation will decelerate to 14.8% in 2023 and will return to a single-digit level in the next years Inflation will decelerate this year thanks to a combined effect from lower global energy prices, restrained domestic demand, and the impact of the NBU's monetary policy. Already this year, the economy will return to growth, which will accelerate in the coming years on the back of a decrease in security risks assumed by the forecast In view of the rapid recovery in the energy system and the loose fiscal policy, the NBU improved its economic growth forecast for 2023, from 0.3% to 2.0%. Provided that the assumptions about the security situation materialize, no significant shortages of electricity are expected, except for some local and situational shortages that might occur in H2. At the same time, an increase in budgetary spending on the back of large volumes of international financial assistance will support economic activity and consumption. Significant volumes of official financing, coupled with the further development of the domestic debt market, will prevent the need for monetary financing of the sizeable budget deficit. Despite an increase in the government's tax revenues and domestic borrowing, these funds are not enough to finance the considerable expenditures of the state budget in wartime and during the post-war recovery. International assistance will remain an important source of financing to meet state budget needs. 1/3 BIS - Central bankers' speeches Overall, inflows from international partners could exceed USD 42 billion this year. The inflows from partners will, among other things, contribute to the growth in international reserves to about USD 35 billion as of the end of this year. This will strengthen the NBU's capability to further maintain exchange rate sustainability and gradually ease FX restrictions. As before, the key assumption of the forecast is that high security risks will persist until early 2024. The war continues. The key risk to this forecast is that the war lasts longer and is fiercer than anticipated. They could have a significant adverse effect on economic activity, while also worsening inflation and exchange rate expectations. This will pose additional challenges to the country's macrofinancial sustainability. The war is also generating other risks. They include: the emergence of additional budgetary needs and substantial quasi-fiscal deficits in the energy sector difficulties with, or the halt in, the operation of the "grain corridor" and greater problems arising from the limitations imposed on imports of Ukrainian food by some European countries further damage inflicted on energy infrastructure, which could again cause substantial power shortages a slower decline in global inflation than expected. Conversely, the rapid implementation of Ukraine's recovery project, together with European integration reforms, could significantly accelerate the pace of economic growth. The arrival of substantial financing for recovery could also provide Ukraine with greater opportunities for easing FX restrictions. Taking into account the risks outlined above, high uncertainty, and a significant amount of expected budget expenditures, maintaining exchange rate sustainability amid a pursuit of currency liberalization plans will require the NBU to continue to take a monetary policy approach that makes hryvnia-denominated savings highly attractive. With this in mind, the NBU Board decided to keep the key policy rate at 25%. Keeping the key policy rate at 25%, introducing additional instruments for preventing household savings from being eroded away by inflation, coupled with measures to increase competition among the banks for time deposits, contributed to greater exchange rate sustainability. These same instruments boosted demand for hryvnia instruments, while cutting demand for FX. At the same time, exchange rate sustainability is primarily being ensured by tight currency restrictions. Their effectiveness wanes over time, while their restrictive effect on business activity grows in intensity. It is therefore becoming increasingly desirable to liberalize FX restrictions in the foreseeable future. 2/3 BIS - Central bankers' speeches To this end, the NBU is making policy efforts to establish appropriate preconditions for an easing of administrative controls. With uncertainty still being high and the risks of current account balances growing further amid significant budget expenditures, the key prerequisite for preserving exchange rate stability and sustaining the decrease in inflation is to make sure that hryvnia savings are attractive. To maintain exchange rate sustainability, improve expectations, and steadily reduce inflation, the NBU will continue to ensure the needed monetary conditions. Keeping the key policy rate high will support the effects of the NBU's previous measures and leave room for further growth in the investment appeal of hryvnia savings. At the same time, the improved macroeconomic situation, including a deeper decline in inflation and the accumulation of a comfortable amount of international reserves, is creating prerequisites for revising the key policy rate forecast. The updated macro forecast envisages the launch of a cycle of key policy rate cuts in Q4 2023. Even if such a scenario materializes, monetary conditions will remain fairly tight over the forecast horizon as inflation continues to slow, inflation expectations improve, and real returns on hryvnia instruments remain high. The NBU stands ready to adjust the time and pace of changes in the key policy rate in view of FX market developments, inflationary dynamics, the sustainability of international support, and the effectiveness of measures to make hryvnia instruments attractive. Our monetary policy decisions will continue to be consistent with our key goals of reducing inflation and maintaining exchange rate sustainability. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 15 June 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 15 June 2023. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. This will help maintain the attractiveness of hryvnia-denominated instruments, preserve the sustainability of the FX market, and reduce inflation. Combined, these results will pave the way for the further easing of FX restrictions. The pace of consumer price growth continued to decline faster than expected. Inflation eased to 15.3% yoy in May. Apart from the base effect, the pullback in inflation was driven by an ample supply of food and fuel, a stronger hryvnia cash exchange rate, and improved exchange-rate and inflation expectations. Among other things, the NBU's efforts to keep the key policy rate high and make hryvnia instruments more attractive made it possible to stabilize the FX market and improve expectations. Although headline inflation has decelerated, underlying inflationary pressures remain rather high. Thanks to the removal of supply chain disruptions, the reduction of prices in the global commodity markets, and the NBU's consistent monetary policy, the central bank expects that inflation in Ukraine will continue to decelerate. However, this process will not be as rapid as in previous months. First, the base effect, which contributed to a significant drop in inflation in H1 2023, will gradually fade. Second, price dynamics will be affected by increases in certain utility tariffs and the announced return of pre-war taxes on fuels. In addition, the destruction of the Kakhovka HPP Dam will have an adverse impact on prices. 1/3 BIS - Central bankers' speeches By the NBU's early estimates, this will contribute about 0.3 pp to this year's inflation rate because of how it has complicated the operation of multiple enterprises, and due to the partial loss of crops, primarily vegetables, that it has led to. The war is taking an increasingly large toll, but steady inflows of international aid and the revival of the domestic debt market have made it possible to cover the significant budget deficit without resorting to monetary financing. Since the beginning of the year, international partners have granted Ukraine about USD 20 billion in assistance. In addition, the NBU's and the government's joint efforts have increased the amount of funds that goes into the state budget from the sale of domestic government debt securities. All of this made it possible to successfully finance the significant deficit of the state budget in January–May. Given the sustainability of international support and the gradual revival of the economy, Ukraine will be able to continue to cover all necessary expenditures without going back to monetary financing. The key risk to inflation dynamics and economic development is the longer duration, and the unpredictable nature and intensity, of the full-scale war. Although Ukraine is gradually liberating its territories, high uncertainty persists over when the active phase of hostilities will end. Targeted attacks have led to the loss of civilian lives and caused environmental disasters. The long-term effects of the destruction of the Kakhovka HPP are unprecedented in magnitude. It will take time to fully assess them. The prolongation of hostilities continue to threaten Ukraine with significant losses of economic potential and with unpredictable inflationary shocks. Other risks also persist. They include: the continued destruction of critical infrastructure facilities, including energy infrastructure the emergence of additional budget needs and substantial quasi-fiscal deficits, including in the energy sector and disruptions or a shutdown of the "grain corridor" and the ongoing limitations imposed on imports of Ukrainian food by some European countries. Conversely, the rapid implementation of Ukraine's recovery project, together with European integration reforms, could considerably accelerate the pace of economic growth and reduce inflation at a faster rate. 2/3 BIS - Central bankers' speeches In order to maintain exchange rate sustainability, with a view to ensuring a decline in inflation and creating the right conditions for an easing in FX restrictions, it is important that hryvnia instruments remain highly attractive. In view of that, the NBU Board decided to keep the key policy rate at 25% per annum. The key policy rate continues to play an important supporting role in ensuring the sustainability of the FX market and protecting international reserves. Keeping the key policy rate unchanged, together with other NBU measures, was instrumental in substantially increasing the attractiveness of hryvnia instruments. This has bolstered households' interest in hryvnia deposits and domestic government debt securities in recent months. Time hryvnia deposits also returned to growth. Coupled with other factors, this helped boost the resilience of the FX market, laying the foundations for a continued easing in FX restrictions. The NBU allowed residents to transfer money abroad, with a view to repaying certain foreign loans. What is more, the central bank is currently working on additional measures to ease FX restrictions. The NBU will continue to deliver the monetary conditions required for maintaining exchange rate sustainability and ensuring a steady drop in inflation. The NBU is ready to start a monetary easing cycle earlier than it envisaged in its April macroeconomic forecast. If the growth in real yields on hryvnia instruments and the reduction of risks to exchange rate sustainability continue to occur faster than expected. This could be facilitated by a faster decline in consumer and core inflation and a more rapid increase in international reserves than envisaged in the forecast, as well as by the greater effectiveness of the measures taken to make hryvnia instruments attractive. Obstacles to a faster transition to a monetary easing cycle could arise from new challenges for exchange rate sustainability and a steady drop in inflation resulting from the Russian invasion. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 27 July 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 27 July 2023. *** The Board of the National Bank of Ukraine decided to cut the key policy rate to 22%. Rapid disinflation and sustained FX market conditions enabled the central bank to start the cycle of key policy rate cuts. Taking into account an improvement in inflation expectations and inflation forecast, the current and forecast rate cuts conform to maintaining the attractiveness of hryvnia savings. This is an important element for ensuring exchange rate stability at the stage when FX restrictions are eased and the NBU makes the exchange rate more flexible. At the same time, reducing the key policy rate against the backdrop of sustained macrofinancial stability will support economic recovery. Consumer inflation decelerated to 12.8% in June, which exceeded the NBU's expectations. In addition to the base effect, supply factors and a decrease in global energy prices played an important role. Measures taken by the NBU – in particular, an increase in reserve requirements and a change in the operational design of monetary policy – also had a significant impact on price movements. These steps contribute to a significant increase in bank interest rates on term deposits and the strengthening of the cash exchange rate of the hryvnia. The NBU's AML/CFT and currency supervision measures also contributed to FX market sustainability. The exchange rate factor eventually drove a decline in inflation and an improvement in expectations, which was also supported by the absence of monetary financing of the budget this year. Having considered the favorable dynamics of H1, the NBU revised its 2023 inflation forecast significantly upward, from 14.8% to 10.6%. The growth in prices will slow due to a gradual decline in global inflation and monetary conditions remaining tight in Ukraine. The NBU will safeguard sustainability of the FX market and keep hryvnia assets attractive enough. This will restrain price pressures. Tariffs being frozen for the majority of utility services will play an important role. 1/4 BIS - Central bankers' speeches At the same time, further disinflation will be slower than in the previous months. This is driven by the waning of the base effect, returning to the pre-war level of the fuel tax, and the increase in electricity prices in June. Moreover, Russia's attacks in the south of Ukraine will also have an impact on price dynamics. The disinflation trend will continue in the coming years: inflation will decline to 8.5% in 2024 and to 6% in 2025. Lower security risks will allow restoring optimal logistical routes and increasing industrial production and crop harvests. This will also enable investment inflows to Ukraine. A further decline in global prices will also contribute to the slowdown in inflation. These factors outweigh the pro-inflationary impact of an increase in domestic demand, a rise in wages, and changes in some utility tariffs in the post-war period. The economy has proven to be resilient to new challenges of the war and is to grow by 2.9% this year An increase in domestic demand contributed to the further revival of economic activity. On the other hand, the economy has been restrained by constant missile attacks, blocking of the grain corridor, and damage inflicted on infrastructure. Trade barriers imposed on Ukrainian agricultural products had an adverse effect on business. At the same time, actual results of Q1 turned out to be better than envisaged in the previous macroeconomic forecast. Economic activity continued to pick up in Q2, in both the manufacturing and services sectors. In the coming years, economic growth will accelerate, based on the NBU's forecast assumption about a decline in security risks in mid-2024. Exports will recover more actively after maritime logistics is restored and attacks on infrastructure cease. The gradual return of migrants will spur consumer demand, and investment will pick up during the country's reconstruction. The loose fiscal policy will remain important for stimulating the economy. Taking this into consideration, the NBU forecasts real GDP growth at 3.5% in 2024 and 6.8% in 2025. Since the start of the year, Ukraine has received almost USD 27 billion from international partners. This was much more than the amount of the NBU's sales of foreign currency to balance the FX market. Thanks to regular inflows of external assistance, Ukraine's international reserves reached an all-time high of USD 39 billion as of the end of June. Thanks to the external support, the government was able to cover the wide budget deficit without resorting to monetary financing. International assistance is expected to reach USD 42 billion as of the end of this year. International support will remain very important for maintaining macrofinancial stability in the coming years. Considering the still high expenditures on defense, financing the budget deficit in 2024 will require no less than USD 37 billion. 2/4 BIS - Central bankers' speeches Ukraine needs to continue its successful cooperation with the IMF and other international partners. The key risk to inflation dynamics and economic development is the longer duration and the unpredictable nature and intensity of the war The NBU's new forecast is based on the assumption that security risks will decline considerably in mid-2024. A full-scale war that lasts longer than expected could result in the additional losses of economic growth, in particular through greater damage and increased migration. This could also adversely affect price movements, due mainly to higher pressures on exchange rate and inflation expectations. There are other significant risks. These include: international aid arriving in decreased amounts or on a less regular basis the resumption of significant power shortages because of damage sustained by energy infrastructure new attacks, which would limit export logistics and the country's economic potential in general the emergence of additional budget needs (to support the country's defense capability, recover from attacks and so on) and substantial quasi-fiscal deficits, including in the energy sector and the ongoing difficulties with exporting agricultural products. The new macroeconomic forecast is based on the conservative assumption that the grain corridor will remain non-operational. The resumption of its operation or the expansion of alternative routes will help expand export opportunities, facilitating more robust economic recovery. The implementation of large-scale projects for Ukraine's recovery could speed up economic growth. At the same time, a faster-than-currently-expected decline in security risks could have the most significant positive impact on economic development. In view of the faster decline in inflation, long-lasting stable conditions on the FX market, a high level of international reserves, as well as the effectiveness of previous measures to boost the attractiveness of hryvnia assets, the NBU Board decided to start a key policy rate easing cycle. The NBU's previous measures tightened competition among the banks for hryvnia term deposits. The banks continued to raise their interest rates on hryvnia deposits. Increasingly more depositors preferred hryvnia term deposits. Favorable trends have provided the NBU with room to launch a monetary policy easing cycle more quickly. The NBU Board decided to cut the key policy rate to 22%. The NBU Board also decreased the interest rate on overnight certificates of deposit to 18%, and to 24% on refinancing loans. The interest rate on three-month certificates of deposit will continue to equal the key policy rate. 3/4 BIS - Central bankers' speeches On the one hand, taking into account improved inflation expectations and the inflation forecast, the current and projected decrease in interest rates on NBU operations will maintain the attractiveness of hryvnia savings. On the other hand, the cut in NBU interest rates will support economic recovery on the back of persisting macrofinancial stability. The NBU will continue to cut its key policy rate, provided the FX market remains stable and inflation declines over the forecast horizon. When easing FX restrictions and transitioning to a more flexible exchange rate regime, the NBU will take into account the need to maintain the high attractiveness of hryvnia assets. The NBU's revised macroeconomic forecast envisages further key policy rate cuts. The key policy rate will be cut gradually, and provided the conditions allow it, so as not to undermine the trend towards a steady decline in inflation or FX market stability. That said, the NBU is not compelled to stick to its key policy rate forecast. Given high uncertainty, any further decisions and revisions of the NBU's key policy rate forecasts will largely depend on whether or not the forecast's assumptions materialize, as well as on the trends of key macroeconomic and financial indicators. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Speech by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, at the 9th ECB conference on central, eastern and south-eastern European (CESEE) countries, Frankfurt am Main, 17 July 2023.
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Sergiy Nikolaychuk: Speech - 9th European Central Bank conference on central, eastern and south-eastern European countries Speech by Mr Sergiy Nikolaychuk, Deputy Governor of the National Bank of Ukraine, at the 9th ECB conference on central, eastern and south-eastern European (CESEE) countries, Frankfurt am Main, 17 July 2023. *** Dear all, I am greatly honored to speak at this event hosted by the ECB and I would like to sincerely thank the ECB for the invitation to participate in this conference. For the National Bank of Ukraine it is extremely important to be the part of the family of European central banks highlighting Ukraine's EU integration efforts. I understand that my intervention today will differ from what my fellow panelists spoke of. Other countries in the region discuss macroeconomic responses to the secondround effects from the Russian invasion of Ukraine and can afford to underline other, often long-term, risks and challenges. In the meantime, we are in the epicenter of this horrific reality while trying to navigate the economy and ensure macroeconomic and financial stability. Since Russia's invasion last year, Ukraine has been facing enormous challenges in conducting all elements of macroeconomic policy. Along with other state actors, the National Bank of Ukraine has been forced to make decisions under constant shelling, risk of occupation, power blackouts, destruction of whole cities and overall exceptional uncertainty. Nevertheless, we have successfully maintained our focus on safeguarding price and financial stability. At the initial stage of the war, in order to prevent the panic and preserve uninterrupted functioning of the banking system and payments, the NBU adopted a wide range of "classic" anti-crisis measures, such as fixing the exchange rate introducing tough capital controls easing requirements for banks and providing them with vast liquidity. Moreover, to ensure uninterrupted funding of critical public expenditures, the NBU started supporting state budget via purchasing government bonds. But while these early measures helped the banks, businesses and households to quickly adapt to the new reality, this mix was not sustainable in the long run. That's why we started to adjust our policies and ration our resources as the blitzkrieg moved to a war of attrition. The need for such changes in policy was clearly indicated by fast depletion of the international reserves as NBU's FX sales were not covered by the official inflows. Thus, we had to repeg the exchange rate (ER) at a weaker level (devaluation of 25%), recalibrate capital controls and hike the key policy rate from 10% to 25%. 1/4 BIS - Central bankers' speeches Our life became easier as international aid grew and the IMF approved new programs with Ukraine: first, Program Monitoring with Board Involvement, in end-2022, and then full-fledged program (EFF) in March 2023. This support allowed us to fully focus on ensuring macroeconomic stability – and I will now walk you through the outcomes we were able to achieve. In fact, today we are considering path to normalization of our policies – something difficult to imagine a year ago, in the summer of 2022. Let's start with FX market as since February 2022 exchange rate has been our main nominal anchor. Meanwhile, in summer of 2022, we saw that the initial peg supported by tight FX restrictions diverted from the fundamentals: reserves approached the dangerous level multicurrency practice was entrenched and led to additional demand via permitted channels. Thus, we repegged the exchange rate by 25% while further tightening the capital controls. This gave us space on the FX market but spread widened again after a while. As FX mismatches shrank (partially due to the grain deal), international support accelerated and the reserves position improved, we refocused the goals of our FX regulation towards minimizing the spread between exchange rate on cash and interbank segments of FX market. So, we expanded the options for population to satisfy its demand for FX while in addition strengthened our financial monitoring and made additional effort to improve the attractiveness of assets in national currency. As a result, ER expectations stabilized and the spread between exchange rates has almost disappeared. In our policy mix, the key policy rate became a secondary policy tool. The hike from 10% to 25% in June a year ago was done primarily to stabilize the FX market and ensure attractiveness of assets in national currency. As in many other, even advanced, economies, we have faced weak transmission amid vast banking sector liquidity. In our case, the excessive banking reserves were the outcome of central bank purchases of bonds and FX from the Government. In order to strengthen the transmission, we employed both conventional and unorthodox tools: reserve requirements were revived as monetary instrument. The ratios were increased in several steps by 10–20 pp depending on currency and term helping to freeze some part of liquidity on corresponding accounts the allowance to fulfill some part of required reserves (up to 50%) with eligible government bonds allowed us to push the revival of domestic borrowings and eliminate the monetary financing of the budget 2/4 BIS - Central bankers' speeches the NBU introduced 3-month CDs at preferential rate linked to the banks' retail term deposits stock. All that led to further increase of banks' deposits rates and increase in the share of term deposits in all deposits of households. This growing attractiveness of assets in national currency amid stability in FX market allowed us to reverse the inflation trend and bring it down significantly, to below 13% in June from the highs of almost 27% at the end of last year. However, inflation, especially core, is likely to show persistence moving forward, as in the region overall. Here, I would like to underline that the headline inflation path was not out of line with the region's trends. That contrasts with monetary policy outcomes during the first wave of Russia's invasion in 2014–2015. We expect that in the next years, inflation will decelerate further thanks to tight monetary policy (MP), subsiding security risks, proper recovery of logistics, and larger harvests. But bringing inflation to the target also has a long way to go, which in our case is complicated by extreme level of uncertainty, as just recently was confirmed by Kakhovka HPP destruction by Russia. This sole act is expected to add 0.3 pp to annual CPI this year. Presented success in stabilizing FX market and reducing inflationary pressures was in significant part determined by a fixed exchange rate regime supported by tight FX restrictions. However, over time, the costs of such framework could outweigh the benefits. First, it leads to increase in market distortions, expansion of the shadow economy, and the diversion of resources to unproductive uses. Second, it pushes both stakeholders and market participants to internalize expectations of a fixed exchange rate and stimulates the accumulation of FX risks. Finally, the economy is deprived of the opportunity to adapt to changes in external and internal conditions through exchange rate flexibility. Thus, NBU has been actively working on creating proper conditions for gradual return to inflation targeting with a floating exchange rate. This ambition has been recently reflected in the Strategy for gradual normalization of monetary policy developed with the IMF personnel as part of EFF conditionality. The Strategy is primarily conditions-driven and heavy on assessment of risks from implementation of its steps. We are confident that this cautious approach will bring us closer to our goals of longlasting macroeconomic stability and economic growth even under conditions of extreme uncertainty. In conclusion, I would like to underline the following. 3/4 BIS - Central bankers' speeches Despite all the terrible consequences of war, our people have shown incredible resilience while the economy has successfully adapted to new conditions. Preservation of macroeconomic, monetary, and financial stability facilitated heavily this adaption. The current macroeconomic situation is conducive to carefully embark on the path of MP normalization. In fact, we have already implemented some measures of the FX liberalization roadmap and are progressing on creating final preconditions for return of ER flexibility. At the same time, the support of international partners, both financial and military, remains crucial for Ukraine's macroeconomic stability and quick post-war recovery. That's also important for macroeconomic performance of the whole region of CESEE and of the whole world. Again, thank you very much for your unwavering support. 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 September 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 September 2023. *** The Board of the National Bank of Ukraine has today decided to cut the key policy rate to 20%. The further pullback in inflation and the NBU's ability to ensure FX market sustainability are making it possible to continue the cycle of key policy rate cuts while maintaining the sufficient attractiveness of hryvnia savings. Such a step will support the economic recovery without posing threats to macrofinancial stability. Although headline inflation has been declining faster than expected, core inflation is close to the NBU's forecast In year-on-year terms, inflation slowed to 8.6% in August. Price movements came out better than the NBU anticipated, primarily due to an increase in the supply of food products. However, the drop in core inflation (down to 10% in year-on-year terms) was close to the forecast the NBU made in July. The NBU's measures to keep hryvnia assets attractive and the FX market sustainable played an important role in easing underlying price pressures. Among other things, the NBU's actions helped further improve exchange-rate and inflation expectations. The overall downtrend in inflation is set to persist, but there is little to no potential for a rapid slowdown in price growth On the one hand, better harvests will continue to restrain price increases in the following months. The impact of the fixing of some utility tariffs will also remain. The NBU is committed to persevere in ensuring the sustainability of the FX market to keep exchange-rate and inflation expectations in check. On the other hand, business costs will remain under significant pressure to increase because of war-related losses as well as higher prices for electricity and fuel. Although significant amounts of official financing have maintained Ukraine's international reserves at a high level, further international support is vital amid significant budgetary needs Official financing enables the NBU not only to make up for a significant shortage of foreign currency in the market, but also to maintain international reserves at a high level. In August, they exceeded USD 40 billion. 1/3 BIS - Central bankers' speeches Budget revenues and investments are not sufficient to meet expenditures. International aid will therefore continue to be the primary guarantee that the budget is funded without relying on central bank financing. With this in mind, it is critically important to meet the conditions of the IMF-supported program on time and in full. War grinds on and remains a key risk to the economy and inflation developments High uncertainty persists over when the active phase of hostilities may come to an end. Prolongation of hostilities continue to pose the risk of dealing more significant damage to the Ukrainian economy's potential and triggering unpredictable inflationary shocks. Other risks also persist, including: decreased amounts or disruptions of international aid disbursements, in part due to failure to meet the conditions of the IMF-supported program on time or in full the emergence of additional budget needs to maintain defense capabilities and substantial quasi-fiscal deficits, in the energy sector in particular the resumption of significant power shortages because of the substantial damage sustained by energy infrastructure, which will restrain economic activity and exports, fuel the growth in imports, and raise pressure on the FX market and therefore on consumer prices ongoing difficulties with exporting agricultural products, in particular if countries extend or expand their trade restrictions, and if the shelling of port and agricultural infrastructure continues amid the termination of the Black Sea Grain Initiative. Taking into account the balance of risks, a sharp fall in inflation, and the NBU's ability to safeguard exchange rate stability, the NBU Board decided to cut the key policy rate, to 20%. The cycle of interest rate policy easing the NBU launched in July decreased nominal interest rates in the banking system, as was to be expected. In spite of that, the yields of hryvnia assets remained attractive, thanks to the dramatic fall in inflation and improved expectations. Interest rates on term hryvnia deposits and domestic government debt securities have continued to exceed both current inflation and the inflation rate expected by households. As a result, household demand for bank deposits with maturities from three to 12 months and domestic government debt securities has continued to rise. Maintaining relatively high yields on hryvnia instruments is important for the continued implementation of the Strategy for Easing FX restrictions, Transitioning to a More Flexible Exchange Rate and Returning to Inflation Targeting. However, given the high sensitivity of the FX market and a substantial surplus of hryvnia liquidity, more rapid cuts in the key policy rate would increase risks to exchange rate stability and the steady decline in inflation. 2/3 BIS - Central bankers' speeches In view of that, starting in 15 September 2023, the NBU Board decided to cut the key policy rate by 2 pp, to 20%, which is in line with the trajectory of the July forecast. The interest rate on three-month certificates of deposit will continue to equal the key policy rate. Meanwhile, the NBU Board cut the interest rate on overnight certificates of deposit by 2 pp, to 16%, and that on refinancing loans by 2 pp, to 22%. The controlled easing of interest rate policy will provide additional impetus to the economic recovery, without threatening macrofinancial stability during the implementation of the Strategy for Easing FX Restrictions. What is more, the NBU will adjust the parameters of the operational design of its monetary policy. More specifically, the NBU will decrease, to 35%, the share of existing household term deposit balances which are used to calculate the limits on the banks' purchases of three-month certificates of deposit. This will further encourage the banks to compete for depositors, and to expand their term deposit portfolios. These changes will come into effect from 18 September. Looking ahead, the NBU plans to continue its key policy rate cutting cycle. The central bank will do this, while balancing the cuts against the need to maintain the attractiveness of hryvnia assets, which is key to a sustainable FX market and a steady decline in inflation. That said, given great uncertainty and high war-related risks, the NBU will act cautiously, so as to be able to safeguard macrofinancial stability in future. If expectations deteriorate, the attractiveness of hryvnia instruments declines noticeably, and risks to exchange rate stability increase, the NBU will adjust its decisions and key policy rate forecast accordingly. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 26 October 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 26 October 2023. *** Today the Board of the National Bank of Ukraine has taken a decision to set its key policy rate at 16% effective 27 October 2023, making it equal to the rate on overnight certificates of deposit (CDs). In such a way, the NBU is modernizing the operational design of its monetary policy in line with the lower-bound system. Interest rates on the NBU's other transactions with the banks have been set as follows: the key policy rate + 4 pp (20%) for three-month CDs and the key policy rate + 6 pp (22%) for refinancing loans. The rates on the NBU's transactions with the banks will thus actually remain unchanged. The modernization of monetary policy operational design will reinforce the signaling role of the key policy rate amid the structural liquidity surplus. In particular, such changes will enable the NBU to maintain short-term hryvnia interbank rates close to the key policy rate. As a result, the NBU will have more power to influence expectations of economic agents and motives of their economic behavior. At this point in time, keeping rates on the NBU's transactions with the banks unchanged conforms with the need to maintain the attractiveness of hryvnia instruments, which is important for ensuring moderate inflation and exchange rate sustainability over the forecast horizon. Inflation has been decreasing rapidly over past months, primarily on the back of strong harvests of agricultural crops In September, inflation declined to 7.1% yoy. Such price dynamics were driven by large supply of agricultural produce of the new harvest and the moratorium on raising some utility tariffs. Stable FX market conditions limited the rise in prices for goods with a significant import component. As a result, core inflation also slowed considerably in September, to 8.4% yoy. According to the NBU's estimates, inflation continued to decelerate in October. Among other things, this was driven by the maintained exchange rate sustainability against the backdrop of the successful transition to managed exchange rate flexibility. At the same time, other underlying factors continued to put pressure on the inflation rate. The gradual economic recovery is being accompanied by a revival of demand for consumer goods and services. The shortage of skilled workers, particularly due to migration, is prompting companies to raise wages relatively quickly. Moreover, the pressure on business costs remains high due to the consequences of the war. 1/4 BIS - Central bankers' speeches Inflation will remain below 10%, albeit rising temporarily next year The NBU has improved its end-2023 inflation forecast, from 10.6% to 5.8%. This was mainly driven by the impact of the large harvest on food price dynamics. At the same time, the NBU has revised its 2024 inflation forecast upward, from 8.5% to 9.8%. The accelerated growth in prices will be caused by this year's low base for food prices, persisting pressures on business costs due to revised security risk assumptions, higher wages, and faster increases in administered prices. Going forward, inflation will decelerate to 6% in 2025. This will be primarily driven by the expected decline in security risks assumed by the NBU's forecast. The recovery in optimal logistics and production in the post-war period will enable an increase in supply of goods and limit price pressures. The expected decline in global energy prices will also have a major impact on price movements. Economic growth will resume as of the end of 2023 and will continue further on The NBU improved its real GDP growth forecast from 2.9 to 4.9% in 2023. The faster pace of economic recovery is driven by a number of factors. They include improved adaptability of businesses and households to wartime conditions, better estimates of harvests, more alternative routes of export supplies, and larger budgetary spending. In 2024, the economy will grow by 3.6% despite persistently high security risks. The economic recovery will be supported by continued development of alternative supply routes and sustained loose fiscal policy, which will support consumer demand. On the other hand, still complicated logistics and investment being limited by the war will be a drag on economic growth. The NBU forecasts that real GDP growth will accelerate to 6% in 2025. This will be primarily driven by the expected decline in security risks. As these risks subside, migrants will gradually return from abroad, consumer and investment confidence will improve, optimal supply and production chains will be restored, and damaged infrastructure will be reconstructed. Thanks to official financing, the NBU will be able to maintain a sufficient level of international reserves and therefore the sustainability of the FX market One of the assumptions is that Ukraine will receive a total of USD 45 billion in financial aid loans and grants this year. These disbursements remain the main source of covering the high budget deficit, which stands to widen to almost 29% of GDP this year. Through aid, Ukraine has also been able to finance its considerable current account deficit, and the NBU has maintained a high level of international reserves and balanced the FX market. Ukraine's needs for external financing in the years ahead will remain significant despite the gradual mobilization of domestic financial resources and fiscal consolidation. 2/4 BIS - Central bankers' speeches An important assumption underlying the forecast remains the sufficiency and regularity of such aid, which requires that Ukraine meet its commitments to international partners. This will make it possible to finance the budget's critical expenditures and avoid having to rely on monetary financing, going forward. For its part, the NBU will be able to maintain international reserves at above USD 40 billion despite making significant interventions to preserve the sustainability of the FX market amid further currency liberalization measures, among other things. The key risk to the forecast is the longer duration and the unpredictable nature and intensity of the war The war continues. The NBU has revised its main assumption regarding the longevity of high risks to security. The updated forecast envisages that they will persist until at least the end of 2024. Uncertainty over the length of the war remains high. An expedited end to the war would promote faster economic growth and eliminate a large part of the inflationary risks. By contrast, if security risks were to persist for longer than currently expected, they could lead to additional losses of Ukraine's economic potential and heavier inflationary pressures throughout the forecast horizon. The following risks also remain relevant: decreased or less regular disbursements of international aid emergence of additional budget needs to maintain defense capabilities and substantial quasi-fiscal deficits, in the energy sector in particular significant damage to port and energy infrastructure that will restrain exports adverse trends in migration. In contrast, the implementation of large-scale reconstruction projects in Ukraine could help accelerate the economic recovery significantly. What is more, economic growth in the short run may be quicker than expected, if the capacity of sea export routes increases more significantly. Taking into account the balance of risks and the need to continue to ensure that hryvnia-denominated assets are highly attractive, especially as FX market participants adjust to the managed flexibility of the exchange rate, the NBU Board has decided not to change the interest rates for the NBU's transactions with the banks The previous steps to loosen the interest rate policy led to anticipated decreases in rates on hryvnia instruments. At the same time, current rates on hryvnia domestic government debt securities and deposits are sufficiently protecting the hryvnia from inflation-driven erosion of purchasing power. On the other hand, the potential for easing the interest rate policy is currently limited, given the need to keep real interest rates on hryvnia instruments in positive territory. 3/4 BIS - Central bankers' speeches In addition, to stimulate the further improvement of the term structure of bank deposits, the NBU has decided to adjust the parameters of the banks' investments in three-month certificates of deposit. Specifically, from December 2023 forward, the only basis for calculating the cap on the banks' investments in three-month CDs will be the increase in hryvnia retail term deposits with maturities of more than three months. This will induce the banks to actively work with depositors to ramp up term deposits. The ongoing interest rate policy easing will be balanced against the need to maintain the attractiveness of hryvnia assets. Provided there are no signs that the balance of risks is deteriorating, and provided that market participants have successfully adapted to the new FX regime, the NBU sees the possibility of cutting the key policy rate further at its upcoming meeting. That said, the expected trajectory of inflation and planned steps to liberalize the FX market some more limit the room for easing interest rate policy next year. The NBU will only be able to return to the key policy rate easing cycle in 2024 if risks to exchange rate sustainability and inflation decline substantially. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 December 2023.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 December 2023. *** Dear colleagues, Today the Board of the National Bank of Ukraine has decided to cut the key policy rate to 15% effective 15 December 2023. This decision comes along with a decline in inflation and an improvement in inflation expectations, which will contribute to sustained attractiveness of hryvnia savings instruments. In November, inflation declined slightly faster than expected, to 5.1% The slowdown in inflation was driven by an increase in supply of food products from the new harvest as well as by an improvement in expectations brightened by the stronger hryvnia exchange rate. The stronger hryvnia also made core inflation decline faster than expected by the NBU. The NBU estimates inflation readings in December to remain close to the current levels. At the same time, the risks that inflation might accelerate are persisting due to logistical problems at western borders and effects from large harvests waning faster. The adaptation to managed flexibility of the exchange rate has been successful The FX market remained sustainable after the introduction of the new exchange rate regime. Demand for foreign currency spiked only in the first days of the managed flexibility regime, and the balance of supply and demand improved after that. This also led to a decrease in the NBU's net FX sales. In November, the balance of the NBU's interventions was USD 2.5 billion, which was less than in previous months. As declared, every day the NBU covered the structural deficit of foreign currency, letting the hryvnia exchange rate sway in either direction influenced by changes in supply and demand. The new exchange rate regime resulted in a notable pickup on the interbank market, in particular by boosting volumes of transactions between the banks without the NBU's participation. An increase in the depth of the FX market is important for reducing its susceptibility to situational factors and for improving exchange rate sustainability. Moreover, the link strengthened between the cash and cashless segments of the FX market as restrictions were lifted for the banks to sell cash foreign currency to households. 1/3 BIS - Central bankers' speeches The NBU will remain active on the FX market The structural deficit of foreign currency will persist due to the consequences of the war. This will require the NBU to maintain an active presence on the FX market – both to meet the structural demand for foreign currency and to smooth out significant exchange rate fluctuations. As proper macroeconomic preconditions are created, the NBU will increase the flexibility of the exchange rate and step up its role as the means for the economy to adapt to external and internal shocks. In addition, the NBU will continue to take measures to support the attractiveness of hryvnia savings instruments: deposits and domestic government debt securities. This will restrain demand for foreign currency and, together with FX interventions, will help maintain exchange rate sustainability. Such policy will allow keeping inflation moderate throughout the next year. International reserves remain sufficient for supporting exchange rate sustainability The NBU's international reserves were close to USD 39 billion as of the end of November. In the past several months, the reserves decreased only slightly, despite irregular arrival of external financing. The current volume of international reserves is much larger compared to both the start of this year and the period before the invasion. The way the war develops remains the key risk to inflation and the economy. Risks to international aid have also increased The war is grinding on. Great uncertainty over the duration and intensity of the war persists. As before, the NBU predicts that there will not be any significant reduction in security risks until 2025. If hostilities last longer, the NBU expects additional economic losses and stronger inflationary pressures. The risks to the regularity of external financial assistance have also materialized in part. That said, the NBU expects that external financing will become regular again in the near future. The reasons for optimism include, among other things, the successful completion of the second review of the Extended Fund Facility, as well as assurances in that regard from Ukraine's international partners. These assurances are an integral part of this program. The NBU also takes into account the high adaptability of Ukrainian businesses and households to wartime challenges. This adaptability largely offsets the negative effects of certain risks. An example of this is the much faster-than-expected increase in exports via the new sea corridor. The expansion of maritime logistics has fully replaced the suspended 2/3 BIS - Central bankers' speeches "grain corridor" and mitigates the effects of the trade and transportation restrictions imposed by some countries. Taking into account the successful adaptation of market participants to the new exchange rate regime, the further decline in inflation and improved inflation expectations, the NBU Board decided to cut the key policy rate and other interest rates on NBU operations by 1 pp. Previous steps taken to ease interest rate policy resulted in a moderate decline in nominal market interest rates on hryvnia instruments, which was in line with the NBU's expectations. At the same time, given the decline in inflation and improved expectations, interest rates on hryvnia instruments even rose slightly in real terms. As a result, hryvnia instruments continue to be an attractive instrument for savings. A cut in the key policy rate will not pose any risks to the attractiveness of hryvnia savings thanks to the further decline in inflation, improved inflation expectations, and the FX market's successful adaptation to the new exchange rate regime. Therefore, the NBU is continuing its interest rate easing cycle. Starting from 15 December 2023, the key policy rate and the interest rate on the NBU's main operation – the overnight placement of certificates of deposit – will be 15%. The interest rate on three-month certificates of deposit and that on refinancing loans will be also cut by 1 pp, to 19% and 21% respectively. Looking ahead, the NBU stands ready to adapt its interest rate policy flexibly, factoring in changes in the balance of risks to exchange rate sustainability and inflation Any further changes in the key policy rate will depend on the development of inflationary processes, the state of the FX market, how regularly international aid arrives, how sufficient international aid is, how security risks evolve, and other factors. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Introductory speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the NBU-EABCN Workshop on Monetary Policy in Emerging Markets, Kyiv, 15 December 2023.
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Andriy Pyshnyy: Introductory speech - Workshop on Monetary Policy in Emerging Markets Introductory speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the NBU-EABCN Workshop on Monetary Policy in Emerging Markets, Kyiv, 15 December 2023. *** Dear colleagues, Welcome to our traditional workshop on Monetary Policy in Emerging Markets. For the third time, we gather to discuss the main challenges for central banks and outline ways to overcome them in emerging markets. First and foremost, I would like to express my gratitude to the Euro Area Business Cycle Network (EABCN) for their support in organizing this event. For the second consecutive year, we are organizing this workshop together, and I sincerely appreciate our productive collaboration. This year, we have placed a special emphasis on understanding the causes and consequences of the new wave of inflation worldwide. The one that shook the world during the post-pandemic recovery and gained particular momentum after the onset of the war in Ukraine. Almost every country in the world has felt the new wave of inflation, with emerging markets being the most affected. This is confirmed by the Economic Outlook presented by the IMF in October. According to the IMF, in 2022, inflation in developed countries averaged 7.2%, while in emerging markets, it was 10.1%. In some emerging markets, inflation exceeded 20%. Among these countries is Ukraine, where we observed a substantial inflationary surge driven by the escalation of the war. The causes of inflationary processes, and even more importantly, the nature of risks for its escalation, can vary significantly across different countries. It seems that inflation has attacked the world from all sides, and in each country, it is targeting the 'vulnerable' points in defense: from both demand and supply sides through uncertainty and turbulence in global energy and food markets through structural fragmentation in labor markets and changes in production and supply chains through potential debt crises and financial destabilization ultimately, through the security risks and active military conflicts. 1/4 BIS - Central bankers' speeches All of these factors have presented distinctive challenges for central banks, particularly given the constraints of our toolkit. In particular, these challenges stem from structural liquidity surpluses, escalating debt burden, dependence on the policies of developed nations, and the dynamics of international capital markets. Economic theory and practical experience have demonstrated successful strategies in addressing inflation. Nevertheless, today we are confronted with new questions: Will the world revert to an era of high and poorly controlled inflation? Are we capable of avoiding new mistakes? Based on empirical data and macroeconomic assessments of individual countries, the recent wave of global inflation has already reached its peak and is steadily trending downward. Among the key factors contributing to its deceleration, several can be highlighted today. Firstly, there has been a decrease in energy and food prices. Initially, these prices surged rapidly last year following the onset of invasion of Ukraine. However, the market proved to be resilient to geopolitical challenges. Secondly, the concerted efforts of countries worldwide to reorient supply chains after imposing sanctions on Russia played a significant role. Another factor that has restrained inflation is the timely and resolute monetary policy response. In 2022 and 2023, central banks proactively raised key interest rates to prevent a resurgence of inflationary processes. This applies to central banks in both developed countries and emerging markets. The Federal Reserve System has decisively embarked on a cycle of rapid monetary policy tightening, marking the first such move in over a decade. Similarly, the European Central Bank has implemented rate hikes at the swiftest pace since the inception of the euro. However, the timely response was even more pivotal for the emerging markets. Devaluation risks arising from potential 'capital flight' prompted the central banks of these nations to proactively adjust interest rates. The active communication strategies of developed countries to stabilize volatile capital markets also played a role. It can be confidently stated that emerging markets have coped much better than anticipated, sometimes even outperforming developed countries. However, in my view, the linchpin of successfully addressing the recent global inflationary surge has been none other than trust in central banks. Research, including studies conducted by experts at the National Bank of Ukraine, underscores that the economic cost of disinflationary policies is significantly lower when there is a high level of trust. Trust plays a pivotal role in anchoring inflation expectations and, ultimately, expediting a return to low and stable inflation. 2/4 BIS - Central bankers' speeches The results of painstaking and long-term efforts to cultivate trust in central banks are evident today. Inflation expectations are firmly anchored, and inflation is on a downward trajectory, with the economic repercussions of disinflation remaining relatively modest. The concerted work to bolster trust has allowed emerging markets to sidestep the conventional crises often faced by small, open economies. While it may seem that the recent global inflationary wave has been effectively tackled, with central banks successfully navigating the challenge, a new set of challenges arises due to the high stakes of losing control over inflation. According to the IMF projections, global inflation is expected to decelerate to 6.9% in 2023 from 8.7% in 2022, further dropping to 5.8% in the following year. The anticipation is that most central banks will achieve their inflation targets by 2025. Even in Ukraine, amidst a war and active military operations, we have managed to bring inflation close to our target of 5%. However, can we afford to let our guard down? I am convinced that the answer is no. The noticeable slowdown in inflation sets the stage for nuanced discussions regarding the pace of monetary policy normalization and the support of economic growth across different countries globally. Central banks find themselves at a crossroads: what is the greater risk – being too cautious or not cautious enough? What is the comparative cost of overly tight policies versus excessively loose ones? Domestically, we are actively engaging in these discussions. Overly strict monetary policy in a low inflation environment can detrimentally impact certain economic sectors and hinder overall growth, especially during times of war. Simultaneously, inflation risks tied to resurging consumption and uncertainties in commodity markets remain elevated. Given these circumstances, a premature shift to interest rate easing poses substantial risks to the entire macroeconomic system and the broader economy. We recognize that this challenge extends beyond Ukraine and is relevant to the majority of central banks worldwide. Each of us understands the potential cost of missteps and acknowledges that a return to high inflation poses risks of destabilizing inflation expectations, eroding trust, and reverting to an era of elevated inflation. Complicating matters further is the difficulty in gauging the full impact of policy measures already implemented in individual countries, as policy transmission takes time. Consequently, most central banks today adopt a cautious approach, characterized by vigilant observation and preparedness for active response. It appears that forward-thinking central banks in emerging markets are presently adhering to a strategy of prudent policy. The National Bank of Ukraine is also adhering to such a strategy. Despite the temporary pause in inflation targeting, we remain steadfast in our commitment to ensuring price and financial stability and promoting sustainable economic growth. 3/4 BIS - Central bankers' speeches Last year, we had to pause inflation targeting, fix the exchange rate, and restrict capital movement. These measures allowed us to prevent panic in the early months of the invasion and maintain control over expectations, ensuring downward trend in inflation. As a result, we brought inflation close to the pre-war inflation target, the financial system remains stable, the economic downturn has stopped, and gradual recovery has begun. However, in the long term, the exchange rate peg deprives the central bank of the ability to effectively manage inflationary processes and leads to the accumulation of macrofinancial imbalances. Ukraine knows this well from the experience of past currency crises. On the other hand, inflation targeting and a floating exchange rate policy from 2016 to 2021 allowed the National Bank to ensure relative exchange rate stability, despite noticeable fluctuations in certain periods, reduce inflation and keep it close to the 5% target. It also helped minimize cyclical economic fluctuations and contributed to economic growth, especially through a steady decrease in interest rates on hryvnia loans for businesses to historic lows. In July, the NBU clearly stated its intentions in the Strategy for Easing FX Restrictions, Transitioning to Managed Flexibility of the Exchange Rate, and Returning to Inflation Targeting. According to the Strategy, the transition to a more flexible exchange rate regime was to take place with the fulfillment of certain prerequisites, and the NBU's steps towards the strategic final goal - going back to inflation targeting - were to be gradual and well-balanced. Remaining committed to this strategy, the NBU successfully transitioned to managed exchange rate flexibility in early October when the necessary prerequisites were met. In addition, step by step, we are easing restrictions on the foreign exchange market. We have also started a cycle of gradual reduction of the key policy rate to support economic recovery and see conditions for liberalizing the foreign exchange market and normalizing monetary policy in the future. While following global central banking best practices, we proceed cautiously, ensuring a gradual approach as macroeconomic prerequisites become clear to avoid compromising our achievements. Maintaining trust in the national currency, the banking system, and the NBU's policy is paramount. Today, our discussion will delve into the role of trust in shaping inflation expectations in Ukraine, offering valuable insights for each participant. The war grinds on. We acknowledge the risks and the cost of error. Our decisions and actions must be well-founded and balanced, it requires expert discussion and dialogue. That's why today's event is so important for us. We've assembled strong experts from the IMF, ECB, BIS, central banks, and academia. I wish everyone to get the most out of this workshop, which will help us all to successfully implement our mandates and return to an era of low and stable inflation. 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 January 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 January 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 15% per annum. This decision comes along with the need to maintain exchange rate sustainability, keep inflation moderate in 2024, and bring it to the target range of 5% ± 1 pp over the monetary policy horizon. Despite Russia continuing its aggression against Ukraine, the inflationary pressure eased significantly last year, including due to the NBU's consistent monetary policy Inflation slowed to 5.1% yoy in November and stood at this level in December. Good harvests and lower global energy prices were major factors behind the decrease in the pressure on prices. The moratorium on tariff increases for certain utilities played an important role. At the same time, a decline in core inflation to 4.9% as of the year end also points to a sizeable contribution made by the NBU's consistent monetary policy, in particular measures to ensure exchange rate sustainability and attractiveness of hryvnia assets. These measures helped improve exchange-rate and inflation expectations. Despite the expected acceleration of inflation in 2024, it will remain moderate and will return to the target range in 2025 Inflation will be within the target range in the coming months. From the middle of the year, it will accelerate somewhat as effects of last year's bumper crops wane. Additional pressure on prices will come from the further recovery in consumer demand, as well as the pass-through of business costs to consumer prices, in particular due to persistently high security risks and wage increases. However, inflation will remain moderate, in part due to the NBU's measures to maintain exchange rate sustainability and the attractiveness of hryvnia assets. Inflation is expected to reach 8.6% as of the end of the year. In 2025, it will return to its target range, slowing to 5.8% as of the end of the year. In 2026, inflation will meet the target of 5%. This will be primarily driven by a decline in security risks, which is assumed by the forecast. It will ensure an overall improvement in expectations, and will allow restoring the logistics and production processes. The price pressure easing will continue to be also driven by the NBU's interest rate and currency policy measures. 1/4 BIS - Central bankers' speeches The economy returned to growth in 2023, and the recovery will continue in the coming years The economy has been recovering throughout the entire 2023 thanks to the high adaptability of businesses and households to wartime conditions and thanks to the loose fiscal policy supported by large-scale international financing. In Q4, the growth in real GDP exceeded expectations, primary due to better harvests of late crops and the development of alternative export routes. This created grounds for an improvement in estimates of real GDP growth for the whole of 2023, to 5.7%. The economic growth will continue despite the war. In 2024, real GDP will rise by 3.6%, mainly thanks to budget expenditures remaining high in view of expected sufficient inflows of international financial assistance. In 2025–2026, economic growth will accelerate to 4%–6% per year, thanks to a decline in security risks, which is the main assumption of the NBU's forecast, an improvement in consumer and investment sentiments, and the implementation of European integration reforms. In the post-war period, the loose fiscal policy will continue to support the economy. At the same time, the budget deficit will significantly narrow as the internal resource base increases. International financial support of Ukraine will continue, albeit declining in volume. This will enable the NBU to maintain international reserves at a high level and ensure exchange rate sustainability Thanks to external support and the NBU's consistent policy, Ukraine's international reserves increased by 42% in 2023 to USD 40.5 billion. Despite delays in international aid disbursement at the beginning of the year, its regularity is anticipated to resume in the coming months. Under the baseline scenario of the NBU's forecast, Ukraine is expected to receive about USD 37 billion in foreign loans and grants in 2024. As security risks expectedly decline in the coming years, Ukraine will restore its ability to independently finance its own needs, and so the volume of official external financing will taper off. At the same time, this aid will be enough to maintain a sufficient level of international reserves and ensure exchange rate sustainability. Combined with domestic market borrowing, international support will also help meet the still significant fiscal needs of the government. The course of the war continues to be the key risk to inflation dynamics and economic development The war is grinding on. As before, the key assumption in the NBU's forecast is that high security risks will begin to ease considerably from 2025. A longer persistence of high security risks will adversely impact business and consumer sentiment and exchangerate and inflation expectations. It will also put more pressure on public finances and aggravate problems in the labor market. Under such a scenario, the potential for economic growth will be lower and inflationary pressure higher than currently expected. 2/4 BIS - Central bankers' speeches What is more, significant risks exist of consistent failure to provide regular international aid and/or of a deeper decline in its volumes compared to the baseline scenario. Other significant risks persist. These include: emergence of additional budget needs (to maintain defense capabilities, eliminate the consequences of attacks, and more) and substantial quasi-fiscal deficits, in the energy sector in particular port and energy infrastructure damage significant enough that it restrains exports continuation of the partial blockade of freight transportation at border crossings with some countries, which will reduce exports and make imports more expensive deepening of adverse trends in migration. On the other hand, more positive scenarios could also happen, and some of them have already materialized. In particular, the rapid expansion of alternative export routes in Q4 2023 helped compensate for the losses from the halt of the grain corridor. Ukraine also began transporting other goods, including metallurgical products, via the new route. Continued positive trends will push up exports, while a further increase in the effectiveness of currency supervision measures will ensure the timely receipt of FX earnings. This, in turn, will contribute to a faster economic recovery, boost the NBU's ability to maintain exchange rate sustainability, while also enabling the central bank to speed up the easing of FX restrictions. The implementation of large-scale reconstruction projects in Ukraine could give considerable impetus to economic recovery. In addition, in recent months, Western partners have been more actively looking into transferring frozen russian assets to Ukraine. Taking into account the balance of risks, the need to safeguard exchange rate sustainability and to maintain moderate inflation in 2024, which in 2025 will be brought to its target range, the NBU Board decided to keep its key policy rate and other interest rates on its operations unchanged In July–December, interest rates on hryvnia instruments declined moderately in response to the NBU's easing of its interest rate policy. The ongoing incentives for banks – i.e. three-month certificates of deposit – restrained the drop in interest rates on hryvnia term household deposits. Yields on hryvnia instruments exceeded current and expected inflation. As a result, hryvnia term household deposits and households' investments in domestic government debt securities continued to rise, which was in line with the NBU's tasks. In view of the expected acceleration of inflation in 2024 and the upward shift of the balance of risks, the NBU considers it appropriate to keep the key policy rate unchanged. This will help maintain the attractiveness of hryvnia instruments, which will limit demand on the FX market, while also helping the NBU to discharge its mandate for 3/4 BIS - Central bankers' speeches safeguarding exchange rate sustainability. In addition, the NBU will maintain an active presence on the FX market to smooth out excessive exchange rate fluctuations within the scope of the managed exchange rate flexibility regime. In turn, maintaining exchange rate sustainability will remain an important tool for keeping 2024 inflation and inflation expectations in check, and for bringing inflation to its target range in 2025. The baseline scenario of the NBU's forecast, which assumes that Ukraine will receive sufficient international financing and that security risks will subside from next year, provides for a slight reduction in the key policy rate starting in H2 2024. At the same time, the NBU will adapt its monetary policy if the balance of risks for inflation and exchange rate sustainability changes. Any further decisions on the key policy rate will depend on inflation dynamics, the state of the FX market, the regularity of international aid inflows, the evolution of security risks, and other factors. 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the High-Level Conference for the Governors of the International Monetary Fund Constituency on "Central Bank Independence in a Changing World", organised by the National Bank of Belgium, Brussels, 9 February 2024.
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Andriy Pyshnyy: High-Level Conference for the Governors of the IMF Constituency Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the HighLevel Conference for the Governors of the IMF Constituency on "Central Bank Independence in a Changing World", organised by the National Bank of Belgium, Brussels, 9 February 2024. *** Dear colleagues, First and foremost, I would like to thank Pierre [the Governor of the National Bank of Belgium Pierre Wunsch] and his wonderful team for the opportunity to take part in this conference and share the experience of the Ukrainian central bank. I want to present for your professional judgment some conclusions made by myself and the National Bank of Ukraine team over the past two years. These insights have been shaped during the 716 days of the full-scale Russian war against Ukraine that takes place in our country but influences the entire world. On 24 February 2022, as Ukrainians were jolted awake by explosions, the global order changed . This made us look at many things differently, including at the central bank's mandate and the ways of its implementation. I could tell a lot about the NBU's experience and our mandate at the times of war. However, due to time constraints, I will focus only on key issues. First, we faced the issue of security in a broad sense. Our usual peaceful environment turned into the martial law reality at once. When our armed forces defended the borders on land and in the air, the foremost task for the NBU was to safeguard the functions of the national currency, guarantee uninterrupted payments, and alleviate panic. In the first hours of the full-scale war, the central bank initiated its action plan that was prepared in advance. The NBU immediately fixed the exchange rate, imposed necessary restrictions, and activated protocols for uninterrupted operation of the banking system. Even in the midst of battle for Kyiv, people could use their payment cards in shops, withdraw cash, and make transfers. Hence, the first conclusion or insight I would like to share: in crises, we do not rise to the level of our potential occasion; we fall to the level of our preparedness. And the level of our preparedness will ultimately determine our ability to fulfill our mandate. Second, we faced the challenge of power terror and massive cyber-attacks. 1/4 BIS - Central bankers' speeches Between October 2022 and March 2023, Russia launched 875 missiles and hundreds of drones targeting critical energy infrastructure. Cities and villages suffered many hours and even days without electricity and communication, and the looming threat of week-long blackouts became a reality. What did it mean for us as a central bank? A new task emerged: to ensure seamless operation of the banking system and uninterrupted access to banking services under any conditions. A wide-scale project POWER BANKING, implemented in cooperation with Ukrainian banks, provided a solution. It consolidated over two thousands branches of different banks into a single network. These branches were equipped with alternative power sources, backup communication channels, had enhanced cash collection capacity, additional staff, and a shared system of continuous operation protocols. Even during the darkest and coldest winter days, people could conduct cash transactions or just charge their phones and find warmth in these bank branches. But POWER BANKING is more than a mere response to missile attacks. Once again, we adopt a broader perspective, since a blackout may be caused by a cyber-attack or a natural disaster. Our POWER BANKING protocols comprehensively address these scenarios, and you will agree that they can happen anywhere. Therefore, my second insight is this: a central bank must execute its mandate under any conditions. The NBU has ingrained this principle into its DNA. In May 2023, we updated the NBU Strategy, broadening our mission statement. Same as before, the NBU should ensure price and financial stability. However, we have now made a commitment to fulfill this mandate under all conditions. Third, spotlighting the sanction track became one of the survival conditions. The matter of resources is essentially the matter of opportunities. For Ukraine it signifies the ability to endure and eventually win. For Russia it represents the means to continue its aggression and the global order destruction. Sanctions help change the balance of power. Thus, their enhancement and ongoing monitoring have been added to our list of tasks since financial companies are always a part of this "supply chain". We are taking all the necessary steps domestically, severing any connections of our financial sector with Russia. We successfully nationalized Russian banking assets in order to ensure financial stability. These actions mitigate the risks related to terrorist attempts of Russia to target our financial system and to undermine our defense. Additionally, we cooperate with our partners to strengthen international sanctions pressure. It is unacceptable to turn a blind eye to the global impact of Russian war against Ukraine. Here is my third insight: sanctions are a crucial element of global policy. Central banks are inevitably involved in their implementation and face associated challenges. 2/4 BIS - Central bankers' speeches Fourth, support of the defense effort became an integral part of our mandate in the times of war. In 2022, we made difficult yet necessary steps to provide short-term assistance in the government's financing of defense expenses. The war caused unprecedented increase in the budget needs. The war cannot be put on hold. It is impossible to find sources of budget financing in a couple of days. So, the NBU had to make a swift and sensible decision and resort to monetary financing. Simultaneously, it had to develop a remediation plan and avoid monetary financing in the future. Cooperation between fiscal and monetary authorities is an integral element of such plan. This matter is frequently discussed at global conferences. I've heard it emphasized by our IMF and ECB colleagues. We have gained some extraordinary experience. Reboot of our relations amid the full-scale invasion allowed us to revive the domestic debt market and avoid monetary financing in 2023. We successfully restored confidence in the local currency, which eased pressure on the exchange rate and prices. As a result, we effectively mitigated the risks of forced monetary financing. The independence of the NBU played a crucial role in that. As a result, the inflation that peaked at 27% in 2022, decreased to the pre-war inflation target of 5%. We successfully halted the decline in economic activity and transitioned to gradual recovery: last year, the GDP grew by more than 5% after nearly one-third slump in 2022. The unity of Ukrainian authorities and the mutual respect of both institutions' to each other's mandates allowed us to prove our capability and raise the required finances. I want to thank Ms Kristalina Georgieva for trust, support and leadership of the International Monetary Fund that consolidated the donor coalition around Ukraine, becoming its cornerstone. I hope, this collaboration will persist. This year, the significance of international support and the consolidation of efforts will not diminish; it will only intensify. The war continues. Thus, my fourth insight: efficient cooperation with fiscal authorities and international partners not only provides resources for the implementation of the central bank mandate but also serves as a source of capacity. And the last, the fifth point. It is crucial to develop and implement measures to ensure steady recovery and post-war reconstruction. This was clearly manifested in both internal policy and documents on cooperation with our partners. While the first stage of our program with the IMF defined the key task as "maintain macroeconomic, external, and financial stability, in order to strengthen 3/4 BIS - Central bankers' speeches Ukraine's capacity on its way to victory", the second stage focuses on recovery and reconstruction. These words are mentioned in the Memorandum with the IMF more than 80 times. To achieve this, it is important to switch from anti-crisis measures to forward-looking and balanced policy. For this purpose, we moved from the fixed rate to ER managed flexibility. We are cutting our policy rate. Gradually, we are easing the FX market restrictions and moving towards our strategic objective: return to inflation targeting. We are returning to normality, and I remain hopeful that we will continue on this path, despite the ongoing war. Strong economic recovery requires revival of lending. This is why we prepare our Lending Revival Strategy taking into account war realities, including the need to boost the defense of the country. In conclusion, I would like to emphasize that Ukrainian experience shows, that despite the fact that the mandate of a central bank is clearly defined, new challenges make us look for the new ways to fulfill it, and these ways may vary. And the most important insight from the two years of the full-scale war is that we, as central bankers, should learn to take a broader perspective. Today it is the 716th day of war in Ukraine. During this time, there were 978 air raid alerts in Kyiv alone. The number and magnitude of challenges have grown, and their impact extends beyond Ukraine. I am convinced, that everyone present at this conference would agree. Full-scale, cruel, destructive war of Russia against Ukraine aggravated the risks of global war, geopolitical fragmentation and deglobalization. It has disrupted the "metabolism" of the financial system. This challenge is global, and a risk to global security and global macrofinancial stability, now and in the future. 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 March 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 14 March 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to cut the key policy rate to 14.5% effective 15 March 2024. A further decline in inflation, sustained stable FX market conditions, and positive developments in the prospects to receive external assistance lay ground for an earlier resumption of the easing cycle of interest rate policy. At the start of 2024, inflation slowed more rapidly than expected by the NBU In February, inflation decelerated to 4.3% yoy. Among other things, this was facilitated by higher supply of some food products and effects from last year's strong harvests. The reorientation of some producers to the domestic market also had an impact on food prices. In addition, the moratorium on raising some utility prices continued to restrain inflation. Core inflation decelerated as well, to 4.5% yoy. Stable FX market conditions – among other things, owing to the NBU's monetary policy and currency supervision measures – improved inflation and exchange rate expectations across the majority of respondent groups. This reined in underlying price pressures. The official and cash exchange rates became almost equal, and the hryvnia exchange rate fluctuated moderately in both directions, which was in line with the managed exchange rate flexibility. Since the previous monetary decision taken in January, market rates on hryvnia instruments have not changed much. Yields on bank deposits and domestic government debt securities continued to exceed inflation expectations of businesses and households. Together with the controlled situation on the FX market, this supported interest in domestic currency savings. In particular, Ukrainians' holdings of domestic government debt securities increased, and retail deposits placed for three months and longer showed steady growth. Inflation will remain moderate, in particular thanks to the NBU's consistent monetary policy The NBU estimates inflation will remain within the target range of 5% ± 1 pp in the coming months and will accelerate only moderately in H2. A gradual increase in incomes of Ukrainians and higher business costs during the war will fuel the inflationary pressure. At the same time, some utility tariffs being frozen and the NBU's monetary policy aimed at supporting the attractiveness of hryvnia assets and exchange rate sustainability will continue to curb growth in consumer prices. 1/3 BIS - Central bankers' speeches The course of the full-scale war continues to be the key risk to inflation dynamics and economic development The NBU's January macroeconomic forecast was based on the assumption that the security situation would improve significantly from 2025. However, the risk of protracted Russian aggression against Ukraine still exists. The protracted war would slow economic recovery and make it more difficult for the NBU to keep inflation close to the 5% target in 2025–2026. The risk of insufficient inflows of international financing also persists. That said, positive developments have been seen recently in this respect. At the end of February, the Council of the European Union approved the launch of Ukraine Facility instrument to the total amount of EUR 50 billion for 2024–2027. Under this instrument, Ukraine should receive EUR 4.5 billion of bridge financing already in March. Ukraine has also reached the staff-level agreement on the third review of the program with the International Monetary Fund and expects to receive the decision of the IMF Executive Board in a week. Overall, the country might receive more than USD 10 billion in March–April. A pickup in external assistance inflows in the near future will allow Ukraine to significantly increase its international reserves. In addition, the following risks remain relevant: the emergence of additional budget needs to maintain defense capabilities or cover substantial quasi-fiscal deficits, in the energy sector in particular significant damage to infrastructure, especially port infrastructure, which will limit exports the continuation of the partial blockade of freight transportation at border crossings with some countries, which will reduce exports and make imports more expensive the deepening of adverse trends in migration. On the other hand, positive scenarios could also materialize. Thus, a significant expansion of the capacity of the maritime corridor could help Ukraine's exports recover faster, and given the enhanced effectiveness of currency supervision measures, increase foreign exchange earnings. The implementation of large-scale reconstruction projects in Ukraine could give considerable impetus to economic recovery. Discussions have also recently intensified about the use of immobilized Russian assets in Ukraine's favor. The implementation of these initiatives could significantly improve key macroeconomic indicators. Taking into account the further deceleration of inflation and a steady improvement in expectations, a stable FX market, and a partial reduction in the risks associated with obtaining international assistance, the NBU Board decided to cut the key policy rate by 0.5 percentage points, to 14.5%. 2/3 BIS - Central bankers' speeches The easing of interest rate policy will support economic recovery, without threatening macrofinancial stability. The new level of interest rates on the NBU's operations is sufficient to maintain the attractiveness of hryvnia assets, safeguard exchange rate sustainability and retain moderate inflation. In particular, for these purposes, the NBU plans to continue operations with threemonth certificates of deposit as an effective element of the operational design of interest rate policy, which has proven to be effective over the past year. At the same time, in the context of the interest rate policy easing cycle and a steady slowdown in inflation, the need for a significant difference between the interest rate on this operation and the key policy rate is diminishing. In view of the above, the NBU is cutting the interest rate on three-month certificates of deposit by 1.5 percentage points, to 17.5%. What is more, the NBU is decreasing the interest rate on refinancing loans by 1.5 percentage points, to 19.5%. The interest rate on overnight certificates of deposit will continue to equal the key policy rate. If required, the NBU will continue to modify the parameters of operations with threemonth certificates of deposit. In particular, starting from 19 April, to determine the limit on banks' investments in three-month certificates of deposit, the growth of hryvnia household deposits with a maturity of more than 93 days will be calculated for the last 12 months (rather than from 4 April 2023, as is currently the case). This will encourage banks to increase their portfolios of hryvnia household term deposits, which is important for maintaining exchange rate sustainability and protecting international reserves. The NBU will continue the cycle of interest rate policy easing, provided that risks to inflation and exchange rate sustainability are sustainably reduced The NBU continues to be prepared to adapt its interest rate policy dynamically in response to changes in the balance of risks to inflation and exchange rate sustainability. Maintaining a controlled situation in the FX market and moderate inflation, as well as increased foreign aid inflows, will create preconditions for further steps to cut the key policy rate and ease FX restrictions. They will promote lending and support economic recovery. 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 April 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 April 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to cut the key policy rate from 14.5% to 13.5% effective 26 April 2024. Considering a decline in actual and expected price pressures and lower risks to inflows of international financial support, the NBU continues the easing cycle of its interest rate policy. This will support lending development and economic recovery without posing additional risks to price and financial stability. In Q1 2024, consumer inflation slowed more rapidly than expected by the NBU Actual consumer inflation slowed to 3.2% yoy in March and was below the NBU's forecast. The deviations from the forecast were primarily driven by temporary factors that were difficult to predict. Mild winter led to higher supply of raw foods and lowered the pressure on business costs, in particular the cost of energy. In addition, effects of last year's strong harvests continued. Core inflation also slowed (to 4.2% yoy) but was rather close to the NBU's forecast. On the one hand, further growth in labor costs and consequences of the blockade of the western borders supported underlying inflationary pressures. On the other hand, the underlying inflationary pressures were eased by an improvement in inflation expectations and pass-through effects from lower prices of raw foods to the prices of processed foods and some services. The NBU has improved its inflation forecast for 2024 to 8.2% and expects inflation to settle within the target range of 5% ± 1 pp in the coming years As before, the NBU forecasts a moderate increase in inflationary pressure in view of the expected vanishing of effects from last year's strong harvests, continued recovery in consumption, and a rise in business costs amid the war. At the same time, taking into account the improved dynamics of actual inflation and better inflation expectations, the NBU has lowered its end-2024 inflation forecast, from 8.6% to 8.2%. In the coming years, inflation will return to the target range of 5% ± 1 pp and will settle at this level. This will be facilitated by a gradual normalization of conditions in which the economy functions, an easing of external inflationary pressures, and the NBU's consistent monetary policy. Inflation is expected to slow to 6% at the end of 2025 and to 5% at the end of 2026. 1/4 BIS - Central bankers' speeches The economic recovery will continue, but will be restrained – primarily, due to significant damage to energy infrastructure According to the NBU's estimates, real GDP growth in Q1 2024 was weaker than expected, mainly as a result of limited budgetary spending amid the uncertainty about inflows of external financing. The blockade of the western borders was an additional factor restraining the activity in some economic sectors. At the same time, the operation of the sea corridor, favorable weather, and an increase in domestic demand supported economic growth. The NBU forecasts further recovery in economic activity in the wake of recent developments in the issue of receiving international assistance and an expected pickup in domestic and foreign demand. At the same time, the real GDP growth forecast has deteriorated due to the consequences of Russia's attacks on Ukraine's energy infrastructure. The economy is expected to grow by 3% in 2024 and by 4.5%–5% in 2025 and 2026. The continuation of international financial support and measures to strengthen the resilience of public finances will secure further macrofinancial stability necessary for sustainable economic recovery As expected, Ukraine received USD 9 billion from international partners in March, which allowed the country to increase its international reserves to almost USD 44 billion. Moreover, in the past days, Ukraine received positive news from the United States about the approval of the military and financial assistance package. Ukraine also received another tranche from the EU in the amount of EUR 1.5 billion. In such a way, Ukraine can count on receiving USD 38 billion in external budgetary support this year. In the meantime, the country continues to implement measures to increase its selfsufficiency. The government is strengthening its own resource base and increasing borrowing from the domestic market. For its part, the NBU is improving currency control measures. Combined with the resumed regular inflows of external assistance, this will allow financing the planned budget expenditures and supporting the controllable situation on the FX market. The course of the full-scale war continues to be the key risk to inflation dynamics and economic development Russia's aggression continues and causes new losses to the Ukrainian economy. The NBU assumes that security risks will subside and that economic conditions will normalize over the forecast horizon. However, a prolonged, high-intensity war threatens to further destroy cities, infrastructure, and production facilities, and the extent of the destruction is difficult to estimate in advance. Compared to the previous forecast, the risk of insufficient international financing this year has eased considerably, but the risks to regular financing remain. The following risks also remain significant: 2/4 BIS - Central bankers' speeches the emergence of additional budget needs to maintain defense capabilities or cover substantial quasi-fiscal deficits, in the energy sector in particular heavy damage to infrastructure, especially energy and port infrastructure, which will limit economic activity and put supply-side pressures on prices the continuation of the partial blockade of freight transportation at border crossings with some EU countries, which will depress exports and make imports more expensive the deepening of adverse trends in migration, and the aggravation of the situation in the Middle East, which, in particular, increases the risks of possible disruptions to energy supplies and a rise in energy prices for the global economy. At the same time, a number of positive scenarios may still materialize, including further expansion of export opportunities, the transfer of funds from immobilized Russian assets to Ukraine, the acceleration of European integration processes, and the implementation of a large-scale recovery program. Taking into account the balance of risks, as well as favorable macrofinancial trends, in particular better inflation dynamics, the NBU Board decided to cut the key policy rate by 1 pp, to 13.5%. The previous steps to ease interest rate policy and changes in the operational design of monetary policy gradually decreased nominal yields on hryvnia deposits and domestic government debt securities. At the same time, on the back of the overall improvement in inflation expectations, these instruments remained attractive and in demand. A moderate cut in the key policy rate should not diminish interest in hryvnia assets, as they will continue to protect savings from being eroded away by inflation. The NBU is also cutting the interest rates on overnight certificates of deposit and threemonth certificates of deposit, to 13.5% and 16.5% respectively. What is more, the NBU is decreasing the interest rate on refinancing loans more pronouncedly – by 2 pp, to 17.5%. In the context of the interest rate policy easing cycle, the need to maintain a significant difference between the interest rate on refinancing loans and the key policy rate is diminishing. With the level of international reserves being sufficient, the situation on the FX market being under control, and there being expectations of further international assistance inflows, the NBU is preparing a number of steps to liberalize the FX market in the coming weeks. These steps will be in line with the Strategy for Easing FX Restrictions, Transitioning to a More Flexible Exchange Rate, and Returning to Inflation Targeting. These steps have already been taken into account in the revised macroeconomic forecast, which assumes that international reserves will remain close to their current level this year and next year. The NBU sees some room for the further easing of its interest rate policy, provided that favorable macrofinancial trends continue 3/4 BIS - Central bankers' speeches The baseline scenario of the NBU's forecast envisages a cut in the key policy rate to 13% this year. This easing of interest rate policy and the planned steps to liberalize the FX market should not pose any additional threats to macrofinancial stability and FX market resilience. At the same time, the NBU will adapt its monetary policy if the balance of risks changes significantly. Thus, lower risks to inflation and exchange rate sustainability could create preconditions for further cuts in the key policy rate and an easing of FX restrictions, which would support lending and economic recovery. 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the 8th Annual Research Conference "Navigating the changing landscape - central banks in a new normal", organized by the National Bank of Ukraine and the National Bank of Poland, Kyiv, 21 June 2024.
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Andriy Pyshnyy: Navigating the changing landscape - central banks in a new normal Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the 8th Annual Research Conference "Navigating the changing landscape - central banks in a new normal", organized by the National Bank of Ukraine and the National Bank of Poland, Kyiv, 21 June 2024. *** Dear guests, colleagues, and viewers of the broadcast! My greetings to all participants of the 8th Annual Research Conference of the central banks of Ukraine and Poland. I am very glad this professional discussion has returned to Kyiv. This is symbolic. At the same time, it adds appropriate context to the discussion. After all, the topic we have been discussing over the conference's two days concerns a very important issue – Navigating the Changing Landscape: Central Banks in a New Normal. It is remarkable that not a single speaker has questioned the very fact that this new normal exists. Nor has anyone cast into doubt that this landscape has indeed become a fast-changing environment. The theme that permeates all debates today in one way or another is the challenges and tasks posed by the new reality that emerged on 24 February 2022. And central banks are no exception. In February 2022, the National Bank of Ukraine faced central bankers' greatest fears, which materialized simultaneously: the country lost a third of its GDP, 20% of the territory was occupied, migration reached staggering numbers of more than 16 million people. The war was generating an ever-increasing budget deficit every minute. The NBU had to resort to monetary financing of budget to support the country's defense capabilities. Inflation was growing rapidly. We found ourselves in the eye of a perfect storm – as powerful as it was unpredictable. No central bank probably had ever experienced such a concentration of shocks. We had to respond instantly: by implementing emergency protocols, by looking for optimal solutions in the shortest possible timeframe, by using unorthodox and innovative tools... If I were to put it into one term, I would call it "extreme uncertainty." Uncertainty that fundamentally changed Ukraine's and the world's reality. Uncertainty that has already become a new normal for us. The paradox of this situation is that the upsurge in uncertainty triggered elevated expectations for the projections and decisions generated by the central bank. We have been seeing this for the third straight year, and now it is even more tangible: 1/6 BIS - Central bankers' speeches people want our work and decisions to be an island of stability in the middle of a storm that keeps raging. Our observations have been confirmed by Banque de France's Governor François Villeroy de Galhau, who said, "The credibility of central banks and their resolute course of action have a consequence: they are fueling growing public expectations." There is a direct relationship: the more effective the policy that a central bank pursues and the higher its credibility, the more people expect from the central bank's decisions. This is what unites us with other central banks. They also deal with expectations. Central banks in different countries may have differently worded their statutory mandates, but each central bank directs its efforts toward shaping and managing expectations and maintaining trust, which is a key aspect of ensuring the effectiveness of central bank policy. We have some insights that I will share, but we certainly do not have all the answers. So, today we will look for answers together, and the first question is: How to maintain a central bank's credibility amid high uncertainty while undergoing a dramatic transformation? Despite the tremendous experience the NBU has gained, as the war wears on, uncertainty is constantly generating new challenges. Challenges for us. Challenges for the whole world. The echoes of the storm that started in Ukraine can be felt now both on the European continent and across the ocean. The war has already affected global food security, migration flows, and redistribution of budgets in favor of military spending. The war is affecting logistical and production capabilities, encouraging tighter border control on land and water and in cyberspace. The war is being reflected by slowing rates of economic growth and rising global inflationary pressures. The world is highly interconnected through trade, financial, and geopolitical networks. As a result, we are seeing that big shocks can have avery different asymmetric and nonlinear effects due to complex interrelated economies and rapidly worsening expectations. And under the laws of perfect storm, the worst-case scenario can happen... Hence question two: Are central banks ready to face the challenges of war if it comes close to their countries' borders? The NBU's experience proves that conventional approaches and tools are no longer enough to effectively implement the central bank mandate. And in some cases, new 2/6 BIS - Central bankers' speeches challenges dictate the need to change not only the approaches, but the very philosophy of central banking. Since the war's onset, we have accumulated a unique base of knowledge and solutions that has proved effective amid high uncertainty. Over this time, the financial sector and the economy have gone from survival and adjustment stages to gradual recovery. Along with solutions, we have also developed several insights that I expect you and I will augment during the panels today. 1. Central banks should prepare for crises. In emergencies, we do not rise to the level of our expectations, we fall to the level of our preparedness. The idea of crisis preparedness is nothing new. It lies at the core of ensuring financial stability, which became a widespread part of central banks' mandates after the Asian market crisis and was cemented as such by the 2007–2008 global financial crisis. In essence, crisis preparedness involves creating a system of buffers and an early warning system that operate on the principle "prepare today for what may come tomorrow." Central banks should not be afraid to take into account the relevant experience from different cases. The NBU started preparing immediately after Russia annexed Crimea in 2014. Thanks to prearranged action protocols and a package of anti-crisis measures put into effect on 24 February 2022, we were able to stabilize the situation. We managed to prevent panic, stem capital outflows, and help the country fight and defend its independence. We pegged the exchange rate to the U.S. dollar and imposed administrative restrictions on FX transactions and cross-border movement of capital. We activated the banking system's business continuity protocols. Have you ever heard of any countries where people could easily use payment cards amid a full-scale war, even on its first day? I know of only one such country. Ukraine. Not a single payment was denied, not a single Ukrainian bank stopped operating. People had uninterrupted access to their money and continued to keep their deposits in banks. We supported the country's budget by issuing UAH 400 billion in monetary financing as Ukraine waited for financial support from partners. We did it because the defense forces needed immediate funding. A tactical medicine phrase I often use to explain the essence and importance of crisis response is very apt. In the event of severe injury (which is how you can describe the invasion's impact on the Ukrainian economy), compress the damaged blood vessels with a tourniquet to stop the bleeding as soon as possible. Our emergency measures became such a tourniquet for the financial system. Over time, however, the tourniquet itself starts posing a threat and must be loosened up and then removed in order for the 3/6 BIS - Central bankers' speeches body to begin to recover. Our second insight is about how to do this safely in the face of a war: 2. In times of uncertainty, strategic planning helps you stay on course. The war raged on with no quick ending in sight, and so the economy, businesses, and people had to adjust to operating under martial law. This required us to calibrate our toolkit. In effect, we had to invent monetary policy under wartime conditions. We had to find a new normal. So, how were we to proceed? Strategic planning became our solution. It helped us identify the right signposts and answers. Despite wartime uncertainty, we updated two key strategic documents: the NBU Strategy and the Strategy of Ukrainian Financial Sector Development. And then, jointly with IMF experts, we developed the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting. The NBU strategy came to be called Financial Fortress, a name that refers to a certain level of strength and stability expected of us by stakeholders, financial sector participants, businesses, and households, meaning the end users of financial services or virtually everyone. Gradually, by making step-by-step headway towards our strategic goals, we were able to achieve a point where the economy began to recover despite the war, and where the financial sector continued to undergo reform, because we could not afford put off our European integration efforts until after the war ended. 3. Not only is the new reality forcing central banks to transform, but also it is motivating other institutions – governments and IFIs – to do so. In 2023, the IMF approved an EFF program for Ukraine that I really consider historic. Not only because we managed to secure an unprecedented amount of financial assistance from partners. And not only because, under the program, Ukraine is implementing an ambitious reform plan that strengthens its stability and capacity. The program was evidence of the IMF's new perspective on reality. It set a precedent in which the IMF reconsidered its own lending policies and opened up to the possibility of working with countries that face extremely high uncertainty generated by exogenous factors. The IMF showed maturity and leadership in responding to the challenges posed by the new reality. Another example of such a transformation is the reset of the relationship between the NBU and Ukraine's Ministry of Finance based on a clear understanding of the limits of each other's mandate, and at the same time on awareness of our common goal. 4/6 BIS - Central bankers' speeches In one of her interviews, Christine Lagarde emphasized the growing role of coordinated actions by monetary and fiscal authorities amid high turbulence. "Monetary and fiscal policy play a complementary role in fighting price pressures. They must work hand in hand and not contradict each other," she said. This is hard to deny. Such cooperation somehow expands the NBU's mandate, engaging the central bank to resolve the problem of closing the fiscal gap, a task that is usually beyond the scope of the central banks' attention. Ms Gita Gopinath also mentioned this at our meeting yesterday. But the emergency situation – the new reality – requires that we take novel approaches. It was thanks to the new quality of interaction with the fiscal authorities that we were able to revive the domestic debt market, making it possible to raise more than UAH 1 trillion in domestic financing amid a full-scale war. What is more, the NBU's participation in the clampdown on shadow schemes that used to cause the billions of hryvnias losses of the state budget has made this fight increasingly more effective. Today, these funds are going towards the budget and fueling our ability and capacity to resist. And most important, such synergy makes it possible to find nonmonetary channels for boosting revenues to the budget. Even as the war grinds on, we have not resorted to central bank financing of the budget deficit since the beginning of 2023. 4. As central bankers, it is vital for us to learn to take a broader look, to search for new ways of pursuing our mandate in order to maintain macrofinancial stability in the new reality. The NBU took this approach by participating in the implementation of the government's sanctions policy against Russia. The tightening of sanctions, the monitoring of sanctions compliance, the continual tracing down and detection of sanctions evasion schemes, the isolation of Russia's financial system – all of these efforts are gradually draining the resources that Russia is using to bankroll its war. 5. Uncertainty generates global risks to central banks' independence. Kristalina Georgieva, Managing Director of the IMF, also talks about them in her program article: Strengthen Central Bank Independence to Protect the World Economy. I would like us all to remember that central bank independence is both a goal and a huge resource for countries. The results of the IMF study cited by Ms Georgieva confirm that independence is critical to winning the fight against inflation and achieving stable long-term economic growth. Independence is the basis for trust in a central bank's actions. The value of such credibility in unstable times is extraordinary. And so we must keep this challenge in mind today. Last but not least, I will mention a phrase that has been enshrined in the NBU's mission since 2023. It is a very simple and clear message: we remain committed to our goals of 5/6 BIS - Central bankers' speeches ensuring price and financial stability. And we take responsibility to achieve these goals under any circumstances. This sentence covers all of the talking points laid out above and leads us to the third, key question: How should a central bank transform itself to remain sustainable and effective in the new normal? What should be changed, and what should stay the same? We have three panels and a keynote speech by Ms Gita Gopinath ahead of us, and these questions will be raised without a doubt. This discussion is crucial for us. We are open to searching answers together. It is important that we "write this textbook" on the operation of central banks in wartime, and that we write it together under conditions of extreme uncertainty. I look forward to watching the panels and gaining new insights. Let's have a fruitful day of discussions. 6/6 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 July 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 25 July 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 13% per annum. This decision is intended to ensure the sustainability of the FX market and bring inflation closer to its 5% target within the forecast horizon. Inflation has expectedly accelerated and approached 5% in recent months After a long period of decreases, inflation returned to growth in May and picked up to 4.8% yoy in June. This inflation trajectory came out only slightly below the NBU's forecast. Lower-than-expected increases in food prices made up for a more significant increase in household electricity tariffs. At the same time, core inflation came in at 5% yoy in June, matching the NBU's forecast. Underlying price pressures intensified as businesses' expenses on labor and power grew. In addition, developments in some of the core CPI's components reflected a weakening of the hryvnia's exchange rate. Inflation will rise going forward, but will begin to ease next year already Price pressures will persist in the coming months, fueled by further increases in business costs and higher excise taxes. This will also be driven by the fading effects of last year's large harvests and the adverse impact of the summer drought on this year's crop yields. Early estimates of inflation in July confirm its further acceleration. However, inflation will remain moderate, at 8.5% at the end of the year, the NBU's updated forecast shows. This will be partly due to the NBU's measures to safeguard households' hryvnia incomes and savings from inflation and ensure the sustainability of the FX market. The ongoing moratorium on increases in utility tariff for natural gas, heating, and hot water supply will also have a restraining effect on prices. The NBU's balanced interest-rate and exchange rate policies and the weakening of external inflationary pressures will make it possible to slow inflation to 6.6% as soon as 2025. In 2026, inflation will return to the NBU's 5% target as the economy gradually normalizes and the energy situation continues to improve. Economic recovery will carry on, but will be restrained by the war's impact, including extensive damage to the energy system Economic growth continued in H1 2024, but has decelerated in recent months, impeded by Russia's attacks on energy infrastructure. However, businesses have partially 1/3 BIS - Central bankers' speeches adapted to rolling blackouts. The stable operation of the sea corridor has also provided significant support for economic activity. Despite power shortages and smaller harvests compared to a year ago, the NBU has even slightly upgraded its economic growth forecast for this year, to 3.7%. This was made possible by better Q1 results and an anticipated expansion of fiscal stimulus, as well as by the development of distributed generation with support from large-scale lending programs. The step-by-step normalization of economic activity and the steady pursuit of loose fiscal policy, combined with the development of export routes and the revival of external demand, will help speed up real GDP growth to 4%–5% in 2025–2026. Significant international financial aid will enable the government to finance the budget deficit, and the NBU to maintain a comfortable level of reserves Under the forecast's baseline scenario, Ukraine will keep receiving substantial external financing inflows. However, they will slowly decline with the growth in the internal capacity to use domestic resources to finance budget expenditures. International partners are expected to provide about USD 38 billion in soft loans and grants to Ukraine this year, and no less than USD 31 billion next year. Such volumes of external inflows, coupled with growing domestic borrowing, will make it possible to cover a significant budget deficit of about 23% of GDP in 2024 and 18% in 2025. For its part, the NBU will be able to maintain a sufficient volume of international reserves to ensure the sustainability of the FX market and moderate inflation. The course of the war continues to be the key risk to inflation dynamics and economic development The duration and nature of Russia's aggression will continue to have a notable impact on Ukraine's inflation and economic development. A prolonged high-intensity war will curb the economy's return to normal conditions and make it difficult to bring inflation to the NBU's target. There are other risks, most of which are also directly or indirectly related to the war, including: the emergence of additional budget needs, mainly those to maintain defense capabilities the pass-through to prices of certain new business taxes, the introduction of which is currently being discussed at the state level further damage to infrastructure, especially energy and port infrastructure, which will limit economic activity and put supply-side pressures on prices the deepening of adverse trends in migration. There is also a risk that international partners will reduce their support for Ukraine more significantly, in particular due to elections in many countries. 2/3 BIS - Central bankers' speeches At the same time, a number of positive scenarios are also likely to materialize. These scenarios are related to the further expansion of export opportunities, the acceleration of European integration processes, the implementation of a large-scale recovery program, and a faster pace of repairs in the energy sector. In addition, the practical implementation of the Extraordinary Revenue Acceleration Loans (ERA) mechanism, secured by future revenues from immobilized Russian assets, could provide Ukraine with additional financial resources starting in 2025. This will reduce risks to the timely and regular inflow of international financing. Taking into account the need to ensure the sustainability of the FX market and to bring inflation closer to its 5% target over the forecast horizon, the NBU Board decided to keep the key policy rate at 13% Despite a gradual decline in hryvnia deposit rates and in interest rates on domestic government debt securities, the yields of these instruments currently protect households' hryvnia savings from being eroded away by inflation. In particular, the rates on these instruments exceed both the NBU's inflation forecast and households' inflation expectations. At the same time, household hryvnia term deposits stopped growing in June. Given that a further acceleration of inflation could worsen expectations and decrease the real yields on hryvnia instruments, it is advisable to keep the key policy rate at 13%. The NBU will also maintain an active presence on the FX market to cover the structural deficit of foreign currency, support bilateral exchange rate fluctuations, and smooth out excessive volatility The NBU aims to ensure that the FX market is in such a state that the central bank will be able to control inflation expectations and achieve its inflation target over the forecast horizon. The baseline scenario of the forecast assumes that the NBU will only return to a key policy rate easing cycle in early 2025. However, the NBU will respond flexibly to changes in the balance of risks to inflation and the FX market If the risks to inflation and the FX market ease, in particular as a result of Ukraine receiving more financial support, the NBU will consider resuming the key policy rate easing cycle at an earlier date. At the same time, the NBU will be ready to tighten its monetary policy in the event of a significant increase in price pressures and risks of expectations becoming unanchored. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 19 September 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 19 September 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 13%. This decision will help gradually bring inflation back to the target of 5% in the coming years and support the sustainability of the FX market. Inflation has expectedly accelerated in recent months In August, consumer inflation rose to 7.5% in annual terms, which was close to the forecast the NBU made in July. The underlying inflationary pressure, measured by core inflation, also increased to 6.5%. The growth in consumer prices was driven by the impact of lower harvests, businesses' larger expenses, and the effects of the weakening of the hryvnia in the previous months. However, inflation expectations remained rather sustainable. The pressure on prices will persist in the near future, but inflation will slow next year Inflation will rise moderately in the coming months due to an increase in aggregate demand against the backdrop of budgetary spending, businesses' larger expenses on wages and electricity, and higher excise taxes. However, the NBU's prudent monetary policy and lower external price pressures will contribute to a gradual decline in inflation and its return to the target of 5% in the coming years. To meet the target, the NBU will, in particular, maintain a manageable situation on the FX market. International reserves are being kept on a level sufficient for ensuring the sustainability of the FX market In August, Ukraine received a large amount of international financial assistance. At the same time, the NBU's interventions to sell foreign currency declined substantially on the back of a decrease in net demand from businesses and households. As a result, Ukraine's international reserves exceeded USD 42 billion as of the start of September. The staff level agreement on the fifth review of the IMF program reached in September was another positive signal that volumes of international assistance will continue to be sufficient and macrofinancial resilience will be maintained. 1/3 BIS - Central bankers' speeches Considering the above and the sufficient set of available instruments, the NBU will remain fully capable of supporting the sustainability of the FX market, prevent excessive exchange rate fluctuations, and ensure that the exchange rate moves both ways. International financial support and measures to mobilize internal resources should help the government finance the budget deficit without resorting to monetary financing The war is grinding on. The russian aggression continues to put significant pressure on public finances. Given the need for large expenses on defense capability, budget expenditures for 2024 have been raised considerably. The draft state budget for 2025 envisages that expenditures will remain high – the budget deficit will exceed 19% of GDP. The budget expenditures are planned to be financed on account of further increases in budget revenues, financial support from international partners, and more domestic borrowing though selling domestic government debt securities, made possible thanks to efforts of the government with the NBU's assistance. This will enable the country to mobilize necessary resources and avoid returning to monetary financing over the forecast horizon. The course of the full-scale war continues to be the key risk to inflation dynamics and economic development The time needed for inflation to return to the 5% target and the sustainability of Ukraine's economic development will strongly depend on the nature and duration of the war. The russian aggression continues to generate the following risks: the emergence of additional budget needs, mainly those to maintain defense capabilities the likelihood of an additional hike in taxes, which – depending on its parameters – might spur the pressure on prices further damage to infrastructure, especially energy and port infrastructure, which will limit economic activity and put supply-side pressures on prices a deepening of adverse migration trends and further widening of labor shortages on the domestic labor market. The uncertainty also persists over the volumes of international partners' further support for Ukraine. Among other things, this is due to many countries being focused on their internal election cycles and russia making sabotage attempts in other countries and at the level of international institutions. At the same time, a number of positive scenarios might also materialize in relation to large inflows of funds to Ukraine coming from frozen russian assets. These scenarios may also be related to a further expansion of export opportunities, the acceleration of European integration processes, and a faster pace of repairs in the energy sector. 2/3 BIS - Central bankers' speeches Taking into account the balance of risks, the need to bring inflation back to its 5% target in the coming years, and to ensure the sustainability of the FX market, the NBU Board decided to keep the key policy rate at 13% In recent months, interest rates on hryvnia instruments have been declining, reflecting the impact of previous monetary easing measures. However, the yields on hryvnia deposits and domestic government debt securities remain sufficient to protect hryvnia savings from being eroded away by inflation. The latter remains one of the important tasks for the NBU. In July, the NBU suspended its interest rate easing to maintain an appropriate level of yields on hryvnia instruments. The central bank currently believes it expedient not to resume the cycle of key policy rate cuts. The September's decision to keep the key policy rate at 13% aims to maintain interest in hryvnia savings and to restrain demand on the FX market. The NBU Board also decided to change the parameters of other monetary policy instruments and operations More specifically, from 20 September 2024, interest rate on three-month certificates of deposit will be cut to 15.5%. Interest rate on refinancing loans will be also decreased, to 16%, while the maximum loan term will be limited to two weeks. Interest rate on overnight certificates of deposit will continue to equal the key policy rate. At the same time, from 11 October 2024, the NBU will raise its reserve requirement ratios by 5 pp (excluding term hryvnia household deposits with maturities of more than 93 calendar days). Moreover, from that day, the NBU will also increase, to 60%, the share of required reserves the banks can meet using benchmark domestic government debt securities. The NBU believes that these steps will not pose any risks to the sustainability of the FX market and the return of inflation to its target over the policy horizon. Instead, the combination of these measures will increase the flexibility of banks in managing their liquidity and stimulate additional demand for domestic government debt securities. This will strengthen the government's ability to raise the necessary funding on the domestic debt market. The NBU will continue to flexibly adapt its monetary policy if macroeconomic indicators deviate from expectations and if the balance of risks to inflation, the FX market's sustainability, and economic development changes significantly. Thank you for your attention! Glory to Ukraine! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 31 October 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 31 October 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to keep its key policy rate at 13%. Coupled with maintaining the sustainability of the FX market, this decision will allow keeping inflation expectations under control, slow down inflation next year, and bring it back to the 5% target going forward. As expected, inflation has increased in recent months. However, the pace of the increase was somewhat faster than forecast In September, inflation accelerated to 8.6% yoy, and continued to rise in October, according to the NBU's estimates. The increase in the price pressure in H2 2024 was expected, being reflected in the NBU's previous forecasts. At the same time, the growth in both consumer and core inflation was faster than forecast. An important contribution to these dynamics came from an increase in food prices on the back of smaller-than-expected harvests of various crops, and from the related growth in the cost of food industry inputs. The rise in inflation was also driven by further increases in production costs, including the costs of electricity and labor, as well as by exchange rate effects from the weakening of the hryvnia in previous periods. Despite the acceleration of inflation in recent months, economic agents' inflationary expectations remained sufficiently stable and controllable, albeit worsening marginally. The pressure on prices will persist in the coming months, but inflation will start to slow in spring 2025 In the coming months, the pressure on prices will persist due to the further impact of food supply factors, increases in budget expenditures, rapid wage growth, and wider energy shortages during the heating season. As a result, inflation will hit 9.7% at the end of 2024. That said, inflation will start to decline in spring 2025. The slower price growth next year will be driven by the NBU's prudent monetary policy and weaker external price pressures, as well as by an improvement in the energy sector and an increase in harvests. The NBU forecasts inflation to decline to 6.9% at the end of 2025 and return to the 5% target in 2026. The economy continues to grow, although the growth remains limited due to the war 1/4 BIS - Central bankers' speeches The waves of Russia's attacks on the energy infrastructure, an increase in migration, and labor shortages slowed the economic recovery. However, real GDP kept growing, in both Q2 and Q3 2024. That said, smaller shortages of electricity and somewhat larger harvests of early grain crops enabled the NBU to revise its forecast for real GDP growth in 2024 upward, to 4%. Significant budget stimuli, backed by large volumes of international financing, rising household income, growing outputs in crop farming, and sustained external demand will support further growth in the Ukrainian economy, at 4.3%–4.6% in 2025–2026. The uncertainty about volumes of international assistance decreased. Sufficient inflows of external support will allow the government to continue financing large budget expenditures and enable the NBU to maintain the sustainability of the FX market In October, the IMF disbursed another tranche to Ukraine in the amount of USD 1.1 billion as a result of the fifth review of the Extended Fund Facility. Around USD 300 million of concessional financing came from Canada. By the end of the year, Ukraine is expected to receive more than USD 15 billion, of which USD 4.8 billion under the World Bank's SPUR program supported by financing from the United States. In addition, considerable progress was made in confirming future volumes of assistance. International partners came much closer to the disbursement to Ukraine of a non-repayable loan secured by proceeds from frozen Russian assets, to the total amount of USD 50 billion, as part of the ERA mechanism. Therefore, international support for Ukraine will remain significant. Taking into account the expected inflows, the NBU has improved its assumptions about external financial support for 2024–2026. The total amount of international financing is expected to reach USD 41.5 billion this year and USD 38.4 billion next year. The continued external support, together with sufficient volumes of borrowing from the domestic market, will enable the government to keep covering the large budget deficit without resorting to monetary financing. For its part, the NBU will be able to maintain an adequate level of international reserves to preserve the sustainability of the FX market. The projections for these reserves have been revised upward compared to the July forecast – to USD 43.6 billion for 2024, and to USD 41 billion for 2025. The course of the war continues to be the key risk to inflation dynamics and economic development The war continues. Accordingly, the risks of a further decline in economic potential remain, in particular due to the loss of people, territories, and production facilities. The speed of the economy's return to normal will depend on the nature and duration of the war. 2/4 BIS - Central bankers' speeches What is more, it continues to generate the following risks: the emergence of additional budget needs, mainly those to maintain defense capabilities the likelihood of an additional hike in taxes, which – depending on its parameters – may drive up pressures on prices further damage to infrastructure, especially energy and port infrastructure, which will restrain economic activity and put supply-side pressures on prices a deepening of adverse migration trends and a further widening of labor shortages on the domestic labor market. There is also a risk of increased geopolitical tensions in the world amid the war in the Middle East, the electoral cycles in some countries, and Russia's attempts to form a coalition of states. At the same time, a number of positive scenarios are still likely to materialize, resulting from further acceleration of European integration processes and recovery in the energy sector. In order to maintain the sustainability of the FX market, bring inflation back to its target over the coming years, and keep inflation expectations in check, the NBU Board decided to keep the key policy rate at 13% per annum Given that inflation has not yet peaked, and that pro-inflationary risks have even increased for the coming months, the NBU believes it appropriate to remain cautious while conducting its interest rate policy, and to take prudent measures to safeguard the sustainability of the FX market. To counteract price pressures, the NBU suspended its interest rate policy easing cycle in July. This has supported interest in hryvnia savings, the interest rates of which currently provide adequate protection against inflationary depreciation. In particular, the inflow of households' hryvnia term deposits resumed in the fall, and investments in domestic government debt securities continued to grow. The policy of protecting hryvnia savings from being eroded away by inflation will continue to help limit pressures on the FX market and preserve international reserves. Using the regime of the managed flexibility of the exchange rate, the NBU will compensate for the structural shortage of foreign currency in the private sector and smooth out excessive exchange rate fluctuations. The exchange rate will fluctuate moderately in both directions in response to changing market conditions, which will further strengthen the adaptability of the FX market and the economy. Exchange rate movements will be in line with the NBU's objectives of keeping inflation expectations under control, slowing inflation next year, and returning it to its 5% target on the policy horizon. If pro-inflationary risks continue to materialize, the NBU stands ready to deploy all available monetary policy tools 3/4 BIS - Central bankers' speeches The revised NBU forecast envisages keeping the key policy rate at 13% for a longer period – at least until the summer of 2025. In the event that price pressures continue to rise above the forecast and threaten to unanchor inflation expectations, the NBU will be ready to tighten its interest rate policy and take additional monetary measures. Thank you for your attention! 4/4 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 12 December 2024.
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Andriy Pyshnyy: National Bank of Ukraine press briefing - monetary policy decisions Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at a press briefing on monetary policy decisions, Kyiv, 12 December 2024. *** Dear colleagues, The Board of the National Bank of Ukraine has decided to raise the key policy rate to 13.5% per annum. This decision is intended to preserve the sustainability of the FX market, keep inflation expectations in check, and gradually bring inflation down to the target of 5%. In recent months, inflation has been rising faster than forecast by the NBU In November, inflation accelerated to 11.2% yoy. On the one hand, consequences of limited food supply due to this year's weaker harvests were an important driver of price growth. The impact of this factor on inflation is expected to be neutralized next year as new harvests enter the market. On the other hand, the inflationary surge is starting to look more and more fundamental, which is evidenced by further growth in core inflation. The latter is associated with increases in businesses' expenses on electricity and labor, as well as with exchange rate effects from the weakening of the hryvnia in previous periods. Inflation expectations are relatively stable as of now. However, the risk that they might unanchor is increasing as households pay more attention to inflation processes. Inflation is expected to slow in 2025 and move toward the 5% target further on In the coming months, inflation is likely to continue to rise in annual terms due to the further impact of food supply factors, large budget expenditures, significant pace of wage growth, and wider energy shortages during the heating season. However, going forward, inflation should decelerate as the situation in the energy sector improves and harvests increase. This will also be facilitated by the NBU's monetary policy measures and an expected easing of external price pressures. In 2025, volumes of international financial assistance will be sufficient for nonmonetary financing of the budget deficit and maintaining the sustainability of the FX market In recent months, the risks of international financing inflows being insufficient in 2025 have declined substantially thanks to the progress made in the implementation of the Ukraine Loan Cooperation Mechanism, which envisages non-repayable macrofinancial 1/3 BIS - Central bankers' speeches assistance, as well as in the allocation of funds under Extraordinary Revenue Acceleration Loans. The NBU's forecast that next year Ukraine will receive more than USD 38 billion in international assistance remains relevant. This financing will enable the NBU to maintain an adequate level of international reserves to ensure the sustainability of the FX market. The course of the war continues to be the key risk to inflation dynamics and economic development The war continues and poses the risk of a further reduction in economic potential, in particular due to the loss of people, territories, and production facilities. The speed of the economy's return to normal functioning conditions will depend on the nature and duration of the war. The main risks remain the same: the emergence of additional budget needs, mainly those to maintain defense capabilities the likelihood of an additional hike in taxes, which – depending on its parameters – might drive up pressures on prices further damage to infrastructure, especially energy and port infrastructure, which will restrain economic activity and put supply-side pressures on prices a deepening of adverse migration trends and a further widening of labor shortages on the domestic labor market. At the same time, positive scenarios could also materialize, resulting, among other things, from the continued acceleration of European integration processes and recovery in the energy sector. In order to maintain FX market sustainability, prevent expectations from becoming unanchored, and to gradually bring inflation back to its target, the NBU Board decided to raise the key policy rate from 13.0%, to 13.5% The NBU sees a need to tighten its interest rate policy to reverse the inflation trend and bring back inflation to its 5% target on the policy horizon. A higher key policy rate will help keep inflation expectations under control and support real yields on hryvnia instruments. This will fuel interest in hryvnia term deposits, and thus help reduce pressures on the exchange rate and prices, as temporary inflation drivers wear off. Safeguarding the sustainability of the FX market will remain an important factor in bringing inflation back onto a downward trajectory. Given the sufficient amount of international assistance, the NBU's ability to compensate for the structural currency deficit in the private sector and smooth out excessive exchange rate fluctuations will remain strong. 2/3 BIS - Central bankers' speeches The NBU will take further decisions to tighten its interest rate policy at upcoming meetings of the Board on monetary policy issues if there are persistent signs of unrelenting inflationary pressures and the threat that inflation expectations might become unanchored. Thank you for your attention! 3/3 BIS - Central bankers' speeches
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Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the NBU-EABCN Workshop on Monetary Policy in Emerging Markets, Kyiv, 4 December 2024.
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Andriy Pyshnyy: Speech - Workshop on monetary policy in emerging markets Speech by Mr Andriy Pyshnyy, Governor of the National Bank of Ukraine, at the NBUEABCN Workshop on Monetary Policy in Emerging Markets, Kyiv, 4 December 2024. *** Dear colleagues, I am delighted to welcome you to this workshop dedicated to monetary policy in emerging markets! Every year, this event brings together leading experts from central banks, international financial institutions, and think tanks. As ever, it provides we professionals with a chance to mull over the most pressing challenges facing us, and to discuss the policy responses that we can use to meet these challenges. The topic of the workshop is highly relevant and at the same time extremely complex – requiring as it does the crafting of integrated and consolidated solutions. We must discover not only how to respond adroitly to rapidly changing conditions, but also how to effectively shape these conditions in our favor. The world today is not what it was yesterday. Tomorrow it will change again. But at all times we have a duty to pursue our mandate. Moreover, fulfilling our mandate is becoming increasingly important in these uncertain times, as one of a central bank's functions is to reduce uncertainty. The Russian invasion of Ukraine was an inflection point at which a new reality began. Not only did the war pose a tremendous challenge to our country, it also triggered tectonic shifts in the global socio-economic landscape. The shockwaves have spread far beyond Ukraine, causing disruption to global supply chains, energy crises, and the imposition of sanctions. Significant uncertainty is the new economic normal. In Ukraine, the war challenged us to take quick, bold decisions. As I have repeatedly said, there is no textbook in the world that answers the question, "How do you conduct your monetary policy when your country is being attacked by a state with a much larger economy?" In fact, we are adding chapters to textbooks even as the war grinds on, through our actions to counteract inflationary and depreciation pressures in the face of subdued investment activity, unprecedented migration, and structural changes in the economy. Not just Ukraine, but all countries are facing the challenges and consequences of uncertainty – emerging markets are no exception. Striking a balance between shortterm emergency measures and strategic goals is a task that faces us all. The purpose of our workshop is to discuss integrated solutions that match the complex nature of our modern challenges. 1/4 BIS - Central bankers' speeches And so let me start out by outlining three key challenges facing central banks. The first is the aforementioned heightening of uncertainty. Russia's war against Ukraine, the unstable geopolitical situation, and global economic shocks are fueling sharp energy price fluctuations, supply chain disruptions, FX market pressures, and significant capital mobility. All of these require effective and strategic responses from central banks. The second key challenge comes in the form of the pressures on our financial systems. These include a growing debt burden, increased risks to the banking system, and capital outflows – and, again, all are significant threats to emerging markets. Monetary policy must therefore continue to be flexible, but consistent in its aim to retain its credibility with businesses and households. The third key challenge is the limited effectiveness of conventional policy instruments. Traditional approaches to policy implementation are inadequate for today's unprecedented challenges. Strong supply-side shocks, when they materialize, expose this deficiency of monetary policy, as its capacity to affect them is limited. For this reason, emerging markets are particularly affected by the policies pursued by developed countries, which in turn raises even greater obstacles to conducting an effective independent monetary policy to ensure macroeconomic and financial stability. How should we respond to these challenges? We at the NBU have no silver bullets, but we do have experience to share. I will outline the stages through which Ukraine's monetary policy has evolved amid the war. I hope this adds an important element to the discussions and provides inspiration. In the earliest months of Russia's invasion, the NBU was forced to take stringent anticrisis measures. These included an exchange rate peg, FX restrictions, and financing the government. All this was done to minimize panic and keep the economy afloat. But the NBU quickly realized that these were not sustainable, long-term solutions. So, as soon as the initial shocks of the war subsided, and the proper prerequisites were in place, the NBU began to move back towards a more balanced and predictable policy. First, we introduced a set of measures to enhance the impact of the key policy rate. This was done by modifying reserve requirements and the operational design of interest rate policy. When more prerequisites were met, we switched to a policy of managed flexibility of the exchange rate. And in 2024, we were able to introduce flexible inflation targeting as an intermediate monetary regime. Using this approach, the NBU is pursuing the policy of steering inflation to a point target of 5% within an extended policy horizon of up to three years. Inflation targeting reduces uncertainty, while flexibility allows us to take current economic conditions into account – including structural shocks caused by the war. Flexible inflation targeting has its own distinct features. 2/4 BIS - Central bankers' speeches First, we focus on long-term goals. Even in crisis conditions, we adhere to inflation benchmarks, paving the way for a gradual return to full-fledged inflation targeting. Second, our monetary policy reacts to the conditions of the day: We have a broader monetary policy horizon under the transitional regime, which allows us to quickly adapt and respond to new shocks, such as energy crises or supply chain disruptions. Third, flexible inflation targeting involves the use of a combination of instruments. Apart from interest rate policy, we maintain an active presence in the FX market and impose caps on capital movements. As favorable prerequisites emerge, however, we continue our movement towards more market-based mechanisms. We will give special attention today to this third feature, as the use of a combination of policy instruments is not unique to Ukraine and is increasingly seen in other small open economies. In fact, the main task of this workshop is to find an effective balance between the instruments used – in particular those based on advanced macroeconomic analysis. The fourth important feature of a flexible monetary regime is a high level of interaction between the fiscal and monetary authorities. The NBU cooperates closely with the government in raising external financing and implementing reforms in Ukraine. At the same time, this cooperation implies that authorities must respect each other's mandates. Which brings us to the fifth feature: The NBU strives for transparent, active communications with every target audience. We freely explain our decisions to avoid misleading market participants, experts, government officials, investors, and the public. We do this to maintain their trust – the primary anchor for an effective policy. Through this approach, Ukraine has been able to retain macrofinancial stability while setting the stage for economic recovery, despite continuing to face massive challenges. In addition to internal transformation, an important component of resilience is close cooperation with international partners. For Ukraine, cooperation is now an integral element of macrofinancial stability. And at this point I'd like to reiterate our gratitude to our partners for the expert, financial, military, and humanitarian assistance they have provided. Today we are one thousand and fifteen days into the war. In the first hours of the invasion, and further on, the NBU received overwhelming support from central banks and international organizations and institutions. The unprecedented support we have obtained from the International Monetary Fund, the World Bank, the European Union, and the United States has been truly invaluable, and has enabled Ukraine not only to confront the consequences of the war, but also to look ahead and plan for long-term recovery. 3/4 BIS - Central bankers' speeches We took full advantage of this help, and now that we are on the path to recovery, we are actively exchanging our experience with our colleagues from other countries, via events such as this workshop. Sharing knowledge is also a powerful resource, and, we are excited to share our expertise with you while continuing to refine our approaches. The challenges facing us may differ, but we all share a common goal – to create a sustainable economy capable of ensuring the stable development of countries. I believe that integrated approaches, the exchange of experience, and international cooperation are key elements for success in this endeavor. Today we will review cutting-edge research into topics such as FX interventions, capital controls, international reserves, and the interaction between fiscal and monetary policies. We will be honored to hear a report from leading IMF economists Jesper Lindé and Marcin Kolasa on the Integrated Policy Framework. I'm confident that their presentation will set the foundation for fruitful discussions on the practical aspects of an integrated approach. Another highlight of today's workshop will be a presentation of the IMF's extended Quarterly Projection Model, or QPM. Following the QPM presentation, we will hold a panel discussion with leading industry experts, chaired by Natan Epstein of the IMF, about the specifics of implementing an integrated approach in our core macro models. This is of great practical importance to us, as we have been working closely with the IMF team to improve our own modeling toolkit. I hope that today's event will be a source of new ideas and solutions for us all. Thank you for your attention, and I wish you productive discussions! . 4/4 BIS - Central bankers' speeches
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Speech by Mr David Klein, Governor of the Bank of Israel, to The Directors' Forum, The Association of Electronics and Information Industries, Tel Aviv, 29 April 2001
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David Klein: Israel’s policy of integration in the global economy: the difficulties Speech by Mr David Klein, Governor of the Bank of Israel, to The Directors’ Forum, The Association of Electronics and Information Industries, Tel Aviv, 29 April 2001. * 1. * * The economic strategy For the past decade the object of Israel’s macroeconomic policy has been to achieve economic integration within the global economy. The main aspects of this policy are well known: • Reducing tariffs and abolishing non-tariff barriers, so that goods and services can move freely; • Removing foreign-currency control, enabling the free flow of capital; • Introducing structural changes to render the economy more competitive and reduce the government’s share in it; • Adopting international standards of economic management, inter alia in the macroeconomic sphere, the most prominent among them being to adhere to the fiscal discipline required in order to reduce the government’s debt burden, and to attain price stability via an independent central bank. The logic underlying this policy is two-fold: • Contending with competition in world markets will require us to become more specialized and more efficient. Utilizing the resources available to us, this will result in a higher growth rate. • Abolishing foreign-currency control, introducing structural changes, and adopting international standards of economic management will enable us to build another stratum on this basis: improving the investment climate and attracting foreign capital to Israel. As a result, Israel will be able to finance investment not only by domestic saving but also by foreign saving, making an even faster growth rate possible. We are evidently referring to a policy that focuses on sustainable growth accompanied by an ongoing increase in productivity, and led by a rise in investments and exports; while the improvement of the standard of living is not the leading factor, but the result of that structure, alongside adherence to budgetary restraint and price stability. This policy differs substantially from that adopted in the first four decades of Israel’s existence, although it embodies elements-such as tariff-reduction-that have been on the agenda in the past. On the other hand, the change in Israel was made possible because of the significant shift towards globalization in the world at large. Nonetheless, the adoption of the new approach, in all its aspects, has not gone smoothly. Many interests and habits were based on the old framework, and although the number of advocates of the old view is dwindling they are still able to drag out the process of change unduly, as they did in the last decade. My aim here is to describe some of the difficulties that confronted us in the last decade in attempting to implement the new approach. 2. The difficulties in adapting the policy instruments a. The first difficulty: the exchange-rate regime This difficulty kept cropping up, for two reasons: • Foreign-currency liberalization cannot exist alongside a fixed exchange rate such as existed in Israel, between depreciations, for about 40 years. The combination of the free flow of capital and a government commitment to a given exchange rate is a prescription for speculation and financial crises. • On the other hand, Israel’s exchange rate, especially since the Economic Stabilization Program of 1985, served as a nominal anchor, i.e., the main instrument for stabilizing inflation at a low level was supposed to be a fixed exchange rate. This contradiction between the need to make the exchange-rate regime more flexible because of the liberalization and the need to fix it in order to stabilize inflation had to be resolved. It is worth noting here that in every transition process, whenever we encountered basic dilemmas that obliged us to decide which path to take, we always asked ourselves what other countries did in similar circumstances. In general, we aspired to re-invent as few wheels as possible, saving our creativity – such as it was – for other matters. Thus, using the experience of others, we adopted the following solution: • The exchange rate would be gradually made more flexible, parallel to the liberalization process. This began early in 1989, when the exchange rate band was first introduced, and continued when its determination was transferred to the market five years later, in 1994; • Its place as a nominal anchor would be taken by the short-term interest rate, to be determined by the Bank of Israel in view of the inflation target; this transition was also implemented gradually. • That shift turned out to be difficult for various elements: – Those, mainly in the business community, who had become accustomed to a policy of a fixed exchange rate (thus, for example, the transition from a horizontal to a crawling band at the end of 1991 was still being justified by the need to give economic agents engaged in international trade greater long-term certainty regarding the development of the exchange rate-a commitment that could not be met, as has been proved innumerable times in the history of exchange-rate bands). – Those in the policy-making community who still believed in the exchange rate as a nominal anchor: they continued to vigorously oppose each stage of the relaxation of exchange-rate controls. These elements continue to this day to resist the abolition of the exchange-rate band, even though their reasons have changed and it is perfectly clear that it will be impossible to defend it should the need arise. – Those who did not like the by-product of the change under which the Bank of Israel acquired greater independence in managing monetary policy: the tradition in Israel is that changes in the exchange rate can be made only with the agreement of the Ministry of Finance, while changes in the interest rate can be made solely on the basis of the Bank of Israel’s decision. The person who immediately grasped that aspect of the change-although that was not the reason it was introduced-was the Minister of Finance, Yitzhak Modai, when the shift was made from a horizontal to a crawling exchange-rate band, in December 1991. – One question still remains open: can the Bank of Israel’s intervention in the foreign-currency market serve, in certain circumstances, objectives that are also important for the central bank? This question can be placed on the agenda once the exchange-rate band has been abolished. In the last three years the Bank of Israel has refrained from intervening in the foreign-currency market in any way. As long as that policy continues, changes in the Bank of Israel’s foreign-exchange reserves can result primarily from the government’s foreign-currency cash flow, because only the government has direct access to the Bank of Israel for selling and buying foreign currency, and from profits made from investing the reserves. There are small changes from time to time because of shifts in the banks’ voluntary deposits with the Bank of Israel. The level of the reserves is not affected, as some still think, by private capital flows and interest-rate differentials. Only a few days ago an analyst explained in an interview why “Israel’s foreign-currency market is not a classic target for assault by foreign speculators.” One of the reasons for this, he claimed, was that “the foreign-currency reserves are very high” (Ma’ariv, 17.4.2001). Since we are not active in the market, there is no relevance in this context to the question of how large our foreign-currency reserves are. b. The second difficulty: managing monetary policy so as to attain price stability in a regime of inflation targets Israel’s economic integration within the global economy requires inter alia accepting the standard of price stability prevailing in the developed countries, obtained via an independent central bank. This transition also created several difficulties: • • At one time the slogan ‘inflation isn’t everything,’ meaning that other objectives such as growth and employment also need to be considered, was very popular. The debate was conducted between those who believed that expansionary monetary policy (i.e., reducing the interest rate) could stimulate employment and those who thought that the end-result would only be inflation which, if it persisted, would eventually increase unemployment. The discussion of this subject was concluded in the world, and the general consensus comes down to the following two points: – Monetary policy has to be geared first of all towards maintaining price stability; – To the extent that it does not contradict that primary aim, interest-rate policy can also be administered so as to aid the government in attaining other policy objectives. As long as we were endeavoring to reduce the inflation rate-until two years ago-the argument as to whether price stability was at all possible in Israel continued. It was claimed that it was not feasible because of structural reasons, defined as ‘nominal rigidities’ or a ‘monopolistic structure.’ In any case, a low inflation rate was said to be achievable in Israel only if it was ‘latent,’ in which case it would be bound to re-emerge at the first opportunity. For example, a low inflation rate would be possible only with a large balance-of-payments deficit and ‘cheap imports flooding the economy’-an unsustainable situation. Thus, according to this scenario, there would eventually be massive devaluation, followed by accelerated inflation. The inevitable conclusion was that it would be better not to try to eliminate inflation, as it would not last. We appear by now to have acquired sufficient experience to be able to see that this argument was baseless. On the basis of these considerations, until 2000 the government continued to display reluctance to set annual inflation targets (it deferred determining a target for as long as possible, leaving it to the end of the year, ignoring the logic regarding the lags with which monetary policy takes effect; from time to time it considered accepting the inevitability of rising inflation; it refused to set a long-term or final target). In August 2000 conditions were created in which the government decided to adopt a target of ‘price stability’ for 2003 and subsequently. This brought to an end a period in which it was necessary each year to take a stand with regard to the inflation target. The target from now on is to maintain price stability, defined as an annual inflation rate in the range of 1 percent to 3 percent. • In the Bank of Israel, too, the shift to managing a policy based on inflation targets created difficulties. In the first half of the 1990s we were still wavering between reducing unemployment and lowering the inflation rate; between defending the exchange rate so that it did not deviate far from the mid-point of the band and aiming for price stability. In 1994 the inflation rate was 14.5 percent, compared with a target of 8 percent-the most outstanding failure of monetary policy in the last decade-and in mid-1996 inflation expectations were still 14 percent. Altogether, 1995–96 was a period of impending crisis. Fiscal policy was at breaking-point because of growing deficits, and monetary policy was contending with a new problem: defending the lower limit of the exchange-rate band against the massive capital inflow of billions of dollars while persevering with the effort to attain the inflation target. Only in the last third of the 1990s did inflation start declining, albeit not continuously, towards price stability. The lack of focus in the first half of the decade obliged us to display greater decisiveness in conducting monetary policy in the second half, so that we could indeed advance towards the target. • The list of difficulties would be incomplete without mentioning the need to uproot all the habits and institutionalized arrangements acquired and established in the long years of inflation in order to enable us to live ‘in peace’ with it. Most prominent among them are the arrangements with regard to public-sector wages, the various kinds of indexation in the goods and services markets, and inflation-adjusted taxation and reporting regulations. The government needs to address all these issues in order to get rid of them once and for all. c. The third difficulty: managing fiscal policy in order to reduce government debt In this sphere, too, several problems have arisen: • First, there was a longstanding tradition in Israel and the world according to which the budget can serve as a counter-cyclical instrument, with a surplus during a period of prosperity and a deficit during a slump. Experience shows that it is easier to create a deficit in a slump than to maintain a surplus in a period of prosperity. The result is rising government debt, an increase in the share of debt-servicing costs in the budget, and a heavier tax burden. The conclusion throughout the developed world was that priority has to be given to reducing government debt to a reasonable level by limiting the budget deficit, and to easing the tax burden by cutting government expenditure as a share of GDP. This conclusion has not yet been accepted by everybody in Israel, even though the basic approach has been adopted by all governments in the last decade. • Second, the way the budget deficit was defined in Israel differed from that in the rest of the world, so that our measured deficit was significantly lower than it would have been had the generally-accepted definition been used. This misled many people, including prime ministers and members of the government, made it very difficult to compare the situation in Israel with the rest of the world, and also hampered efforts to explain the need to reduce the deficit. The advocates of our own special method of defining the deficit, which is still used, claimed that it is more correct and refused to change it. For years the Bank of Israel has avoided arguing about which definition is more correct, suggesting that both figures be presented to the government and the public, but so far without any success. The reduction of inflation has served to greatly narrow the gap between the two definitions, but has not eliminated it completely. Naturally, it is not difficult, statistically or otherwise, to measure and present the deficit in the same way as is done elsewhere, and it is time we did so. • Third, the need to adhere to fiscal discipline over the long run requires a change of approach in setting the order of priorities in allocating government resources. Whereas in the past it was possible to solve any problem, whether genuine or imaginary, by increasing expenditure and the government debt, the need to maintain the declining path of government expenditure-albeit not absolutely but as a share of GDP-raises new issues all over the world, for example: – Should the social services that the government provides be extended universally or depend on a means test? Should the government’s plans to reduce poverty make a distinction between people of working age and others? – Is there a place for private services alongside the public services in the spheres of education, health, and welfare? – Should the government be the sole agent involved in developing and operating the economic infrastructure, or is there room for the activity of private for-profit elements in part of it, in accordance with a framework determined by the government? In Israel, too, we have begun dealing with these and other questions, but we are still a long way away from their implementation as an integral, routine aspect of the long-term effort that features prominently-as it rightly should-in the government’s discussions of the budget. In the world in general considerable progress has been made on these subjects, extensive experience has been acquired by other governments, and we can and should benefit from it; there is no need to invent everything ourselves. 3. Coping with problems of adaptation A decade of administering a macroeconomic policy designed to open up the economy and reduce the government’s share in economic activity, against the backdrop of the changing geopolitical situation, has served to create closer economic integration between Israel and the rest of the world. There no longer seems to be anyone who disagrees with the view that this is the way to fulfill Israel’s potential for sustainable economic growth. An organic part of this approach is to adhere to accepted standards of economic management, including fiscal discipline, price stability, and an exchange rate that is determined by market forces. This framework obliges us to cope with several additional problems, some of them as yet unresolved, as we have just seen. Because of the extensive economic involvement of foreign elements in Israel that is a result of that policy, we are subject to constant review by foreign analysts, who rank our economic performance. In addition, many of Israel’s foreign liabilities and assets are traded on international stock markets, which also continually indicate their confidence in us. We are not isolated from the rest of the world, and we must grow accustomed to that idea in order to continue developing the economy, creating jobs, and raising the standard of living.
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Address by Mr David Klein, Governor of the Bank of Israel, to the Israel-America Chamber of Commerce, held in Tel-Aviv, 10 May 2001.
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David Klein: Three differences between Israel and the US in the 'quality of the environment’ in managing monetary policy Address by Mr David Klein, Governor of the Bank of Israel, to the Israel-America Chamber of Commerce, held in Tel-Aviv, 10 May 2001. * * * The background On 3 January, 2001, after the US Federal Reserve announced the first interest-rate cut of the year, the demand was made that the Bank of Israel follow suit. The demand was reiterated after the additional interest-rate reductions that followed. No such demand had been made in 1999 and 2000, when the Fed raised interest several times, so that it had to be assumed that the demand to follow suit was no more than an attempt to vary the list of reasons, which changes from time to time, behind the demand that is always on the agenda in Israel to reduce the interest rate, and the faster the better. Nevertheless, it may be instructive to consider the differences between Israel and the US in referring to the management of monetary policy. Understanding these differences can shed light on the question of whether it is reasonable to automatically imitate the Fed–naturally only when it reduces interest. The differences What, then, are the differences? 1. The culture of inflation Ever since the trauma that Americans experienced in the wake of the oil crisis of the 1970s, when the inflation rate reached an intolerable level of 13.5 percent in 1980, there has been no argument in the US regarding the need to keep inflation low. The US has no formal inflation target, and the law – which has not changed in this respect in the last 50 years – instructs the central bank to relate to growth and employment, too. Despite all this, throughout the 1980s the American central bank focused on getting the annual inflation rate down, to the 2-3 percent that has characterized the last eight years. The unemployment rate ranged from 5 to 7 percent all those years, and still the central bank did not relent. The message was: employment is generated not by accepting inflation but by making structural changes and raising productivity. Thus, ultimately, the unemployment rate declined to 4 percent, and the US economy showed that maintaining price stability does in fact go hand in hand with reducing unemployment. The upshot is that the US consumer is prepared to invest time in comparing prices and to travel quite a long way to buy the same product for less money. At any rate, the Cent is still legal tender, and the efforts to replace the one-dollar note with a coin have not succeeded. As you know, the Agora is no longer legal tender in Israel, though it still features in prices, and an interesting debate is currently being held about the rules of price-rounding when payment is in cash. Anyone who thinks that the rules of price-rounding are simple – after all, this was settled in the Bank of Israel Law – should study the proposed law on the subject that has already passed its first reading in the Knesset. In addition, the note with the smallest value is the NIS 20, and it is quite a long time since the NIS 10 note was replaced by a coin. Despite the differences in average income, the attitude of the Israeli consumer to money and prices seems to be somewhat less careful than that of his American counterpart, and he is also somewhat less confident that the low inflation rate will persist. It is hardly surprising. When actual inflation deviated upwards from the target people said that this constituted a proof that it was impossible to lower the inflation rate in Israel. When the deviation was downwards, they said that the Bank of Israel had failed – as if monetary policy was an exact science and the interest rate a laser beam. When the inflation rate diverged upwards from the target, people said that the target had to be raised, and that a little more inflation was preferable to a little more unemployment; and when it diverged downwards from the target people said that a commission of inquiry should be set up and, naturally, the Governor dismissed. The Chairman of the Federal Reserve in the US once defined 'price stability' as a situation in which no-one considers inflation as something that has to be taken into account in economic decisions. Apparently we have not yet reached the stage where we regard low inflation and price stability as natural. We still require proof, and that obliges Israel's central bank to be a little less indifferent than its US counterpart to threats to price stability. Thus, anyone who claims that the Fed thinks that there is substitutability between inflation and growth, and that it now tends to prefer growth to inflation, is mistaken. The Fed is reducing the interest rate aggressively because it is indeed convinced that it is needed in order to shorten the period of slowdown in the US economy, but this policy is undertaken on the assumption that it will not accelerate inflation. This assumption is based on both the rise in productivity that characterizes the era of information technology and the longstanding credibility that the Fed has acquired in its struggle to maintain price stability. In that, too, we are very different from them. 2. The dollar and the shekel The dollar, as you know, is a currency that many people in many countries are prepared to use as a means of payment and hold in order to maintain the value of their assets. The shekel, as you know, has not yet attained that status. It is true that because of the decline in the inflation rate we have stopped running after the dollar, but the habit of linking the prices of certain goods and services to the dollar has not yet disappeared. That provides the background for the fact that the balance-of-payments deficit has been part of the American scene for many years. In the last year, for example, it amounted to $ 400 billion – about 4.5 percent of GDP. Till now the Americans had no real difficulty financing their import surplus. The world was willing to take the difference in dollars, which were invested in various assets in the US. Foreign investment in US Treasury bonds alone is nearly a massive $ 1,300 billion. Our situation is, of course, very different. Although for us, too, a balance-of-payments deficit is a matter of routine, we cannot finance it with our currency. In other words, both we and the Americans need dollars in order to cover the import surplus. The difference is that they can print them. We need to borrow them or, as has happened in recent years, benefit from the foreign investment in Israel that has enabled us to maintain an import surplus without increasing our foreign debt, and even to accrue foreign-currency reserves and reduce our past foreign debt. Naturally, all this was possible because our balance-of-payments deficit shrank significantly. This was not the case in the mid-1990s, for example, when the deficit amounted to 6 percent of GDP – a rate that was taken as signalling an approaching crisis. The fears were so great that in deciding on its economic policy targets for 1997 the government placed the need to reduce the balance-of-payments deficit first, before growth, and certainly before reducing inflation (the inflation target set for 1997 was 7-10 percent). That balance-of-payments deficit had grown because fiscal and monetary policy was loose, there had been economic growth because of the rise in consumption and the standard of living, and that had brought both the balance-of-payments deficit and inflation in its wake. Only the policy shift saved us from certain disaster, teaching us once again the lesson that we have learned several times in the past: growth led by consumption cannot be sustainable in Israel. The Americans, on the other hand, are building on that alone to revive their economy. Both their monetary and their fiscal policy are expansionary – the former by rapid interest – rate reduction and the latter by tax reduction – in order to stimulate growth through an increase in private consumption. If as a result there is a rise in the balance-of-payments deficit, so be it. It is true that from time to time somebody stands up and says that things cannot go on like that, but so far it has worked. Maybe because the alternatives are less appealing. Another angle of the same situation is that US Secretaries of the Treasury advocate a strong dollar, while Israeli Ministers of Finance prefer a weak shekel. 3. The financial markets The third difference lies in the structure of the financial markets. It is widely known that the US has the most developed financial markets in the world. In the last few years the Nasdaq has attracted widespread publicity, but the main point is that the Americans have a developed system of non-bank financial intermediation, comprising inter alia a huge market for both Treasury and corporate bonds. There are also markets for the financial instruments that have developed in the last twenty years, primarily derivatives of various kinds on interest rates, exchange rates, and share prices. In addition, there is an institutional system outside commercial banking that includes investment banks, financing institutions, asset- and financial-management services, and brokers of various kinds, offering a variety of financial services. And what about us? • The stock market may be replete with companies registered for trading, representing a large number relative to the size of our economy, but with a small turnover and a concentrated ownership structure. All this is despite the fact that the management of the stock exchange has done all it could – and even more – to introduce trading and clearing systems that are among the most advanced in the world. • The market for government bonds is drying up a little more each year because of the proliferation of non-tradable earmarked government bonds, and if nothing is done it will gradually die. The market for tradable bonds will dwindle even more rapidly once the switch (commendable in and of itself) from a pay-as-you-go pension system to a pay-as-you earn one gains momentum, and especially once the proposal to introduce an obligatory pension scheme in the present institutional structure is accepted. • Israel's Treasury bill market is paralyzed by the folly of the ceiling on the amount that may be issued, so that while the market for Treasury bills is one of the most developed in western money markets, ours is unable to take off, and the spreads between the bank borrowing and lending rates are higher than they should be. • The market for commercial papers has barely reached lift-off. • The market for mortgages and the financing of other long-term investment has not managed even to get to the drawing-board. • The banks' control of the provident and mutual funds is as tight as ever, regardless of their performance. • And on top of all the above, serious distortions were created because of tax regulations that were introduced at a time when the government was involved in everything, and that really was a long time ago. Our ability to change these regulations seems to be further away now than ever. The reason why I am bringing all this up here is because monetary policy only begins when the central bank sets 'its' key interest rate. Shifts in this interest rate should have an impact via the changes it causes in the behavior of households and firms. One of the differences between us and the US is that the Americans are involved in the financial markets to a far greater extent – whether as borrowers or as investors – than Israelis. A rise in share prices, not to mention in bond prices, means a fall in the cost of capital, and vice versa. This of course affects both investment and consumption. The result is that the interest-rate changes that are initiated by the central bank have another channel of transmission in the US that does not in effect exist in Israel, namely, the channel of the financial markets. As you know, the interest rate is one of the factors influencing the financial markets-when these exist, of course. This additional channel intensifies the impact of interest-rate changes on the economy, and shorten the lags with which a given interest-rate change affects economic activity. In Israel, the Bank of Israel has had to conduct its interest-rate policy primarily vis-à-vis the banks, and even the little that can be done via the capital market cannot be achieved to the full because of the ceiling that limits Treasury bill issues. It is obvious that a policy conducted in such conditions is far less effective, and as an instrument the interest rate is more blunt. A concluding remark When at some future date you hear that someone has told the Bank of Israel to imitate the actions of the Fed – of course, only when it reduces the interest rate – I suggest you recall the saying: Israel is not America. It is no empty phrase, at least as regards interest-rate policy. A lot needs to be done here before we resemble America, and we are talking here also about improving the welfare of the consumer – whether individuals or businesses – and this is definitely up to us.
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Address by Mr David Klein, Governor of the Bank of Israel, to the Herzliya Interdisciplinary Center, Herzliya, 17 May 2001
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David Klein: The opening of the financial markets and the efficiency of Israel’s macroeconomic policy Address by Mr David Klein, Governor of the Bank of Israel, to the Herzliya Interdisciplinary Center, Herzliya, 17 May 2001. * * * The policy targets and the financial markets We have become accustomed to examining the reform of the financial markets, which we have been implementing at intervals for over a decade, from the consumer's point of view: more competitive markets mean better service, a higher return for savers, lower costs for borrowers, and narrower spreads for financial intermediaries. Those, however, are the direct benefits. There are also indirect ones, deriving from the fact that developed financial markets make for more efficient macroeconomic policy. It is these that I will address here. Fiscal policy The aim of fiscal policy is to reduce the burden of government debt from its current 95 percent of GDP to 60 percent of GDP. This is now overshadowed by the restriction embodied in the obligation to issue earmarked government bonds for the pension funds. Why is this a restriction? • Because the reduction of the debt burden is achieved by diminishing the budget deficit; only by doing that will it be possible to decrease borrowing by issuing bonds. Since the obligation to issue earmarked bonds does not depend on the deficit financing needs but only on accrual by the pension funds, which has risen every year, limiting borrowing through issues of government bonds can be done only by reducing issues of tradable bonds. • In the first half of the 1990s there was a trend change in the composition of long-term saving: the share of the pension funds increased relative to that of the provident funds. There are several reasons for that structural change, which has not yet been concluded. These include fewer fears regarding the stability of the pension funds as the old funds with their large actuarial deficits were closed and new ones, which were supposed to be actuarially balanced, were opened, starting in 1995. Another reason was the poor performance of the provident funds-which are not entitled to get earmarked bonds-in the transition to a low inflation rate and in view of the fluctuations in the stock market. This structural change in itself reduces the stock of tradable bonds and enlarges the amount of earmarked bonds. • Moreover, the accrual by the pension funds could rise even further in the future, exceeding its natural rate of increase, for the following reasons: • A change in the tax regulations which will reduce the benefits of saving in provident funds by self-employed persons (currently withdrawals are possible after 15 years, not only upon reaching retirement age, as is the case with wage-earners), and on the other hand, the fact that since 1995 the pension funds have been opened to self-employed persons. • The reduction of tax benefits for capital saving (a one-off withdrawal upon retirement instead of the right to a monthly pension) for employed persons, in provident funds and insurance schemes. • The transition from a pay-as-you-go to a pay-as-you-earn pension scheme. • The introduction of a Compulsory Pension Law. This problem embodies another one. As is generally known, earmarked bonds are indexed to the CPI. On the one hand, because of the low inflation rate and declining demand for indexed bonds, most borrowing by means of tradable bonds is through unindexed bonds. The result is that the pension funds have a monopoly on obtaining indexed liabilities from the government – an increasingly rare asset, yet nonetheless one whose price is not subject to market forces. On the other hand, the crisis which has affected other markets is being exacerbated, the most prominent instances being the banking system's market for mortgages and indexed loans for financing long-term investments. They do not have sufficient indexed sources because the accrual in savings schemes and provident funds has been negative for some time. Since the purpose of most gross borrowing by the government in a given year is not to finance the deficit but to recycle bonds that have reached maturity, in the future this recycling will be achieved not on a voluntary basis by issuing new, tradable bonds but by compulsory borrowing by means of earmarked bonds. Holders of tradable bonds that have reached maturity will find it difficult to recycle them by investing in a similar asset. The result will be that the nontradable bond component of government debt will grow, while that of tradable bonds will shrink. In any event, each year brings us nearer to the point where the government will no longer need to issue tradable bonds to finance the deficit, and then to the point where the government will have surplus funds since it cannot control the amount of earmarked bonds issued. Even beforehand there will be a time when things will be right for part of the year, because of the seasonal nature of the deficit during the year, and this will give rise to fluctuations in yields and an increase in the risk of holding government bonds. This process will also fetter the pension funds themselves, since they are required to invest 30 percent of their portfolio in the market, and part of this is naturally directed to government bonds. Some people are against sending the pension funds to the capital market because of the risk involved, but the prevailing earmarked bonds arrangement is the main reason for the existence of this risk. Thus, the earmarked bonds arrangement: • Constitutes a growing obstacle to the government's ability to finance the budget deficit in a rational manner; • Raises the cost of net borrowing to finance the deficit, and hence of debt-servicing, thereby reducing the government's ability to allocate resources to social and economic objectives; • May bring the government back to being a financial intermediary, because of surplus budget finance, and we have a wealth of experience of the negative implications of that; • Systematically destroy the market for tradable government bonds, the yields on which constitute a benchmark for determining the bank rate on long-term investments and loans; • Prevents the development of a market for both long- and short-term corporate bonds, which in every worthwhile stockmarket is based on the existence of a developed market for government bonds; • Hampers the chances of the stockmarket, which is based on the possibility of borrowing and trading in debt instruments as well as in equity; • And hence undermines the economy's ability to grow. There is no choice but to bring the chapter of earmarked bonds to a close. This arrangement not only damages the economy but also constitutes a very high barrier to the development and expansion of the funded pension savings route which, as is known, is itself far from being as widespread in Israel as it should be. Monetary policy In August 2000, for the first time in Israel's history, the government decided on a target of price stability for the economy. This target was defined as between 1 and 3 percent, and was supposed to come into effect in and after the year 2003. Three obstacles deriving from the structure of the financial markets currently obstruct the conduct of monetary policy. • One final stage remains to be implemented in the foreign-currency market. The process of the liberalization of foreign exchange proceeded along two parallel tracks: gradually reducing foreign-currency control and gradually making the exchange-rate regime more flexible. The restriction on investment abroad or in foreign currency in Israel by institutional investors (provident and pension funds, and life insurance schemes), which currently stands at 5 percent of their assets, is yet to be removed. There is no reason to delay this measure, which is required in order to finally make the the NIS fully convertible. Concurrently, it is possible to abolish the exchange-rate band. In any event, it will be impossible to defend it, should the need arise, and there is no point waiting and deluding people on that score, allowing them to make decisions on the basis of that erroneous assumption. These changes will not have a dramatic effect on the economy if they are introduced at a time when the foreign-currency market is not exceptionally volatile, and they will make monetary policy more efficient. This is because it will not be necessary to make monetary policy subservient to attaining targets in the exchange-rate sphere-as we had to do in the past-and which could conflict with price stability. Thus, capital flows will be less influenced by short-term, 'speculative' considerations, and will contribute to Israel's financial stability in the long term. Long experience, and logic, have taught us that speculation and shocks in the foreign-currency market are an inevitable by-product of exchange-rate regimes that are not subject to the discipline of the market. • Another obstacle exists in the form of the quantitative ceiling imposed on the issue of Treasury bills. This ceiling currently obliges us to administer most of our monetary policy visà-vis the banks. Interest-rate changes are introduced via shifts in the money supply, which are currently caused by changes in the extent of banks' deposits with the Bank of Israel. If we were to introduce these changes in the capital market by changing the quantity of Treasury bills we would expand the market markedly, strengthen the substitutes for the public's deposits with banks and bank credit, and contribute to reducing the spread between the borrowing and lending rates. The spread would narrow not only because of the higher borrowing rate but also because of the lower lending rate. A deep and liquid market for Treasury bills will make it easier to create a parallel market for commercial papers, which constitutes a substitute for borrowers for short-term bank credit. • A third obstacle is endemic in the absence of any financial intermediation outside the banks. The reference here is to financial services involved in raising short- and long-term capital, whether on a one-off basis or in the framework of investment funds; the management of asset and liabilities portfolios for individuals or firms, and intermediation in the capital marketall of them outside the banking system. In order to create significant nonbanking intermediation it is necessary to return to the problem of the current concentration of the financial services, and introduce the measures we have mentioned on various occasions for dispersing the foci of financial power in Israel's economy. Because of the process of globalization that Israel is currently undergoing, this involves building cooperation with international financial institutions rather than reducing the existing size of commercial banks. Why would this make monetary policy more efficient? Because the aim of monetary policy is to influence the public's economic decisions. The existence of developed nonbank financial intermediation enables the interest rate to have a direct effect, not only via the banks, on the behavior of savers and borrowers. A better balance between banking and nonbanking intermediation also improves management by the business sector, because the public, which provides firms with capital sources via the capital market, has long-term considerations, while the banks, which provide firms with loans, have short-term ones. The combined outcome is that monetary policy is provided with another channel of influence, which could produce more rapid results than in a situation where it operates solely via the banking channel. This promotes lower fluctuations in the interest rate and greater stability in the financial markets. This stability is one of the major preconditions for sustainable economic growth. Conclusion Opening the financial markets is necessary for the benefit of both the individual and the business sector, not only because of the advantages ensuing from a more competitive market. This policy also enables more efficient use to be made of policy instruments, and everyone benefits from that. Note in this context that the process of the structural change of the financial markets, only part of which has been mentioned here, has come to an almost complete halt. The reasons for this should be examined, the necessary conclusions drawn, and steps taken to return to the implementation of the changes required for a modern country that wishes to integrate in the global economy.
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bank of israel
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Remarks by Mr David Klein, Governor of the Bank of Israel, at the Ninth Annual Economic Conference, Caesaria, 21 June 2001.
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David Klein: From price stability to financial stability: the situation in Israel Remarks by Mr David Klein, Governor of the Bank of Israel, at the Ninth Annual Economic Conference, Caesaria, 21 June 2001. * * * En route to price stability After a fairly protracted process, we are beginning to grow accustomed to the concept of price stability. · At the outset there were heated discussions on whether it was at all possible to achieve price stability in Israel. · When we asked ourselves what were our objectives regarding inflation, we answered, following the Economic Stabilization Program of 1985: “we will make every effort to lower it.” · Towards the end of 1991 we set out on the path of annual inflation targets without knowing where it led or what obligations it entailed. · Every year we came back to the questions of what was the appropriate target for the following year, when should it be decided upon, and whether we could allow ourselves to look further ahead than the next year. · We debated whether inflation was the be-all and end-all, and whether it was possible to buy more growth at the price of higher inflation. · We discussed whether inflation in Israel should be the same as that in the OECD, with or without Turkey. · More than once we were uncertain whether it was right to adjust the inflation target upwards. · We saw almost the whole world, advanced and emerging economies, gradually adopt the norm of price stability as a trait of properly run countries wishing to integrate into the global economy. · On 16 August 2000 the government made the decision: a regime of price stability suits us too. · As is our wont, we chose a roundabout route to price stability: before we finally come down to earth in 2003, the decision said, let’s first fly a little higher in 2001–02, perhaps for old time’s sake. It is not very clear why we first had to raise inflation before it could come down, maybe it was a yearning for the old, pointless arguments about how we may be able to create a few more jobs by juggling with inflation. Price stability does not arrive like manna from heaven, and we must remember that several obstacles still obstruct the path to achieving it, and these have to be removed. Some derive from the arrangements which were intended to make living with inflation more comfortable – these now make it more difficult to beat inflation. Some of them arose out of attitudes widely ascribed to in the past regarding the effect of the rate of interest on real activity. One obstacle which has attained prominence recently is based on the almost mystic belief that the rate of interest has the power to offset far-reaching real effects – for example the effects on high-tech and related industries of the slowdown in the US, and the effect on tourism, construction, and agriculture of the security-related events – without our having to pay the price of a rise in the balance of payments deficit and accelerated inflation. Above all we must bear in mind that price stability is a system based on habit, and it takes time to acquire new habits. What is financial stability? As awareness of the importance of price stability increased in recent years, so did worldwide recognition of the fact that a country aiming for sustainable growth must attain financial stability too. Financial crises have been a standard feature of advanced and emerging economies in the last two decades, Israel among them. Such crises are characterized by wide fluctuations in prices of assets (real estate and shares) and in the exchange rate, and by bankruptcies, or severe hardship, of financial institutions. A list of the most prominent examples of such crises in Israel in the last twenty years includes: · Persistent government difficulties in selling bonds at the beginning of the 1980s against the background of a two-digit deficit in terms of GDP, and three-digit inflation; · The bank shares crisis of 1983; · The unrestrained acceleration of real estate prices which accompanied the large-scale immigration of the 1990s; · The bursting of the stock-exchange bubble in 1994; · The imposition of limitations on the old pension funds in 1995 as part of a recovery program, in the light of their huge actuarial deficits; · The provident-fund crisis in summer 1996. Several smaller crises also occurred en route, such as: · The banks’ “special offer” of loans for the purchase of mutual funds in 1993; · The large devaluation in October 1998, and the growing awareness of the significance of exchange-rate risk, which had hitherto been considered a problem for the Bank of Israel to tackle. This referred to the threat to banks’ stability not as a result of their own exposure, but of their customers’ unrestrained exposure. · The lack of resources in the mortgage market which added to the problems facing the real estate industry in trying to adjust in the period following the influx of immigrants. The threats to financial stability in Israel Financial crises occur for two main reasons: The first is mismanagement of financial institutions. Dealing with this falls within the province of supervision, and I will not here go into the question of supervision of the financial markets, except to say that a mechanism for proper coordination between the various supervisory authorities in Israel’s economy is sorely needed, and it is a pity that it has not yet been activated. The second is artificial restrictions that were imposed by the authorities at some time or other on the mechanism of the market. The removal of such restrictions is essential if financial crises are to be avoided. The major ones are: 1. Earmarked bonds The arrangement regarding bonds earmarked for the pension funds provides the clearest example of such restrictions on the market mechanism. This arrangement systematically destroys the market for tradable government bonds, the existence of which is one of the preconditions for a market for private bonds, providing the banking system with a basis for pricing for the system of medium- and long-term deposits and credit. This phenomenon of earmarked bonds will spread even more quickly · if the required tax reform assigning the tax benefits on pension savings mainly to savings for retirement is introduced; · if the budget constraint on tax relief requires a distinction to be made between savings which entitle the member to a pension and lump sum savings for retirement; · if the move from unfunded to funded pensions follows the planned path; · and if a Compulsory Pension Law is passed incorporating the rules which apply currently to the pension funds. The best way out of the earmarked bonds arrangement is similar to the method used in the life insurance field in the transition from guaranteed yield life insurance schemes to profit-sharing schemes. That is: · not to change the rules in the existing new pension funds, but to close them to new members; · to ensure that pension funds established from now on are based only on the market. If the government can support pension savings and wishes to do so beyond granting tax benefits, it would better do so directly vis-à-vis pensioners, and on a means tested basis. 2. The crawling exchange-rate band The band is intended to contain, currently within fairly wide limits, possible fluctuations of the rate of exchange. It is well known that the conditions which brought about the creation of the band disappeared long ago: · Initially the band served as an advanced version of the exchange rate, as a nominal anchor for inflation. The exchange rate has not had this role to play for many years; · Then, with the transition to an upward-sloping band, the slope of the band was defined as reflecting differences between inflation in Israel and that in other countries; these too have disappeared; · Next, in the wake of the development of high-tech industry, capital import for investment began on a large scale. This capital inflow is not connected with differences in interest rates or in inflation between Israel and other countries, so that it is illogical to limit exchange-rate fluctuations because of it; · While these changes were taking place, and as we agreed in 1994 to allow the market to determine the rate of exchange, a domestic foreign-exchange market developed. It involved domestic banks and foreign financial institutions. Daily turnover is growing, and the market has low volatility. The fact that the Bank of Israel avoids market intervention, and the experience of external financial shocks have led to a better awareness among the public of exchange-rate risk. This had a dual effect: a. Speculative activity is a rarity in the market. b. When assets and liabilities portfolios are being put together, interest-rate differentials between Israel and abroad, which have existed for a long time and still exist are outweighed by exchange-rate risk. Consequently, it is difficult to discern a change in the composition of assets and liabilities portfolios in response to changes in interestrate differentials around their current level, so that this component of capital flows has hardly affected the rate of exchange. In other words, interest-rate differentials do not explain why the actual rate of exchange is close to the bottom limit of the band. The main reasons for the closeness lie in the inflow of long-term capital coupled with the upward slope of the limit of the band. For the sake of accuracy we should add the recent weakness of the euro against the dollar. On the other hand, protecting the lower limit of the band will cause financial complications: · The purchase of foreign currency to lead towards a new equilibrium must be undertaken while prices are falling. The current positive slope, even if it falls to zero, does not allow this to happen, so that it is a non-stabilizing factor. · The obligation to purchase foreign currency means that the initiative in implementing monetary policy is transferred to the importers of capital, although they have no intention of participating in such management. They import capital according to their own needs, and not to inject into the economy in an ordered manner the liquidity it requires. It is clear that under such conditions monetary control may be affected. · The instruments of absorption available to the Bank of Israel to neutralize the injection deriving from the purchase of foreign currency are in the form of the banks’ deposits in the Bank. The banks already deposit about a fifth of their unindexed sources in the Bank of Israel as a result of the problematic defense of the lower limit of the band in the years 1995– 97. A recurrence of such an episode would increase the banks’ dependence on the Bank of Israel, a complete contradiction of the successful policy of deregulation pursued in the first half of the 1990s. Such increased dependence may raise questions concerning the banks’ stability. · Under such circumstances the Bank of Israel would again have to choose how to deal with the losses inherent in such an activity. It could transfer them to the banks by paying them a similar rate of interest on their NIS deposits in the Bank of Israel to the rate it receives on its foreign-currency investments. The banks would of course pass this on to their customers by cutting the interest they pay their depositors and raising the interest they charge borrowers. And then there would be complaints about the high banking spread. Alternatively, the Bank of Israel could record the losses in its books, as it did on the previous occasion. In the final analysis this cost is of course borne by the taxpayer, and I believe that the last thing the government wants to do is to raise the tax burden in such a roundabout way. We should bear in mind that we cannot evaluate in advance the importance of such a course of action. We know that on the last occasion, the Bank of Israel purchased $ 16.5 billion. An increase of only $ 1 billion in the money supply would currently mean a rise of about 4 percent, whereas an annual increase of 10 percent is considered too fast. The simplest solution is to abolish the exchange-rate band. If the Bank of Israel has to defend it, the end result would be its abolition in any case, but after incurring a high and unnecessary price. It is preferable to take such a step on our own initiative, and not under pressure from the market. 3. The ceiling on Treasury bills issues By law Treasury bills are an instrument for carrying out monetary policy, but we cannot fully use them for this purpose because the creator of the tool also limited its quantity. In other words: Yes, you have an inflation target. You want tools for the job? Improvise! The outcome is that instead of implementing monetary policy via the capital market, we do so via the banks, a more expensive and less efficient method. Why must we act in this tortuous way? To find the answer to this question we may have to go back to the traditional work methods of the pre-State era. If the story were to end with the improvisations of the Bank of Israel, so be it. The rate of interest would be, all in all, a little higher than it could have been. But this absurd limitation causes consumers and the economy real harm. In any normal country the Treasury bill market provides the basis for the government bond market. As such it also provides the infrastructure for nonbank financial intermediation. In Israel, it strengthens the banks’ monopolistic hold over the money market. The implications are unequivocal: · The banking spread in the unindexed sector is higher than required, to the disadvantage of depositors and borrowers; · It is another obstacle to the development of the market for tradable securities, short-term commercial paper, as an alternative to bank credit; · It harms the economy’s ability to withstand financial crises, as the economy is totally dependent on the banks for financial intermediation. The Treasury bill ceiling causes persistent damage, and it should be abolished. It increases the cost of monetary policy, and causes harm to consumers and the economy as it acts as a millstone around its neck and prevents the development of a nonbank money market. Can the horizon of monetary policy be broadened? Price stability is measured by changes in the CPI. The question is whether there is a connection between the stability in the stock market and foreign currency market on the one hand, and price stability on the other. It should be emphasized that the question is not whether the central bank should also have objectives in the securities market (for example, to prevent sharp falls in the stock market) and in the foreign currency market (for example, to navigate the exchange rate along a particular route). It should not! As long as the arrangement of earmarked bonds, the exchange-rate band, and the Treasury bill ceiling exist, the central bank must steer clear from any intervention in the financial markets, both in its actions, and in its statements. A similar conclusion applies, and to a similar extent, if fiscal discipline is not maintained, and if the performance of the budget does not lead to a lowering of the government debt/GDP ratio towards the level accepted as the norm worldwide. When these limitations no longer apply, we will have to reexamine the normal horizon of monetary policy. When there are no restrictions limiting the central bank’s choice of policy instruments, and when the culture of price stability has taken root, the Bank of Israel will be able to include reference to the financial markets among its functions, with the aim of contributing to their stability.
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bank of israel
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Speech by Dr David Klein, Governor of the Bank of Israel, to The Financial Forum, Tel-Aviv, 11 July 2001.
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David Klein: The framework of Israel's economic policy for 2002 Speech by Dr David Klein, Governor of the Bank of Israel, to The Financial Forum, Tel-Aviv, 11 July 2001. * * * Every year, in the framework of the budget discussions, the government passes two resolutions regarding macroeconomic policy for the coming year. If we take last year as an example, on 16th August 2000 the government reached a decision (no. 2182) about “Economic policy for 2001budgetary aggregates-fiscal policy.” This decision, with no preamble, determined: 1. The extent of the budget deficit for 2001 in absolute terms (NIS 8.2 billion) and as a share of GDP (1.75 percent); 2. The extent of government expenditure (NIS 194.2 billion); 3. The extent of the budget deficit for 2003 (1.25 percent of GDP). The next decision (no. 2183), on the same date, refers to “Economic policy for 2001-monetary policy.” The approach to monetary policy differs from that to fiscal policy in two respects: First, the decision regarding monetary policy has a preamble specifying the “objectives of economic policy for 2001,” and mentioning three of them: · Maximizing the economy’s ability to grow on a sustainable basis; · Increasing business-sector employment; · The inflation targets for 2001, 2002, and 2003, with the one for 2003 (1-3 percent) being defined as ‘price stability,’ There is no interest-rate target because there are other factors that also affect inflation. Hence, no specific interest rate is invariably consistent with the inflation target, and it must therefore change as the circumstances require. It is somewhat odd to regard monetary policy alone as having a role to play in determining growth, employment and price stability targets, keeping fiscal policy detached from them. In the past we proposed that the goals of macroeconomic policy should be presented as relevant also for fiscal policy, and should feature in the preamble to both decisions. Second, the two decisions-on fiscal and monetary policy-differ in another respect: the monetary policy decision states that the Bank of Israel must submit reports on the performance of monetary policy to the government and the public, inter alia explaining deviations from the inflation target and their policy implications. The Bank of Israel does this in the framework of its semi-annual Inflation Report. The absence of a parallel reporting requirement with regard to fiscal policy is noteworthy. As a result, for example, this year there is some vagueness regarding the expected deviation from the budget deficit target, and estimates of the actual deficit currently range from 2.5 to 3.5 percent of GDP. This vagueness is accentuated by additional factors: · An interpretation that has been submitted to the State Controller by the Ministry of Finance is that the budget deficit target is binding only at the planning stage. Does this mean that there is no practical significance to the question of how the budget is implemented relative to the target? · It is not clear what the implications are of the departure expected this year for the path of the deficit target in coming years, and for the medium-term real interest rate; · Has there been a change-and if so, who made the decision-in the definition of the rules by which the deficit should be managed, so that what is binding is only that part of the government’s decision that relates to its expenditure ceiling but not to the budget deficit? The justification for ignoring the income side appears to be based on the assumption that changes in actual relative to planned revenues always derive solely from the gap between predicted and actual growth-an assumption that is unfounded also with respect to 2001. · The experience of 2001, when the inflation reserve may be utilized in order to increase expenditure in real terms, illustrates the need to review the necessity of including an inflation reserve in the expenditure budget. If this tradition persists, it should be given a place of its own in the government’s decision noting the assumption of inflation and its implications for tax receipts too. This last estimate is required this year, for example, in order to answer the question of what role is played by the deceleration of inflation, relative to the rate assumed in the budget, in explaining the underperformance of tax receipts. This factor, rather than slower growth, may explain most of the shortfall. Thus, it is necessary to update the formulation of the fiscal policy decision, not only because of the change in the data but also in order to strengthen the discipline of fiscal policy as well as its transparency. These remarks refer to the accepted format of the macroeconomic framework that was in place till now, and that may be submitted to the government once again when the budget for 2002 is discussed. It appears to us that the perspective should be expanded in several directions. As far as fiscal policy is concerned, the routine decision regarding the deficit and expenditure for 2002 may take the following directions: · The definition of the budget deficit should also be presented according to the definition used in the rest of the world, making it possible during the discussion to present data that are comparable with those available elsewhere. After the changes that have been made to date, there is only one outstanding difference in the definition: in the rest of the world it is customary to include all the government’s interest rate costs on the expenditure side, while we include only real interest. This definition, which is unique to Israel and serves to make our budget deficit smaller, has misled many people in the past, and sent out a reassuring message about the size of our budget deficit. Furthermore, even when the deficit is presented in accordance with our definition, over time it must be given in consistent terms, and preferably in accordance with the most recent definition. Thus, for example, the reduction of the deficit from 1999 to 2000 was not from 2.5 percent of GDP to 0.5 percent of GDP, but from 3.5 percent-a rate which is equivalent to the definition according to which the budget is calculated at 0.5 percent for 2000. · What is needed is a blueprint for the deficit and government expenditure for the next ten years. The purpose of this would be to make it possible to fix the national debt at 60 percent of GDP, and reduce the consequent debt servicing burden. The government’s long-term plan for reducing the tax burden would also derive from this draft. The discussion of the national debt and its developoment, as well as of its repercussions on the tax burden, on the one hand, and the need to release significant budget sources for servicing the past deficit rather than solving the problems of the future, on the other, would shed additional light on the proposals to further increase the deficit for these and other purposes. · It is important to deal with the matter of private members’ bills since they generally increase government expenditure or reduce its revenues. The attempt to make the discussion of these bills contingent on alternative financing has failed miserably. These proposals upset the conduct of fiscal policy and arbitrarily alter the priorities set by the government and ratified by the Knesset. Dealing with this issue does not mean dismissing, or even restricting, the possibility of tabling private members’ bills. It must, however, evaluate these proposals in the context of national priorities as a precondition for approving them. A proposal of this kind was submitted by the Bank of Israel (as a draft bill), in effect determining that a private member’s bill should take effect only after being reviewed in the framework of the budget debate. Before continuing, I would like to note that we are referring here to the outer wrapping of fiscal policythat which serves as the focus of the government’s decision when the budget is being discussed. We have not spoken about content-priorities in expenditure, the government’s social policy, and the composition of tax receipts-and its contribution to the process of economic growth. These topics have not been discussed in the framework of the government’s budget discussions in the past, even though they should have been. With regard to monetary policy, since the government has decided on convergence towards price stability from 2003 on, the emphasis must be shifted from a discussion of the inflation target to an analysis of the conditions for creating an environment of financial stability. Financial stability is disturbed when the equilibrium of one or more of the asset markets-securities, foreign currency, or real estate-is upset, as expressed in price volatility in that market. Concurrently, there is distress, and possibly even bankruptcies, among financial institutions. This scenario, which is known to us from many countries, is the outcome of two basic causes: · The unchecked behavior of agents active in these markets and those who finance them. The best-known examples of this in Israel were the bank shares crisis of 1983, credit for buying mutual funds at the height of the bull stock-market in 1993, the provident funds ‘crisis’ in 1996, the stampede to replace local-currency credit with foreign-currency credit in 1994-97, and the unchecked expansion of the real-estate industry in the wake of the influx of immigrants in the early 1990s. · Another constant source of financial instability was created by the regulations introduced by the government. These may have been all well and good in their time, but eventually turned out to stand in contradiction to the logic of the market. When there is neither the strength nor the sense to abrogate them in time, or when for reasons that are not relevant they are stubbornly left in place-and regrettably both these reasons apply in our case-they constitute a destructive force causing a financial crisis. In instances like these a large segment of the population may suffer serious damage, which could have been avoided or at least limited had timely action been taken. Permit me to cite just the main issues which should be decided by the government in the framework of the debate on financial stability: 1. Closing existing pension funds to new members and opening purely market-based funds: only in the wake of this decision will it be possible to proceed with the discussion of the proposal to make membership of a market-based pension plan compulsory for all employees. The pension funds which are to be closed-and this refers to those of them that were opened since 1995-will be eligible for earmarked bonds in their current format until their task is completed. The purpose of this decision is to keep the tradable bonds market from continuing to dry up, together with the savings and credit channels based on it, including the provident funds and the mortgage market. 2. Concluding the process of making the NIS a convertible currency by abolishing the last vestige of foreign-currency control: this refers to the restriction preventing the provident funds, insurance companies, and pension funds from investing more than 5 percent of their asset portfolios abroad or in foreign currency. This restriction lost its logic long ago, and its existence harms the stability of the market and the robustness of long-term saving in Israel. This is the last stage on the road to full convertibility of the NIS. 3. Abolishing the exchange-rate band: its continued existence is in complete contradiction to the liberalization of foreign currency and long-term capital flows which were-and continue to be-the fuel of the engine of Israel’s growth, the high-tech industry. The continued existence of the exchange-rate band imperils Israel’s financial stability. Three assessments prevail in this connection: · The first assessment is that “There is an area where change can be speedily expressed on the ground … The price of money…is determined solely by the Bank of Israel. The instruments it controls affect another important variable: the exchange rate” (opinion in Ha’aretz, 8.6.2001). The automatic reiteration of the view that the interest rate by itself affects the exchange rate does not make it true. Note, for example, that between the end of 1998 and June 2001 the Bank of Israel reduced its key interest rate by some 7 percentage points, and the spread between the interest rates on the NIS and the dollar narrowed by some 6 percentage points-large changes by any criterion-without this having any real effect on the exchange rate. In order for a reduction in interest to affect the exchange rate the public must feel that we have abandoned the target of price stability and that the circumstances have been created that prevent us from restoring it in the foreseeable future. That, as you know, has not been the case in the last two and a half years. If a situation is created in which the public is given to understand that steps have been taken to prevent us from being able to maintain price stability, even at the present interest rate there will be a shift in capital flows that will cause more rapid local-currency depreciation. However, a change of this kind in the exchange rate will not bring the benefits those who have been clamoring for it for years expect – a reduction in the interest rate in order to create devaluation – because stimulating economic activity by encouraging exports requires real depreciation, i.e., nominal depreciation without an increase in prices. · The second assessment is that “Currently, the Bank of Israel is reducing the interest rate because the exchange-rate band exists” (interview in Yedioth Aharonoth, 6.7.2001). In other words, the reason why the Bank of Israel reduces the interest rate is to keep the exchange rate away from the lower limit of the band. This view could have a foundation if the reduction of the interest rate did in fact generate devaluation. As you know, this has not been the case in the last two and a half years, when there was a continuous downward trend in the interest rate. Consequently, this consideration was never relevant for interest-rate decisions. The fact that the interest rate was reduced, and the extent to which this was done, was determined solely on the basis of inflation expectations and the consideration of matters pertaining to financial stability. If, because of the existence of the exchange-rate band, on the other hand, inflation could accelerate-a reasonable outcome in certain circumstances-the band would oblige us to change the interest-rate policy. There is absolutely no doubt that without the band Israel’s interest rate could be lower than with it. 4. Abolishing the ceiling on Treasury bill issues: this limit, like the lower limit of the exchange-rate band, is intended – as various government representatives repeated at the recent Caesarea conference – to restrain monetary policy. The story sounds somewhat Kafkaesque: on the one hand, you set a target, while on the other you impose limits in order to make it more difficult to attain. The quantitative restriction on Treasury bill issues does indeed hamper monetary policy, as it obliges us as policymakers to influence the market via the banks. As a method, this is very expensive and not very efficient. Its practical significance is that the economy has to function with a higher interest rate in order to maintain price stability, so that the country pays unnecessarily for this restriction. No less important, however, is the effect of the Treasury bill ceiling in checking the development of the money market as a substitute for banking intermediation. The absence of a deep Treasury bill market is one of the reasons for the spread in the unindexed localcurrency segment and for the absence of a market for short-term corporate bonds based on Treasury bill prices. The upshot is that anyone depositing money in a bank receives lower interest, while borrowers pay higher interest. This does further-and quite superfluous-harm to the capital market and the economy. 5. Annulling tax distortions on individuals’ financial income received directly and via institutional investors: because of the attempts to connect these changes with a ‘large’ tax reform that also addresses taxation on work income, this subject has also come to a halt. What we are talking about here is equalizing tax rates and making taxation dependent as far as possible on nominal income, and these changes should be neutral as far as government revenues are concerned. There are intolerable gaps in Israel today between taxation on income from different financial instruments, as well as between taxation on investment in Israel and abroad. These distortions must be removed in order to bolster financial stability and make the financial markets more competitive. In some cases it is necessary to increase the tax rate, and in others to reduce it, and the combined results need not necessarily affect government revenues. 6. Establishing a joint body to coordinate the various authorities supervising the financial markets: obscuring the limits between the various spheres of activity of Israel’s financial institutions, as well as Israel’s integration within the global economy – including the involvement of foreign financial institutions in the domestic market – require greater coordination and exchange of information between the supervisory bodies in order to make the system more efficient. Several financial crises have developed due to the exploitation of the boundaries between the various supervisory bodies. In the last decade Israel’s governments have adopted the norms of macroeconomic management that have become accepted throughout the world. These include: · Fiscal discipline, thereby keeping the national debt and debt-servicing costs at a reasonable level; · Price stability; · This framework must be completed by committing ourselves to a competitive financial system and financial stability. Empirical studies indicate that there is a positive relation between sustainable growth and developed financial systems. Not only are these norms not superfluous in an economy that wishes to maximize its growth potential and reduce unemployment, they are essential. We had better not delude ourselves that we can attain sustainable growth and create more jobs suitable for a modern economy if we give in just a little as regards the budget deficit, and perhaps conceal this by changing definitions; if we accept a rise in inflation, at first by talking about it, then by hiking up the target, and finally in actual terms; if we dismiss the changes required to ensure financial stability, and in order to make it quite clear where we are headed we also constrain the Bank of Israel. If we choose to retreat from accepted macroeconomic practice in the world, we will find that the world can manage perfectly well without us and, what is worse, that Israeli companies and individuals prefer to secure their economic future outside Israel’s borders. This should be particularly worrying to those who are sensitive to the country’s social problems and who are forever demanding more resources. Even the Jewish genius cannot produce something from nothing. When the government meets next to determine the framework of economic policy for 2002 it would be well advised to think about this.
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Speech by Mr David Klein, Governor of the Bank of Israel, for the Euro Conference, Tel Aviv, 4 September 2001.
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David Klein: Israel’s macro economic policy and the European standards Speech by Mr David Klein, Governor of the Bank of Israel, for the Euro Conference, Tel Aviv, 4 September 2001. * * * Israel is an open economy, more than many other countries in the world. A few indicators tell the story: - The share of exports plus imports, relatively to GDP, is almost 100%; - The stock of Israeli assets, shares and loans, private and public, held by foreigners, amounts to US $130 billion - more than our GDP; - The stock of foreign assets, shares and loans, held by Israel’s residents, amounts to some US $65 billion. - Exchange controls have been almost fully removed and the exchange rate is freely determined in a growing interbank foreign currency market; - Israel is party to bilateral and multilateral international agreements, with the US, the IMF, the EU, and the WTO, committing the economy to open trade in goods and services and open capital account. This background is, of course, not accidental. Economic thinking in Israel was very much influenced, in the last decades, by the agenda of the more developed industrial economies. Early on we realized that free trade agreements and low custom duties, although painful in the short-run, are a necessary condition for sustainable growth of a small economy like that of Israel. This state of affairs is taken to-day as given and nobody contemplates seriously protecting Israeli industry from foreign competition by tariff and non-tariff barriers, as we used to do in the past. *** Nevertheless, there is still a bridge that we have not completely crossed. We already understand that to get integrated with the world economy we have to follow some rules. Paramount among them are Maastricht-like criteria relating to fiscal discipline, public debt and price stability. However, since we are not a member of the EU, and not even one of the accession countries that wait to join in, there is no external pressure to abide by these rules. Hence, we have to do it on our own, which turns out to be a rough process. The major hurdle to-day is fiscal discipline. The essence of this rule, as is well known, is to limit the general government deficit in order to reach a reasonable level of public debt ratio to GDP. The public debt ratio of Israel is still high, above 90%, although it was a lot higher before we embarked on this road. This means that we cannot pause, and certainly not change direction, in our attempt to maintain a low deficit. Raising the deficit is not an option, especially because our public spending level is already one of the highest, if not the highest, in the world. Our estimate is that in the current year, 2001, our ratio of public spending to GDP amounts to 54%, compared to an average of 42% in 20 of the OECD countries, where all of the individual countries ratio are lower than ours. So what can the government do, given the current slowdown, to help the economy get out of the recession? The only viable option is to change the composition of spending so that growth-enhancing expenditures will get priority. Government investment in infrastructure, for example, ought to get precedence over government programs to support those who are not working. This does not mean that these programs should be scrapped altogether. But it does mean that they should be refocused. The question should not be how the state can help those who are not working to maintain a modest standard of living, but rather how the state can help them join the labor force. Another example, often quoted, relates to the efficiency of our public education programs. International comparisons indicate that, in some instances, we get less for our money, compared with other countries. Furthermore, we still grapple with the question whether, and to what extent, there is room for private sharing of educational expenses - not necessarily to save public money but, for example, to focus more on education in development towns. These are only some aspects of fiscal discipline or, as it is sometimes called, fiscal consolidation. They serve to illustrate why it seems, sometimes, easier to bypass the need to be more efficient, and just increase overall government spending and the deficit. *** A good reason to resist the temptation to give up fiscal discipline is its implications for financial markets: - The first, and most immediate, effect of increased deficit is an increase in the interest rate on government instruments to finance the deficit. This has already started to take place in the last few months. The outcome holds not only for the increase in public debt, but also for that part of the debt that needs recycling every year. Interest payments take already some 15% of the government current resources, and are larger than the education budget and very much larger than government investments. - The increased interest on government instruments reverberates to private ones. This is the second effect. We know that the yield on government bonds serves as a benchmark for pricing long-term loans, like mortgages. The increased deficit level in the current year casts already some doubts about the future trend of the cost of mortgages. Another example has to do with the government initiative to commission private entrepreneurs to invest in infrastructure (the so-called P.F.I.). These will need capital resources, or long-term loans, and they will be priced based on the yield on government securities. Hence, increased budget deficit will increase the cost of capital also for privately financed long-term investments. - The third effect is on inflation and/or on the balance of payments. It takes more time to materialize, but it is a certain outcome. We went through such a period in the middle of the last decade where, following an expansionary fiscal policy in the first half of the decade, supported by an expansionary monetary policy, we got a large and non-sustainable deficit in the balance of payments and increasing inflation. To avert crisis, we had to back off and the economy slowed down. This is why it is so important that the government added to its decision, to increase the deficit in 2002, a commitment to lower it in the three consecutive years. The only question now is whether the markets will believe. - If the credibility of the government is in doubt, we will get the fourth effect of a higher government deficit, this time in the foreign currency market. We often note the relative stability of this market, despite the decline of long-term capital inflows and the regional tension. But we should not overlook the factors that hold the balance in this market: - On the one hand we have foreign investors who started, in recent months, to buy foreign currency on a relatively large scale, apparently to hedge their exposure to the shekel, due to their long-term investments in Israel. The timing may reflect a concern lest the stability of the currency will be impaired due to the rising military tension. - This added demand for foreign currency is met by supply of Israelis, mainly from the business sector. They sell foreign currency, in the spot and future markets, that they get either from their export receipts, or from foreign currency loans, or from drawing on their foreign currency deposits in Israel or abroad. It seems clear that Israelis who sell foreign currency have more faith in the stability of the shekel than their foreign counterparts. This is what keeps the market in a relative balance. Here is where the credibility of the government enters: - In the eyes of the Israelis - if their trust in the government’s ability to maintain fiscal control will be shaken; and if they will loose their confidence that the government is indeed committed to price stability - they will draw the conclusions. The relative balance in the foreign currency market will be replaced by excess demand. - From similar episodes we know that it is the domestic sector that reacts first, but that foreigners follow suite. Right now they just reduce their domestic currency risk. The situation does not justify going beyond that, although foreigners have reduced some of their traded portfolio in Israel. On the wayside stand foreign analysts and rating agencies. They publish newsletters, interview policymakers, collect data and offer their considered view to their customers and the public. We know their agenda: fiscal discipline, price stability, low public debt, stable financial system, structural reforms. They are not very good in seeing the future, but they are very quick to join the party in its early phases. For them too, perhaps especially for them, the credibility of the government is all-important. *** Hence, a government that starts by raising the deficit, especially after a year where the deficit is expected to be larger than planned, is already on an inferior ground and has to do more to convince the public that its commitment, to reduce the deficit in the following years, is credible. What can it do? The first thing is to confine the increased level of spending to investment, put a lid on current expenditures, and show it explicitly. The government ought to ratify not only the ceiling on total spending for 2002, but also its breakdown to current and capital expenditure, and present the figures in comparison to the estimated figures for 2001. It is one thing to borrow more for investment, and completely another - to borrow more to finance current spending, even if it is called teachers’ salaries, hospitals’ maintenance and poverty reduction programs. The approved capital spending aggregate ought to be accompanied with a list of projects and time-table for their implementation. Finally the government ought to discuss, and publish to the public, a quarterly report on the budget execution, compared to its plan. The second thing is to make absolutely clear that the government is committed to price stability. Hence: - If somebody says that short-term interest should be reduced, he should also add: provided that it does not undermine price stability; - If somebody says that we should follow in the footsteps of the US central bank that reduced interest rates in 2001, he should also quote the Fed’s emphasis that, given the conditions in the U.S economy, these interest-rate reductions are consistent with price stability; - And if somebody says that price stability is important and so are growth and employment, he should also explain that if we have more than one target we should employ more than one instrument, and we should not expect to attain all targets using one instrument. Partial statements may convey the message that an interest rate reduction is an end to itself, regardless of the consequences, thus increasing skepticism regarding the intention of government policy. But clear statements are not enough. The government should strengthen the ability of the Bank of Israel to maintain price stability and go on with the reform required to change the structure of the domestic financial markets. The main elements of the reform are well known: - Removing the obstacles preventing the creation of a non-bank money market, that will include short-term bills (Makam), commercial papers, certificates of deposit, repos and various derivatives; - Enhancing the competitive structure of long-term institutional investment, by gradually abolishing the issuance of non-tradable government bonds to pension funds, and reduce concentration in this industry; - And abolish the remaining controls on foreign currency transactions, including the archaic exchange rate band, thus reaching full convertibility of the Shekel. *** The mission to lead the economy out of the recession is indeed awesome. Nevertheless, we should not loose sight of our ultimate destination: durable growth, based on a competitive market, integrated with the world economy and operating based on the same ground rules. Such an economy should be also better equipped to deal with poverty reduction and other sensitive social issues.
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Speech by Mr David Klein, Governor of the Bank of Israel, at the conference on 'Israel's Economy as 2002 Approaches', Tel Aviv, 31 October 2001.
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David Klein: The damage which rapid increase of government expenditure causes to economic growth Speech by Mr David Klein, Governor of the Bank of Israel, at the conference on “Israel’s Economy as 2002 Approaches”, Tel Aviv, 31 October 2001. * * * The background Every year the question “what is the desired budget deficit?” is raised, even though all governments in the last ten years adopted a policy which was supposed to reduce the deficit. Those favoring a rise in the deficit argue that the tax burden should not be raised, certainly not across the board, but that government expenditure should be increased to meet certain “needs”. Such needs are natural and understandable, whether one is dealing with security, or helping families in need, or increasing the water supply in hot, dry Israel, or providing aid for factories encountering difficulties in a competitive market, or improving education, particularly in development areas, or updating the items covered by the national health scheme, or relieving traffic congestion in the major metropolitan areas, etc., etc.; the list is endless. If the needs criterion were the only one, the budget deficit, and with it the government’s debt, would rocket. The reason that this does not occur is the worldwide consensus that a policy which increases government expenditure and the budget deficit by more than the rate of growth of the economy willbeyond a certain limit-cause more harm than good. But where is that limit? The US provides an interesting example of this. As a result of the terrorist attacks on 11 September the need arose to increase federal government expenditure, and voices can already be heard referring to a return to “big government” in the US. To put matters into proportion, however, anyone looking at figures published recently by the OECD will see that public-sector expenditure in the US in 2001 prior to the attacks was estimated at 30 percent of GDP, the lowest in the world. The increase in expenditure under discussion resulting from the state of emergency is less than one percent of GDP, with the main support being provided by tax cuts-some of that temporary due to concern about a rise in long-term interest and the depressing effect this would have on growth. Israel, on the other hand, using the same yardstick, has the highest figure, 54 percent of GDP, more than the other members of the OECD. Have we crossed the limit? All Israel’s governments and the parliaments which approved the budgets in the last decade answered in the affirmative: the share of public-sector expenditure in GDP in Israel is too high, and reducing it is the best way to cut the deficit and the huge government debt. Leading the process, as the entity responsible for seeing the broad picture, was the Ministry of Finance, with the backing of the Prime Ministers, and insofar as it matters, also of the Bank of Israel. However, there were always government ministers, Members of Knesset, various experts, commentators, and others who thought that a further response must be given to meet some specific needs. Thus it was, and thus it always will be. The question “where is the limit?” is clearly of concern to other countries too. Following several decades of rapid increases in government budgets throughout the world since the middle of the twentieth century, increases which exceeded their countries’ rates of economic growth, and accompanied by increases in the tax and debt burden, the process halted, and with good reason. We will detail below the damage caused by rapid increases of government expenditure, and relate it to the current situation in Israel’s economy. Financing a rise in government expenditure by raising the tax burden When the increase in government expenditure is financed by higher taxes, two types of damage are caused: • People are less willing to invest and work, an “underground” economy is created, and there is a build-up of strong pressures to distort the tax system by granting exemptions for all sorts of reasons (the latest example is that of the Negev laws; the next in line is the recognition of mortgage interest as tax deductible. It is estimated that total tax benefits in 2001 will come to NIS 29 billion, 60 percent of which is via the capital market). The tax burden is being borne by a smaller and smaller part of the population. • The second effect, to which we were exposed only in the last few years, offers an even more serious threat: international competition on taxes. This encompasses all types of tax: on individuals’ labor income; on companies; and on income from capital. Failure to meet this competition provides an incentive to Israelis and Israeli companies to build their economic future abroad, and is an important factor for nonresidents considering whether to operate in Israel. It is clear that in open economy such as Israel’s the tax burden cannot in the long run be higher than that abroad. The tax burden in Israel relative to GDP is higher than the average in the OECD, although there are countries (France, Denmark, Italy, and Sweden) where it is higher than ours. Distortions in the taxation of financial income Despite what was said above, the main problem in Israel is not so much the total tax burden as the composition of tax revenues. Among the numerous subjects requiring attention in this regard (such as the sharp rise in tax rates on labor income as the latter increases, with the top tax bracket applying at a relatively low level of income; the heavy burden of indirect taxes; low taxation on capital), we will concentrate here on just one, taxation of interest income of individuals and mutual funds. The current situation suffers from the following distortions: • Local-currency deposits are tax exempt; foreign-currency deposits in Israel are taxed. • Savings schemes are exempt; tradable government and private indexed bonds are taxed. • Unindexed government bonds are tax free, while similar private bonds are taxed. The tax, where applicable, is 35 percent, and in some cases higher. There is thus a very grave distortion here. This situation causes serious damage to the functioning of the financial markets in the following ways: • It obliges the business sector to depend on banks as almost the sole source of finance in Israel, and does not enable it to develop alternatives via the capital market. Similarly it creates a preference among households for savings via banks. The tax system thus strengthens the banks’ monopolistic hold over financial intermediation in Israel. • Changes in the composition of the assets portfolio, i.e., switching between local-currency and foreign-currency assets, is affected by considerations of taxes which were introduced in a period when no NIS/foreign-currency market existed in Israel, and which needlessly affect the exchange-rate appropriate for Israel at any time. In this way one of the pillars supporting Israel’s economic growth-foreign trade-is undermined. • The tradability of the government bond market is adversely affected as tax rules effectively exclude households from this market-another blow to the infrastructure of any advanced capital market. • The tax distortions deter foreign financial institutions from developing services for Israelis, thus also impairing the financial markets in Israel. These all undermine financial stability and the economy’s ability to withstand financial shocks, whether caused domestically or from abroad, placing an open economy such as Israel’s at a great disadvantage. The opportunity to iron out these distortions was sacrificed together with the program for sweeping tax reforms, although it is quite simple to do what is necessary without reference to any other reform. What needs to be done is to introduce one low rate of tax, say 5 percent on average, on all interest income above a certain threshold; that threshold should be determined in such a way that on the one hand it is not worth the trouble of deducting the tax at source, and on the other it is justified on social grounds. The change should be planned in such a way that it is neutral with regard to the total revenue obtained, i.e., the drop in tax revenues on one side should be matched by increases on the other. It is important to ensure that the collection system is simple as far as the definition of the tax base is concerned, and to set a lower rate, say 4 percent, on nominal interest, and a slightly higher rate, say 6 percent, on real or foreign-currency interest. This change could be implemented without much preparation, and would be of great benefit to the economy. Clearly it should not made effective retroactively. Financing an increase in government expenditure by borrowing from the public Financing an increase in government expenditure by borrowing from the public (by the sale of government bonds) causes damage in the following ways: • The first derives from the fact that the government already has a large debt of NIS 430 billion, more than 90 percent of GDP, due to budget deficits in past years. This debt obliges the government to allocate part of its tax revenues each year to service the debt. In 2001 this interest payment will total some NIS 30 billion, more than the total education budget, and several times larger than the government’s investments. The increase in the debt caused by budget deficits reduces the government’s ability to use its sources for current purposes, and creates pressure to further increase the debt to enable expenditure to rise nonetheless. • The second adverse outcome results from the effect of the government debt on the rate of interest. In Israel, as in every economy, the rate of interest on government bonds is used as a benchmark for fixing interest in the private sector. Mortgage interest rate is determined in this way, and interest on long-term loans, both those advanced directly by banks and those issued in the form of private bonds on the stock exchange is based on the interest the market requires from the government on bonds it issues. In other words, the greater the government debt, the greater the pressure on the cost of capital for the whole economy. A rise in the price of long-term capital eventually affects the price of short-term money, and this clearly harms investment and growth. This effect is clearly evident this year: the yield on 10-year government bonds declined in the first half of the year (from 5.6 percent in January to 4.3 percent in June), but went back up (to 4.6 percent in September) when the government had to increase its borrowing because the deficit significantly exceeded the level originally planned. • The third way in which damage is caused by an increase in the government debt is by drawing Israel further away from the international norm according to which its economy is rated. This increasing deviation from the norm that requires the government debt/GDP ratio to be around 60 percent-and this year for the first time in many years we have recorded a rise in the ratio-will make it difficult to improve Israel’s rating and may even combine with other factors to exert an influence in the opposite direction. This would mean a rise in the price of raising capital internationally, both for the government and the private sector. • The fourth derives from the connection between a rise in the budget deficit and a rise in the balance-of-payments deficit. This was very clearly illustrated in the mid-1990s when due to expansionary fiscal and monetary policies the balance-of-payments deficit grew to a potentially critical level. As a result we had to adopt contractionary policies. A repeat of the first act in that performance is unfolding before our eyes now in 2001, with a rising budget deficit contributing to a rise in the balance-of-payments deficit. We say “the first act” because there is a not insignificant chance that next year’s budget deficit will be higher than this year’s, meaning possible added pressure to further increase the balance-of-payments deficit. In contrast to the US, which can print dollars, we have to borrow them to finance the balance-of-payments deficit, and this would occur just at a time when foreign investment in Israel is falling. A declining foreign debt was one of the indications of the stability of Israel’s economy; that can change. The relation between the two deficits can be explained quite simply: a rise in the budget deficit normally derives from an increase in current government expenditure. This expenditure does not generate exports, and sometimes prevents it, but it always increases imports. This has a bearing on the proposed budget for 2002: the greatest part by far of the increase in expenditure over the level in 2001 is in current expenditure, with only a small part directed towards increasing investment, and the proposed rise in total government expenditure will almost certainly exceed the rate of economic growth. In other words, the budget for 2002 proposes to increase the government debt by at least NIS 12 billion, and to burden it, and the following budgets, with additional interest payments close to NIS 1 billion a year, and all this just to increase the government’s current expenditure. It is thus possible to contribute to growth by increasing the budget deficit thereby raising the standard of living, both public and private, for a time, but this cannot be maintained, because the rise in the budget deficit creates inflationary pressure, pressure on financial markets, and a rise in the foreign-currency deficit. This is a short-term policy, with part of the bill presented for immediate payment and part carried forward. Eventually the outstanding balance of the bill has to paid, and it always comes out very expensive. The composition of the government debt Additional damage is caused to the economy, not deriving directly from the existence of the deficit but from the fact that almost half of the government’s domestic debt is not tradable. As the government moves to raising unindexed loans, the share of its tradable indexed debt in its total debt falls. In 1995 it made up 30 percent of the total debt; in the middle of 2001, it is down to 23 percent. The market for tradable indexed government bonds is drying up, and that is the market which determines the longterm rate of interest in Israel. A two-pronged course of action is required: 1. The process of extending the term of unindexed government bonds from 10 years to 30 years already started by the Ministry of Finance must continue, to provide an additional benchmark for long-term interest rates, in addition to the disintegrating benchmark provided by indexed bonds, to encourage the development of long-term unindexed uses in the mortgage market and other long-term projects. 2. At the same time, the chapter of earmarked bonds in pension savings should be brought to a close, as has been done in all other savings channels, to deepen and stabilize the tradable bonds market. This should not be applied to existing funds, including those launched in 1995, but only to new ones introduced from the date the change is implemented. Such a change would enable the realization of an important idea, which cannot be adopted as long as there are earmarked bonds: mandatory pension schemes up to a certain level of income, covering all employees and the self-employed. A superficial examination of the country’s support structure for the weak, elderly sections of the population also shows the need for the situation to change. Mandatory pensions schemes (without earmarked bonds!) could provide another important layer to the meager support which old-age social security grants currently offer this low-income population. Summary: the importance of an order of priorities Those responsible for deciding on the extent of government expenditure and the rate of the budget deficit, from the government to the Knesset (parliament), must balance gains and losses, the pluses and the minuses. They must have a long-term view-based on the fact that Israel’s economy is an open one-of the trends of the budget aggregates: the tax burden, the government expenditure/GDP ratio, the budget deficit, and the government debt burden. The basic attitude should be that government expenditure can grow only if there is economic growth. No less important, however, is that there is a clear order of priorities within each of the above four components: How can the composition of tax revenues be improved over time to meet international competition, to broaden the tax base, and to reduce the inequality in the distribution of income in the economy? Should the order of priorities for government expenditure be changed, both between its different elements (e.g., current expenditure as against investment) and within them (e.g., focusing expenditure on education on specific geographical areas, or ages, or types), and how can more responsibility and authority be devolved to government ministries in this field? The answers to these two questions contain great potential regarding the government’s contribution to economic growth. Two further questions: How should the budget deficit be financed (long-term as against short-term debt; indexed as against unindexed debt)? How can the share of the government’s tradable debt vis-à-vis nontradable debt be increased? The answers to these two questions contain the key to the government’s contribution to financial stability in the economy. The attitude towards the trends of the aggregates and the order of priorities within them should be guided by: • the general aim of placing the economy on the path of sustained growth, and • the socially just approach of supporting the weaker sections of the population not of working age, and encouraging others to join the labor force. This is not an exact science. It is clear, however, that much more can be done in this direction. Finally, when the budget is presented to the Knesset for approval, the basis of growth for 2002 should be reconsidered, as this provides the basis for estimates of tax revenue. Instead of discussing the probability of a sharp turnaround in the economy’s growth rate next year, the budget could be based on a more modest estimate of say 2 percent, instead of 4 percent, and a certain amount of the government’s approved expenditure could be frozen to ascertain that the target deficit is being met, even if the rate of growth is below the forecast. It can be made clear how the government will act if tax revenues exceed the forecast because of a higher rate of growth. We would prefer the extra revenue to be used to broaden the tax brackets on individuals, but part could also be used to increase expenditure more favorable to economic growth, provided that a certain decline in the share of government expenditure in GDP is maintained.
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Prepared by Mr David Klein, Governor of the Bank of Israel, as background to a meeting with 'Haaretz' economic journalists, Tel Aviv, 20 November 2001.
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David Klein: A “package deal”? - the policy changes needed for 2002 and thereafter Prepared by Mr David Klein, Governor of the Bank of Israel, as background to a meeting with “Haaretz” economic journalists, Tel Aviv, 20 November 2001. * * * Clarification of the term The term “package deal” was the name given in the past to a plan of action agreed between the government and non-government entities-the employers’ and employees organizations-to achieve certain objectives. The objectives were usually to lower inflation and reduce the deficit in the balance of payments. Today we are facing a different situation: the economy is in recession, there is high unemployment, and there is no significant improvement in sight. In other words, it is clear that the current policy needs to be revised. Is a package deal necessary for this, or does the government have the required tools at its disposal to act alone? It is best to answer this question after identifying the policy changes needed to boost growth and raise employment without undermining stability and without increasing the balance of payments deficit. What characterizes the current policy? Policy is reflected by laws, government decisions, and agreements, some old ones, and some new. What set of laws, decisions, and agreements is relevant to today’s objective? There are two anchors to macroeconomic policy: 1. Fiscal policy, aimed at reducing the government’s size and debt. The implementation of the appropriate policy in this sphere will enable the tax burden and interest rates, mainly the mediumand long-term rates, to be reduced. Both of these factors are vital to growth. We know that the budget for 2002 is not positioned on the path needed to attain these goals: – The deficit will be greater than planned because the estimate of revenues is based on an unrealistic growth assumption. Moreover this will be the second year in succession with a deviation in the deficit, which undermines confidence in the government’s commitment to return to the downward deficit and debt path from 2003. – By far the greatest part of additional government expenses is directed to current expenses, and only a small part (less than one tenth) to financing investments. What is needed, therefore, to attain the objective, is: – To adjust the budget for 2002 to ensure that the deficit set by the government is adhered to; – To alter the composition of government expenses so that the addition directed to investments increases. To do this, another subject must be addressed: Private legislation It has been shown conclusively that existing laws do not prevent private legislation from changing government decisions on budgetary aggregates (tax benefits are granted which reduce revenues, and laws are passed which raise expenses), imposing an order of priorities on the government different from the one it approved, and adversely affecting growth and employment. An amendment to the law is required which will ensure that all initiatives by Knesset members will have to be checked in the light of the budget policy determined by the government. All the private bills introduced in the last two years must be covered by this amendment. 2. Monetary policy, aimed at preserving price stability and supporting financial stability. The more firmly established this stability, the lower the rate of interest needed to maintain it. Stability and low interest are another essential key to sustainable growth. Without stability, there is no investment, and without investment, there is no growth. Certain additional steps are required to complete monetary policy, just as in the case of fiscal policy: – The abolition of the ceiling on Treasury bills issues. – The abolition of the exchange-rate band. – The abolition of the remaining foreign-currency controls, and making the NIS fully convertible. – Unification of tax rates on interest income of individuals and mutual funds, without affecting total revenue from this source. These adjustments would shift the center of gravity of monetary policy from the banks to the financial markets, and enable price stability to be achieved at a lower rate of interest. Furthermore, and no less important, these changes would make the financial markets more efficient, improve their competitive structure, and thereby encourage savings and support growth. 3. In addition to the two anchors mentioned above, we must give attention to various aspects of the labor market and wages policy in the public sector. The relevant topics are: a. The law currently in force determines that the minimum wage is updated according to the average wage. To avoid exposing the minimum wage to irrelevant changes in the wage structure in the economy, and to comply with the original concept underlying the Law (ensuring a minimum income for workers at low wage levels), it would be better to link the minimum wage to the Consumer Price Index (CPI). In order to share the fruits of economic growth with those at low wage levels, the possibility of adding the rise in productivity should be examined. Efficient methods of enforcing the Law should be introduced. At the same time, the salaries of the most senior public-sector office holders, which are currently indexed to the average wage, should also be switched over to linkage with the CPI. b. The policy of reducing the number of foreign workers, in particular the illegal ones, should be implemented. c. The policy aimed at replacing income support with a program to increase the participation rate in the labor force should be implemented. d. A special work plan should be drawn up to retrain those who have been unemployed for more than a year. e. The programs of support for small and medium-sized businesses should be reviewed and strengthened, with special attention paid to those in outlying areas. f. Wages policy should concentrate on the public sector. To carry out the policy of maintaining the real wage, the rules for determining wage drift (compensation for seniority; large differentials between grades; the pace of advancement through the grades; and other related expenses) should be amended. 4. Dealing with factories in difficulties A governmental approach must be determined to deal with the problems of factories in difficulties: a. A legal framework is necessary (“Chapter 11”). b. A process must be instituted to distinguish between factories whose continued existence cannot be justified on economic grounds, and those facing temporary difficulties. c. Any recovery program for a particular factory should require the participation of the owners (including investors in the capital market), creditors, and employees, and not just the government. On the other hand, they are all, including the government, entitled to some benefit if the recovery program proves successful. What is the next step? The professional team and working teams In a meeting called by the Minister of Finance which took place on 14 November, 2001, with the Chairman of the General Federation of Labour in Israel (the New Histadrut), the President of the Manufacturers’ Association, and the Governor of the Bank of Israel, a decision was reached to appoint a professional team. The team’s role would be to formulate a work plan such as that which I have outlined above. A work plan is not the same as an operative plan, and working teams must be appointed to go over the details. Four such teams can work in parallel: 1. One team will be led by the Budget Department, and will include representatives of the Prime Minister’s office. This team will formulate the change needed in the budget for 2002, both in the aggregates and in the composition of expenses; it will also deal with the amendment which will regulate the rules governing private legislation. 2. The second team will include representatives of the New Histadrut, and representatives of the Wages and Labor Agreements Department of the Ministry of Finance, and will formulate the overall changes needed in public-sector wages so that the policy of maintaining the real wage can be implemented. 3. The third team will include representatives from the Ministry of Finance, the New Histadrut, and the manufacturers. Its task is to look into the changes needed in the Minimum Wage Law, and ways of reducing the number of foreign workers in Israel. 4. The fourth team will include representatives from the Bank of Israel and the Ministry of Finance, and its function is to propose changes to remove the obstacles obstructing the conduct of monetary policy and to boost the development of the capital market. The working teams can complete their tasks in a few weeks, so that the professional team will be able to submit its proposals to the forum which appointed it by the end of the year. Summary The main changes required must be instituted as part of the normal process by which the government reaches decisions. This necessitates the political agreement of the various members of the coalition, but not the agreement of the employees or employers. What is under consideration this time is not a package incorporating a wage and price freeze, a large devaluation, a change in the short-term interest rate, or the adjustment of subsidies, as was the case in the package deals of the 1980s. Some of these are not necessary at this time, some cannot be implemented on a practical basis, and some would cause more harm than good. In any event, the importance of the required change in fiscal policy far outweighs that of the changes mentioned above. In certain areas, mainly those connected with the labor market, it would be preferable, now as it was with earlier packages, to arrive at solutions with the agreement of the employees and employers. The package under discussion on this occasion is thus different from its predecessors. In the past, the issue was one of clearly defined, quantified, steps introduced for a specific time period. In the past it could have been asked “Who is giving, and who is receiving?” Today’s package must incorporate changes in the operating rules-laws, decisions, and agreements-without time limits being imposed. This is an adjustment to the policy path, and not just ad hoc changes, because the problems being dealt with are not ad hoc problems. Investments, growth, and creating job opportunities cannot be realized from today to tomorrow; creating a climate which will encourage them requires a transparent and credible long-term policy.
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| 2,001 | 11 |
Speech by Mr David Klein, Governor of the Bank of Israel, for the Israel-Japan Friendship Society and Chamber of Commerce, 9 January 2003.
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David Klein: Israel’s economy after the elections Speech by Mr David Klein, Governor of the Bank of Israel, for the Israel-Japan Friendship Society and Chamber of Commerce, 9 January 2003. * * * Following the elections we will have a new government. This may be an opportunity to assess the economic and social policy for the term of the next government. A reasonable starting point would be to ask where the economy will be heading if the present background factors – namely the world slowdown and the conflict with the Palestinians – will endure, and we continue with present policies. A not improbable answer would be that: - the economy will keep contracting, - the rate of unemployment will increase, - more families will find themselves below the poverty line, - the government debt will increase, - tnterest rates, short and long, will remain high. None of these is unavoidable If policies will be adjusted there is a good chance to steer the economy away from continued recession with all its repercussions. What, then, are the required changes? I will sum them up for you, but not before stating that we are fortunate not to have on our plate two major constraints that limited our ability to grow in the past, namely: - shortage of foreign currency, - inflation. Foreign currency We don’t have a problem of foreign currency because we abolished exchange controls on one hand, and let the market determine the daily exchange rate on the other. When a foreign analyst wants to convey the salient features of the Israeli economy from this perspective, this is what he says to-day: - foreign currency reserves are high and stable. In the last six years they reached a level of 5-6 months of imports, some USD 24 billion, - net foreign debt of the economy as a whole is low and declining. In the last two years it amounted to a negligible 2% of GDP, - short-term assets of the economy exceed by a wide margin its short-term liabilities, meaning that we should not expect any liquidity problem, - the foreign currency market, created by the Bank of Israel in mid-94’, keeps widening in terms of daily turnovers and number of participants, operating at reasonable spreads and characterized by relatively low volatility. Inflation When one is reviewing the progress we have made in taming inflation, the noteworthy landmarks are: - We have succeeded in going down from three-digit inflation in the first half of the 1980s to a low two-digit inflation in the first half of the 1990s, and then to a low one-digit inflation at the turn of the century. In this respect we have joined a worldwide trend and to-day there is no meaningful inflation differential between Israel and the developed world. - In the first half of last year, 2002, inflation rose temporarily to 6% for the period, but then declined practically to zero in the second half of the year. In this sense we returned to the record set in the years 1999-2001, when the annual pace of inflation was set in the range of zero to 1.5%. Hence we can, and should, devote all our energy to follow one major target: stop the contraction of the economy and start growing again. Employment and growth What, then, are the policies required to change course in terms of employment and growth: 1. Fiscal consolidation, by which we mean: - Reduce the deficit to redirect downward the government debt ratio, to reduce long-term interest rate, to promote investment. Special care should be taken that the 2003 budget will indeed result in a deficit no higher than 3%, as the government decided. - Restructure government spending to increase infrastructure investment, cut the government wage bill, arrest the increase in defense spending, and implement series of programs to divert potential employees from welfare to work. The most promising way to reduce poverty is to upgrade programs to increase the overall employment rate, were we lag very much behind the world. - Follow scrupulously, if not expedite, the program to cut the individual income tax rate, to reduce the marginal rate, including social security, to 49%. We ought to remember that our ability to compete with the world depends also on our tax regime. 2. Foreign workers Change track in dealing with the urgent need to reduce significantly the number of foreign workers in Israel. Foreign employment in Israel has reached a level of 11% of the labor force, almost the highest in the world. The number of foreign workers in Israel exceed the number of the unemployed. The new track should aim at equalizing, at least, the cost of employing a foreign worker to that of employing an Israeli one. The difference now may amount to 40% in favor of the foreign worker. Immigration police is indeed necessary, but far from being enough. 3. Social pact The government should reach an understanding with the labor union and the employers association regarding a new set of rules governing wage determination. This is particularly important regarding wages in the public sector, the minimum wage in the economy, wages and other benefits of senior management in the private sector, and economy-wide pension arrangements. 4. Structural changes Move ahead with required structural changes in the economy to improve competition in key industries like financial services, energy, water, transportation and communication. 5. Short-term interest rate If all these changes will be implemented the Bank of Israel will be able to gradually reduce the short-term interest rate while maintaining price and financial stability. The challenge ahead This is an extremely difficult package to implement. But we all remember the story from Alice in Wonderland, where Alice met a cat at a cross-road: “Which way should I take” asked Alice. “It depends where you want to go”, answered the cat. “I don’t care” said Alice. “Then” retorted the cat, “it does not matter which way you take”. We know where we want to go. We know what is at stake. We should, then, get organized to implement the required changes to start growing again. We certainly have the potential to do it and I trust that we will.
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bank of israel
| 2,003 | 2 |
Speech by Mr David Klein, Governor of the Bank of Israel, at the IMF/World Bank Annual Meeting, Dubai, 23 September 2003.
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David Klein: Coping with the challenge to reduce poverty Speech by Mr David Klein, Governor of the Bank of Israel, at the IMF/World Bank Annual Meeting, Dubai, 23 September 2003. * * * Mr. Chairman, Mr. Köhler, Managing Director of the IMF, Mr. Wolfensohn, President of the World Bank Group Distinguished Governors, Delegates, Ladies and Gentlemen, The world recognized the need to give priority to the global poverty problem, and expressed a wide consensus on this matter in the Millennium Development Goals. Let me devote my statement today to this subject, and say a few words on the challenges facing Israel in its efforts to reduce poverty. We believe that poverty cannot be tackled effectively if policy is not focusing on growth. Growth is not a sufficient condition for reduction of poverty, but it is, at one and the same time, the highway to raise the living standards of those who are able to work, and the provider of resources to support those who are unable to help themselves. We also believe that in order to realize its potential growth, the Israeli economy - perhaps like some other small and medium-sized economies - has to be open to free movement of goods, services and capital, and to adhere to international standards of macro-economic management, including the standards for fiscal deficit and price stability. Such a framework maximizes Israel’s potential contribution to science and technology as a major vehicle of growth through international trade. However, this approach also requires to make our tax regime competitive with that of other countries, which necessarily means to commensurately reduce government expenditures to keep a lid on its debt. Therefore, the macro economic framework constrains the room to handle the challenge of reducing poverty by just increasing welfare payments. When we come to formulate an alternative strategy, we rely on the experience and advice of the World Bank and the IMF and the policies of other countries, like those adopted by the European Union. One fundamental element in our strategy consists of various reforms in the labor market leading to an increase in the ratio of employed persons in the working age population. This is one dimension in which we lag behind the developed world. I need not elaborate here on the significant relation between the rate of employment and the incidence of poverty. A second key element in our strategy is targeting of the policy to reduce poverty. Like some other countries, we have a history of increasing welfare payments without making a distinction between those who are able, or unable, to work, and without applying an income test for welfare entitlement. The new policy of reducing poverty will have to target the poorest and least empowered population, and let them have a dominant role in shaping their future. To evaluate the progress we are making in poverty reduction we add to the traditional relative definition of the poverty line a need-based (absolute) definition of poverty. Once we have a meaningful and measurable target, we will be able to make our policy more effective: to introduce quantitative indicators for follow-up, define legislative measures and budgetary instruments, determine accountability for policy implementation and to make sure that full transparency of the policy making and implementation is in place. Mr. Chairman, The DC Communiqué published yesterday stated: Today we renewed our commitment to achieve the Millennium Development Goals and to continue our work on implementing the strategies, partnerships and actions agreed in Doha, Monterrey and Johannesburg. Israel has been, and will continue to be, a firm supporter of this worldwide effort to reduce poverty. Finally, Ladies and Gentlemen, I would like to extend special thanks to the government and people of the United Arab Emirates for their warm hospitality to all the participants of our Annual Meeting and for their generous assistance to the efficient organization of the Meeting. Thank you Mr. Chairman.
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bank of israel
| 2,003 | 9 |
Speech by Mr David Klein, Governor of the Bank of Israel, at the Euro-Mediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004.
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David Klein: The changing exchange rate regime - background, policy and implications; the case of Israel Speech by Mr David Klein, Governor of the Bank of Israel, at the Euro-Mediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004. * * * The exchange rate regime is an important component of macro-economic policy. After experiencing a period of sluggish growth and rapid inflation in the ‘70s and the first half of the ‘80s of the last century, Israel changed its economic strategy. In a series of agreements with the European Union and the United States, all barriers to international trade were removed. Unilaterally Israel removed those barriers on trade with other countries as well, and cemented all these changes in a number of agreements in the framework of the WTO and by accepting Article 8 of the IMF Articles of Agreement. Furthermore, in the ‘90s and the first few years of this decade, Israel gradually abolished all exchange controls. The concept behind this economic strategy was that a small economy like that of Israel, can exhaust its growth potential only by being open to the world. As a result of this basic strategy, the central bank, which was its main promoter, had to overhaul its policy to maintain price and financial stability. The change entailed replacing the exchange rate by an inflation target as the nominal anchor. To do that a few steps had to be implemented simultaneously: First, to render the exchange rate regime more flexible. We realized that removing exchange controls would make it difficult, if not impossible, to maintain a fixed exchange rate. This meant moving from a fixed exchange rate regime through a horizontal exchange rate band, to an upward sloping diagonal band, to an ever-widening band and, finally, to a floating exchange rate regime. The gradual approach was required to give time to an inter-bank foreign currency market to develop, including the creation of financial instruments, traded and over the counter, to hedge against the exchange rate risk. Second, in order to go along with the lifting of the foreign exchange controls, the central bank and the government had to implement an extensive deregulation of the domestic money and capital markets. This meant abolishing numerous directed credit facilities, and extensive commercialization of government debt in the framework of capital market reform. Third, working with inflation and price stability targets required shaping of appropriate monetary policy instruments. In this context we scraped the high and rigid reserve requirements, and replaced it by daily, weekly and monthly auctions of monetary loans and deposits of commercial banks with the central bank. In the last two years we are gradually replacing these monetary auctions with treasury bills which will be our main instrument for conducting monetary policy vis-a-vis the market as a whole. Judging from the results, the outcome is rather satisfactory: • Israel enjoys price stability. • The foreign currency market functions smoothly, with relatively narrow spreads and low volatility. At the background, the central bank watches the market but does not intervene and the shekel, the domestic currency, is fully convertible. • The foreign currency position of the Israeli economy is positive: the current account is roughly balanced; FDI and portfolio investment started to go up again in the wake of the rebound in world financial markets; and foreign exchange reserves held by the central bank are ample. To sum it up: the decision to regard the exchange rate as a policy instrument or let it be a marketdetermined variable is an integral part of the general strategy of macro-economic policy. In our case we let it be determined by the interbank market and used the short-term interest in its stead. A final word on the financial relations among Mediterranean countries. While the potential for intraregional trade does not seem to be large at this stage, there seems to be some scope for furthering financial ties, especially under the auspices of the European Central Bank: • One example can be joint missions and consultations to review the stage of development of various financial markets. • Another example, based on the trend toward a flexible exchange rate regime, is a framework for collaboration among central banks to promote the stability of the financial system and open information channels among supervision authorities. • A third example deals with the sequencing of liberalizing the capital account in connection with changing the exchange rate regime. The initiative of Bank of Italy and the European Central Bank should, therefore, be seen as a successful beginning. This is the most suitable forum to discuss and strengthen financial ties between the Eurosystem and Mediterranean Central Banks.
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bank of israel
| 2,004 | 2 |
Lecture by Dr Meir Sokoler, Acting Governor of the Bank of Israel, at the scholarships award ceremony at the Technion, Haifa, 17 March 2005.
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Meir Sokoler: The time has come for a new Bank of Israel law Lecture by Dr Meir Sokoler, Acting Governor of the Bank of Israel, at the scholarships award ceremony at the Technion, Haifa, 17 March 2005. * * * First, I would like to thank you for inviting me to address such a distinguished gathering in such an eminent institution as the Technion. Many years ago I was a student of economics here, and I remember the excellent students of this august institute and the wonderful experience of outstanding instruction I received. I am sure that you have all heard of the Bank of Israel, the country's central bank. It appears, however, that many Israelis do not know much about it, apart from the fact that it prints Israel's money. A few months ago a 6-year-old from an Israeli primary school wrote to the Governor. In the carefully drafted letters of a child who had just learnt how to write, he asked: "Mr. Governor of the Bank of Israel, I heard that you in the Bank of Israel print the country's money. Why don't you print more money so that there won't be any more poor people, and there will be more roads and schools?" It might seem natural that such a young child would not know the answer to the question, but it transpires that many citizens, adults as well as children, ask us the same question in one form or another. At first glance the question seems to be justified. You might think that operating the banknote printing machines for a few more hours would solve all the economy's problems. In fact, that is how Israel's governments acted until the mid-1980s. Till then the Bank of Israel printed huge quantities of banknotes for all sorts of purposes, some of them highly commendable. The results, however, were disastrous. The value of the notes at the time eroded rapidly, with catastrophic economic consequences. What led the Bank of Israel to print so many banknotes at that time? Why did it allow such a rapid increase in the money supply and the monetary base? Didn't it know that this would create high inflation that would rapidly erode the purchasing power of the currency? It is clear that to the governors of the Bank at that time, to the Bank's economists, and to many other people the outcome was very obvious. This was something that had been known for hundreds or even thousands of years, certainly since the first central bank was established - that of Sweden which was established at the beginning of the seventeenth century - and started printing notes that served as legal tender. Until 1985 the Bank of Israel was not independent, and it had to print money, at the government's request, to finance the government's deficit, with no upper limit (they called it lending the government money, even if the government did not actually pay it back). In 1985 - a milestone in Israel's economy, with the introduction of the Economic Stabilization Program that significantly lowered inflation, but only to between 15 percent and 20 percent a year, higher than the level in the advanced economies - the Bank of Israel Law was amended, and the government was prohibited from asking the Bank to print money for it. This legislative change (known as the Non-Printing Law) is the only one introduced since the establishment of the Bank in 1954. In contrast to us, many advanced and emerging economies have changed their central bank laws in the last two decades, all moving in the same direction in several major aspects: • Price stability was set as the major objective of interest policy. This means that the central bank has full control over the rate at which money is printed, in most cases by means of control over the very short term rate of interest, known as the central bank interest rate, which is the cost of money. In addition, the central bank must help in the area of long-term growth, as long as price stability is maintained. • Secondly, the independence of the central bank in its use of the policy instruments to achieve the target was clearly specified. The central bank must have complete freedom to exercise its discretion regarding the various instruments it has available to control the money supply in the economy and thereby to meet the price-stability target. • Thirdly, the entity deciding on the central bank's policy was defined - a monetary council comprising professionals who are independent of the business and political establishment. • Fourthly, a framework for reporting and transparency of the central bank's policy vis-à-vis the government, the legislature and the public was determined. In this context communication with the public is important as a means of increasing the effectiveness of the policy. In Israel, the main target of the Bank of Israel's interest-rate policy is in the area of inflation, and since the beginning of the current decade it has been in the sphere of maintaining price stability. Hence since banknotes have been printed sparingly, starting with the governorship of the late Professor Michael Bruno, and in the periods of office of his successors Professor Jacob Frenkel and Dr. David Klein, and to be continued under the newly appointed Governor Professor Stanley Fischer - the purchasing power of the banknotes in your pockets is maintained long term. This is a relatively novel experience for us in Israel. The annual inflation rate since 1999 has averaged 1.7 percent, i.e., close to the 2 percent midpoint of the target range of between one and three percent. You probably all remember the beginning of the 1980s, with two- and even three-digit inflation, which reached more than 500 percent a year. It is important to remember that the banknotes in your pockets are only part of the money supply or monetary base: the rest is the money in your current accounts. It is true that in the old law other objectives are mentioned, apart from that of preserving the value of the currency (or in modern terminology, maintaining price stability) - objectives such as a high rate of employment, and a high level of investment - without price stability being specifically granted priority. However, there is no contradiction between focusing on price stability on the one hand and objectives regarding employment and investment on the other. Quite the opposite: price stability is a sine qua non for sustainable economic growth and for long-term high employment and buoyant investment. This said, to remove any possible doubt the Law should be changed to specify price stability as the Bank of Israel's prime objective. It is worth noting that experience both here and abroad has shown that specific mention of price stability as the major purpose of the central bank increases its credibility, and the greater its credibility, the more freedom it has to support the other objective of long-term growth without jeopardizing price stability. In the area of independence in the use of monetary instruments too it would be well worth introducing some order in Israel, and formalizing the Bank's freedom of action. Another considerable change required in this field relates to the exchange-rate regime. Since the Law was passed in 1954, the reality has changed completely: there is no foreign-currency control, the Bank of Israel has not intervened in the foreign-currency market for almost ten years, and the exchange rate is determined by the market forces of supply and demand. This situation should be reflected in the new law. With regard to a monetary council, the Bank of Israel is in favor of the establishment of such a body that would make decisions on interest policy and would also bear responsibility for it. The establishment of such a council is desirable as part of a system of checks and balances for an independent central bank. At the same time the tremendous importance of the creation of a mechanism to ensure the appointment of the most suitable people to the council must be borne in mind: they must have no axe to grind, and cannot come from the business sector, government, or politics. Turning to the issue of transparency and reporting, the Bank of Israel already publishes a half-yearly inflation report which explains the interest policy to the public, its results, and the implications of the developments during the previous half year, and describes the policy likely to be adopted in the future. The Bank of Israel continues to cooperate fully with the Prime Minister's Office and the Ministry of Finance in discussions devoted entirely to the drafting of the new Bank of Israel Law. This legislation, firmly founded on the principles outlined above, will propel Israel and its economy further along the path towards joining the family of modern countries and economies. The importance of this for Israel lies in its ensuring the existence of a proper framework for the government and the Bank of Israel to operate macroeconomic strategy intended to create long-term growth and employment as a sine qua non for raising residents' standard of living and level of welfare. Such a strategy will provide the necessary resources and the correct framework for promoting a welfare policy for the weaker sections of the population that will not leave them out in the cold. To summarize: the Bank of Israel today has in practice a not inconsiderable degree of independence. This independence derives from changes in economic thinking and in experience gained in setting and implementing interest policy both in Israel and world wide. The legal environment in which the Bank of Israel operates, however, is outdated and should be amended to make it compatible with the new reality. If we enact a new central bank law here in Israel, we will join the many countries that have done so successfully.
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bank of israel
| 2,005 | 3 |
Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the EBRD Annual Meeting, Belgrade, 22 May 2005.
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Stanley Fischer: A central banker’s look at key issues facing the EBRD Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the EBRD Annual Meeting, Belgrade, 22 May 2005. * * * Mr. Chairman, Mr. President, Governors, Delegates, Ladies and Gentlemen: It is a pleasure for me to be here in Belgrade for the first time in 15 years - eventful and extremely difficult years for the peoples of this city and country and of neighboring countries - and to participate in this 14th Annual Meeting of the EBRD as Governor of the Bank of Israel and the representative of Israel. It is a special pleasure for me to take part in a meeting of the EBRD, whose record has more than justified its creation. As a researcher I benefited greatly from the basic research and analytic work on the transition process done by the Bank, under the leadership of a series of outstanding Chief Economists, John Flemming, Nick Stern, and Willem Buiter. The Bank has also managed to achieve impressive operational and financial results. In 2004, for example, the financial commitments and disbursements of the Bank were higher than ever before, the number of projects was greater than in previous years, and there was a record amount of commercial co-financing of its projects. I would like to express my congratulations to the Bank's management and staff for these achievements, and to thank and congratulate Jean Lemierre for his highly effective leadership of the institution. I would also like to express my appreciation to Noreen Doyle, First Vice-President of the EBRD, and Willem Buiter, for their distinguished service to the EBRD, and to wish them well in their future endeavors. The countries of this region continue to face formidable economic and political challenges. Nonetheless the prospect of dealing with them in the context of growing integration with Europe, together with progress in our host country, Serbia and Montenegro, make the outlook brighter than it has been for many years. This meeting provides all of us with an opportunity to strengthen our commitment to the region, and I would like to thank the authorities of Serbia and Montenegro and the city of Belgrade for being such good hosts and for making this meeting possible. I would like to use this opportunity to make brief remarks on three key issues facing the EBRD: first, SMEs and microfinance; second, currency risk; and third graduation. 1. SMEs and microfinance It is well known that the SME sector is a key contributor to growth and employment, including and perhaps especially in the transition countries. It is equally well known that in most countries this is a difficult sector to finance: the financing of small and medium scale enterprises requires detailed local knowledge of the relevant companies and entrepreneurs, and is likely to be very labor-intensive. This work is best done by local financial institutions, which are more likely to have developed branch networks that enable them to understand both the economic conditions facing these companies and the quality of the firms' management. The EBRD has been successful in promoting SME financing in several countries, including in Russia, through onlending to local financial institutions. The Bank's work and familiarity with financial intermediaries throughout the region has increased its effectiveness in assisting smaller enterprises in its countries of operation. It is highly desirable that the Bank continue to promote SME lending, especially in the countries of this region, both through its lending and by helping create a business environment in which the private sector can flourish. At the same time, let me put in a plug for the potential role of microfinance in helping even smaller businesses than the SMEs to obtain financing, and also in helping the poorest consumers to obtain access to the financial sector. Governments can contribute to this process by ensuring that their regulatory framework does not discriminate against microfinance institutions. Private sector financial institutions can contribute by working together with microfinance institutions, for instance by helping them gain access to financing and by assisting in the development of microfinance products. The EBRD has been successful in promoting SME financing in several countries, including in Russia, through onlending to local financial institutions. The Bank's work and familiarity with financial intermediaries throughout the region has increased its effectiveness in assisting smaller enterprises in its countries of operation. It is highly desirable that the Bank continue to promote SME lending, especially in the countries of this region, both through its lending and by helping create a business environment in which the private sector can flourish. 2. Local currency financing Governments in several regions have been attempting to develop local currency bond markets in which foreign investors and institutions participate. In part this is designed to deal with the so-called problem of "original sin", according to which developing countries are able only to borrow internationally in foreign currencies, and consequently suffer financial losses in their own currency if forced to devalue. Despite the belief that original sin will always be with us, several developing countries, including Mexico and Malaysia, have recently been able to borrow from international investors in their own currencies, and there is good reason to believe that this trend will continue. Another reason to develop local currency bond markets is that it is desirable that local firms that need to borrow have the option of doing so in their own currency. In this regard, the EBRD's initiative to gain access to local currency funding for onlending to the private sector, rather than requiring that private sector borrowers take foreign currency loans, should be strongly commended and encouraged. Given the greater sophistication and financial strength of the international financial institutions, they are in a much better position to in essence provide hedges against the risks of foreign currency financing than are local institutions. The EBRD has been able to gain such access in some countries, and it deserves our encouragement as it seeks to broaden this initiative. 3. Graduation Despite many setbacks, and an unexpectedly difficult beginning, the transition process has on the whole been successful - more so in some countries and less so in others in which the EBRD operates. This year, eight of the countries of operation of the EBRD are already full-fledged EU member states, and other countries of operation are preparing to achieve this status in the next few years. The Bank has started a process of shifting resources away from the new European Union member states to countries in South Eastern Europe and the CIS. Looking forward, further discussions of the process of graduation from EBRD financing will take place later this year, within the context of the next Capital Resources Review. This exercise should be oriented towards formulating the Bank's strategy on graduation through the year 2010. I believe that the EBRD should continue to shift its operations away from the more developed countries that are already in the EU, and should strengthen its focus on operating in the less advanced countries of operation, where the challenge of transition is greater, and where the available capital and knowledge resources are more limited. It would be useful to set guidelines for the dates by which the Bank would phase out and cease operating in certain countries - but these guidelines should leave room for some flexibility, particularly in fields of operation in which the EBRD has special technical expertise. *** In conclusion, let me say that the remarkable success of the EBRD in fostering transition in the region deserves the appreciation of all its shareholders. I wish the Bank continuing success. Thank you, Mr. Chairman.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Finance Committee, Jerusalem, 30 May 2005.
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Stanley Fischer: Overview of Israel’s economy Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Finance Committee, Jerusalem, 30 May 2005. * * * Chair of the Finance Committee M.K. Yakov Litzman, Members of Knesset, honored guests. I am very grateful for the invitation I received from the Chair to come and speak to you. As Governor of the Bank of Israel, I attach great importance to this dialogue between the Bank and the Knesset Finance Committee. In fact, after almost a month in my new role, I am pleased that my first appearance in public since the inauguration ceremony at the President's Residence should be before you. I would like to note at the outset that Israel's economy has important achievements to its credit, and although there is much still to do, we are already benefiting from the economic infrastructure that has been, and is still being, constructed. Israel's economy is currently enjoying the benefits of economic and financial stability. This can be seen in a number of areas: First, inflation in Israel has for quite a long time been within the long term price-stability target range set by the government of between 1 percent and 3 percent a year. Moreover, inflation expectations and the forecasts by various experts reflect the assessment that looking a year ahead, inflation will remain within the price-stability target range. Second, the interest rate is very low, perhaps its lowest level since the establishment of the State. This is all the more notable alongside the reality of long-term price stability. In this context I would like to say to you that the fact that the economy succeeded not only in achieving price stability but in maintaining it along with low interest is an important reflection of the credibility that monetary policy has acquired over time - and it is essential that we maintain this credibility. I would also like to mention that all this occurred against the background of the process that began almost a year ago of the US Federal Reserve raising the dollar interest rate. This process is expected to persist, but till now it has not affected the financial situation in Israel. Third, the NIS/$ and the NIS/currency–basket exchange rates have been very stable, and this has occurred without Bank of Israel intervention since 1997, but just through market forces. The volatility of the NIS exchange-rate against the dollar is lower than that of many other currencies. Thus last year, for example, the standard deviation of the NIS against the dollar was about 4 percent, those of the euro and the pound sterling were both about 10 percent vis-a-vis the dollar, and of the Mexican peso, about 7 percent. These are just some examples to illustrate the situation of the currencies of most advanced and emerging economies vis-a-vis the dollar. This stability is vital for us: without it, it is very difficult to achieve long-term growth. This is especially the case in the era of globalization, with real competition for international investment, a competition in which it is important to succeed. And indeed, Israel's economy benefited from an inflow of foreign investment that totaled some $ 5 billion in just the first four months of 2005, not far below the total of about $ 6.5 billion in the whole of 2004. Such inflows are of a magnitude larger than those to many other markets. Growth is the most important issue - not simply growth, but sustained growth. Without it we cannot ensure a rise in the standard of living and in the welfare of the population. Nevertheless, it must be borne in mind that economic growth in Israel is affected also by international economic developments, and here it should be noted that currently there is uncertainty regarding the growth of the global economy. On the positive side, data relating to the Japanese economy in the first quarter of 2005 indicate a very rapid growth rate of about 5 percent in annual terms, but at the same time growth in Europe was very weak and the OECD cut its forecast growth for the eurozone to only 1.2 percent for 2005. Hence, the picture that emerges is rather unclear, showing no definite pattern. Data relating to Israel's economic growth in the first quarter of 2005, 2.9 percent, suggested a certain slowing of economic activity. Other data, however, point in the opposite direction. Most important are the data in the Labour Force Survey indicating a significant improvement in 2005:I: unemployment continued to drop, going down from 9.8 percent to 9.1 percent, and there was an improvement in employment - the number of employees rose by 33,000, with a significant increase in the number of full-time employees, and with the business sector absorbing about two-thirds of the increase in the number of employees. High-tech exports rose markedly in April 2005; although there was a slowdown in the rise in private consumption, it is still at a very high level following its increase in 2004; tourist entries continue to rise gradually; and the composite state-of-the-economy index for the first few months of the year was retroactively revised upwards last week by the Bank of Israel. Hence, the picture that emerges regarding economic activity in the first few months of the year does not justify changing the Bank of Israel's forecast of 4 percent growth for 2005. This situation of a growing economy with economic and financial stability did not come about by chance. It is the result of a correct macroeconomic policy, in particular of monetary policy that focuses on stability, and without jeopardizing it, helps growth, combined with fiscal policy that operates within the framework of long-term fiscal discipline alongside structural reforms that support growth. As far as fiscal policy is concerned, I am in favor of the Ministry of Finance program to reduce taxes; care must be taken to ensure that during its implementation special attention is paid to the welfare aspects of the program, and that the government debt and its high share in GDP continue along their downward path. I would like to turn now to two important issues facing us, and which the Finance Committee will also have to deal with: the recommendations of the Bachar Committee, and the Bank of Israel Law. With regard to the Bachar Committee, I would like to make it perfectly clear that I support the proposed reform of the capital market along the lines recommended by the Committee. The high degree of concentration in the capital market has an adverse effect on economic growth and efficiency. It is very difficult to pursue a policy of economic reforms without dealing with this issue in a thorough and comprehensive manner. The proposals of the Bachar Committee offer a good solution to the problems of concentration afflicting Israel's capital market. Most of the credit market is in the hands of the banks, and although nonbank credit has been expanding recently, the rate at which this is happening still leaves the bulk of credit within the banking system. There are certain detailed aspects of the reform that are still being addressed. But the question to be asked is whether after the reform the situation in the capital market will be better than before. If the answer is "yes," then we must go ahead and implement it. In this case my answer is a definite "yes." The second vital issue, and to the Bank of Israel this is the first issue, is the Bank of Israel Law. I would like to state at the outset that despite the fact that the Bank has been operating for 50 years under the same antiquated Law, it does a very good job. So why is a new law needed? Someone actually advised me that it is not worth my while to push for a new Bank of Israel Law. "Why not?" I asked. To which he answered, "Because currently you have all the power. You basically make all the decisions alone - on the interest rate and even on which of the various objectives specified in the Law you choose to concentrate." Honorable Members of Knesset, the Bank of Israel Law is not at all about how much power the Governor yields, or if it suits him to make decisions alone. The Bank of Israel Law is about constructing a mechanism that will strengthen the central bank and its ability to act for the good of the economy and the state. The existing Law is inappropriate for a modern central bank. It is true that for many years the Bank of Israel has had an ordered, professional decision-making process in which the relevant departments and professional parties are involved, which helped my predecessors to make decisions. Nevertheless, under the current Law the final authority and responsibility for decisions rests with the Governor alone. And that is not the optimal situation. Since the Bank of Israel was established 50 years ago, the attitude towards central banks - both world wide and in Israel - has undergone fundamental changes, regarding their objectives, their decision-making processes, the instruments they need to have at their disposal, and their obligations towards the government, parliament and the public. What, then, is required from the new law? First, a clear definition of the objectives of the central bank must be specified. It is important that we adopt the concept accepted throughout the world, and define the achievement of price stability according to a target set by the government - as the major goal. In addition, the Bank should also support the orderly activity of the financial system. At the same time it is important to specify that the Bank should support other objectives, such as growth and employment, as long as these do not undermine price stability. Second, the Bank must be given independence to employ the instruments needed to achieve its purposes, according to its professional judgment. This is obvious. Third, an ordered decision-making framework should be established, i.e., a monetary committee that will decide on monetary issues, and an administrative council that will decide on or authorize decisions on such issues as the Bank's budget and employees' salaries. Such systems will on the one hand ensure the Bank's independence in making decisions, and on the other will constitute an important control mechanism. This is necessary because independence must always be accompanied by responsibility and appropriate checks and balances. Fourth, a proper system of reporting and transparency should be established - reporting to the government, the Knesset and the public. I am currently working together with the Prime Minister and the Minister of Finance on the Bank of Israel Law in an atmosphere of mutual understanding regarding the importance of concluding this matter quickly. I hope that in the next few months a proposal for a new Bank of Israel Law will be laid before the Knesset, and with your valuable help we will at last celebrate the successful conclusion of this important process. Thank you very much.
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Remarks by Professor Stanley Fischer, Governor of the Bank of Israel, at the Rehovot Conference for Science and Technology, Rehovot, 9 June 2005.
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Stanley Fischer: The relationship between economic growth and science and technology Remarks by Professor Stanley Fischer, Governor of the Bank of Israel, at the Rehovot Conference for Science and Technology, Rehovot, 9 June 2005. * * * Esteemed Minister of Finance, Mayor of Rehovot, President of the Weizmann Institute, President of the Israel Academy of Sciences and the Humanities, Director General of the Ministry of Science and Technology, honored guests, ladies and gentlemen: It is a great pleasure for me to be here today, especially since this important event, the first Rehovot Conference for Science and Technology, is being held at this eminent and illustrious institution, the Weizmann Institute. When the organizers of the conference asked me for a topic on which I would lecture today, I decided to speak about the topic of “Is Economics a Science?” Later on, I realized that the Academy of Science and the Humanities had already made a decision about this matter when it chose my friend, Professor Menahem Yaari, to be its president. I concur with the Academy, of course: economics is indeed a science! Therefore, I will speak today not about the theme that appears in the conference program but rather about several results of economic research on the relationship between economic growth and science and technology. In this matter, it is natural to begin with work performed by the Nobel Prize laureate, Professor Robert Solow, almost fifty years ago. It is possible to write a production function showing that the level of production is the result of levels of use of factor inputs - especially of labor and capital - and of the level of technology. Solow asks, “What did greater use of labor and capital contribute to growth in the United States in the 1909-1949 period, and how much did technological progress contribute to growth during that time?” His famous answer was that more than 80 percent of growth during that period traces to the technological changes in the economy during those years. Solow’s answer was robust enough to have withstood many tests since then. In Solow’s work, the level of technology is an exogenous factor, meaning that it is determined outside the economy. In the 1960s, economists began to investigate the origins of the technological level, but in the 1970s, when immense macroeconomic problems began to crop up in almost every corner of the world, we economists turned our attention to problems other than growth. Since the 1980s, economic research has made a focused and intensive attempt to include the factors that affect the increase in productivity, within the framework of economic models, in what is known as “the new theory of economic growth.” The results of this new theory of economic growth are spelled out at length in an excellent book that my friend, Professor Elhanan Helpman, published in 2004 under the title The Mystery of Economic Growth. Allow me to present several of the main findings in capsule form: 1. International comparison shows that the main result of Solow’s work is correct. There is evidence that the differences in total productivity among countries - differences that originate in different levels of technology - explain more than 60 percent of the differences among these countries in per-worker income and growth rates. 2. Although growth has its ups and downs in the course of the economic cycle, the average growth rate of the global economy has been accelerating over time. By inference, the rate of increase in technological level in global economies has also been accelerating over time. 3. Education plays an important role in explaining the differences in growth rates and per-worker income from country to country and over time. 4. One important result: society earns a much higher return on an investment in research and development than the investor earns. Allow me to insert a parenthetical remark. There is a substantial difference between the marginal improvement of existing technologies and the development of new technologies that can serve many purposes - what we call multipurpose technologies. These are general- purpose technologies - such as mechanization, electrification, and computerization - from which other technologies derive many uses. The contribution of these technologies to productivity is large and long-lasting. However, it can take many years for an economy to assimilate multipurpose technologies. Furthermore, at the beginning of the process the rate of productivity growth in a given economy may even decline as the new technology crowds out antiquated technologies. Fifteen years ago, this led Robert Solow to postulate that the computer revolution is taking place in every part of the economy except for the productivity data. This situation, however, began to change in the middle of the 1990s. 5. Economists emphasize the importance of the openness of an economy for its growth rate. There is no economy in the world, in the modern era, that has managed to grow rapidly over a lengthy period without increasing its exports and its imports steeply. And on the technology side, countries have become interdependent due to the crossing of knowledge among them. It has been found the more a country’s trading partners invest in research and development, the more the country’s total productivity will increase. It is encouraging to see how greatly less-developed countries are benefiting from the R&D investments of the industrialized countries. These results, however, have a negative side: the investment in technological innovations may widen the gap between rich countries and poor ones. How can this outcome be prevented? Only by making a focused effort to rise to, and stay at, the forefront of global technology. And how can this be accomplished? By investing in education and by providing support for general and applied science-including research and development. This, however, is a complicated thing. Almost everywhere in the world, direct government intervention in R&D is regarded as a failure. There are two exceptions - Finland and Israel. The Office of the Chief Scientist in our country has been a success - even though it is necessary to continue investigating the factors that are responsible for our success and to draw inferences for possible changes in the future. Let me sum up this part of my remarks: 1. Increasing productivity is crucial for sustainable economic growth. 2. Being at the forefront of knowledge and of technological innovation is crucial for economic growth. 3. Countries that wish to stay at these forefronts must make sure that their pool of technological knowledge expands steadily. 4. Evidence from around the world speaks clearly about the importance for Israel of enhancing human capital in education and technological infrastructure, so that we stay at the forefronts of knowledge and technological innovation. These will lead to increases in productivity and per-capita growth. To bring this about, it is important to establish a correct set of incentives and a correct institutional structure. It is important to develop a set of incentives that will promote education, with emphasis on technological education, for the entire population. Concurrently, it is important to create various forms of incentives for processes that promote innovation and invention. 5. If I may, I would also like to address the relationships between growth and inequality and between inequality and poverty. The first result in regard to the relationship between growth and inequality is called the Kuznets curve. The data in Kuznets’ possession led him to believe that inequality rises at the beginning of the growth process and afterwards starts to fall. However, the data available back then were very scanty. It is now clear that there is no simple relationship between growth and inequality. The reason for this is simple: a. Inequality may be influenced by means of economic policy, including the education system. b. The relationship also depends on the origins of the growth, for example, the kind of technological progress on which the growth is based. As for the difference between reducing inequality and reducing poverty, we have to realize that poverty may decline even as inequality rises. This is happening, for example, in China. There may be a short-term substitution relationship between reducing poverty and reducing inequality. If such a relationship exists, then society has to decide where it wishes to be in the short term. I conclude by quoting remarks that my late friend, Professor Yoram Ben-Porath, wrote in 1986 in a book titled The Israeli Economy: Maturing Through Crisis: “The potential is there. Israel has a reservoir of human capital and a scientific infrastructure that can be used to increase productivity and expand exports. Its national determination, used to achieve political independence and self-defense, could also be harnessed to achieve economic independence. Thus, economic maturity may still prove to be a starting point for a new phase of sustained growth”. In fact, we are already on the right path. If we stay on it, we will be able to attain our potential fully and to take up a position alongside the most developed countries in the world.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Finance Committee, Jerusalem, 5 July 2005.
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Stanley Fischer: Capital market reforms in Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Finance Committee, Jerusalem, 5 July 2005. * * * Mr Chair of the Finance Committee MK Yakov Litzman, Members of Knesset, ladies and gentlemen: This is my second appearance here before you, and I am pleased that the subject concerning which you invited me is also one of the most important to have reached the Knesset in the recent past––the reform of the capital market in line with the proposals of the Bachar Committee. Let me clearly state at the outset that I support the reform proposed by the Bachar Committee. That is what I said a month and a half ago here when I first addressed you as Governor, and again last week to the participants in the Caesarea conference. When I say that I support the Bachar Committee reforms I mean the following: 1. I agree that the purposes of the reform have great impact on the financial system's ability to support growth in Israel. These purposes are: a.To reduce the concentration in the financial system and to increase competition in the capital market. b.To reduce the possibility of conflict of interest in the financial system. c.To create significant alternatives to the banking system as sources of finance. 2.I favor separating the provident funds and the mutual funds from the banks as this is a way of achieving all three of the above objectives. 3.I favor allowing the banks, after the above separation, to give objective advice about, and to distribute life insurance, pension schemes, provident funds and mutual funds, provided we find a way to prevent the banks from abusing the power and dominance they hold owing to their extensive distribution network to give them an unfair advantage. In this context the proposed restrictions on bank fees are intended to ensure that this will not happen. 4.I am in favor of banks known as emerging banks selling their mutual funds and provident funds as is proposed for the big banks and operating within the same framework proposed for the big banks. Otherwise the present potential for conflicts of interest will remain. We have recently heard from the emerging banks that they need the various funds to preserve their financial robustness. I believe that separation will not adversely affect their robustness; on the contrary, after the implementation of the reform of the capital market, the developments in the financial system, and in particular in the banking system, will lead to the creation of incentives to the emerging banks to find ways to strengthen their ability to compete with the big banks, including via mergers. The following serious questions arise in the course of discussions of the capital market reform: a. The stability of the banking system. I think that this will not be affected by the separation of the provident funds and mutual funds from the banks. The stability of the system depends on the quality of the asset portfolios held by the banks and the manner in which they manage them. I believe that when the banks focus on classic banking they will manage their portfolios even more efficiently than they do today. I am not saying that the banks are inefficient now; I am saying that they will become even more efficient. b. The stability of the financial system. In this regard too I see a great advantage in separating the funds from the banks. During the severe global financial crises in the 1990s we discovered that the broader the range of financial institutions a country had without any institution being dominant, the more stable was its financial system. This is the case because a problem experienced in one sector did not roll over into other sectors, and the system benefited from the flexibility to act efficiently. When our financial system is more diverse, we can have greater confidence in it. c.The concentration among banks. It is true that from the customers' point of view, initially there will not be any great changes. Nevertheless, the reform will reduce the dominance of the large banks in relation to the others, and this will eventually be reflected in a more competitive system. One important aspect of the bill placed before you as part of the reform of the capital market is the supervisory aspect. It is clear that this subject comprises an important basis for the reform of the capital market. On the one hand we hope to create a foundation in which the market––when it is competitive and free from conflicts of interest––will constitute an effective supervisory mechanism, but on the other hand we must strengthen the supervisory setup in order to ensure that the capital market really is more competitive and free from potential conflicts of interest. We therefore suggest that within the framework of the proposed legislation that you are considering, the Banking Ordinance should incorporate the authority of the Supervisor of Banks to issue directives on the proper conduct of banking business. This he would do after consultation with the Bank's Advisory Committee and with the approval of the Governor. With regard to the concentration in the banking system, the Supervisor of Banks is working to make it easier to move from one bank to another, which should have a direct beneficial effect on customers. I would like to add a few remarks from a personal angle: my standpoint on this matter is affected by my experience in the private sector in the last three years in Citigroup, the largest financial institution in the world. Five years ago Citigroup was a universal bank that encompassed commercial banking, investment banking, a large insurance company, pension funds etc. Originally Citigroup thought it to their economic advantage to own and manage a range of financial products. However, in 2003 and 2004 Citigroup decided to sell the insurance company, because after three years' experience they realized that a large bank such as Citigroup derived no financial benefit from owning and managing an insurance company. A few months ago Citigroup decided to sell their funds too. Charles Prince, Citigroup CEO, is quoted in one of the leading financial papers as saying that one of the reasons for selling the funds was the concern of the supervisory authorities, and not just them but also investors themselves, regarding potential conflict of interest that exists when a bank, in this case Citigroup, offers funds that it owns to the public. This concern made it less economically worthwhile to continue to do so. Prince remarked that other banks that owned funds would eventually reach the same conclusion. In this context I would also like to tell you what an analyst in an important financial company in Boston said. He commented, in reference to the sale of funds by Citigroup, that during the 1990s huge financial companies were anxious to merge financial intermediation activity with that of financial-asset management, such as funds. With regard to the potential for conflict of interest in the new reality created, he said that the distribution and management of funds are two distinct occupations that require different qualifications. Distribution is related to marketing and consultancy, and it is important for customers––both from the point of view of the supervisory authorities and from that of customers themselves––that the consultant be objective. That cannot occur, however, when the same bank holds the funds that it is trying to market and give advice on. I would say that a bank that owns funds has an economic advantage if it occupies a dominant position in the capital market and it faces no restrictions with regard to potential conflict of interest. But when a real mechanism exists that prevents such potential from arising, the bank apparently derives no economic advantage from such a situation. In Israel we tried to deal with this problem by erecting firewalls. By the way, that is what was done also in the US. But as we were to discover eventually, these firewalls in Israel were not effective enough, and all attempts to shore them up and increase their effectiveness were unsuccessful. In the US, because the banks––even the big ones, even Citigroup––are small in relation to the financial system and are not dominant in it, the firewalls worked, and market forces resulted in a bank like Citigroup deciding to sell its insurance company and its funds, for economic reasons. In Israel we have tried various methods of solving the problem, including firewalls, but without success. This is because the banks remained as dominant as they had been. That is why the Bachar Committee opted, and rightly so, to go in the direction of legislation. I hope that in time, once the reform has been carried out, when the banks in Israel are less dominant, market forces and economic considerations will also make the banks realize that it was not worth their while to hold a range of financial products, but to focus on areas where they have a comparative advantage. Then we can claim that the reform was really successful. Thank you very much.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Democracy Institute Conference on Economic Policy ('Caesarea 2005'), Jerusalem, 30 June 2005.
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Stanley Fischer: The Economic Stabilisation Program and its effect on the Israeli economy today Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Democracy Institute Conference on Economic Policy (“Caesarea 2005”), Jerusalem, 30 June 2005. * * * The Minister of Finance, the President of the Israel Democracy Institute, the Academic Director of the Caesarea Conference, honored guests, ladies and gentlemen: I am happy to be here today, at the Caesarea conference, surrounded by so many friends and colleagues. It gives me special pleasure to have been given the opportunity, for the first time, of participating in this celebratory "barmitzvah" conference as Governor of the Bank of Israel. As you know, the conference organizers thought it appropriate to hold a special event two days ago to mark twenty years since the Economic Stabilization Program of 1985 (the ESP). The older ones among us surely remember that twenty years ago, in the mid-1980s, Israel was wallowing in the throes of a deep economic crisis. Annual inflation had soared to three-digit figures, and everyone in the country-householders, businesses, factory owners-was engaged principally in the day-to-day search for ways to avoid the damages caused by hyper-inflation. Economic and financial instability did not simply occur by chance. It occurred against the background of an oversized government with a large, nay huge, deficit. Alongside the government acted a central bank which was far from being independent, as it was obliged to print money to finance the government's large deficits. The stabilization program introduced in 1985 was a turning point for the economy. Among those who formulated the program and propelled it forward were the then Prime Minister Mr Shimon Peres, the then Finance Minister the late Yitzhak Modai, my friends the late Professors Michael Bruno, who became Governor of the Bank of Israel, Eitan Berglas and Herbert Stein, and Emmanuel Sharon, Professor Nissan Liviatan and many others. For me, marking twenty years since the ESP closes an important circle, not only because since I participated in it I have become the Governor of the Bank of Israel. It is because the reality in which Israel's economy operates today is the outcome of the macroeconomic strategy that was launched then and that has been developing constantly, not without difficulties and occasional disagreements, right until the present. The Bank of Israel participated fully in the strategy, and more than once provided the main motive force behind it, particularly in the 1990s when we moved from foreignexchange control to free capital flows, from a fixed exchange rate to an exchange rate determined by market forces, and from inflation at a level of 15 percent to 20 percent a year to price stability. For these achievements we owe thanks to the previous Governors, Professor Jacob Frenkel and Dr David Klein. The government operates within a framework of long-term fiscal discipline the purpose of which is to reduce the burden on the economy of debt, taxation and government expenditure. The public in Israelhouseholds and the business sector-benefit from complete freedom in regard to foreign currency; the economy is an open one in the areas of trade and capital movements; the capital market is developing constantly, and the government has severely curtailed its involvement in it and in the economy in general; and the Bank of Israel pursues an independent monetary policy-mainly due to the NonMoney-Printing Law of 1985 which simply forbade the Bank to print money for the government's budgetary requirements. It is important to observe at this early point that the main target of that long-term strategy is the achievement of sustained growth which we all wish for. It is the basis for improved welfare of the whole population and for welfare policy that will deal with its weaker strata. And indeed, Israel's economy achieved a growth rate of over 4 percent in 2004, and although the data relating to real activity in 2005 are not unequivocal, it seems to us that growth for the year as a whole will be between 3.5 percent and 4 percent. Employment data so far show an impressive improvement, at least in the first four months of the year. Are these accomplishments enough, and can we now take it easy? Obviously that is a rhetorical question, the answer to which is a resounding "No!" Many important challenges still confront us: The main challenge is to continue to maintain the achievements that have been attained. Much work has been put into reaching this situation and much energy invested in it over many years. Relinquishing the accomplishments would soon take us back to where we were and make us start the whole procedure over again. That is too dangerous a game to play, and we should not consider playing it. One of the lessons I learned while at the IMF was that one can destroy in less than a year an economic achievement for which one worked for more than a decade-a lesson applicable not only in the field of economics. Now in particular, when the economy is stable and on a path of growth, we must constantly examine what potential situations could harm or weaken it, and what we must do to deal with them. Underlying all the above is the continuation of the macroeconomic policy based on the one hand on long-term fiscal policy, and on the other hand on monetary policy that acts directly to underpin price stability and support financial stability. The long-term path that the government decided upon-within the framework of the legislation that determines the maximum real increase in government expenditure (1 percent a year) and the budget deficit (up to 3 percent of GDP)-serves, together with the privatization policy, as bellwether to the required fiscal policy. In this context, the tax program recently adopted by the government also incorporates a component that supports a reduction of government debt. This fiscal arm of policy will contribute to economic growth. In the monetary area, it is essential that the Bank of Israel be able to continue acting, like other modern central banks, to preserve price stability in the long run, in line with the government's decision. Obviously I am referring to a new, up-to-date Bank of Israel Law. This is a vital issue to the Bank, and I will revert to it in greater detail further on. In addition to the macroeconomic strategy that I have described, the microeconomic sphere offers challenges too, of no less importance. I will refer specifically to an area currently on the agenda of the Knesset, and that is the reform of the financial markets, or the recommendations of the Bachar Committee. The reform is aimed at a) reducing the concentration in the financial system and boosting competition in the capital market, and b) lowering the chances of conflict of interests in the system. The Bank of Israel supports this reform. It comes together with several other structural reforms and instances of privatization that have taken place with the intention of giving households and the business sector greater freedom and flexibility. Alongside all the above, it is very important that we give attention to welfare policy. In the last few years the Research Department of the Bank of Israel has invested considerable resources to formulate recommendations in this field, and I intend this to continue. There is close cooperation with the Prime Minister's Office and with the Ministry of Finance, but not only with them. It is clear to us all that we must make a concentrated effort in the social area. Welfare policy must be focused, and should act along two channels: The first is to encourage people to go out to work, in other words, to raise the rate of participation in the labor force, a rate which is lower in Israel than in the OECD countries, and to help those who are working but earning too little to climb out of the poverty trap. The recommendation of the Bank of Israel in this regard is a negative income tax, or what is known in the US as an Earned Income Tax Credit (EITC). The second is to give assistance to those in the population who are unable to participate in the labor force, such as the elderly and the disabled. The social issue leads us naturally to the question of education including technological education. Education, which is available to all sections of the population, is important both from the aspect of growth and from the aspect of welfare problems. With regard to growth, education is important because a large part of growth must be based on increased productivity, on technological advance, and on a rise in the human capital of labor force participants-an area in which Israel has a tremendous advantage. It might be natural for an economist to speak of education in terms of productivity, but education has an extra importance in that it offers equal opportunity to all sections of the population, according to the individuals' abilities, to acquire skills that will help them to improve their situation. Finally, I said that I would revert to the question of the Bank of Israel Law. Twenty years ago I thought that the legal framework for central banks is not of such great importance. But after what happened until the mid-1980s I understood just how important it was to enact the Non-Money-Printing Law as part of the stabilization program. The fact is that a central-bank law affects the bank's ability to achieve the objectives of monetary policy. In essence, that is the reason why a new, modern Bank of Israel Law is of interest to each and every one of us as citizens of this country. In a spirit of mutual understanding, the Bank of Israel is actively cooperating with the Prime Minister, the Minister of Finance and their offices to promote the legislation, and to close another circle that started twenty years ago and that has taken long enough; it is clear that the time has come to bring this matter to an end-we must remember that 8 years have passed since the excellent report of the Levin Committee. The following are the most important aspects: First, the new law that we in the Bank of Israel propose clearly defines the independence required for a central bank, similar to the situation in other developed countries, but it is apparent to us that independence must go hand-in-hand with responsibility. The new law that we propose therefore also incorporates a clear system of decision-making mechanisms, of internal and public controls, and of reports to the government, the Knesset and the public. Second, on the side of its responsibility, the proposed law clearly defines the Bank's objectives: 1) maintaining price stability, according to the target set by the government, as the prime target; 2) supporting the government's other economic goals, including growth and employment, without harming price stability and the proper functioning of the financial system. This replaces the vagueness in the current Law. The economic literature states that the central bank will not have independence in its objectives, in other words, the law and the government determine the central bank's objectives. Third, the proposed law grants the Bank full independence to use the instruments needed to achieve its objectives. In the literature this is referred to as instrument independence. Fourth, with regard to decision making, two new bodies are proposed-a monetary committee and an administrative council. The monetary committee will make decisions in the field of monetary policy, and will report accordingly to the public. It is proposed that the Governor will chair the committee, which will have a majority of members from outside the Bank, who will be selected according to their qualifications in the relevant economic area and free of conflict of interests. The administrative council will authorize administrative issues such as the Bank's budget and staff salaries, and will report accordingly to the public. In this council too members from outside the Bank will constitute the majority; one of them will be the chairperson (not the Governor, who will be an ordinary member). The members from outside the Bank of Israel will be selected according to their qualifications in the business and administrative sphere, and will be free of conflict of interests. Fifth, the proposed law defines a system of periodic reports to the government, the Knesset and the public-annual, biannual, and quarterly-as well as a special report which the Governor will submit if the Bank consistently deviates from the price-stability target defined by the government. The question of the law, as I said above, is vital for the Bank of Israel so that it can operate in the future, in the near future I hope, in a legal framework that will describe precisely the goals of monetary policy, the areas of the Bank's responsibility, and the meaning of its independence. This is also important as part of the integration of Israel's economy into the family of advance economies. Thank you very much.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Globes Israel Business Conference, Tel Aviv, 5 December 2005.
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Stanley Fischer: Overcoming poverty in Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Globes Israel Business Conference, Tel Aviv, 5 December 2005. * * * Israel's economy is experiencing fairly rapid growth, an annual rate of 4.8 percent from the third quarter of 2003 to the third quarter of 2005. This is expressed by, among other things, improved figures of employment and unemployment, particularly in the business sector, as was shown in the data issued last week by the Central Bureau of Statistics. Against this background, and assuming that the government's macroeconomic policy will continue, the Bank of Israel published its forecasts for 2006, according to which GDP is expected to rise by 4 percent, and business-sector product by more than 5 percent. These are certainly high rates of growth. It is important to bear in mind, however, that the current favorable situation of Israel's economy did not simply occur by chance. It is the outcome of three main factors: the first is the state of the global economy; the second is Israel's macroeconomic strategy; and the third is the security situation. The first is external, and relates to the positive effects on Israel of the global economy, which is showing a clear growth trend. This is reflected inter alia by the expectation that the global growth rate in 2006 will be a relatively high 3.5 percent. The main domestic economic explanation for Israel's economic situation is the macroeconomic strategy decided upon. Thus, for the last two-and-a-half years a clear strategy has been pursued of reducing the government's share in the economy, and lowering the tax burden and the governmentdebt/GDP ratio. Yet despite the reduction achieved in the latter, there is still a very long way to go, as the ratio of government debt to GDP in Israel is still extremely high compared to that in other advanced countries. It is clear to me that had we not adopted the approach we did, we would eventually have had to pay the price, in the form of higher rates of interest in the financial markets and lower rates of growth and employment, among other things. At the same time the government spearheaded a series of structural reforms, such as those in the labor market, in the public sector, in the capital market, and in the ports; implemented privatization, e.g., of Bank Leumi, Discount Bank, Bezeq and El Al; and invested in infrastructures, such as in the railways. The steps already taken will continue to bear fruit in the future. But our work in these areas is far from over. The Bank of Israel is also playing its part in this strategy, mainly by carrying out an interest-rate policy that underpins price stability, according to the government's target, and supports financial stability. This strategy is essential, as it creates the conditions for sustained growth. The great importance to economic growth of the calm in the security situation - and expectations with regard to the peace process - must not go without mention; these have a positive effect on the economy, in particular via tourism and domestic and foreign investors' desire to invest in Israel's economy. Nevertheless, despite all the above we may not rest on our laurels. Various goals confront us, and I will refer to two of the most important ones: The first is in the sphere of Israel's economic strategy. We are already in an election period, and at the height of the democratic process. At such a time many questions raised in the past are raised again, and it is natural that this is accompanied by uncertainty regarding what is to follow. Since the Economic Stabilization Program of the 1980s, and especially since the 1990s, Israel's economy has followed the path to openness and exposure to the global economy and towards the adoption of economic norms based on those accepted in the advanced economies. It is of great importance that uncertainty in the political arena not be allowed to become uncertainty with regard to economic strategy in the broad meaning of the term. Clearly, Israel's economic strategy is not an end but a means to the very important objective of sustained growth. On the face of things it would seem that it is clear enough to everyone why that objective is so important, but it is worth focusing on one or two points in this regard. Continued growth is vital to enhance the welfare of Israel's citizens, to improve Israel's ability to attract immigration, including that from the advanced countries, to boost Israel's security, and to improve its ability to tackle its social problems, and in particular, to reduce poverty. This brings me to the second objective facing us. We must deal with social problems. This subject is important to all of us as human beings, and also as economists; after all, economics and society are two sides of the same coin. Responsible policy towards social issues is one which acts within the framework of the strategy described above, and which does not undermine it. It will be of little avail if we achieve economic growth long term and attain a European standard of living without attending to the social issues. But we cannot handle them properly without such growth, and would even quickly increase their severity. For example, one could deal with the question of social gaps by means of drastic hikes in taxes and transfer payments, but such a policy would also have a serious adverse effect on growth, and after a few years this would lead to a situation in which we would all be more equal, but also poorer. That is no way to attract immigration; on the contrary, it would boost emigration. And that is a position we do not want to be in. Before dealing with the social problems we should examine them realistically, as a sine qua non for formulating the appropriate policy. The problem of poverty is too complex to be viewed from only one aspect, and it must be analyzed from several aspects. For example, although here it is generally accepted to measure poverty in relative terms, and thus to consider the problem of poverty as a question of social gaps, we should be aware of other possibilities. To illustrate: poverty can be viewed in absolute terms, i.e., in such a way that the poverty line is determined in terms of the level of real income considered the minimum required to buy a certain basket of goods, such as food, clothing and housing. If we define the poverty line of 1997 as the level of income defining poverty in absolute terms, we would get the result that the rate of poverty, using this definition, hardly changed from 1997 to 2004, and actually went down a little. It declined until 2001, and rose somewhat thereafter. The Bank of Israel is engaged in this complex matter of measuring different aspects of poverty, and I hope that in the Bank's Annual Report for 2005, due to be published in the first quarter of 2006, we will be able to refer to the subject at greater depth, and that this will contribute to the public debate and to the formulation of policy on this issue. An aspect of poverty seen from another angle is the identification of the population that suffers most from poverty. We know that the highest incidence of poverty is in the ultra-orthodox ("haredi") and Arab sectors of the population, mainly because of the low participation rate of haredi men and Arab women in the labor force. According to an estimate we carried out, these sectors of the population account for more than 40 percent of the poverty in Israel. This is important for purposes of adapting policy instruments so that they are effective for these groups. Although specific steps for dealing with poverty are very important in the short run, there are other measures of equal importance for the medium and long terms, and these must not be forgone. One such is the attainment of continued growth as the basic solution to the problem of poverty. But that is not all. Another required step is a policy that will enable all Israel's citizens to realize their full potential. This would contribute to economic growth and help the more vulnerable to avoid falling into the poverty trap. In this context the following steps should be promoted: increasing the resources in the education budget allocated to the weaker strata in order to improve the ability of the next generation to achieve greater equality of opportunity; enhancing the government's system of professional retraining, with the focus on essential skills; encouragement of professional retraining by the business sector, for example by adapting the Encouragement of Capital Investment Law to focus on human capital; and extending the programs for providing adults with basic education. It is also important to promote policy measures to deal with the problem of poverty in the short term. Such a policy should be based on the principle of providing incentives for those capable of working, giving assistance to poor workers (in such a way that will encourage them to stay in the labor market), and providing relief for those unable to work, such as the handicapped and the elderly. The following are some examples of policy measures consistent with the above principles: the first is instituting a system of negative income tax. This is one step which the Bank of Israel supports, and which has featured in discussions held by the team headed by Yossi Bachar in which representatives of the Bank also participate. A second example is government participation in the costs connected with encouraging the weaker sections of the population to go out to work, for example, day care centers for children, and transportation. A third example is establishing a legal and supervisory infrastructure that would encourage the institution of reverse mortgages, which would enable the elderly to obtain a monthly income flow from the apartment they own. The Bank of Israel has been engaged in the subject of poverty for a long time, and has published position papers, policy proposals and many research papers on it. I hope that as the government's economic advisor we will be able to contribute on this matter, in two main fields: the government's social policy, and no less important, in the public debate on social problems, which are both of the highest importance. And as they are so important, we must analyze them extremely carefully, and in particular must understand that the problem of poverty cannot be resolved in the medium and long terms without persisting on the need for continued economic growth.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Annual Meeting of the Association of Banks, Tel Aviv, 24 November 2005.
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Stanley Fischer: Monitoring healthy and sustained growth in Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Annual Meeting of the Association of Banks, Tel Aviv, 24 November 2005. * * * I would like to start by thanking the Association of Banks for inviting me here, and for giving me the opportunity to address you. I would also like to take this opportunity to congratulate Eitan Raf and Galia Maor on the privatization of Bank Leumi. That is certainly an important event signifying the end of a sad era in Israel's economic history, an era which started with the collapse of bank shares more than twenty years ago, in 1983, and which obliged the government to nationalize almost the entire banking system. Now, at last, we have reverted to a situation in which the banking system has regained its natural position as far as ownership is concerned, and it is currently in the hands of the business sector. The main thing is to draw the right conclusions from the whole episode. Some lessons have been learned, viz. the reform of the capital market proposed by the Bachar Committee. But that is by no means the end of the road, and the important goals facing the banking system in the near future are related to it. I will revert to those goals later. The banking system plays a very important role in Israel's economy-it is affected by it, and affects it. Israel's economy does not stand isolated, however, but is part of the world economy. That is the result of the globalization process that has taken place since the end of World War II and particularly since the 1980s. Stated quite simply, Israel's economy cannot be reviewed in isolation from the global economy. The global economy is currently experiencing a growth trend, and according to various forecasts the global growth rate in 2006 is expected to be between 3.3 percent, according to the World Bank, and 3.6 percent, according to most investment houses. Europe's economy, which has merely marked time in the last few years, is also expected to show a growth trend. Nevertheless, these developments are not without certain risks. These are expressed by some acceleration in world inflation, expected to be close to 3 percent in 2006 according to most investment houses, and this brings in its wake forecasts of further rises in central banks' interest rates, not only in the US but in Europe too. These risks derive mainly from the trend of rising energy prices - specifically, but not only, oil prices. The problem of the US balance of payments has also cast a cloud over the global economy for a considerable time. Having said all this, the overall global picture is a relatively optimistic one. The same global growth is one of the factors providing a boost for the growth which Israel's economy is currently enjoying, but it is not the only one. Israel's growth derives from the government's macroeconomic policy during the last few years, expressed in fiscal discipline-in accordance with the fiscal targets it determined-and in a series of reforms (in the labor market, the capital market, the ports, etc.), privatization (of banks, and companies like Bezeq and El-Al), and investment in the infrastructure (for example in the railway system). Another aspect of the same strategy is the monetary policy pursued by the Bank of Israel, which focuses mainly on maintaining low inflation in line with the government's target. Against this background, and assuming that the government will persist in the macroeconomic policy, the Bank of Israel recently published its forecasts for 2006, which show an expected growth rate of about 4.3 percent for GDP, and an even higher rate of 5.4 percent for business-sector product. Investment is expected to rise by 4.5 percent, and it must be understood that economic growth in the last two years has not led to a resurgence of investments; if growth is sustained, the day will come when a resurgence of investments will provide it with additional momentum. It is only natural that at the present time, in the run-up to a general election, questions should arise as to whether these forecasts, and those from other sources, are still valid. We are in a period of political uncertainty, which goes together with economic uncertainty, even if we are talking of a relatively short period of a few months, and it is good that the period of uncertainty should be relatively short. It is therefore well worthwhile to dispel all this uncertainty here and now, at least in the economic area. It is vital that the new government, however it is composed, be committed to the same macroeconomic strategy and structural reforms that created the conditions for healthy and sustained growth. Domestic and foreign investors must be sure that this strategy is not at issue, and that everyone is committed to it. And it is important that they should feel that right away. On our part, the Bank of Israel will continue to pursue an interest-rate policy consistent with the inflation target of between 1 percent and 3 percent a year, with the intention of reaching the mid-point. The economy does have the problem of poverty, and this should, indeed must, be tackled responsibly by adopting the necessary measures. But it must be tackled with open eyes, with reality constantly in view, and with a commitment to the strategy of long-term growth. Without such growth, problems such as poverty cannot be resolved, and it is therefore essential that economic policy be constantly directed towards the achievement and maintenance of growth. As I stated at the outset, the banking system is very important in every economy, and of course Israel is no exception. The importance, however, clearly lies in the banking system being healthy, stable and competitive. I have also mentioned the important, even dramatic, development that affected the financial system as a whole, and in particular the banking system-and that is the reform proposed by the Bachar Committee. I am pleased to see that the banks, or most of them, are already preparing themselves for this, and sales of provident funds and mutual funds are already taking place, and with some measure of success, so it seems to us. When I see this I am happy that the pessimistic scenarios predicted by some are not being realized. In the past, too, such scenarios preceded successful reforms, for instance in the foreign-currency market. It is natural that concern is felt before reforms and changes, but it must be understood that Israel's financial system is in need of additional reforms. It is up to the banking system today, and to a great extent also up to the Bank of Israel, to prepare itself to confront the new targets it faces in a proper manner: At the top of the list I would put Basel II. The Bank of Israel has placed high on its list of priorities the preparedness of the Banking Supervision Department to adopt the rules of the New Basel Capital Accord (Basel II). This also requires the banking system to organize itself accordingly, and that is no small matter. The second target is gearing up to meet the internal audit standards set out in Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX 404"). This subject is also high on the priorities of the Banking Supervision Department, and of the whole banking system, and will be for the next two years. I have learned from my experience in Citigroup that SOX 404 is a burden, but I also know that it greatly improves management's internal control. These two important projects together constitute an overall format of management and control that will instill the highest standards in Israel's banking system, standards consistent with the most advanced world wide. The third target relates to the implementation of the Bachar reform. This involves the sale of provident funds and mutual funds by the banks; redefining banks' activity and profit centers in general and in the capital market/their capital-market activity; reorganization in the field of consultancy regarding pensions; preparations for competition in the credit markets from nonbank alternatives, etc. The fourth target is for the banking system to face up to current and future changes (we hope) in the capital and money markets, for example, the development of the interbank market following the abolition of transactions with "previous day's value date" by the Bank of Israel; future development of sophisticated financial instruments; future development of mortgage securitization; and the introduction of the Real Time Gross Settlement (RTGS) system in which the Bank of Israel is deeply involved. Obviously that is not the whole story. These targets will result in a more efficient banking system and in greater competition in the capital and money markets and in the credit market. Competition on the retail banking side leaves much to be desired. Although some steps have been taken to improve competition in this area, such as the directive issued by the Supervisor of Banks making it easier for customers to transfer from one bank to another, the situation is still far from satisfactory. As long as there is no increase in the number of large banks - whether through the merger of small and medium banks or through the entry of foreign banks into the field of full retail banking in Israel - we will have to continue examining ways of removing the barriers in this area. It should be clear that this goal of strengthening competition in the banking system is one of the prime objectives of the Bank of Israel, and, I would assume, of every government in Israel.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Sixth Herzliya Conference on the Balance of Israel's National Security, Herzliya, 24 January 2006.
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Stanley Fischer: Israel’s economic agenda Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Sixth Herzliya Conference on the Balance of Israel's National Security, Herzliya, 24 January 2006. * * * Ladies and Gentlemen. This year, and specially today following the publication of the Poverty Report, public debate relates in one way or another to the issues connected with growth and social problems. I would like to share with you some thoughts on various topics on Israel's economic agenda for the next few years. This is a good opportunity to do so, not only because this conference provides a good setting, but because we will soon be electing a new government that will have to make decisions about that agenda. 1. Economic developments in Israel in 2005 First I would like to devote a few words to Israel's economic developments in the year just ended. The picture that emerges from the initial estimates of the National Accounts published by the Central Bureau of Statistics is one of an economy growing nicely, with GDP increasing by 5.2 percent, with business-sector product leading the way with a fine 6.6 percent rise. On the uses side, goods and services exports, with a 7 percent increase, topped the list, followed by domestic investment, which rose by 6.5 percent. In addition, together with the relatively rapid growth, the unemployment rate went down and employment rose, especially in the business sector. Against this background, and assuming that the next government will follow the same macroeconomic policy, an assumption which appears eminently reasonable, the Bank of Israel's forecasts for 2006 are of a 4.3 increase in GDP, and 5.4 increase in businesssector product. In other words, relatively high growth rates are expected this year too. When I repeat over and over again, at every opportunity, how important it is to persist with this economic strategy, I do so because without this strategy we will not be able to create the conditions necessary for long-term growth. In the context of this strategy, the government has for some years pursued a budget policy of long-term fiscal targets directed to reducing the government's share in Israel's economy, and lowering the tax burden and the government debt/GDP ratio (I will revert to this in greater detail later). At the same time the government introduced a series of structural reforms, and undertook privatization and investments in the infrastructure. The Bank of Israel is making its contribution mainly by following a monetary policy, i.e., an interest-rate policy, that acts to strengthen price stability, in line with the government's target, to help economic growth and employment in the long run, and to bolster the stability of the financial system. This strategy is a fundamental factor, but not the only one, that has enabled us to grow. To complete the picture we must relate to the global economy and the security situation. With regard to the world economy, its growth in the last few years has greatly assisted our economic recovery and the growth momentum we are now experiencing. It is therefore important to bear in mind that Israel's future growth will be affected also by future global growth. The latter is expected to be about 4 percent in 2006. Of course we must be alert to the risks to global growth and see whether they will really affect it. I mean the possibility that energy prices, particularly oil prices, will continue to rise, the effects of the rise in interest rates world wide, and the possibility that the US economy will grow more slowly than originally estimated. As far as the security situation is concerned, it is clear that a state of calm, and specifically expectations of a peace process, have a positive influence on Israel's economy and thus constitute a very important factor. This is expressed in particular via tourism and domestic and foreign investors' willingness to invest in Israel. 2. Topics for discussion I will now turn to several issues of economic importance for the coming years. I would like to do this by relating to some aspects of economic policy; this is not, however, a comprehensive economic agenda. • The first subject I would like to address is that of the government's budget policy, and in this context I would stress the need to boost the reduction in the debt/GDP ratio. • The second item is the policy of increasing competition in the banking system, and more generally in the financial markets overall, including the need to reinforce the legal infrastructure required to enable the modernization and streamlining of the markets. • The third subject is that of social policy. Here I would emphasize the issues of growth, education (including the changes necessary in the financing of higher education) and health as the cornerstones of this policy. a. Budget policy For more than two years the government has acted within a framework of fiscal targets, as I mentioned above, one of whose aims is to bring about a sharp and persistent reduction in the government's share in Israel's economy, and a reduction in the government debt/GDP ratio. There are three important reasons for concern over this ratio and for stressing the need to lower it: The first is the burden of servicing the government debt in GDP. Lowering the debt/GDP ratio would reduce the burden of interest payments in both GDP and the budget. As the debt/GDP ratio is very close to 100 percent and the average rate of interest paid by the government on its debt is about 6 percent a year, it transpires that the burden of servicing the government debt is about 6 percent of GDP. This means about NIS 33 billion a year! A huge amount by any measure. To put this in perspective, let me say that if the debt/GDP ratio were to fall to about 50 percent, a reasonable ratio by international standards, interest payments would fall to less than 3 percent of GDP and less than 8 percent of the budget, because the interest rates would fall, and about NIS 17 billion a year would be available for other economic uses. The second reason for concern about the debt/GDP ratio is the economy's sensitivity to external shocks. With debt/GDP ratios as high as Israel's, the government budget and the economy are very sensitive to shocks such as changes in interest rates abroad, particularly for the medium and long terms. As the financial markets are well aware of this, it affects Israel's credit rating and thus also the rates of interest that the government and the business sector must pay in the capital markets to finance their activities. The third reason, no less important, is that reducing the debt/GDP ratio would enable the government to implement a countercyclical budget policy. In other words, at times of recession in economic activity, the government could adopt a policy of tax cuts and perhaps increase its expenditure to encourage a rise in demand and thereby contribute to quicker recovery. That is what the US did in 2002 when the recession started there. And that is what Israel, Germany and France were unable to do at that time. Why not? Because a countercyclical policy in a recession increases the budget deficit, and hence the debt, too quickly. And if the debt/GDP ratio is already too high, as in our case, a countercyclical policy is dangerous as it is likely to cause a financial crisis, and that just in the midst of a recession. Thus in such a situation the government cannot permit itself to carry out a countercyclical policy, but must cut its expenses and even raise taxes, also in the midst of a recession. It is important to grasp that I am not describing some hypothetical scenario but the situation that prevailed in Israel in 2003. Then, to our relief, the government took the correct measures that re-established economic stability.Nevertheless, it is important that we do not find ourselves again in the same state as in 2003, that is, a state in which we need to pursue a countercyclical policy but are unable to do so because of the size of the debt. This description brings to mind Pharaoh's dream of the seven good years followed by the seven bad years. We are currently on the growth part of the business cycle, and we should utilize this period to cut the debt/GDP ratio. This is especially the case as we do not know how long this period is likely to continue, and we must take into account the very real possibility that it will not last forever. In the current growth phase there are two main channels through which the debt/GDP ratio can be reduced: • From the aspect of the size of the debt, as the budget deficit is reflected in the size of the debt, it is important that the deficit be low. In 2005 the budget deficit was 1.94 percent of GDP. That was an important achievement. We ought to continue reducing the deficit this year and in the next few years, and this is easier to do now, in the good years. • From the aspect of GDP, the faster it grows the faster the debt/GDP ratio falls. In 2003 we reached a position where the ratio was 104 percent, and it looks as if the ratio in 2005 was slightly below 100 percent. This reduction was the result of the low deficit, rapid growth and the proceeds of privatization. Although Israel's debt ratio declined in 2005, it remains very high by international standards (in most of the OECD countries it is between 40 percent and 60 percent). We still have a long way to go. b. Competition in the financial markets I turn now to the question of increasing competition in the financial markets and their reform. The reform of the capital market, centered on the separation of the various funds from the banks, is an historic event, but it is not the end of the story. The team headed by the Director General of the Ministry of Finance, Yossi Bachar, determined subjects that should be acted upon as the next steps in the reform, for example dealing with the matter of Repo transactions, and examining the structure of supervision of the financial markets. The committee formed by the Securities Authority also put forward recommendations regarding securitization, and it important that these be advanced too. And there are many other subjects. Among the required changes, however, it is also important to draw attention to the arrangement of the necessary legal infrastructure. At present we are in the throes of a very long legislative process that is not yet over in relation to a law to deal with Repotype financial transactions and the issue of netting. But there are several other laws that it will be necessary to advance, for instance a law that will relate to mortgage and loan securitization in general, and a law relating to the reform of the payment and settlement systems that the Bank of Israel is leading (the RTGS system). The government should certainly give maximum impetus to the promotion of the legislation in these areas. Such legislation is one of the most important means for removing barriers to the development of the capital market as it sets the ground rules for the market, rules of transparency, and grants supervisory and enforcement authority to the relevant bodies. With regard to the development of and competition in the financial markets, I would like to say a few words about competition in banking. The reform of the capital market introduces greater competition into the financial systems, especially in the credit market, but competition between the banks on the retail side leaves much to be desired. This is mainly due to the fact that the largest two banks are very dominant in the banking system. Their share in the system should be reduced, either by the merger of other banks or by the entry of foreign banks into retail banking in Israel. Such steps are the outcome of decisions by the banks themselves, but we on our side will continue to examine steps to remove barriers where they exist in this area and in the area of increased interbank competition. Boosting competition in the banking system is one of the most important objectives of the Bank of Israel and, I assume, of the government. c. Social policy As far as social policy is concerned, I do not wish to refer here to the short-term measures required. I have referred to them at length on various other occasions, and today Dr Karnit Flug, Director of the Bank of Israel's Research Department has spoken about them. I would only say that the steps decided upon in the discussion with the Prime Minister last December are important and the right ones. Here I would like to refer to the long-term measures needed, as these are the foundation of the required social policy. First, it is important to continue focusing on a policy that serves to create sustained growth, which is vital for the enhancement of the economy's ability to cope with the social problems––especially the reduction of poverty. Second, it is important to focus on education and health for the entire population, including its weak groups. The accessibility of better education and health to the weaker groups is very important, to provide them with equal opportunities to realize their potential and to progress in the labor market.
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Acceptance speech by Professor Stanley Fischer, Governor of the Bank of Israel, for an Honorary Degree, Hebrew University, Jerusalem, 11 June 2006.
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Stanley Fischer: The Israeli economy Acceptance speech by Professor Stanley Fischer, Governor of the Bank of Israel, for an Honorary Degree, Hebrew University, Jerusalem, 11 June 2006. * * * It is a pleasure and an honor for me to speak today as the recipient of an Honorary Doctorate of Philosophy from the Hebrew University, and it is an even greater honor to have been asked to speak on behalf of my distinguished fellow honorees. I would like to start by congratulating the students on whom doctoral degrees are being bestowed today. You have earned the congratulations and good wishes of all for the ability and dedication you have shown in completing your doctorates, and we wish you every success and happiness in your future careers. By European and American standards, this is a young university. Its founding ceremony took place in 1925, at this spot, in the presence of Lord Balfour, Viscount Allenby, High Commissioner Herbert Samuel, Haim Nachman Bialik, Nahum Sokolov, Harav Kook, Harav Meir, and 10,000 others. That extraordinary turnout testifies to the importance the inhabitants of the Yishuv and of the Zionist movement attached to the founding of what they called the University of the Jewish people. The University already possesses a proud history, an essential part of the history of modern Israel, of the history of the Jewish people and their successful but ongoing struggle to establish a modern state in the ancient land of our forefathers. Each of the honorary degree recipients here has been closely associated with the Hebrew University in the past, and for each of us this day brings back memories, of times, of colleagues, of friends. In my case among the personal memories are those of Don Patinkin, former President of the University, of Yoram Ben-Porath, also a former President of the University, and of Michael Bruno, former Governor of the Bank of Israel. And for many of us, this spot and this occasion will always be associated with the image of Yitzhak Rabin, receiving an Honorary Degree from the University immediately after the Six Day War. For me, the Hebrew University has always been special. When I graduated from the London School of Economics it was at the Hebrew University that I most hoped to teach. Later I did teach here, but as a visitor on sabbaticals, not as a faculty member. This is the community in which Rhoda and I have formed some of our firmest and most lasting friendships. Each of my fellow honorees can talk of the friendships and the attachments they have formed among this community of scholars and in this city. And every one of us will attest to the joy and the pride we feel at being recognized by our colleagues of the Hebrew University of Jerusalem. I have been asked to talk today about the Israeli economy. In brief, the economy is doing well. It grew by 5.2 percent last year, and the data for the most recent quarter show an acceleration of growth. Current forecasts are that the economy will grow by about 5 percent this year again. The budget deficit last year was below 2 percent, and it is likely to be below 1 percent this year. Our inflation rate is low. The exchange rate of the shekel is remarkably stable despite – or perhaps because of – the fact that the Bank of Israel has not intervened in the currency markets since 1997, and does not intend to do so except in truly exceptional situations. We have a current account surplus. The unemployment rate is declining, though unfortunately we have not yet seen a decline in the poverty rate. We are about to enter the fourth year of growth that began in the middle of 2003, at the end of the deepest recession in the history of Israel. That recession started late in 2000 as a result of four adverse shocks to our economy: the collapse of the high-tech boom and the Nasdaq bubble that had enabled so many Israeli high-tech startups to flourish; the global recession that started in 2001; the tailing off of the immigration from the former Soviet Union to Israel; and the second intifada. It was worsened by an inconsistent set of policy responses to the recession. By 2003 the global recession was ending, and in 2004 growth was higher than it had been in twenty years. The high tech sector was recovering. The security situation in Israel improved markedly. And the Israeli government in 2003 committed itself to a fiscal framework designed to restore confidence in Israel's ability to finance itself, to reduce the share of government spending in the economy, and gradually to reduce the tax burden. The government also initiated a program of structural reforms, including privatizations that had been talked about for at least 20 years, and reforms of the benefits system designed to reduce disincentives to work. Over the past three years the government has carried out the program to which it committed itself. This, together with a well-defined inflation-targeting approach to monetary policy, has contributed to strengthening the confidence of Israelis and of foreign investors in the Israeli economy. That confidence is manifest not only in the recovery of growth, but also in the relative stability of our financial markets and of the shekel, most evident during the last few weeks in which general concerns about emerging market countries have led to significant currency depreciations and sharp stock market declines in other countries. This is an impressive performance. But we need to set it in perspective. It was only in 2005 that per capita income in Israel returned to its level in 2000. If we are to move beyond our current status, where our income level is about that of the poorer European countries, below Spain, above Portugal, close to that of Greece, we need to keep growing, and rapidly. Per capita income in Israel is about $18,500. If the economy grows at 5 percent for the next decade, we will reach a per capita income level above $25,500. That would make a real difference to our standard of living and our ability to contend with the range of issues facing us, including poverty, and the security situation. What would it take to keep the economy growing at a rapid rate for a prolonged period? First, a factor that is beyond our control: the global economy needs to keep growing. Second, a factor that is partly under our control: our security situation. Standing here, on the eastern side of Jerusalem, with a view behind us to the West Bank, we must be aware of our need to find a way to live with our Palestinian neighbors. Third, a set of factors that is entirely within our control: our own economic policies. We need a general approach to economic policy that relies primarily on markets to allocate resources, while recognizing the essential role of the state, especially in the provision of public goods. At the same time, we need to accept the fact that no small economy can flourish except by integrating into the global economy, as Israel has so successfully done over the past fifty years. Indeed, the opening of the capital account in the last fifteen years, the end of foreign exchange controls, has had a profound and positive effect on the entire economy. In macroeconomic policy, we need to maintain the fiscal discipline that has served us so well for the past three years. We still have a government debt to GDP ratio that is too high and that makes us vulnerable to any serious loss of confidence in the Israeli economy, by Israelis and by foreigners. To reduce the debt to GDP ratio we need to keep budget deficits small, and we need to keep growing. Government spending as a share of GDP in Israel is still very high by international standards, and needs to be reduced. Tax rates should continue to decline, as already planned. It is possible to do all that while leaving room in the budget to increase social and other essential government spending. We can help alleviate poverty in the short run by restoring some of the cuts in welfare spending, particularly for the elderly and for the disabled, which were undertaken to get us out of economic crisis three years ago. But in doing so, we need to maintain and strengthen incentives to work for those able to do so. In the long run, the best way to improve the welfare of the poor is through growth. And in the long run, growth comes primarily through technical progress, through improvements in knowledge and the ability to apply that knowledge to production. That is obvious in Israel, where the high-tech sector has played such a prominent role in our growth. Here is where higher education and the universities come in. The creation of the Hebrew University is in many ways a miracle. It was no small matter to establish a university that meets international standards in a community as small as that of the Yishuv in Palestine, as far as it then was from the centers of academic life. Idealism, Zionism, and – sadly – the destruction of the Jewish communities in Europe, helped strengthen the University in the pre- and post-World War II periods. It is also no small matter to have established a system of higher education as good as that in Israel. But the university system is under serious strain. At one time almost all Israelis who went abroad for Ph.D's returned. Now most do not. That is partly a matter of relative salaries, it is also a matter of the unavailability of positions. If the universities are to remain strong, indeed to become stronger, and to help keep Israel at the scientific frontier, they need more money. That money does not have to come from the government. Some of it can come from the licensing and sale of intellectual property, an approach in which the Hebrew University has been very successful. But that will not be enough. To strengthen the universities, it will sooner or later be necessary to charge more to the students receiving university education. That can be done without compromising the right to a higher education of any qualifying student, for instance through some variant of the Australian plan which provides loans to students, which they repay as they enter the labor force and begin to earn. In the past Israeli students have strongly objected to any significant rise in tuition. That is understandable. But significantly higher tuition payments are needed to enable the universities to attract the faculty they need and to continue to contribute to advancing Israel's technological progress and prowess. In concluding, I must apologize for making so utilitarian an argument for strengthening the universities. For a good university is far more than a source of technological progress; it is a repository and source of knowledge, of culture, of values, of civilization. That too is why a society – why Israel – needs to cherish and support its universities and its system of higher education. Thank you.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the celebration of the 50th anniversary of the Paris Club, Paris, 14 June 2006.
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Stanley Fischer: “The Paris Club at Fifty” Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the celebration of the 50th anniversary of the Paris Club, Paris, 14 June 2006. These remarks were prepared for presentation at the ”Fiftieth Anniversary conference of the Paris Club”, to be held in Paris on June 14, 2006. I am grateful to Mark Allen of the IMF for helpful discussions. * * * It is a pleasure and an honor for me to take part in this celebration of the fiftieth anniversary of the Paris Club – both as a former official of the IMF, who learned so much from the former Chairman of the Paris Club with whom I had the pleasure of working for over five years, and as Governor of the Bank of Israel. The Paris Club is the gifted child of the French Tresor. But it is also in many ways a British institution – and I take that to be a compliment. It is a club, a voluntary gathering of interested parties, it operates without a written constitution, it operates case-by-case, and it displays a remarkable pragmatism and flexibility that has enabled it to evolve and deal with an enormous variety of debt problems over the years – over 400 agreements with over 80 debtor countries and more than $500 billion rescheduled. In performing its essential task, it has stood the cause of development well over the past fifty years. And at the age of fifty, it faces new challenges that ensure that it will have to continue to evolve with the times. I. Debt relief Like the Bank for International Settlements, the Paris Club grew out of the need for debt relief – a need which has been with us for as long as debt has existed. In gradually developing a flexible set of rules for granting relief on inter-governmental debts, mostly the debts of developing countries, the Club has made a major contribution to the orderly operation of the international financial system. The principle of conditionality is critical. By making the conditionality that of the IMF, the Paris Club gained at least two major benefits for the international community: that of operating with the Fund’s skilled professionals, who understand how to design and monitor an economic program; and the legitimacy of operating within an institutional framework in which both the creditors and debtors are members. In turn, by putting the IMF at center stage in developing and enforcing conditionality, the Club contributed to the development of the Fund’s analytic and operational approach. There are nonetheless major questions about the effectiveness of the combination of conditionality, concessional loans, and debt relief. These can be summarized by recognizing that many countries that received conditional debt relief once, received it again – and again. The underlying question is why it has turned out to be so difficult for many of the poorest countries to begin to grow on a sustained basis, despite receiving aid that amounted to double digit percentages of their GDP over long periods, and despite being in IMF and World Bank programs. I suspect that if we were to go back to the participants in Paris Club discussions in the fifties and sixties, they would say that income levels in many of the countries whose debts they rescheduled are much lower today than they would have imagined in their most pessimistic moments. These concerns relate mainly to some African countries. Many African countries have been growing more rapidly recently, so maybe we are beginning to turn a corner. The renewal of growth is helped by the global commodities boom, and the fact that several African countries are now exporters of oil. Developments in South Africa are encouraging, and South African growth affects the countries around it. Nigeria too is making progress, helped by a Paris Club agreement and by the price of oil. But the facts remain that the number of people in poverty in Africa is increasing, that a greater share of the world’s poor live in Africa than ever before, and that AIDS and other diseases are exerting a devastating effect on populations in many countries. It is easier to raise questions about the effectiveness of conditional debt relief than to answer them. For the problem is not particularly that of conditional debt relief, it is rather the question of what development strategies are most likely to succeed. I will not go into that question in any detail now, beyond saying that while we know many of the necessary conditions for growth, we do not yet know the sufficient conditions. Over the course of its lifetime, Paris Club rescheduling became increasingly far-reaching. The original approach of flow rescheduling combined with new money lasted for about thirty years. In the late 1980s under the Brady Plan, Paris Club reschedulings began to include relief on the stock of debt. Now we all know that to a first approximation what matters is the present value of the debt, so that there is no difference in the economics of flow versus stock reschedulings. 1 Nonetheless the shift from flow to stock debt reduction was a major change, in part because budget accounting in some countries made stock reduction more difficult politically – and in part no doubt because once the principle of not reducing the stock of debt was breached, there was only one logical resting point for the process. That resting point is the cancellation of all outstanding debts, and a switch from loans to grants. That approach has now been accepted by first the G8 and then by most of the creditor nations, in several cases reluctantly. So long as net transfers to the countries in need of aid rise, the grant approach is obviously better from the viewpoint of debt sustainability, ceteris paribus. But it is not yet clear that net transfers will rise as the approach to aid switches from loans to grants. Indeed, the main argument against the new approach is that it may reduce the net flow of aid to countries most in need. It remains to be seen whether that will be the case. In discussing loans versus grants it is sometimes argued – and I confess to having sometimes argued – that by making loans rather than grants, the donors encourage greater responsibility on the part of the recipient governments who have to contemplate repaying the loans. The fact that these loans often have long grace periods, and that governments often have short horizons, reduces the plausibility of this argument. I put more weight on a related argument: that for many governments it is politically easier to make concessional loans rather than grants, and that the IDA cum Paris Club approach in effect turns these loans into some sort of high-risk but concessional bond claim on the recipient country. Those who believe aid is in any case ineffective would see a reduction in aid as a benefit of the new approach. I continue to believe that aid targeted to particular needs, including health and education, and project aid can be useful and should be supported if the circumstances are reasonable, and that for governments following the right policies, general budgetary assistance can also be productive. On balance I believe the empirical evidence supports this view. But there is little doubt that the overall record of the aid process is disappointing, that in some cases aid failures are associated with serious government corruption, and that the aid process itself may contribute to government corruption. All these issues have come to the fore in the last decade, and the increasing attention they have been receiving should help improve the record. II. On the creditor side The Paris Club solved the free rider problem by seeking to bring all the major creditors into the Club, by requiring a consensus for each decision and requiring participant creditors not to seek better terms outside the framework, and by insisting that the debtor not give better terms to any other creditor. Because the Club does not require uniformity of treatment among different debtors – a principle which would be difficult to enshrine in a written charter – it has shown considerable flexibility and ingenuity in dealing with the different forms in which creditors are willing to provide relief, and in inviting relevant non-Paris Club members to take part in meetings as needed. Of course this also means that political considerations visibly play a role in deciding on the treatment each debtor receives, but that is hardly surprising when inter-governmental debt is being considered. For many years the Paris Club protected the senior status of the IMF and the World Bank, and did not request any debt reduction on their part. The logic of this approach was quite simple: generally the Fund and the Bank provided new money. This principle has now been breached, and it remains to be seen what the long-term consequences will be. But we should recall that countries include claims on the Fund as part of their reserves, and that at the time of the HIPC debt relief decision, at least one major country said that it would have to reappraise that view. While the Club is able to produce an acceptable extent of comparable concessions by official creditors operating within its framework, it has increasingly had to deal with the issues arising from the growing In addition, liquidity is likely to be important for a country without market access role of the private sector in financing developing countries, and those that result from the growing importance of official creditors who are not members, prominent among them China. There are two issues with regard to the role of the private sector. The first is the pace at which countries that have received debt relief begin borrowing from the market. So long as a country is in an IMF program, the Fund has been able to exert some – though not necessarily a decisive – influence on the rate of government borrowing from the private sector. If the country has exited from an IMF program, it is left to market and internal fiscal discipline to control its rate of borrowing. We need to remind ourselves that until very recently we were in a phase of optimism about the emerging market and developing countries, with plentiful liquidity, and that these conditions could change. At that point we might discover that market and internal fiscal discipline may not be sufficient to prevent problems in the event of a reduction in capital flows to developing countries. The second problem arises if debt rescheduling then becomes necessary. At this point coordination and equality of treatment between public and private sector lenders becomes difficult, and the Paris Club has yet to arrive at a fully satisfactory solution. In addition, some members of the private sector argued that the claims of the Fund and the Bank should be included in any restructuring. This demand was clearest in the Argentine case, where some private sector participants demanded that the IMF also agree to debt reduction. The logic of this claim on the organization which operates as an emergency lender was not clear. The issue of private-public sector coordination in lending and debt restructuring poses a delicate problem for the official sector, which after all would prefer countries eventually to finance themselves through the markets – provided they do so in a sustainable way. The principles of debt restructuring proposed by the IIF, and described in more detail by Jacques de Larosiere in his comments this afternoon are useful in themselves, but putting them into practice will not be easy in individual cases. This was evident in the Argentine case, but that perhaps was exceptionally difficult. Most recently, the Paris Club has become concerned that countries that have received debt relief are borrowing heavily from other official lenders, who are not members of the Club, notably China. The concerns here are that countries may be taking on more debt than is wise, and that in the event the global financial situation changes, future debt restructurings will be much more difficult than those of the past. The answer to this concern may well lie in the wider context, in which the global financial architecture that was developed after World War II needs to adapt to the presence of important new players, among them particularly the BRIC countries. As these new players from Asia and elsewhere begin to take more responsibility for the system, and as the system gives them and their concerns a greater role, they may begin to appreciate the importance of existing institutions, formal and informal. And we may be sure that in any case, the ingenuity and pragmatism that the Paris Club has demonstrated in its first fifty years, will continue to contribute to the development of the international financial system and its ability to deal with official sector debt difficulties. Thank you.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Democracy Institute Conference on Economic Policy (Caesarea Conference 2006), Jerusalem, 22 June 2006.
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Stanley Fischer: The Israeli economy, the government’s budget policy and the problem of poverty Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Democracy Institute Conference on Economic Policy (Caesarea Conference 2006), Jerusalem, 22 June 2006. * * * Finance Minister, president of the Israel Democracy Institute, conference chairman, Professor Barbara Solow, Professor Robert Solow, honored guests, ladies and gentlemen. The Caesarea Conference always provides an exceptional opportunity for intensive and exciting gatherings of policy-makers and economists, representatives of the business sector and the public sector, and leaders of public opinion. I am delighted to be here – it's my second opportunity to appear here as Governor – and I thank the Israel Democracy Institute for this opportunity. I will begin with a description of the economy, and will then proceed to the government's budget policy and the problem of poverty. As you hear my address, you may feel a sense of déjà vu, as if you heard the same words yesterday in the Finance Minister's speech. But I can assure you that the two speeches were written separately and any similarity is purely coincidental. In any case, it bodes well for the continued cooperation between the Bank of Israel and the Treasury. As you well know, the Israeli economy has now enjoyed three years of strong growth. According to the Bank of Israel's latest forecasts following the publication of the National Accounts figures, GDP will grow this year by a rate of 5 percent. We are seeing strong growth, with increased investments, growth in exports, stable prices, interest rates similar to those elsewhere, a balance of payments surplus, a rise in productivity and an improvement in employment figures. With regards to employment, though the jobless rate is still high, it is on a downward path and in the first quarter of the year it stood at 8.7 percent, down from 10.9 percent in 2003. For comparison, the lowest unemployment rate in the past 15 years was 6.3 percent in 1995. The economy has opened up greatly to the global economy and to show this I will point out that, in 2005, exports accounted for 38 percent of GDP and imports, 42 percent. On the financial side, in the capital account of the balance of payments, nonresidents' investment in Israel reached 8.7 percent of GDP last year, a similar rate to Israelis' investments abroad, which were 8.2 percent of GDP. These all demonstrate the fact that, following liberalization, the Israeli economy is now completely open to the free flow of capital. As for inflation, the Bank of Israel continues the policy of maintaining price stability. Looking back over the past 12 months, inflation has reached 3.5 percent, half a percentage point above the upper limit of the government's inflation target range. However inflation is expected to return to within the range soon. At the same time, forecasts and expectations of inflation from the capital market are around the middle of the target range – at about 2 percent – with the markets and forecasters estimating that the interest rate will rise by about half a percentage point by the end of the year. Apart from two central problems that need treatment – poverty and the burden of debt in terms of GDP – the economic situation is very good. This reality is the result of a number of factors: background and policies. The background factors are the global economic development and the security situation. For example, if the global economy slows down or even falls into a recession, this will affects us. But the international economy is not dependent on us, and the security situation is not solely dependent on us. In contrast, the policy factors are dependent on us. I am referring, of course, to the government's budget policy, and the Bank of Israel's interest rate policy. The combination of these policy factors create the macroeconomic framework of the economy. In recent years, this macroeconomic framework has contributed a great deal to recovery, then to the consolidation and now to continued strong growth. The macroeconomic framework and the structural reforms that the government has instigated in recent years – and which the Finance Minister told us yesterday, on this very podium, that he intends to continue – are very important also for sustainable and fast growth. And when I say sustainable growth I do not mean permanent growth, because there is no such thing. There are business cycles and one assumes that sometimes, though I hope not often, we will need to cope with periods of low growth (a slowdown) or even a recession. So when I talk about achieving strong and sustainable growth, I mean policies that will support on average, high levels of growth, and for as long as possible. And in order to build this framework the right economic planning requires first of all a sensible budget policy. I wish to stress this point, particularly in light of several matters that we must address when discussing the government budget for 2007. Recently, with the economy growing at a decent pace and with high budget revenues, we hear calls – populist calls – for increasing government expenditure for one need or another. And there are always needs. And they are mostly justified. But these calls ignore the macroeconomic situation which is so important for sustainable growth and for dealing with problems of society, not just today but tomorrow too, not just in the short term but in the long term too. And what exactly is the budgetary policy that will support sustainable and strong growth? The answer is simple: it is a policy that continues the government's strategy of the past three years. Only this week, the prime minister made a decision in this field; that the budget deficit target for 2007 will be 2 percent of GDP. And this is in line with the government's basic policy guidelines, which, inter alia, set the deficit target for 2009 at 1 percent. And it is important to note that this target is actually a ceiling. But there's another target, no less important; that government expenditure will not grow by more than 1.7 percent, in real terms, each year up to 2010. Why are these decisions so important? Firstly, regarding the expenditure ceiling; This allows an increase in government spending, which should contribute to the various needs of the economy, particularly the problem of poverty. We heard during yesterday's morning session many recommendations to deal with poverty. It is important that poverty in Israel is addressed. It is important that we help the weaker members of society by giving those that can work the incentive to do so, especially through negative income tax, and that we help the needy who cannot work (the old, the disabled) directly through welfare payments. It is also important that we help the development of human capital, in the long term, through education. But this should still be within the macroeconomic framework of achieving sustainable growth. This combination – a policy for sustainable growth and a policy of correct treatment of society's problems – contributes to creating the necessary balance between economy and society. It is important that we understand, and that we declare, that the best way to deal with poverty in the long run is through economic growth. This is because in this way we create more places of work and more opportunities to earn a higher wage and, in addition, it will provide the government with the necessary resources for its role in combating poverty. Secondly, the new budget deficit ceiling – which is lower than before – helps to cope with another problem of the Israeli economy; the heavy burden of government debt as a ratio of GDP. This is because a smaller deficit leads to a reduction in the debt-to-GDP ratio. In 2005, the government managed to continue lowering public debt by maintaining a low budget deficit. So that at the end of 2005 public debt (of general government, that is government, local authorities and other bodies) fell to 102 percent of GDP, compared to 107 percent in 2003. By the way, the Central Bureau of Statistics plans to release its updated figures for 2005 which will show a debt-to-GDP ratio lower than this by some three to five percent. But we shouldn't rely on this path in the future. We still have a very high debt ratio, not so far from the high rates in Italy, Greece and Japan. For comparison, most of the OECD countries have debt-to-GDP ratios of between 30 and 70 percent, and Australia's is near zero. The debt-to-GDP issue worries us, and not only us. Local and foreign analysts that follow the Israeli economy and the international credit rating agencies are also worried about Israel's debt ratio. If you read their reports you will find alongside their positive evaluations one major point of weakness: Israel's government debt burden as a proportion of GDP. And why is this so worrying? There are three reasons. First, such a high debt-to-GDP ratio does not allow the government to conduct anticyclical budgetary policies. What does this mean? Generally, that in times of recession, the government would want to encourage economic activity and help the economy to recover, and so it would want to raise the deficit by lowering taxes or increasing spending, or both. But Israel cannot do this, just as it couldn't during the recession of 2002. Why? Because when debt is so high, as ours is, then increasing the budget deficit increases debt by such a pace and to such a level that the markets will regard it as dangerous. This situation could lead to a financial crisis, while in the midst of a recession, as in 2003. Secondly, a high debt-to-GDP ratio exposes the economy to the effects of possible external shocks. Lowering the debt burden will improve the economy's immunity and this should be reflected in an improved credit rating for Israel. As a result, the government and the business sector would face lower interest rates in the capital markets when raising finances. This would incidentally also make mortgages cheaper for homeowners, among them young couples. Thirdly our heavy government debt burden brings with it high government expenditure of debt interest payments. In 2005, for example, some NIS 33 billion – 15 percent of the total government budget – was to cover debt interest payments, and this is the second largest item after defense spending. The smaller the debt, the lower the interest payments become and the government can direct more money to those other needs of the economy, social problems and all. We are very proud, and rightly so, of the impressive advance made in reducing the government budget deficit in recent years, but the actual budget situation is not as good as we think. And when I say that I refer to a problem of definition and measurement of the budget deficit. What exactly do I mean? We are currently in contact with the OECD in order to be admitted as a member and to be accepted as one of the world's developed countries, from an economic perspective. Joining the organization will oblige us to meet several conditions to bring us up to the international standards that the OECD demands. One of these is the measurement of government deficit. The definition of budget deficit in Israel is different to the international definition. This difference leads to an understatement of the figures, and there are two reasons for this: Firstly, in Israel, the deficit definition covers only central government, while in the OECD and the EU (according to the Maastricht rules) the deficit refers to general government, which includes central government, local government and other bodies. And secondly, in Israel the indexation component of government expenditure for the part of the debt that is indexed to the CPI is not shown, while internationally this component is also included. To give us an idea of what I am referring to, these differences in definition account for almost 2.5 percent of GDP. In other words, if according to the Israeli definition, the government reported a deficit of 1.94 percent of GDP in 2005, then according to the international definition, this was a deficit of 4.5 percent of GDP. These figures, according to the international definition, are published in the Bank of Israel's annual report. I am not saying that there is a definite intention to mislead. Absolutely not. But the time has come to start a process of change that will bring Israel into line with the rest of the world in this respect, particularly as part of our efforts to join the OECD. In this light, I therefore intend, in the initial stages, to publish the OECD definition alongside the Israeli definition – both in statistics and in terms of budget deficit targets – and at a later stage we will publish and set policies solely according to the international definition. Incidentally, the international rating agencies are aware of this difference in definition and they regularly approach the Bank of Israel for our deficit figures according to the international definition. Concerning the definitions and budget targets I would like to add finally one other matter. Occasionally there are calls to categorize certain items of government expenditure as if they belong to another budget (for example, "the development budget") And there are always reasonable arguments for doing this, but generally these do not stand up to serious analysis. I suggest we do not adopt such ideas and we keep the accepted definition framework, both in international and in economic terms. In conclusion, it is important that we stand up to the pressure – and there will always be pressure – to increase government spending beyond the 1.7 percent ceiling. There are always good reasons for increasing one expenditure item or another, but if it is decided to increase a particular expenditure, the government should change its order of priority so that it stays within the budgetary framework. It is imperative that we continue to maintain the necessary budget discipline. This policy will only increase the chances for growth to continue in the long term and that the resources for dealing with various problems – primarily problems of society – will continue to grow. Last year, the Caesarea Conference marked 20 years since the Economic Stabilization Plan. It's good to be reminded now and again of the great achievements of that plan and the great achievements of the 1990s and the past three years. But looking forward, we must take advantage of these achievements to keep our economy on course, while at the same time solving the problem of government debt and the problem of poverty, which remains one of the central problems that the Israeli economy and society must deal with. Thank you.
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Revised version of a speech by Professor Stanley Fischer, Governor of the Bank of Israel, presented at the Federal Reserve Bank of Kansas City Conference on The New Economic Geography, Jackson Hole, Wyoming, 25-26 August 2006.
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Stanley Fischer: The new global economic geography Revised version of a speech by Professor Stanley Fischer, Governor of the Bank of Israel, presented at the Federal Reserve Bank of Kansas City Conference on The New Economic Geography, Jackson Hole, Wyoming, 25-26 August 2006. I am grateful to conference participants for helpful comments, and to Nir Klein and Mark Nulman for their assistance. * * * When I first saw the title of this conference – the New Economic Geography – I thought it referred to two branches of the economic literature that developed in the 1990s. The first, with the title of the New Economic Geography, pioneered by Paul Krugman, Anthony Venables, Richard Baldwin and others, 1 seeks to explain why and how economic activity tends to be geographically concentrated, and whether such economic equilibria are unique and stable, or may instead be driven by history. The second is about the impact of geography on development, work associated primarily with Jeffrey Sachs and associates. 2 However this conference is not mainly about economic geography in these senses. Rather it is about the startlingly rapid changes in the geographical locus of global economic activity and their consequences: about the rise of Asia, about the BRICs 3 , about globalization, about economic convergence, about changes in the international financial system – in short about the history of the world and the future of the world economy. 4 I shall start by briefly discussing different aspects of these changes, and then focus on the most critical development, the rise of Asia, especially the rise of China. The title of this conference, the first of the Bernanke era, also reflects what a long way this premiere international economic conference has come. In 1980, the theme of the conference was “Future Sources of Loanable Funds for Agricultural Banks”. This year it is about the economic future of the world. I. The changing global economic geography There are several ways of describing the phenomenon of the change in the locus of global economic activity. One is to talk about the rise of the BRICs and the near-BRICs. This would place the focus on Brazil, Russia, India, and China, two and a half of which countries are in Asia, and one in Latin America. But once one extends the group from India and China to include Russia and Brazil, nearBRICs jostle for inclusion, for instance Mexico and South Korea. And it is then not clear where to stop. One answer is to move from the BRICs to the non-G-7 members of the G-20. This defines a group consisting of Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia (a member of the G8), Saudi Arabia, South Africa, South Korea, and Turkey – twelve in all, incidentally raising the question of who will be the twentieth country in the G-20. This group includes countries from the Middle East, Africa, and Latin America, and is thus geographically more representative of global developments than are the BRICs or India and China. But the countries are diverse, and it is difficult without going into the details of each economy to talk about their future role in the global economy, except perhaps as the core of a new directorate for the international financial institutions. Alternatively we could talk about globalization, or about economic convergence, and whether and how it is happening. Or the rise of the South, except that in this case the South is mainly in the East. See for example Paul Krugman, Geography and Trade, MIT Press, 1991; see also Krugman, Annual World Bank Conference on Development Economics, 1998. See John Luke Gallup and Jeffrey Sachs, with Andrew Mellenger, “Geography and Economic Development”, Annual World Bank Conference on Development Economics, 1998, 127-188. Brazil, Russia, India and China, which have been identified by Goldman Sachs as the key economies of the future. Krugman (1991). I shall describe the phenomenon as the rise of Asia, primarily the rise of China and India. The phenomenon is evident in Table 1, due to Angus Maddison. In summary, over the period 1950-2030, the share of global GDP (measured in purchasing power (PPP) terms) produced by the United States, Europe 5 and the countries Maddison calls “other Western offshoots”, Canada, Australia, and New Zealand, is expected to decline from 70 percent to 38 percent, and the share produced by Asia to rise from 19 to 52 percent. 6 Maddison projects that by 2030 Chinese GDP will account for over 18 percent of global GDP measured in purchasing power terms, and will have overtaken United States GDP, also measured in PPP terms (Figure 1). India is projected to be at about half the (PPP) GDP of China. Let me note that although I shall use the PPP numbers, they are in an important sense seriously misleading. 7 In PPP terms, World Bank data show Chinese GDP at 69 percent of US GDP in 2005. But at market exchange rates, Chinese GDP was only 18 percent of US GDP last year (Figure 2). It is the dollar values that represent the current weight of countries in the international economy, and we should bear in mind that using market exchange rates, Japan has the largest economy in Asia, about double the size of that of China. Measured at market exchange rates, Asia accounted for 25 percent of global GDP in 2005, well below the 40 percent that PPP data imply. The share of Asia in global population is projected to remain roughly constant over the period 19502030, rising from 55 to 58 percent (Figure 3). By contrast, the share of the current “West” (excluding Japan) will decline from 30 to 16 percent of the global population. Global population is expected to grow by about 20 percent in the next 25 years, and much more rapidly than that in Africa. However measured, we are now in process in which in economic terms, the west is in relative decline, and Asia is rising. In a longer-term perspective, this is both the rise of Asia and also the recovery of Asia – for according to Maddison 8 , as late as 1820, as the Industrial Revolution was getting under way, Asia accounted for over 70 percent of the world’s population and 59 percent of world GDP. Although I will talk mainly about China and India, it is important in considering the rise of Asia to recall that Japan, the second largest economy in the world, has already risen. And we should also note that less than fifteen years ago, the Asian miracle was regarded as primarily a phenomenon of Japan, Korea, and the ASEAN countries. In focusing on the rise of Asia, I leave out areas and issues that are extremely important for the future of the global economy and the global polity. Among them are the economies of the Middle East, and other challenges of development, especially in Africa, Latin America, and parts of Asia. In discussing the rise of Asia, I will take up five issues in more detail: first, the rise of China; second, that of India; third, regional developments; fourth, implications for the world economy; and fifth, political implications. II. The rise of Asia: China How long will the rapid growth of China continue? There are important historical precedents in the region, Japan, Korea, and the ASEAN countries. 9 Their histories tell different stories: that of Japan, I have taken a generous view of the extent of Europe, by including Eastern Europe and the former Soviet Union. This means that Russia is not included in Asia for purposes of this paper, a view that is at best only half right. Maddison includes parts of the Middle East, including Turkey, in Asia. Why then use the PPP data? Mainly because they do take into account differences between current and likely future exchange rates, which are relevant to future comparisons among countries; in part because they are available and are systematic. The World Economy, A Millennial Perspective, OECD, 2001, Table 3-1c (p127) and Table 1-1 (p28). Maddison (2001), p.143, presents data on the growth performance of the countries of “Resurgent Asia”. The average annual growth rate of per capita PPP GDP for the period 1950-1999 of China, Hong Kong, Malaysia, Singapore, South Korea, Taiwan (China), and Thailand was 4.4 percent. The growth rate of Chinese per capita PPP GDP was highest among the periods shown by Maddison (1950-73, 1973-90, 1990-99) in the last decade of the twentieth century, at 6.4 percent. The most rapid and sustained growth performance over the period was that of South Korea, which averaged 6 percent (per capita, PPP) over the fifty years. Note that Maddison lists data for Taiwan, China separately from those of China; in Maddison’s data, in 1950 Taiwanese GDP (PPP terms) was approximately 3 percent that of China, and by 1999 it had reached 8.5 percent of that of China. that almost full catch-up is possible – although it is hard to know whether we should start counting from 1868 or from 1945; that of Korea that sustained exceptionally rapid growth is possible for over forty years; that of ASEAN that long growth spurts are possible. China has already been growing at rates in excess of 10 percent on average for over a quarter century, and its policymakers have demonstrated considerable economic management skills, not least in warding off foreign pressures for revaluation. The regional precedents suggest that China can keep growing at very high – but declining – rates for a long while yet. Further, if the maximum potential growth rate is related to the distance of the economy from the frontier – as determined by per capita income levels in the most advanced economies – China’s rapid growth can continue well beyond 2030, for even in 2030 according to Maddison’s projections, PPP income per capita in China will be only one quarter that in the United States. And the fact that the bulk of China’s labor force remains rural, and to a considerable extent agricultural, reinforces the view that China’s Arthur Lewis type growth process could have a long way to run. If the Chinese economy were to continue to grow in real terms at a rate 7 percent greater than that of the United States economy at a constant exchange rate – as it has for over twenty years – its GDP would indeed overtake that of the United States in about another quarter century. Further the yuan is likely to appreciate over that period relative to the dollar, ceteris paribus (i.e. with unchanged domestic growth rates) reducing the length of the catch-up period. But China faces considerable challenges, and the economy is unlikely to continue growing at 10 percent for another quarter century. Notable among the challenges are: exchange rate management and realignment; financial sector reform; state enterprise reform; resource and environmental constraints; the ageing population; developing (or redeveloping) a social safety net; reducing social gaps, especially between country and city; and political transition. China’s exchange rate management has until now been impressive and successful from the viewpoint of its goal of supporting export-led growth. It has come at the cost of a massive and likely to be costly buildup of foreign exchange reserves, but so far with surprisingly low costs in terms of inflation. At some point – perhaps because of inflationary pressures and the costs of the continuing reserve buildup – the process of exchange rate appreciation that other countries in the region, including Japan and Korea have experienced, will have to begin. And that will likely contribute to reducing the growth rate of the economy in real terms. 10 Given China’s saving rate, 11 it is likely that when the process of secular appreciation of the yuan gets under way, the currency will appreciate at a rate that maintains a sizeable continuing surplus in the current account, as has happened in the case of Japan. Financial sector and state enterprise reform are closely related. One way of thinking of the occasional recapitalizations of the banks in China is as a fiscal process, in which the banks provide loans to enterprises that are in effect repaid by the state by later recapitalizations. It appears that progress is being made in reforming the financial system, but as of now it remains a point of vulnerability and an obstacle to a rapid opening of the capital account and flexibilization of the exchange rate. China faces the problem of a rapidly ageing population. While this will be a problem from the viewpoint of fiscal transfer programs (which however are on a proportionately much smaller scale than in richer countries), the processes of urbanization and industrialization can continue by drawing on the massive rural population. Environmental issues will have to be dealt with, and it is clear from the trends in global commodity prices that China may well face continuing adverse terms of trade changes as well as rising domestic resource costs. Income disparities in China, between the coast and inland provinces, between the cities and the countryside, between rich and poor, have been growing rapidly, and are receiving increasing attention from the government. These, combined with the breakdown of the social safety net of earlier times, produce social and political tensions that could threaten the continuation of the growth process. And political pressures associated with the desire for democratization, which tends to rise as income levels increase, constitute another source of tension. However, its impact on the growth rate of the dollar value of Chinese GDP would be smaller. China’s high saving rate has been attributed in part to the absence of a convincing social safety net, and to uncertainty about future economic growth. In addition, high growing economies have generally been high savers, a feature which the late Franco Modigliani used to assert was fully consistent with the life cycle hypothesis. The Chinese economy suffers from one disadvantage that the other Asian miracle economies did not: it is already very large. This raises the question of whether it can continue to rely on exports to power its growth – for the capacity of the rest of the world to absorb Chinese exports must be determined by the global growth rate. 12 The answer is that China probably cannot continue to rely on export-led growth, and therefore that the switch to domestic demand led growth, which has been talked about for some time, is essential if growth is to continue in the 7-10 percent per annum range. Is China vulnerable to a 1990s style Asian financial crisis? There are some negative symptoms. The first is a share of investment in GDP that according to the official data exceeds 40 percent. This cannot be efficient, it must be part of the process of generating bad loans, and is reminiscent of pre-crisis investment rates in some of the Asian crisis economies. The second is a financial system that remains weak. But some of the vulnerabilities that led to the Asian crisis are not present: China does not have a current account deficit; nor are there massive short-term capital flows; and capital controls appear to be relatively effective, even if not fully watertight. Further, foreign exchange reserves are so large that it is hard to imagine a successful attack on the currency. On balance, a 1990s style international financial crisis appears highly unlikely. What about other types of crises? The growth processes in Japan, Korea, and the other rapidly growing countries of East Asia were punctuated by occasional economic crises. Since the modern Chinese economic reform process began around the end of the 1970s, there has been only one major economic (and political) crisis. This is an extraordinary record, even among the extraordinary records of the neighborhood. Chinese economic management has benefited from very careful study of the history of its neighbors, and – despite the long list of potential problems just noted – there are no obvious sources of likely crises in the near term. But: trees do not grow to the sky, and trends that appear inevitable at one point of time can appear doomed from the perspective of only a decade or two later. In brief, to continue rolling out the clichés, it is difficult to forecast, especially about the future, and it would be unwise to assume that China will be immune to future economic crises. Nonetheless, even if there were to be a crisis or other interruptions to growth in the future, it is on balance reasonable to believe that Chinese growth will continue at a rate that on average well exceeds that of countries at the current frontier of economic development – and that the Chinese economy will be the largest in the world, measured in dollars at market exchange rates, within the lifetimes of many in this audience today. III. The rise of Asia: India GDP in China and India were roughly similar in 1950. 13 Since then China has grown much more rapidly than India: India’s growth spurt is both more recent and more modest than that of China. At present Indian GDP, measured in exchange-rate mediated dollars, is approximately the same as that of South Korea, joint third in Asia, behind Japan and China. In these terms, Indian GDP in 2005 was $785 billion (World Bank data), twelfth largest in the world, in a group of five countries with very similar GDPs (Brazil, South Korea, India, Mexico, and Russia, in that order). In PPP terms, according to World Bank estimates India had the fourth largest economy in the world in 2005, almost as big as that of Japan, a bit under half the size of PPP GDP for China. And the GDP of India has been growing at rates approaching 8 percent in recent years, less than that of China, but nonetheless impressive. Quite possibly, if China did not exist, we would today be talking about the Indian miracle. India’s growth prospects are enhanced by the existence of a more market-oriented financial system than that of China, by a more flexible and well-managed exchange rate system, by a more marketoriented monetary policy, by the existence of a legal framework that is more developed and more predictable than that of China, and by a stable democratic political system that enables the country to deal with social tensions within its political framework. Its growth prospects are set back by its so-far slow pace of integration into the global economy, the slow pace of the legal process, by excessive I am grateful to Lew Alexander of Citigroup for raising this question. Maddison (2001), p.214 shows Chinese (PPP) GDP at $240 billion (in 1990 PPP$) and Indian GDP at $222 billion. According to Maddison’s estimates, per capita PPP GDP in India generally exceeded that in China until 1978. fiscal deficits, by the political inability to pursue the reform process with as much determination as has China, by an extensive bureaucracy, and by excessive state regulatory intervention in the economy. Indeed, the greatest reason to be optimistic about India’s future growth process is that considering that it has grown so well in the last 15 years without a sustained deep reform process, it will certainly do much better if and when the reform process deepens. While Indian growth rates have not yet reached Chinese levels, the Indian economy appears on the whole to be more robust. India experienced a major foreign exchange crisis in 1990, one response to which was the start of the reforms of the first half of the 1990s. Since then the exchange rate has become more flexible, the growth rate has risen, and some reforms have continued. While no economy is guaranteed against crises, the Indian economy looks less vulnerable to a major crisis than it was over a decade ago. But there are anti-reform strands in Indian politics that could result in policy changes that reduce the growth rate well below its potential. IV. The rise of Asia: regional developments There are already important and rapidly developing economic linkages among parts of Asia, particularly in East Asia, where a grouping of ASEAN plus Japan, China and Korea seems to be emerging. The politics of such a grouping are not simple, for the Japan-China relationship is evolving as the Chinese economy grows, and as it becomes clearer that China will overtake Japan at some point in the not too distant future. The implications of this change can be summarized by noting that Japan is the largest shareholder in the Asian Development Bank, and by tradition appoints its head; that the formation of an Asian Monetary Fund during the Asian crisis in 1998 was not strongly supported by China; and that China will no doubt want to play a greater role in any future regional institutions than it does in the ADB. Some in East Asia talk of following the example of Europe by improving trade and financial links, and later moving to a common market and unified financial system. It is recognized that this will take a long time, but those involved note correctly that it took the European Union a long time to evolve to its current condition. The European equilibrium is simplified by the fact that no single country dominates the union, whereas China would likely be the dominant power in an East Asian union. For many years Europe was driven by the Franco-German determination to build a structure that would prevent any future wars; possibly East Asia could eventually be driven by a similar process of Chinese-Japanese reconciliation, though recent trends have not been in that direction. One could imagine Japan eventually playing a role similar to that of the United Kingdom in Europe, that is, as a leading member, but one whose views on the nature of the organization may often differ from those of other leading members. At present, there is much talk of an East Asian common currency. Whether there would be a basis for such a currency depends on how China’s financial and currency management systems evolve. Since China would eventually be dominant in an East Asian economic bloc, its preferred currency arrangements will determine the eventual outcome. Very likely, the non-Chinese members would like to have a common currency so as to have some impact on region-wide monetary policy, but whether China would grant that role would be up to China. Here again one could see Japan playing an independent role by retaining its currency, rather like the United Kingdom currently does in Europe. Further to the west, a large economic bloc could eventually develop around India, but that prospect is inhibited by the strained relations between India and Pakistan. The dynamics of a South Asian economic bloc built around India would be different from those of East Asia because, unlike in the case of China, there is no Japan – no advanced industrial economy – in the neighborhood. V. The rise of Asia: economic implications The rise of Asia, especially the rise of East Asia and of India, is already reshaping the world economy. Concerns over globalization that have become so prominent a part of the economic debate in Europe and also in the United States, focus on the impact on the wages of less skilled workers in the west of the hundreds of millions of Chinese and also Indian workers who are entering the global labor force. One often hears the view that “China has a comparative advantage in everything”, an argument that every economist can demolish, but doing so does not diminish the anxiety level. Part of the anxiety must derive from the discomforts of the adjustment process forced by the dynamism of Asia; and part must derive from the fact that the wages of unskilled workers in the west may be adversely affected by such competition. Policy can deal with these consequences, through adjustment aid, and through education, but unless that is done, the negative fallout from this competition will likely continue. The last time I heard this degree of anxiety was in Asia during the Asian crisis, when many of China’s neighbors expressed the same concerns. Then I used to ask people whether they would prefer to have a prosperous or a poor neighbor. Most opted for the prosperous neighbor, though I often had the sense that they might prefer that their neighbor progress at a more measured pace. By now most of the developing countries and most of China’s neighbors can count the gains from China’s (and India’s) booming growth. China’s voracious appetite for raw materials, which has produced a boom in commodity prices, has helped many developing countries, as well as commodity rich industrial countries like Australia. China’s investments in Africa – where Indian companies have also long been active – have lately received media attention. China and India’s energy needs have helped push oil and other energy prices to their highest sustained levels, and have contributed to the prosperity of energy producers in the Middle East, in Russia and central Asia, and also in Africa where there are now many oil exporters. China’s and India’s energy needs have driven their oil companies into the international arena, competing for sources of upscale oil. IBM laptops are becoming Chinese. An Indian steel company is now the world’s largest. The trends are unmistakable. The fact that the global economy has been growing very rapidly by historical standards in the last few years despite concerns over global imbalances, in particular that the years 2004-2006 will see high growth rates in Latin America and Africa, is as much due to the rise of Asia as to as the global engine of United States growth. Asian growth has benefited greatly from the relatively open international trading system that was built up after World War II. All the East Asian miracle economies pursued export led growth strategies, with the bulk of the exports going to industrial countries in the west. The recent failure of the Doha Round is deplorable, particularly if it is final, mainly because it reduces the opportunities that some of the poorest countries would have had to export agricultural products. But opportunities to increase industrial exports still remain open to most developing countries. The basis for the current international economic system – and it is a system – was designed by the victors of World War II. The implications of the rise of Asia and of emerging market countries for the international financial system will be at the center of attention at the meetings of the IMF and World Bank in Singapore next month. The newcomers want to play a bigger role in the international agencies, and they should. 14 It is to be hoped that the current dominant forces in the Fund and Bank will make the necessary room, though historically the established powers have lagged in making room for others. While the newcomers want to play a bigger role in setting the rules of the game, it is not clear what rules they would like to change, and whether they will want radically to change the international system. To do that, they will need to further develop the analytic capacity to formulate proposals for change, a process that will involve strengthening research and policy research institutions, and the mechanisms through which they affect policy. However the impact of China and India on the international financial system does not depend mainly on the size of their quotas in the international financial institutions. It depends more on how important Shanghai (or Shanghai-Hong Kong) and Mumbai become as financial centers. It is very difficult to develop a new financial center, and some – like Paris – have declined in importance relative to where they stood a century ago. Others, like Tokyo and Hong Kong, have become important, but do not yet compete with London and New York. If China indeed becomes the largest economy in the world, if it develops a market-based monetary policy, if it gradually liberalizes the capital account of the balance of payments and allows the exchange rate to float, and if it can develop the necessary legal framework for the efficient operation of the financial markets, then there would be very good reason for ShanghaiHong Kong to blossom as a financial center. If that were to happen, we could imagine the yuan becoming a major international currency, along with the dollar and the euro. But that is likely to take a long time. And it is an interesting question as to what language will be spoken in that market – I would bet on English. Some of these issues have their counterparts on the political side, for instance the debate over the reform of the United Nations, especially the Security Council In this regard, it helps that China is already one of the permanent members of the Council. Mumbai has a language advantage, already has a market-based monetary policy and a flexible exchange rate, has a more market-based financial system, and a more developed legal system than has Shanghai. But the potential size of the domestic economy will probably cause Mumbai to develop more slowly than Shanghai as an international financial center. Nonetheless there is every reason to believe it will become an increasingly important player in the international financial markets. VI. The rise of Asia: political implications So far the international economic system has dealt reasonably well with its changing economic geography. While there are major concerns about how the United States current account deficit will be unwound, about the failure of the Doha Round, about protectionism more generally, and about the effects of the entry of another billion low-wage workers into the international economy, the overall impact of the rise of Asia on the international system seems to have been favorable for most other countries. In addition, the rapid growth of Asian economies has contributed to an extremely rapid decline in global poverty in the last quarter century. It is easy to describe crisis scenarios, particularly with regard to the unwinding of the U.S. current account deficit – and many delight and profit from doing so. But overall it seems that the international economy and its market and governmental organizations have sufficient flexibility, and perhaps even the wisdom, needed to deal with the required adjustments. The potential political consequences of the economic rise of two more great powers, and the relative decline of others, could be more worrying. The economic rise of both Germany and Japan in the second half of the nineteenth century and into the twentieth century was accompanied by their growing military might, increasing assertiveness, and, eventually, terrible wars. The rise of the Soviet Union and of international communism was also associated with major wars and political instability, in this case around the world. Are we more sophisticated now than the world was a hundred years ago? How long can the Pax Americana continue to maintain stability in Asia? How wise will the sole superpower be in its future dealings in Asia? How in the long run will the relationship between Russia, with its underdeveloped and underpopulated east, and China, with its massive population directly to the south, develop? Can China and India take their rightful places in the world and in their regions without further major military confrontations? Does the fact that China and India are nuclear powers, and so is Pakistan, make the situation more stable as well as more dangerous, or just more dangerous? How will a potentially nuclear Iran influence the equilibrium? How important is the North Korean nuclear threat, and how long will Japan be willing to remain non-nuclear in the face of that and other threats? These questions are too complicated for economists to answer. Probably, somewhere in a parallel universe, political scientists are discussing them. Perhaps – but not very likely – the parallelism will extend to their concluding that the political issues are likely to be resolved peacefully, and that the economic issues appear intractable. But whatever they conclude, the answers to these political questions, more even than the economic issues we have been discussing, will be key to the future of the world.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Sderot Conference for Society, Sderot, 7 November 2006.
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Stanley Fischer: Issues pertaining to the Israeli economy Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Sderot Conference for Society, Sderot, 7 November 2006. * * * First of all I would like to stress that society and economy are two sides of the same coin. Particularly in Israel, because of its uniqueness, it is impossible to waive the good of society for the good of the economy, but it is equally clear that it is impossible to forego the good of the economy for the sake of society. One complements the other. As in economic policies, so too in social policies one must distinguish between short-term and longterm tools. So it is important to use tools that in the short term will help improve the welfare system for the weaker members of society who cannot join the labor force. However we must not forget that the most important thing for society - and for the economy, for the state, and for its security too - is the long term, and what stands at its center, in the long run, is sustainable growth. So a sensible policy should strike the right balance between short-term and long-term tools, as they can be substituted one for the other. Before I get into these topics, I will begin with an overview of the state of the economy. A. State of the economy The Israeli economy is today in a very good state, even after the war. The economy has enjoyed rapid growth now for three years, and the Bank of Israel forecasts that GDP will grow this year by 4.6 percent. This is a rapid rate of growth by international standards, and Israel is also enjoying an increase in investments and exports, a balance of payments surplus, a particularly high rate of foreign investments, rising productivity and an improvement in employment data. Inflation in Israel is low, levels of interest rate are similar to elsewhere and the markets demonstrate strength and stability. And what led to this extremely good state of the economy? A combination of three factors: the first: the structural changes in the economy during the past 15 years - the liberalization of the foreign exchange market, making it more flexible, privatization, the development of the capital market, opening it up to competition from abroad etc; the second: the responsible macroeconomic policies of the Ministry of Finance and the Bank of Israel; and the third: the background factors which are not always dependent on us. I am referring here to world economic developments and the security situation. In this context, we must understand that the success of the economy and its ability to stand up to the negative impact of the hostilities is a result of structural changes over the past 15 years, and of the macroeconomic policies that the government and the Bank of Israel pursued before, during and after the fighting. Now I would like to address solving the problem of poverty in the short term, and in order to build the correct plan for treating the problem of poverty in the short term, it is important to understand poverty and, if needs be, to deal with it at the level of the individual. 1. Incentives for joining the labor force First of all, it is important to build tools designed to provide incentives to join the labor force. We know that poverty among families with no breadwinner reached about 78 percent in 2005. In contrast, poverty among families with one wage earner fell to 35 percent and among families with two or more breadwinners, to only 4 percent. I am delighted that the topic of Earned Income Tax Credit - which the Research Department at the Bank of Israel has worked on for a long time - is gaining momentum. This is an approach that will increase the disposable income for poor wage earners and will also provide an incentive to join the labor market. But as still more than one third of all families with one wage earner are poor, it is important that these incentives are accompanied by the removal of obstacles to entering the labor market so that more and more families will have two or more wage earners. In this context, we are talking about removing obstacles for women. 2. Dealing with those who cannot work At the same time, it is important to improve the testing of earning capability and to deal with this individually, through allowances, for those who cannot work. 3. Dealing with the elderly who have no source of income Another matter concerns the elderly; poverty among this sector of the population is almost 25 percent. Here I note that this subject is dealt with through increasing allowances to the elderly who have no sources of income, as is the case in the budget for 2005 and 2006. 4. The Arab and ultra-orthodox sectors This last matter concerns the two sectors of the population that have the highest concentrations of poor in Israel. Among the Arab population, the level of poverty was higher than 55 percent last year, and among the ultra-orthodox it was 63 percent. The reasons for this are, for the Arab population, connected to education, discrimination in the labor market and the low level of participation of women in the labor force. Among the ultra-orthodox, the problem is related to size of families and the low level of participation, particularly among men, in the labor market. Also in these cases, it is important to build a series of tailored tools to extricate these populations from these extremely high rates of poverty. B. Sustainable growth Now I will turn to the long term: Today the economy is at a very important crossroads. We are obligated to safeguard the enormous achievements of the economy, and the confidence that investors have in us, in order to improve the chances that this growth will continue in the long run. Clearly what is important for the economy and the state is sustainable growth. The level of GDP per capita in Israel is about $ 20,000 and, in terms of purchasing power parity (PPP), closer to $ 25,000. If we can grow at a rate of 5.5 percent in the next 10 years, and if the population continues to grow at a rate of 1.7 percent, then our income per head will reach $ 29,000; however if we manage to grow by only 3 percent, our income per head will reach only $ 22,000. That's a difference of 28 percent, and if we consider the situation 20 years down the road, then this gap won't be 28 percent but 63 percent. The numbers speak for themselves. But rightly we should ask: How will growth affect Israelis' standard of living? 1. The most important thing is that there will be more jobs, more employment and a higher level of wages. 2. We will have more resources that we can devote to solving problems of society. 3. We will have more resources to devote to security. 4. We will have a larger population, as a result of more immigration and less emigration. Therefore we must stress at every opportunity that sustainable growth determines the future of the economy, of society and of the state. And what led to this extremely good state of the economy? A combination of three factors: the first: the structural changes in the economy during the past 15 years - the liberalization of the foreign exchange market, making it more flexible, privatization, the development of the capital market, opening it up to competition from abroad etc; the second: the responsible macroeconomic policies of the Ministry of Finance and the Bank of Israel; and the third: the background factors which are not always dependent on us. I am referring here to world economic developments and the security situation. 1. Macroeconomic stability - which is a basic necessity; and here we move on to the subject of the next session: I do not want to go into details as we have excellent experts in the next session who will present important recommendations - and by the way, the delegation of the International Monetary Fund that presented its annual report to the Minister of Finance and myself yesterday, also stressed the need to strengthen our budgetary framework. 2. But I will go further on one very important aspect of the fiscal situation, and that is the burden of debt. Regarding the burden of government debt, we must remember our starting point. Thanks to the responsible budgetary policies of recent years, the government has managed to bring this debt down by means of budget deficit and spending targets, so that by mid-2006, the public debt reached around 90 percent of GDP compared to 102 percent in 2003. This reduction - part of which is technical and comes from recent changes in what defines GDP - is one of these achievements of the economy, but it is still not enough. Despite this achievement, we have not yet returned to the debt-to-GDP ratio that we had in the year 2000 - 87 percent - and in international comparison, we still have a very high debtto-GDP ratio. In most OECD countries, this ratio varies between 30 percent and 70 percent. But why should the debt-to-GDP ratio concern us so much? Firstly, because this situation will not allow the government to pursue an anti-cyclical budgetary policy; secondly, our heavy burden of public debt encumbers the government with the heavy costs of interest rate payments - reaching up to 15 percent of the government budget, the second largest single item after defense spending. It would be preferable if some of these monies were redirected to necessities such as education, welfare etc; and thirdly, the high burden of debt-to-GDP exposes the economy to possible external shocks. And how do we lower this debt-to-GDP ratio? It is very simple. In the denominator, we must create growth, and in the numerator, low budget deficits. It is therefore important that in the years after 2007, the budget policy allows the budget deficit to return to its path we saw prior to the fighting, which will emphasize the government's commitment to long-term budget targets and will demonstrate that the deviation in 2007 was an exception. C. Structural changes i) In the financial sector - with the aim of broadening the range of financial instruments and players; ii) Incentives for growth - for example, to pursue a path of relatively low taxation; iii) Flexibility and efficiency in the public system - with the aim of encouraging economic activity in various fields. In this context I would like to draw attention to the Doing Business Report (2007) of the World Bank, which was published a few months ago. The report ranks countries according to the ease of doing business there, that is according to bureaucratic and regulatory processes that one must overcome in order to run a business. Each country receives a score of between 1 and 175, with 1 marking the best. Overall, Israel was placed 26th, which is not bad. But if we look at the individual components we see that we were good at "investor protection" (5th place), "getting credit" (7th place), "international trading" (13th place), "starting a business" (15th place), and "closing a business" (36th place); we were middling in "paying taxes" (ranked 62nd) and "employing workers" (82nd); and we were particularly bad in terms of "dealing with licenses" (101st place), "enforcing contracts" (110th place) and in "registering property" (150th place). So we have much to improve on in many fields and it is important that we do this to create a better business environment. I said last week that the way rumors and misinformation on suspicions and investigations on this and that which are reported as fact harm the business environment, and maybe in this area too we should show more responsibility - and it also impacts very negatively on our political situation. And now to the last topic, which is by no means less important: D. Education The need for reform in education is striking and so important, inter alia, in treating the problem of poverty in the long run, that I would like to expound on it here. Education is a basic tool in every society for giving the young generation the tools to integrate into the labor market, to succeed on a personal level both economically and socially, and to contribute to the prosperity of the economy and society as a whole. On this subject our position is excellent in international comparisons. The rates of those with tertiary-level education aged 25-64 is 45 percent in Israel compared to 25 percent in the OECD countries (as of 2004); the rate of those employed in academic and technological professions stands at 30 percent in Israel (in 2005) compared to 28 percent in the EU countries. Can we therefore sit back and relax knowing this? Certainly not, because there are worrying trends, and I will demonstrate these with the use of two examples (and these are not the only ones). The number of a children in a class reaches 27 in Israel, compared to 21 schoolchildren per class in the OECD countries. Another example is our spending on schoolchildren, which dropped by almost 20 percent over the past decade, compared to a rise in the OECD countries. This means that the current situation in Israel is not bad, but there are some very worrying trends. Regarding higher education, we are close to a crisis, and it is a good thing that the government has established a committee that will make recommendations on how to solve the serious problems of this sector, and even more importantly, that after the committee submits its report, the government will carry out a reform of the higher education system. In conclusion, treating poverty is important and essential - in both the short and long term - without growth we will not be able to cope with long term poverty, and it is essential to plan and pursue economic policies that will promote sustainable growth. This is not just essential, it is possible. Thank you.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the AGM of the Association of Banks in Israel, Tel Aviv, 23 November 2006.
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Stanley Fischer: Israel’s economy and the challenges facing its banking system Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the AGM of the Association of Banks in Israel, Tel Aviv, 23 November 2006. * * * Mr President of the Association of Banks in Israel and Chairman of Bank Leumi, Eitan Raff; Executive Director, Association of Banks in Israel, Freddy Wieder; my banker colleagues and colleagues from the Bank of Israel; ladies and gentlemen: may I start by thanking the Association of Banks in Israel for inviting me and giving me the opportunity to speak before you today. I would like to relate first to the current state of Israel’s economy, in which the banking system plays an important role, both as an active, influential participant and as an entity affected by economic developments. I will then address the challenges facing the new Supervisor of Banks and Israel’s banking system. The economic situation Israel’s economy today is doing very well, even after the war in the north. Although activity slowed during the war - reflected by a negative rate of growth in the third quarter - the latest indicators point to a relatively rapid recovery of economic activity after the war. The economy has enjoyed three years of rapid growth. In the light of the National Accounts data of the third quarter published recently by the Central Bureau of Statistics, the Bank of Israel assesses that GDP will grow by 4.8 percent in 2006. This is a high rate of growth by international standards, and reflects a rise in investment and in exports, a surplus in the balance of payments, a very high rate of foreign investment, increased productivity and an improvement in employment - and all this despite the war’s adverse impact on growth. Budget data show that tax revenues have revived. The government’s budget deficit in 2006 is expected to be about 1.8 percent of GDP. Inflation in Israel is low, and in 2006 is expected to be below the target, mainly due to the fall in oil prices and the appreciation of the shekel. In accordance with the Bank of Israel’s flexible inflation targeting approach, our intention is to bring inflation back gradually to within the target range of 1–3 percent a year. Ten-year interest rates in Israel are below 6 percent a year, and this is important to everyone who has to take a mortgage. The markets are robust and stable. Three main factors account for the economy’s success and its ability to withstand the negative impact of the war: 1. The structural changes that the economy has undergone in the last fifteen years. 2. The macroeconomic policy pursued by the government and the Bank of Israel before, during, and after the war. 3. The background conditions that affect all of us, i.e., developments in the global economy, and the security situation Having said that, the economy is currently facing two important challenges: reducing the government debt, and tackling the problem of poverty. I have spoken in the past, and will speak again in the future, about the solutions to these problems. Today, however, as it is my intention to deal with the problems currently facing the banking system, I will end this part of my address by saying that Israel’s economic situation is very good, but we must try to ensure that this continues and not rest on our laurels. To you, the bankers, I would like to quote the English saying, “bad loans are made in good times;” from a macroeconomic standpoint, we are now in good times. The targets facing the new Supervisor of Banks In the second part of my address I would like to talk about the banking system. The banking system plays a very important role in every economy, and of course, in Israel’s economy too. What is important, of course, is that the banking system be stable, competitive, and fair, and that it serve all its customers - households and the business sector - well. First, I would like to thank the outgoing Supervisor of Banks, Yoav Lehman, for his 28 years of service to the Bank of Israel and to Israel’s economy, and I would also like to congratulate the new Supervisor, Rony Hizkiyahu, and wish him success in confronting the important challenges facing him within the Bank of Israel and vis-a-vis the banking system. Within the Bank of Israel the Supervisor faces the vital and difficult task of managing a large, complex department. The task is far from a simple one, particularly as it involves a transition to a new system of supervision, i.e., Basel II. The implementation of Basel II constitutes a major objective for the new Supervisor and the banks. Although we gave high priority to the implementation of the Basel II guidelines by the banking supervision and the banks, insufficient progress has been made so far. I must stress that Basel II is not just a new rule book, but it entails a whole new approach - with the supervision of management systems, and in particular risk management, taking the place of setting detailed rules. It is easy to tell the banking supervision to determine general principles instead of detailed rules, but it is difficult to carry this out. This also presents a challenge to the banks, who sometimes find it comfortable to operate according to specific rules and even ask for them. I have discussed Basel II with bankers, and I note that in Israel they all want to adopt advanced internal models. Operating according to such models requires sophisticated and costly data and management systems and an extensive database, which are not within reach of small banks. For comparison, in the US it is thought that only the largest twenty banks need to adopt the most advanced models. We are aware of the efforts by the smaller banks to cooperate in the formulation of statistical systems and appreciate their endeavors. More intense efforts to align the system for the implementation of Basel II and for the adoption of the “SOX 404” rules for internal controls will lead to the improvement of the whole system of management and control in banks. This will instill high standards into Israel’s banking system that are on a par with the most advanced in the world. The second external goal for the Bank of Israel and the new Supervisor of Banks is strengthening competition in the banking system, particularly retail banking. Making the banking system more competitive is one of the major objectives of the Bank of Israel, and, I would assume, of every government in Israel. The Bachar Committee dealt with the issue of competition in the areas of credit and the capital market, and there is a need to increase competition in banking services provided to households and small businesses. In this context, I would like to refer to the latest occurrence in which one bank increased its fees, and the other banks followed, creating a distinctly uncompetitive impression. It is not surprising, therefore, that the public and its representatives in the Knesset reacted critically as they did. Here too, competitive conduct would be beneficial to customers, to the bank, and to the banking system. Another factor that does not add to the degree of competition is the long, and perhaps even ridiculous, list of fees. I fail to understand why in Israel the banking system operates thus, while in other countries banks make their money essentially from the spread between their lending and their borrowing interest rates. It would be a very good thing if a foreign bank were to enter the field of retail banking in Israel, and I hope this will happen. I would also like to speak about the need to improve the level of customer service. There are too many justified complaints, and the banks must invest resources to avoid such situations. I would like to clarify the position of the Bank of Israel on the matter of consumer protection. I am in favor of our involvement in this area, but I would like to place the responsibility where it belongs, and that is with the banks. To clarify my position: the situation should be that a dissatisfied customer first turns to the bank with his complaint, and only then, if he feels the complaint has not been dealt with properly, does he approach the Banking Supervision Department. In a competitive banking system the banks must deal with most complaints against them, with the central bank acting only as the customer’s last resort and not his first port of call. In this context I would like to share with you a conversation I had. I was asked how I am settling down in Israel, and if I understand what goes on here. I answered that the hardest thing to understand was my pay slip, but the truth of the matter is that there is something even harder to understand, and that is my bank statement. The last topic I would like to talk about is the cooperation between the various supervisors of the financial system. The supervisors currently cooperate with each other, and it is our intention to institutionalize this cooperation in an MOU (memorandum of understanding). I view this step as a first stage in closer cooperation between the supervisors and the financial system. Finally, the new Supervisor faces enough challenges to stop him from being bored. His approach will be one of less detailed regulation, and more regulation according to principles. His success in this depends not only on him, but on responsible and competitive conduct by the banks. Thank you.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Globes Business Conference 2006, Tel-Aviv, 11 December 2006.
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Stanley Fischer: The openness of Israel’s economy to the global economy and the importance of Israel’s joining the OECD Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Globes Business Conference 2006, Tel-Aviv, 11 December 2006. * * * The subject of my address to you today is the openness of Israel’s economy to the global economy, and I will focus on the importance of Israel’s joining the OECD. A. The state of the economy First, I would like briefly to review the state of the economy, and that picture is quite a rosy one. The economy is recovering rapidly after the war in the north, even faster than we thought at first. National Accounts data indicate a 1.4 percent decline (in annual terms) in GDP in the third quarter. The impact of the hostilities on GDP was weaker than we had assessed previously, and it appears that the rate of growth in 2006 will be 4.8 percent, slightly higher than our initial post-war forecast. Our forecast for 2007 still indicates healthy growth of 4 percent. This was our assessment immediately after the hostilities, and I will not be surprised if it is revised upwards in the future. Furthermore, the most recent unemployment data point to a reduction in the rate of unemployment in the third quarter to 8.3 percent, compared with 8.9 percent in the third quarter of 2005, alongside a rise in the rate of participation in the labor force during 2006. The nominal-financial side completes the picture of a strong economy. Inflation is low, the financial markets are functioning well, including the foreign currency market, which reflects not only global developments but also the large inflow of foreign investment to Israel and the impressive surplus in the balance of payments current account (expected to reach 4.7 percent of GDP in 2007). At this point I would like to refer to the fact that currently inflation is below the lower limit of the target range. At the outset I must state the obvious: external shocks have a significant impact on inflation, and the effects can be strong and immediate. Why do I say this? You will remember that in the first half of the year the rate of inflation over the previous twelve months was above the upper limit of the range, about 3.5 percent. Now, after a cumulative drop of 1.5 percent in September and October, the rate has fallen to below the lower limit. The Bank of Israel’s approach is to try to bring the rate back gradually within the range, and if possible to the midpoint of the range, with a one year forward horizon. The underlying reason for this approach is to avoid causing inflation volatility by sharp changes in the interest rate. Take the following situation as a hypothetical example: the Bank of Israel is acting to keep inflation in the next twelve months close to the midpoint of the target, i.e., 2 percent a year. But let us say that in the next ten months the rolling twelve-month inflation rate is below the lower limit of the range because of the drop in the index of 1.5 percent in September and October mentioned above. We may only see the twelve-month retrospective inflation rate within the target when those two months have dropped out of the calculation. We could have acted differently and reduced the interest rate drastically to bring inflation back within the target much more quickly, but then we could have created an unstable process of overshooting in the opposite direction, with inflation exceeding the target. It is therefore not worthwhile reacting to every shock as it occurs, but it is preferable to persist with the policy of gradually reverting to the inflation target within a year. B. The openness of the economy Now to my main topic for today, the openness of Israel’s economy to the global economy. This is an important issue because economic openness is a new reality that affects all of us, but we may not have internalized it in all areas. This conference, and others like it, take pride in the many and important participants from abroad, and this provides one indication of the new reality in which we live. Israel was one of the first countries to realize that a small economy cannot grow without being open to and participating in the global economy. As early as the 1960s we set out on the path of liberalization of international trade. But the program of exposing the economy to abroad in the mid-1980s and the liberalization of the foreign currency market and capital flows initiated by the Bank of Israel in the 1990s were the most significant aspects of this process. It was not just that they opened the economy to the global economy, but they created a framework for macroeconomic policy that operates according to the norms accepted in the advanced economies, based on budget and inflation targeting. This provides the infrastructure that enables the economy to achieve sustained growth, provided that the policymakers know how to face the challenges that it places before them. This is even more the case when there is no general consensus on the matter of fiscal discipline. We sometimes speak of changes in economic policy, and such changes were essential to developments in the last fifteen years. We must however recognize one important fact: growth derives from the increase in the private sector, and in Israel we have a private sector that in the main is successful, innovative and creative. It is a private sector that day after day proves its ability to compete in the world. Israel’s economy is very open to the world, and this is reflected in various ways: 1. In the current decade (2000–06) the share of exports in GDP has reached an average of about 40 percent. 2. In the same period the share of imports in GDP has reached an average of about 41 percent. 3. Foreign investments in Israel reached about $ 17 billion in January–October 2006, an all-time peak. 4. Israelis’ investments abroad in January–November 2006 reached about $ 21 billion, of which some $ 12 billion were direct investments. 5. Israel is in second place (after the US) in terms of the number of companies listed for trading on the Nasdaq. What is required of an economy that is open to competition from around the world? There are still areas in which we ought to improve, and here I will refer to aspects in the microeconomic sphere. In this context I would like to mention the Doing Business Report of the World Bank, which grades countries according to the ease of doing business in them. Israel is listed 26 out of 175, not bad at all. But if we look at the different components that go into this grading, we will see that we were good in certain aspects (investor protection, obtaining credit, international trade, opening and closing a business), but we scored very badly in others (obtaining licenses, enforcing contracts and registering assets). It is very important that we take steps to improve in these areas in order to contribute to a better business environment. We generally relate to these areas as if they are important for foreign investors. But they are important for all investors in Israel’s economy, domestic and foreign. Every Israeli investor has the choice of investing abroad. If we do not improve the atmosphere surrounding investment in Israel, we are likely to lose some domestic investments of Israeli investors’. C. The OECD The subject of the openness of Israel’s economy brings me to the question of Israel’s joining the OECD. What is the OECD? It is an organization of 30 countries that are committed to democracy and a market economy, most of them among the most advanced economies. Among the members are the US, Japan, Canada, Australia, and European countries. The OECD cooperates with about 70 other countries, and its activities encompass a wide range of fields, such as macroeconomics, finance, foreign trade, investments and capital flows, taxation, education, the quality of the environment, science and innovation, the energy market, social policy, market structure (with the emphasis on competition), companies’ organizational structure, and transparency. The OECD deals with the creation of rules of conduct in these spheres with the objective of promoting international agreements necessary for the global economy. Most of the work of the OECD is performed by intergovernmental teams, and thus its reports are based on the information provided by member governments. In the OECD forums countries exchange information and knowledge, devise methods for confronting economic problems, identify and formulate standards of appropriate conduct in all the relevant economic areas, and develop ways of improving coordination and cooperation between them. Representatives of member countries operate within a framework of some 200 specialist committees in the various policy areas. Why is it important for Israel to join the OECD? Membership would offer the following advantages: 1. It would promote Israel’s position in the important world economic forums, and would strengthen its economic ties. 2. It would enable us to be “in the know” at a relatively early stage of the formulation of standards in the sphere of economic policy, to adapt policy to those standards, and even to contribute from our own experience. 3. It would help us to promote economic reforms. 4. It would also help improve Israel’s rating in the international financial markets. What is Israel’s current position vis-à-vis the OECD? Israel’s economy is open, per capita GDP is high, and the degree of economic openness is good, and even excellent in certain fields, such as R&D. All these give Israel a standing as a potential member of the OECD. Moreover, since 1996 Israel has participated in various formats and committees of the OECD, mainly in the role of observer. The OECD is currently in the process of making decisions about the number of new members to be accepted into the organization, how the expansion will be implemented, and the standards to be required from the new members. These decisions are expected to be taken shortly before the Conference of Ministers in May 2007. Acceptance of a new member country requires a consensus among the member countries. Professionals and specialists in the government, the Bank of Israel and other relevant bodies are in contact with the OECD with regard to Israel’s acceptance as a full member, and we hope there will be a consensus among existing members on the question of our membership. It is important that Israel’s membership of the OECD remain high on the agenda of the various entities involved in this matter, and that progress is made in the areas that need special attention. This is a significant stage in the integration of Israel as an open, modern economy into the global economy. I hope we make it. Thank you.
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Keynote address by Professor Stanley Fischer, Governor of the Bank of Israel, at the 75th Anniversary Conference of the Central Bank of the Republic of Turkey "Dollarization: Consequences and Policy Options", Istanbul, 13-15 December 2006.
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Stanley Fischer: Dollarization Keynote address by Professor Stanley Fischer, Governor of the Bank of Israel, at the 75th Anniversary Conference of the Central Bank of the Republic of Turkey "Dollarization: Consequences and Policy Options", Istanbul, 13-15 December 2006. * * * It is both a pleasure and an honor for me to participate in this conference of the Central Bank of Turkey. In the first place, it is a pleasure to be at a conference of the Central Bank at a time when it is evident that monetary policy in Turkey is succeeding in gradually bringing inflation under control. Inflation is now around the single digit range, and given the experience in other countries – including Israel – that struggled to subdue inflation, it is reasonable to expect that with a sustained and consistent monetary policy, and the continuation of the supportive fiscal policy, Turkey will join other inflation targeting countries in achieving low single digit inflation. All this is a far cry from the situation during one of my most memorable visits to your country, on February 19, 2001, the day of the spectacular foreign exchange crisis that led to the shift to a flexible exchange rate regime and the beginnings of the inflation targeting approach to monetary policy. The Turkish economy has come a long way since then, and the credit for that belongs both to the Central Bank and to successive Turkish governments – both the ministers and the senior civil servants – who have demonstrated the ability to maintain fiscal discipline and continue the reforms that are transforming the economy and bringing it closer to its potential. Of course, the IMF too has made an important contribution to the success of this process, and I am happy that as a member of the Fund and the Fund team, I had the opportunity to work closely with the Turkish authorities. Second, it is an honor for me as Governor of the Bank of Israel to be taking part in a conference on the important topic of dollarization, a topic of interest not only to the Central Bank of Turkey, but also to us in the Bank of Israel, and to many other central banks and economies around the world. I will start by discussing the issue of full dollarization of an economy, that is the replacement of the national currency by a foreign currency, a process that has taken place in recent years in both El Salvador and Ecuador. I will then go on to discuss what must be the main topic of this conference – partial dollarization, with respect both to the assets and liabilities in the economy, and with respect also to the medium of exchange and the unit of account in some transactions. I. Full dollarization During the 1990s many economies were struggling to control or stabilize inflation. Many of them had used a pegged exchange rate to bring inflation down from triple digit levels. It was then that the power of the impossible trinity – of the combination of a pegged exchange rate, free capital movements, and a monetary policy dedicated to domestic goals – became clear, and that a series of financial crises erupted. Further, as the financial crises of that decade unfolded, it also became evident that the impossible trinity should be amended to say that the combination of a pegged exchange rate, free capital movements, and macroeconomic policy – not just monetary policy – dedicated to domestic goals was not possible. The resultant trilemma pointed in three possible directions: one was to attempt to control international capital flows, a solution that for good reasons was rejected by most countries 1 ; the second was to move to a more flexible exchange rate – though not necessarily one that was totally free-floating; and the third was to strengthen the exchange rate peg, either by adopting a currency board, or by getting rid of the exchange rate entirely, that is by adopting a foreign currency, or full dollarization. The major benefit of the third solution as seen at the time – and as emphasized particularly by my then-colleague Michael Deppler of the IMF – was that a country that adopted that solution would Among these reasons is that capital controls tend to: cut the development of the financial sector of the country off from the global economy; cut the economy off from the benefits of international trade in assets; and are frequently ineffective and a source of corruption. However, countries with capital controls, a weak macroeconomic framework, and a vulnerable financial system, need to strengthen the macroeconomic system and the financial system before or as they liberalize. rapidly see the benefits of the enhanced credibility of monetary policy in lower interest rates. When one considers for instance the case of Turkey, where high real interest rates in the late 1990s and in the run-up to the crisis created a massive fiscal problem 2 , the benefits of the lower interest rates were obvious. Those benefits had been seen in the case of Bulgaria when it adopted a currency board solution, a step just short of full dollarization, and they were seen also in the full dollarization cases of El Salvador and Ecuador in the early years of this decade. They were seen too in the cases of the countries joining, or slated to join, the EMU. The benefits of instant credibility were expected to be observed also in a rapid decline in the inflation rate. That benefit was not immediately obtained in the high inflation countries, with prices continuing to rise at double digit rates for nearly three years in the case of Ecuador, a result of the extreme real devaluation of the currency during the crisis that preceded dollarization. Evidently, Balassa-Samuelson effects would continue to operate – and to operate strongly – even in a country that had adopted the currency of another country, an effect that was also visible in the currency board cases of the Baltic countries. More generally, adherence to a currency board or to full dollarization was expected to strengthen overall macroeconomic discipline, in the belief that a government committed to such a policy would have no choice but to maintain fiscal discipline. Part of the reason for that belief was that the authorities would understand that the macroeconomic effects of failing to maintain the exchange rate peg – one on which the entire financial structure of the economy was dependent – would be disastrous. Unfortunately, that theory did not withstand the unfolding of the Argentine crisis. It was true that the collapse of a long-established and relatively long believed-in currency peg was extremely expensive for Argentina. But it was not clear that there was a better way out of the deep crisis in which Argentina found itself at the end of 2001. More generally, when using game theory to evaluate the beneficial effects of imposing large costs on policymakers for breaking a commitment – as in the case of Argentina in the 1990s – it is necessary to take into account the expected costs of breaking the commitment if circumstances arise in which policymakers nonetheless decide that is what they have to do. The costs of even a fully credible full dollarization policy are also clear: they are that the exchange rate is no longer available as an adjustment mechanism: adjustments that could otherwise be made by allowing the exchange rate to change – and that is the most natural adjustment mechanism to macroeconomic shocks, foreign and domestic – then have to be transferred to domestic prices and wages. And that generally means a more painful and prolonged adjustment. All this raises the question of what are the costs and benefits of membership in a monetary union, an issue of great future importance to Turkey, and one with which I will conclude this presentation. II. Partial dollarization In situations with partial dollarization, at least two currencies are being used, to differing extents, to perform the different functions of money – as unit of account, medium of exchange, and store of value. 3 For instance, it is common that the domestic money be used as legal tender, but that some foreign currency be used as unit of account in some transactions, and as a store of value – either directly, or via various indexation arrangements. In some countries, two or more currencies may circulate and serve as medium of exchange for different transactions – the domestic currency for smaller transactions, and a foreign currency for large transactions, for instance for real estate. The term "dollarization" generally refers to the assets and liabilities in use within an economy, and not to those either borrowed from or held abroad, although the impact of exchange rate changes on the domestic economy may be quite similar in the two cases. The emphasis in IMF programs on the primary surplus of the budget – that is, the non-interest surplus – to some extent deflected attention from the depth of Turkey's fiscal problem at that time. In this section I draw on the papers presented in the book edited by Adriano Armas, Alain Ize, and Eduardo Levy Yeyati, Financial Dollarization: The Policy Agenda, International Monetary Fund, 2006. Typically partial dollarization is the result of a period of economic instability in the past, generally a period of high inflation. In such circumstances, economic agents will want to hold safer assets 4 , and the economic and political systems will produce them. That can be done by allowing the banking system to offer foreign currency, or exchange-rate-linked, accounts; and the banking system in turn will want to lend in a similar form. Dollarization typically has a long life, generally surviving long after the period of instability that gave rise to the phenomenon. It is useful to distinguish four types of dollarization: (i) asset dollarization; (ii) liability dollarization; (iii) medium of exchange dollarization in which a foreign currency is used for some transactions; and (iv) unit of account dollarization, in which future payments are indexed to an exchange rate. The last is sometimes called "real" dollarization. Asset and liability dollarization The key questions that arise are whether different types of partial dollarization contribute to financial vulnerability and instability, whether and under what circumstances it would be desirable to have less dollarization, and if so, how that can be achieved. We start with asset and liability dollarization. Consider first the impacts on the banking system of operating in two currencies, on both sides of the balance sheet. It was common in the financial crises of the 1990s to discover that banks that thought they had hedged their foreign currency liabilities (or their foreign-currency denominated liabilities) by lending in dollars, were not in fact hedged, because their non-exporting borrowers were not able to repay their dollar-denominated loans. Indeed, even if the banks thought they had a net long position in foreign-exchange denominated assets, they sometimes discovered that a deep devaluation devastated their balance sheets. Thus unless lenders are very cautious in evaluating their borrowers, partial dollarization can severely increase the vulnerability of the banking and financial systems to exchange rate changes. These exchange rate changes could be driven by foreign developments, but in practice they were more often driven by domestically generated shocks, frequently caused by fiscal problems. That is to say: asset and liability dollarization makes the financial system, and thus the economy, more vulnerable to exchange rate shocks. There has been some discussion in the literature of whether dollarization helps create financial depth. The empirical answer seems to be uncertain. But when one takes into account that economic agents will seek safer assets where they can find them, and that capital controls are never totally watertight, the answer must be that dollarization helps preserve a larger domestic financial system than would otherwise exist. For otherwise much of the financial system would move offshore. Can monetary policy be effective in a heavily dollarized economy? In one writes down the equation of exchange, MV = PY, then it seems that monetary policy can get leverage over prices through the normal quantity theory mechanisms. But there are three qualifications to that answer. First, it is not clear what the relevant M is, and whether the central bank can fully control that M. If the domestic and foreign currencies are close substitutes in terms of what matters for the equation of exchange, the central bank may not have effective control over M. Second, in heavily dollarized economies, fiscal policy is likely to be problematic, and to make it difficult for monetary policy to avoid the difficulties associated with fiscal dominance. Third, there is the question of what determines interest rates in a highly dollarized economy. If the capital account is open, rates of return on dollarized assets and liabilities in the economy are likely to be significantly affected by foreign interest rates, reducing the leverage of monetary policy on aggregate demand. To the extent that the exchange rate is flexible, there may be some leeway between foreign and domestic interest rates, giving monetary policy some leverage. Although I have not so far distinguished between dollarization and exchange-rate linking of assets and liabilities, there is a potentially important difference. So long as assets and liabilities are exchange-rate linked, and payable only in the domestic currency, the central bank still technically has the capacity to serve as lender of last resort in the domestic currency, even without holding massive reserves. But this The literature uses the concept of a minimum variance portfolio for the economy, which includes a significant share of foreign-currency or foreign-currency denominated assets. does mean that the impact on the exchange rate of a significant financial crisis is likely to be very large in an economy with extensive dollarization. Empirical work shows that monetary policy in heavily dollarized economies tends to aim to smooth the exchange rate. This is not surprising given that economic agents in such an economy are very vulnerable to exchange rate changes, and that monetary-policy makers will typically also be concerned about the stability of the financial system. In that regard, it is often suggested, and correctly, that reserve requirements against foreign currency liabilities should be larger than those against domestic currency liabilities, and that especial care needs to be taken in evaluating the risks associated with foreign currency assets. However, it is also the case that the more difficult it becomes to hold foreign-currency assets in the domestic banking system, the more those assets are likely to be held outside the banking system, quite possibly abroad – in other words, actions to limit the extent of dollarization may well contribute to capital flight. Why not simply fix the exchange rate? We have already discussed that issue, under the heading of full dollarization. It can be done, for small economies, and for ones – such as the candidates for entry into EMU – that know how they will ultimately exit the fixed exchange rate arrangement. But it is also a dangerous course of action for those countries that might one day find themselves having to change the exchange rate. There is some evidence that the provision of price-indexed financial assets helps reduce the extent of dollarization. That makes considerable sense, since the underlying issue for asset-holders is increasing the safety of their portfolios. Generally countries that suffer from high inflation, which empirically means also unstable inflation, provide a range of assets, including both price- and foreignexchange indexed assets. But extensive price level indexation, like dollarization or exchange-rate indexation, may also complicate the response of the economy to shocks. Medium of exchange dollarization I will not discuss this issue in detail, except to note that the use of foreign exchange for making large payments may be more tax- than medium-of-exchange related. "Real" indexation – unit of account dollarization Long after a country has returned to price stability, and even after the disappearance of almost all asset and liability dollarization, a country may still find that some domestic prices are specified in dollars. This is currently the situation in Israel. During the course of the nineties, financial dollarization declined dramatically in Israel. For most of the present decade the average inflation rate has been around two percent. Nonetheless, housing and apartment rentals, and the fees for some services, including those of lawyers and accountants, are quoted in dollars. These are all fundamentally nontraded goods. This means that when the exchange rate changes in Israel, not only do the prices of imports change, and feed through gradually into the price level, in the way they do in all economies, but also the localcurrency prices of a significant part of the price index react also immediately. Housing accounts for over 20 percent of the CPI. Empirical estimates show that an exchange rate change feeds through into the domestic price level within a matter of months, with the pass-through coefficient being about one-third. Because the exchange rate is volatile relative to goods prices, month-to-month inflation in Israel also relatively volatile. This complicates monetary policy. We are inflation targeters, with the inflation target being 1-3 percent. But given the volatility of oil prices and the exchange rate, we have found it difficult to stay within the range. Just in the last two months, as a result of the fall in the price of oil and the weakening of the dollar, our price level fell by 1.5 percentage points. That will ensure that we will be well below our target inflation range this year, with inflation likely to end the year at about zero. That is not a major problem given that the economy is growing fast, but we would of course prefer to be within the target range. As it is, we have adopted a flexible inflation targeting approach, in which we aim to return within the inflation range with a horizon of about one year. This approach seems to have gained considerable credibility. Further, the rapid pass-through of the exchange rate into inflation sometimes makes monetary policy easier – for when we change the interest rate and the exchange rate reacts rapidly, the transmission mechanism of monetary policy is very fast. So the tight exchange rate-inflation link is not only a problem, sometimes it is a benefit. But not on average, for our inflation rate reacts rapidly to every external shock that moves the exchange rate. We would prefer a slower pass-through of the exchange rate into prices, so that the inflation rate could be more stable. And the fact remains that the economy continues to pay a price, in terms of inflation volatility, for a period of high inflation that was brought under control over twenty years ago: inflation and its consequences, among them dollarization, have very long-lasting effects. III. What to do? Given that dollarization complicates economic management, and contributes to the uncertainty that ensures its continuation, it is natural to want to get rid of the phenomenon. That is certainly a worthwhile goal when dollarization is extensive. At the same time, in a fundamentally stable economy, there are few good reasons to prevent people from holding the assets they want and from entering into the contracts they want. The first thing to do to reduce the level of dollarization is to get the macroeconomic framework in shape. That means in particular putting fiscal policy on a sustainable track. And it also means developing a monetary policy framework. For most open economies that framework should be one of inflation targeting, with exchange rate flexibility. As the macroeconomic situation stabilizes, as it is doing in Turkey, the extent of dollarization – particularly asset and liability dollarization – can be expected to start declining. For a long time it seemed that the extent of asset and liability dollarization was impervious to improved economic performance. That was certainly the impression one had looking at Latin American developments, where for instance Bolivia stabilized from hyperinflation in the mid-1980s, but the banking system continued to be over 80 percent dollarized into the present century. Now however we have several examples of countries that have dedollarized successfully on the asset and liability sides, including Israel, Poland, Mexico, Egypt, and Turkey. And some signs of declining dollarization are evident in Latin American countries where it seemed that dollarization was impossible to reverse. Could legal restrictions on dollarization speed up the process of dedollarization? Effectively implemented, they could. But that route should not be tried until the preconditions for macroeconomic stability are in place. And the restrictions are likely to be difficult to enforce. This may be especially the case for unit of account dollarization, where people are likely to find ways to contract in their preferred units despite the law. Over the longer run, once normal conditions have been restored, it should be possible to permit more freedom to individuals and institutions to operate in the financial assets and liabilities that they prefer. Just as in the case of price level indexation, when the macroeconomic environment has been stabilized, indexed and foreign currency instruments can be introduced without destabilizing the macroeconomy. IV. Euroization and EMU If dollarization, including full dollarization, should be avoided, why join EMU? This is a question which Turkey will have to ask itself, sooner one hopes, rather than later. The answer is that joining EMU is a more far-reaching step than implementing a currency board, or even deciding to use a foreign currency. For membership in EMU involves signing up to a host of restrictions on policy, not least on fiscal policy, which are designed to prevent the types of crisis that make full dollarization potentially problematic. Further, membership in the EU facilitates some of the adjustment mechanisms – including totally free trade, full capital mobility, and considerable labor mobility 5 – that are frequently absent when a country dollarizes unilaterally. And EMU members do have a say in determining monetary policy. There still remains the fundamental fact that a country that joins EMU gives up the exchange rate as an adjustment mechanism. Countries that have more flexible wages and prices will adjust better than The extent of labor mobility will be a major issue when Turkey joins the EU, as it is in the cases of Bulgaria and Romania. those with less flexibility, and on present performance Turkey is likely to have an advantage in that regard. To set these problems in perspective, we need to remember that the states of the United States also gave up the exchange rate as an adjustment mechanism, and that they manage to adjust to shocks quite well. But at this point we are discussing the topic for the next Central Bank of Turkey conference – how to make the best of the benefits of joining the EU and EMU – and I would like to conclude by thanking our hosts for their invitation and for their hospitality, and by wishing Turkey every success as it continues its impressive economic development. Thank you.
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Main points of the address by Professor Stanley Fischer, Governor of the Bank of Israel, on receiving the Prime Minister's Award, at the Presentation of the Awards by the CFO (Chief Financial Officers) Forum, Tel Aviv University, Tel Aviv, 2 January 2007
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Stanley Fischer: Bank of Israel’s achievements Main points of the address by Professor Stanley Fischer, Governor of the Bank of Israel, on receiving the Prime Minister’s Award, at the Presentation of the Awards by the CFO (Chief Financial Officers) Forum, Tel Aviv University, Tel Aviv, 2 January 2007. * * * First of all, I would like to thank you on behalf of the staff and managers of the Bank of Israel and on my own behalf for granting us this award. I know that we are being given the award because of the Bank of Israel’s achievements as reflected in the survey carried out by the CFO, and my colleagues and I are truly proud of that. I will not be letting out any secrets if I tell you that recently the Bank of Israel has been the object of much criticism. Much of the criticism is unjustified and petty, but some is justified, and we treat that part very seriously and are taking steps to improve ourselves where necessary. I must stress one thing, however. I have not encountered any justified complaints about the professionalism of the Bank’s staff in their work. Professional arguments and differences of opinion regarding the activity of the Bank of Israel are legitimate and will continue to be so. But there are hardly any complaints about lack of professionalism. And the CFO survey corroborates this. Thus, with regard to the decisions on the interest rate, there is no end to the differences of opinion and suggestions as to what to do with the interest rate. But these are generally based on professional considerations. The whole process of analysis and decision making in the Bank of Israel in this area is one of the finest I have come across. I inherited this excellent legacy from my predecessors. Likewise with regard to the Banking Supervision. Sometimes differences of opinion arise, and conflicting claims are made both by the banks and the public. But these are professional disagreements, and there will always be such. The staff in the Banking Supervision Department are rightly considered to be of the highest caliber, and that was one of the points made by the IMF delegation in its report on banking supervision in Israel a year ago. The same applies to the management of Israel’s foreign currency reserves, which currently stand at about $ 29 billion. The Bank of Israel is considered by the international institutions to be one of the best central banks in this area, and experts from the Foreign Currency Department are invited quite regularly to advise other central banks. The picture with regard to the payments system in Israel is the same. Most of the public do not know how it works and are not very interested either. That just goes to prove that the public knows that the payments system works well and that someone, i.e., the Bank of Israel, is taking care of it. I could go on and say similar things about each of the areas of the Bank’s activity, such as its role as economic advisor to the government, and in this context the excellent degree of professionalism of the Research Department, and the Currency Department, and its expertise in its field. But time does not allow me to do so. It would be remiss of me at this point if I did not mention the important role played by the Bank of Israel in fashioning Israel’s economy, in particular since 1986 following the implementation of the Economic Stabilization Program. In the second half of the 1980s and during the 1990s the Bank of Israel initiated many far-reaching changes in Israel’s economy, including liberalization, opening the economy to capital flows, and embarking on the disinflation process. This was not an easy period, and there was heated public debate and controversy all along the way. But the Bank of Israel, and I make special mention of the then Governor Professor Jacob Frenkel, succeeded in pushing the changes through, and the economy is currently enjoying the fruits of that success, and it can certainly be stated that it provided the very important infrastructure for the excellent situation of the economy today. Since I took up office I have been trying to correct things that need correcting and to promote the process of streamlining and modernizing the Bank. In these efforts I am joined by my colleagues, in particular the Director General of the Bank, Jacob Danon. The objectives we are pursuing are: (a) to solve the labor dispute in the Bank; (b) to carry out the reorganization process in the Bank; (c) to allow a few dozen employees who are under-employed to retire, so that the staff complement will drop by about 10 percent; (d) to get a new Bank of Israel Law passed; and (e) to make extensive changes in the decision-making process in the Bank. I have not included the matters we have already dealt with and will continue to deal with, such as setting up procedures for encouraging excellence in the Bank and formulating a new organizational culture. With regard to the new law we have reached a very advanced stage of preparation, after a long period of working vis-à-vis the Ministry of Finance and the Prime Minister’s Office, and the government has adopted the principles we formulated. The proposed law is appropriate for a modern economy, with decision-making processes and mechanisms that ensure transparency and internal and external controls suited to an independent central bank operating in a democracy. The new law will define the aims of the Bank more correctly and accurately, with the maintenance of price stability as its top priority. The independence of the Bank in the use of the instruments to implement its policy will be clearly specified, and a new mechanism will be instituted for decision making regarding the interest rate policy and the management of the Bank. Two new bodies will be established: (1) a monetary committee headed by the Governor, whose members will include people from outside the bank with the appropriate professional background and with no potential conflicts of interest; (2) an administrative council that will act as the Bank’s board of directors, with a majority of members from outside the Bank, one of whom will serve as chair of the council. The council will approve the administrative aspects of the Bank’s operations, including work plans, the Bank’s budget, and salaries. The decisions of the monetary committee and the administrative council will be transparent to the public, the Knesset, and the government. To conclude, I would like to express the hope that the Bank of Israel will be able to continue with the goals we have set ourselves, and that we will soon present to Israel a central bank that will enjoy the continued confidence of the public not just in its professionalism but also in the legal and administrative framework in which it operates.
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Speech by Professor Stanley Fischer, Governor of the Bank of Israel, at the Seventh Annual Herzliya Conference, Herzliya, 23 January 2007.
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Stanley Fischer: Overview and challenges facing the Israeli economy Speech by Professor Stanley Fischer, Governor of the Bank of Israel, at the Seventh Annual Herzliya Conference, Herzliya, 23 January 2007. * * * As you surely know, the Israeli economy is in very good shape. According to initial estimates by the Central Bureau of Statistics, GDP grew in 2006 by 5 percent, which seems all the more impressive as it was a year with hostilities in the north. Furthermore, we saw rises in investment, exports, employment, and productivity, while unemployment continued to fall, reaching 8.3 percent, compared to a record high of 10.7 percent in 2003. The lowest unemployment rate the economy achieved since 1990 was 6.6 percent. That was in 1996, when the labor market was at the start of structural change with the entry of foreign workers, and it is therefore reasonable to assume that the natural rate of unemployment – that commensurate with full employment – is now at a higher level. At the same time, financial stability and price stability have been maintained. This background allowed for cumulative interest rate cuts in recent months such that now, for the first time, there is a significant negative interest rate gap of 0.75 percentage points, between the Bank of Israel and the US Fed rates. These achievements are beginning to give us encouraging signs regarding certain improvements in two problematic areas that the economy faces: • The public sector debt burden. This, one of the biggest problems in the Israeli economy, fell to about 88 percent of GDP compared to 97 percent at the end of 2005. This is a remarkable achievement, but it is important that we continue along this path to bring the ratio down to 60 percent of GDP – the ceiling set by the Maastricht treaty – and after that, to bring the ratio down even further. • Poverty, a major topic of public debate in Israel. The Bank of Israel monitors not only relative poverty – a measure principally of social gaps – but also a measure of absolute poverty. This is a measure of the individual's ability to purchase a basket of essential goods. We have therefore been closely following developments of a measure of the poverty line, calculated in real terms since our base year (which we've taken as 1997 for calculation purposes). From our analyses, we see that in 2005 there was some drop in absolute poverty after it had risen in the years 2001 to 2004. Those years where the absolute poverty index rose could be attributed to the period of recession in economic activity, and in 2004, individuals were suffering from the effects of cutbacks in welfare payments which continued gradually even after the recession. The drop in poverty in 2005 could be attributed to the growth that began in 2003. By the way, though poverty was seen to rise in 2005 – according to the relative measurement – it rose more moderately than in previous years. Only in a few months time, when the Incomes Survey for 2006 is published, will we be able to see what happened with poverty – both in relative and absolute terms – in the past year and we all hope that we'll find that economic growth continues to positively affect all levels of society. We all have a tendency to praise ourselves for our achievements and blame external forces when things go wrong. But the truth is that some of the achievements in the Israeli economy in 2006 stemmed from the favorable condition of the world economy; almost everywhere, and in particular the emerging market economies, registered rapid growth and low inflation in 2006. But even after taking into account the external factors, we may still attribute an important part of our economic achievements to our own actions. I'll start with macroeconomic policy. And I refer to the government's budget policy – and this year the government managed to steer the state budget for 2007 through the Knesset very shortly after the end of 2006 – and to the Bank of Israel's interest rate policy. And it is impossible not to note the most important role: that of the business sector, which for years has grown at a faster pace than the economy in general. Looking forward, we estimate that the economy will grow this year by 4.6 percent and that inflation will reach the target range of 1-3 percent. In terms of inflation-over-the-past-12-months, this is expected only by the fourth quarter of the year. In any case, the Bank of Israel's policy is to adjust the interest rate gradually as and when needed, to avoid unnecessary shocks to the economy and the financial markets. I would like to add a few words about the many affairs that are termed – rightly or not – as corruption scandals. Obviously we'd prefer that such affairs didn't happen, but it is important to stress that the moment they do arise, they are dealt with promptly and seriously. This is a very important bright side, and it is not a trivial point. It shows that the judicial and legal infrastructures are not prepared to put up with such unacceptable behavior. We should also remember, that in most of the cases, we are referring only to a suspicion and it is not clear what the final outcome will be. In the past, we have seen many cases of suspicion that in the end came to nothing. And what is the most important challenge facing the Israeli economy today? It is the challenge to maintain this growth drive and to translate it into what we term "sustainable growth." And what is the most important topic on this agenda? First, macroeconomic policy, i.e. budget policy and interest rate policy, which I noted earlier and the importance of which, I hope, the general public understands. And secondly, further to policy, is the need to continue with reforms. Here I would like to expand on reforms in the Israeli economy. The panel before me spoke about one of the most important reforms in recent years, the reform of the capital market. There were other important reforms, such as the reforms of the ports, and personal income tax. In this context, I would like to present an initial list that we at the Bank propose to put forward. And more so, the Bank's Research Department is working to draft proposals for these reforms. Specifically our list includes: 1. In the labor and welfare fields: Here we return to a subject we have proposed, and which we are working on together with the Prime Minister's Office and the Ministry of Finance: that of negative income tax ("earned income tax credit"). Other topics in hand are the increase in incentives to go to work, inter alia, through helping improve work support services, foremost of which is childcare, and strengthening the Wisconsin Plan along such lines that are currently being discussed. That is tightening the link between incentives for participating companies and absorbing the individuals into the labor force in general, and ensuring quality placements for the workers in particular, as well as adjusting the program to the needs of the various population groups. 2. In education: It is important that a reform of the higher education system, along with the primary and secondary systems, is examined. Concerning higher education, the whole issue of funding must be dealt with. Fortunately, a new committee has been set up headed by former Minister of Finance, Beiga Shochat, to seriously tackle the field of higher education, and the Bank of Israel is involved in two sub-committees on this matter. As for primary and secondary schooling, one must find ways to increase the effectiveness of the system, to direct sufficient resources to it and to ensure equal opportunities for children from all strata of society in order to encourage and nurture excellence. Education is a very important issue that will aid economic growth in the long term as well as reduce social gaps. In Israel, as elsewhere, the yield on education has increased a great deal in recent years. 3. Banking competition: The Bachar committee achieved its mission of increasing competition in the credit field, but now we face the challenge of boosting competition in the retail field. Here, the Supervisor of Banks is the major player, and together with the management of the Bank of Israel and me, is examining ways to strengthen competition in the banking system including making it easier to transfer accounts from one bank to another, and more besides. There is the field of bank charges, and in this context the Bank of Israel has already prepared a bill that would grant the Supervisor of Banks the authority to regulate fees in areas that have no competition. This bill will be submitted in the next few days. 4. In infrastructure: In this context I refer to the fields of transportation – roads, rail, public transport – and the field of electricity – and here it is important to carry out the planned reforms. 5. Real estate: Here our emphasis is mainly on developing a more efficient real estate market, on land ownership (the Israel Lands Administration) and on easing the bureaucratic processes such as planning, licensing and registration. Reform in this field is clearly not a simple matter but it is important to begin freeing the real estate market in Israel from its many current restrictions. 6. Defense spending: This is very much on the agenda of the day, and I am happy to see that a committee headed by former director general of the Ministry of Finance, David Brodet, is dealing with this subject, and the Bank of Israel is involved. Clearly every country has the responsibility of defending its citizens, but it is difficult to know exactly what resources are required. It is easy to err in either underestimating or overestimating the funds needed. So it is important to establish from time to time a select group of professionals, such as the current committee, to check this matter thoroughly, and it is important too to follow through on any resulting recommendations. 7. Health: This subject often pops up on the agenda and, among other things, it is important to examine the pricing of various health services. I would like to add here that overall the health system in Israel is very good by any measure in international comparison. 8. Another matter of concern, particularly when coming to approve the state budget, is that of examining a new approach to the budget process. This includes a multi-year approach to fixing budget aggregates, the involvement and responsibility of the different government ministries in the budget process, decentralizing budget responsibility through quality management of local governments, and increasing transparency of the budget process. Most of these matters are in different stages of treatment by the government, and the Bank of Israel not only supports their progress but also assists as best it can. As I said earlier, this is only a very formative list, part of it already being dealt with and others only partly so, if at all. What is important is to start straight away on creating the necessary infrastructure that will propel the economy forward for many years. In other words, we must do everything possible to ensure this drive toward sustainable growth. This is vital not just for the future of the economy, but also for the future of the State of Israel.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Press Conference on the Publication of the Bank of Israel 2006 Annual Report, Jerusalem, 11 April 2007.
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Stanley Fischer: Brief review of economic and financial developments in Israel in 2006 Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Press Conference on the Publication of the Bank of Israel 2006 Annual Report, Jerusalem, 11 April 2007. * * * I would like to start by congratulating the team that prepared the report, headed by Karnit Flug, director of the Research Department, and Michel Strawczynski, Deputy Director of the Research Department. The team consisted of staff from the Research, Monetary, and Foreign Exchange Activity Departments and the Financial Stability Area. This morning I presented the Report to the Acting President of Israel and Speaker of the Knesset, Ms Dahlia Itzik; the Prime Minister, Mr Ehud Olmert; and the Minister of Finance, Mr. Abraham Hirchson. In economic terms 2006 was one of Israel's most successful years. This was reflected in the high rate of growth, the decline in unemployment, the improvement in employment, the impressive surplus in the current account, the amount of foreign investment in Israel, and price and financial stability. All this took place against the background of rapid global economic growth, but also in a year in which Israel was engaged in a war. Despite the successes, there are three areas in which, although some progress was made, much work still needs to be done: the relatively high unemployment rate, the large share of public debt in GDP, and the high incidence of poverty. Helped by the high rate of growth, however, especially in the last three years, some improvement was evident in all these areas. This drives home the importance of focusing on the main objective of macroeconomic policy – the maintenance of a high rate of growth and converting it into a long-term one. The continued success of Israel's economy depends this year too on three main factors: developments in the global economy, over which we have no influence; (2) the geopolitical situation, on which we have some effect; and (3) the continuation of the government's economic strategy as followed in the last few years, over which we in Israel do have control: • Current fiscal strategy should persist, mainly the preservation of a low budget deficit, leading to further lowering of the debt/GDP ratio, which despite its reduction is still too high. It is important to avail ourselves of the good years we are currently enjoying to persist in reducing it. Reducing the share of debt in GDP would make the economy more resilient to shocks, release resources for other important needs, and enable the government to operate a counter-cyclical policy when necessary. • The monetary strategy should be continued, acting to ensure price stability, as an intrinsic part of economic and financial stability and as a firm base for sustained growth. • Economic reforms should continue. The structural reforms in the areas of privatization, education, competition and the infrastructure should be completed; this would help increase productivity and growth. Moreover, further development of the financial infrastructure and greater competition in the capital market, particularly between the institutions that operate vis-à-vis households, is the right path to follow, and would contribute to growth. I would now like to address three specific issues: 1) monetary policy; 2) the economic situation in light of the political situation; and 3) Israel's membership of the OECD. 1) Monetary policy We are currently at a stage where the economy is growing quickly, and inflation is very low, even lower than the target, and this is expressed among other things in price rises in the financial markets. In operating monetary policy we keep our eye on our primary target – the inflation target – and also on the secondary targets, i.e., to contribute to economic activity and financial stability. As every change in the interest rate also affects, to some extent, the rate of growth and the prices of financial assets, in making our interest rate decisions we have to take into consideration the trade-off between these three factors – inflation, growth and financial stability. This is an essential consideration in the whole issue of monetary policy, and it will feature in our future decisions too, as it has till now. 2) The economic situation in light of the political situation Whenever I speak to investors or analysts from abroad, they always ask the same question, "How can Israel's economic situation be so good despite all the political problems facing the country?" I answer: (a) the global economy is growing at an impressive rate; (b) the government has maintained fiscal discipline, one of the points on which there is a consensus in Israel; (c) in the last fifteen years we have erected a far stronger and more robust economic framework in Israel than existed previously, especially in the areas of the foreign currency market and the financial markets in general; and (d) the business sector, during the war last summer, showed its ability to carry on functioning well and more or less meet its delivery dates for domestic and export orders, and in so doing, contributed to the economy's resilience. 3) Israel's membership of the OECD The OECD is currently deliberating on the enlargement of the organization, in the run-up to its Ministerial Council meeting in May of this year. The Bank of Israel, together with relevant government ministries, has been engaged in a process which we hope will lead to Israel's membership of the OECD. It is important that this retains its high priority in the work plans of all those in Israel involved in this. Israel's acceptance into the OECD would be an important stage in its further integration into the global economy, as an open and modern economy. I hope that we will achieve this.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Seventh Hatikva Conference of the Histadrut in cooperation with the Friedrich-Ebert-Stiftung, Tel Aviv, 17 April 2007.
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Stanley Fischer: Labor relations in Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Seventh Hatikva Conference of the Histadrut in cooperation with the Friedrich-Ebert-Stiftung, Tel Aviv, 17 April 2007. * * * I am pleased to stand here before you today, especially as this platform gives me an opportunity to speak about the important subject of labor relations in Israel, and in particular, labor relations in the public sector. Labor relations is not within my field of expertise in economics, but it has occupied much of my time in Israel since I took up office almost two years ago. It has done so not only because of the issue of salaries in the Bank of Israel. It occupies me because I have the impression that we are unable to resolve labor disputes without going through strikes and industrial action and turning to the labor courts. The question we should address is whether we can manage labor relations with less confrontation and without wasting time and energy on avoidable clashes. On average, Israel loses more working days through strikes than do Spain, France, the UK, and in some years also more than the US. I am not speaking about the percentage of working days lost but their total number. The figures show that we have a serious problem in the area of labor relations. The fact that we have a very large number of strikes by international comparison is not the problem – it is the symptom. The damage caused by strikes is felt by all – the strikers, the employers, the general public and the whole economy. As an example, think of the harm caused to tourism because today every tourist who wants to visit Israel hesitates because of concern over whether his flight will be able to land or whether his return flight will be able to take off on the due date. We need only look at the newspapers of the last few days to get an idea of the number of strikes and instances of industrial action My remarks here are based on the reports of the Koberski Commission and the Zussman Committee at the end of the 1980s, the position paper by a team headed by Guy Mundlak, Industrial Relations in Times of Transition (Israeli Democracy Institute, 2004), the work of my colleagues in the Bank of Israel, especially the late Zvi Zussman, and of other experts outside the Bank of Israel who helped me. I will start by outlining briefly the wage system and labor relations in Israel’s public sector, and then indicate the main problems in the system, and will end with a very general description of some aspects of the reform required in this area. 1. The wage system and labor relations in the public sector in Israel I will relate mainly to the public sector, which includes large companies some of which are on the way towards privatization and some of which have already been privatized. I will speak about the public sector for two reasons (a) it comprises a relatively large part of Israel’s economy, with on average about 30 percent of all employees, while in the OECD the average is less than 20 percent. (b) It seems that labor relations in the public sector are particularly problematic, and most strikes, of which there are many by international comparison as I said, take place in that sector. In general terms it can be said that the wage of a public sector employee in Israel is derived from a number of parameters, chief among them his seniority, i.e., years of service, the system of grades (according to different wage scales: Ahid, the basic or uniform scale; Mahar, the scale for university graduates; teachers; doctors etc.), and the grade within the scale. This component of the wage is the basic wage, and to this many additional payments are added, giving the total wage. By the way, the total list of such additional payments and benefits contains over 1,000 items, not only making it very difficult to understand a pay slip, but even worse, causing lack of transparency. Instead of negotiating over wages in simple terms, negotiations take place in terms of benefits, with hardly anyone really understanding their true value, which may well be the reason for using them. Wages are adjusted generally once every few years in wage agreements following negotiations on a collective basis. This contrasts with the situation in the business sector where, at least in principle, the wage is derived from the employee’s output. And if in the private sector it is difficult to make a precise assessment of an employee’s output, in the public sector it is far more difficult to do so. 2. The main problems in the wage system and labor relations in the public sector in Israel • The basic wage described above, deriving from such factors as seniority, wage scale and grade, is only part of the gross wage, and in most cases does not constitute more than 50 percent of it. • It is worth noting that in the public sector wages are not necessarily based on employees’ output. This is not only because of collective granting of higher grades or increases in seniority, for instance, but also because it is difficult to pay the employee suitably on the basis of his knowledge, responsibility, or generally, his performance. This can reduce an employee’s motivation to provide high-quality service efficiently. On the other hand, there is hardly any way to move an employee with low output to another position in which his output might increase, or to end his employment in cases where he is making no contribution or even causing damage. • The wage-setting system has a chain of linkages. • The manager has very little authority or ability to reward his staff according to their performance. • Wage negotiations sometimes take place according to a party’s ability to exert pressure, and do not necessarily reflect labor-market conditions. • The public sector is beset by many labor disputes, and hence many strikes. The problem with quick-fire solutions to disputes is that in contrast with established mechanisms that create agreement and ongoing norms with regard to labor relations, strikes and courts just hasten the advent of the next dispute. This is an inefficient process that leads to a waste of time and resources in the economy 3. Principles for reforming the wage system and labor relations in the public sector in Israel I will relate in broad outline to three aspects: the structure of wages, the recruitment and promotion of staff, and resolving labor disputes. (a) The structure of wages: this should be simplified. As I mentioned, currently there are numerous payment items (more than 1,000), that can be added to the basic wage, which constitutes about 50 percent of the total wage. These payments distort the wage structure, which is not transparent and which gives rise to discussions on the names of the items instead of the actual bottom-line payment to the employee. This reminds me, and probably lots of you too, of the Gashash Hahiver “Israbluff”. It is important that an employee’s wage be real, open and transparent. (b) Staff recruitment and promotion: it is important to implement the rule that new staff should be recruited according to their level of education and knowledge, and promoted according to their output. Therefore: i) The period of classifying a new employee should be extended, and it should include examining his suitability for more than just one position; the trial period should also be extended. In addition, wherever possible staff should be recruited to a career track, rather than for a particular job. ii) To ensure that promotion is determined by output, there should be a mechanism that enables managers to assess an employee’s output; promotion should then be conditional on how well the employee carries out his assignments and meets his targets, and on the periodic assessments prepared by the manager. Also, outstanding employees should be given special bonuses for excellence. At the same time, grades should not be granted automatically with seniority, nor allocated collectively. iii) Resolving labor disputes: the system of agreed arbitration should be strengthened, and it should become an important factor in settling labor disputes that are not legal disputes, and it should be become an established part of the process in such cases. At the same time, wide room for manoeuvre should be left for negotiations with representatives of the employees on all subjects which require employee involvement. Furthermore, further limitations should be imposed on the right to strike, provided that such limitations are intended to protect the public and the economy and to encourage the solution of disputes. This can be done via injunctions and removing strikers’ protection against legal action. The changes I have suggested would benefit the general public, employees in the public sector who wish to contribute to the welfare of the public, and the public sector as employer. The outline I have presented is a very broad one, as I said, but the Bank of Israel will continue working on it. I hope that this will enable us to present a full, detailed, well formulated proposal that will lead to a change in this area. Although the task is not a simple one, it certainly needs to be undertaken.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Committee of Enquiry on Bank Fees, (within the framework of the Knesset Economics Committee), Jerusalem, 4 June 2007.
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Stanley Fischer: The banking and financial system in Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Committee of Enquiry on Bank Fees, (within the framework of the Knesset Economics Committee), Jerusalem, 4 June 2007. * * * In recent months the Bank of Israel has conducted professional and comprehensive work into the field of competition in the banking system. This work is being held on two plains: a) In-house teams of economists are discussing recommendations on ways to enhance competition in the financial system in general, and in the banking system in particular. In this framework, methods are being examined of bringing in new players into the banking system. b) The Bank of Israel has drafted a legislative bill that would grant the Supervisor of Banks the authority that he currently lacks to regulate banking fees. Competition in the banking and financial systems The financial system has undergone many changes since the late 1980s. These refer to the government's cessation of massive intervention in the capital market; the removal of barriers and liberalization, changes in the taxation system, and the recent separation of provident and mutual funds from the banks (the Bachar reform). These changes were manifold and important. However on the retail side, competition between banks should be strengthened. At present, as I mentioned, we at the Bank of Israel are examining new ways to boost competition in the banking system, with an emphasis on the household sector. Why is the level of competition low? In Israel there are only a limited number of banks, and in effect two large banks capture most of the banking market. On many occasions I meet international financial bodies, including foreign banks, in order to interest them in entering the local retail banking market. Foreign banks have operated in Israel for some years now, but most of their activities are in the corporate sector. One of the reasons for the fact that the foreign banks almost entirely ignore the household sector is that the local banks have a widespread branch network, and the local banks offer financial services based on advanced technological systems. This places a high barrier to entry to any potential newcomer in the market, whether local or foreign. Furthermore, it is important to remember that the fact that the Israeli economy is small, does have an influence on the decision by a financial institution to set up in the Israeli market. Against this background, we are examining the possibilities of bringing in a new type of player into the banking market, for example, an Internet bank, or converting the Postal Bank into a true bank as part of the postal privatization. Regulating prices, in this case banking fees, is generally not the ideal method and we would prefer not to have to take this path. However, as competition in the banking system – and in particular in the household sector – is low, and that it could take some time before our efforts to increase competition bring results, then we have drafted legislation that would grant the Supervisor of Banks the authority to regulate banking fees. We hope that when competition strengthens, and competitive prices follow, then there will be no need for this supervision. The legislative bill allows the Supervisor of Banks to regulate those fees that reflect an uncompetitive price. The bill also allows for the reduction in the number of banking fees and to create a closer connection between the fees and the services offered. This bill is currently in discussion in the interministerial committee on legislative matters and I hope that the bill will shortly be presented before the Knesset. The need for a strong and competitive banking system The Knesset has made several suggestions in this field recently, such as several proposals of private legislation covering the regulation of banking fees, the supply of financial advice, the sale of credit card companies, the banks' credit policy for buying controlling stakes, paying interest on checking accounts, as well as setting up and operating this committee of enquiry into the subject of banking fees. I can understand the reasons for these proposals, but I must point out the following two points: a) The need to allow the relevant supervisors to carry out their specific roles in improving the functioning of the financial system, as well as the need for stability in the supervision system and the regularization of banking activity. The banks and other financial institutions could not operate efficiently under conditions where the legislation, supervision and regularization systems keep changing too often. It is important that dealing with this topic remains in the hands of the supervisory authorities – the Israel Securities Authority, the Supervisor of the Capital Market and Insurance, and the Supervisor of Banks. One could consider making a change here or there in the supervisory structure of the financial system, but it is not advisable, really not advisable, to transfer regulation – or even part of it – to the Knesset. b) The need for a strong and robust banking and financial system. For the Israeli economy to be able to operate efficiently, the banking system must be stable. We must maintain a healthy banking system through supervision and competition, while understanding that the banks operate in order to earn a return on their capital. In this context, I would like to refer to the banks' profits. It is quite natural to regard the banks' profits in nominal terms of billions of shekels, but one should also examine the banks' profits in relation to their capital, in other words, one should look at their return on capital. In these terms, the return on capital for the Israeli banking system is not particularly high, and even low in international comparison. The return on capital for the banking system in 2005, for example, was 14.5 percent, compared to an average 15.4 percent globally. Finally I would like to ask the Knesset to push forward with government-sponsored legislation on the supervision of banking fees by the Supervisor of Banks as soon as the bill is presented, which I hope will be soon. This is an important bill, and every effort should be made to have this legislation passed.
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Speech by Professor Stanley Fischer, Governor of the Bank of Israel, at the IMF-World Bank annual meetings, Washington DC, 22 October 2007.
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Stanley Fischer: Recent developments in the Israeli economy; future paths of the IMF and the World Bank Speech by Professor Stanley Fischer, Governor of the Bank of Israel, at the IMF-World Bank annual meetings, Washington DC, 22 October 2007. * * * Mr. Chairman, distinguished Governors, Mr. Rodrigo de Rato, Managing Director of the International Monetary Fund, Mr. Robert Zoellick, President of the World Bank Group, delegation members, colleagues and former colleagues, ladies and gentleman: These meetings take place not only at a challenging time in the international economy, but also at a time of unexpected changes in the leadership of both the Bank and the Fund. I will use this opportunity to discuss the futures of each of these two great institutions. But let me start with recent developments in the Israeli economy. 1. The Israeli economy The Israeli economy has been growing at an average annual rate of more than 5 percent, since 2004. In 2007, inflation is expected to be within the target range of 1-3 percent per year. The budget should end the year close to balance. The balance of payments is in a surplus of between 4 and 5 percent of GDP, and foreign direct and financial investments continue to flow into the economy. Controls on capital flows have been removed progressively over the last fifteen years, and the capital account is essentially totally liberalized. The exchange rate floats freely and the Bank of Israel has not intervened in the foreign exchange markets since 1997. Fiscal discipline has reduced the share of government spending in GDP from 52 percent in 2003 to 44 percent this year. Fiscal discipline, together with privatizations and sustained growth, has reduced the debt to GDP ratio from more than 100 percent in 2003 to a level expected to be about 82 percent at the end of this year – a level that is still too high but that is expected to continue to decline. Growth has reduced the unemployment rate, from more than 11 percent in 2003 to about 7.5 percent at present. This has been accompanied by an increase in the participation rate, which is very low in Israel. The poverty rate – a relative measure in Israel – is beginning to decline but more needs to be done to improve the standard of living of the poorest members of the population. The impressive achievements of the Israeli economy are due in part to the global boom, but also to improved economic policies based on the understanding that the only way to sustainable growth, particularly for a small economy, is to pursue market-based policies and to embrace the possibilities that globalization offers. At present we are working on a new and modern central bank law that will clearly define the independence of the Bank of Israel, while increasing its accountability and transparency. The problems of our economy can be solved only with continuing growth and policy discipline, mutually reinforcing elements of success. They are also more likely to be solved in an environment in which the prospects for peace with our neighbors continue to improve. 2. The Fund As Managing Director de Rato steps down, we thank him for his many contributions that will bear fruit in the coming years, including the Strategic Review of last year, the work summarized in this year's Policy Agenda Report, and the ongoing work on representation and voice. This agenda defines the major challenges that face incoming Managing Director Dominique Strauss-Kahn. A great deal has been written about the problems confronting the Fund as it reassesses its role in the rapidly changing global economy of the twenty first century. The problems are there, but we need to remind ourselves that they are the problems of success, not failure. As many here can testify, it was exciting to be here when the Fund was at the center of the global financial storm of the 1990s and early in this century. It may be less interesting, but it is certainly more impressive to be present in an era of unprecedented global growth – growth based on the Fund's approach of integration into the global economy – as the increasing economic weight of developing countries, especially of China and India, transforms both economic and political relations among nations. What will be the role of the Fund in the future? Article I (i) of the Articles of Agreement, states as the first purpose of the Fund, "To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems". This is the essential role of the Fund. Even if on some fardistant day, financial crises become only a historical memory, this function will remain central to the Fund, for there is no other organization with the legitimacy of the Fund, with its global membership, with both finance ministries and central banks involved, that can fulfill that role. No less important, time and again the superb staff of this institution has risen to the challenge of implementing the wishes of its member countries. That is to say: the Fund's fundamental strength is that it is the central global financial institution for consultation on international monetary (and financial and economic) problems, with the capacity to implement the conclusions of those consultations among its member countries. Second, firm surveillance over the global economy and over its member countries is vital to the Fund's role. The new Decision on Bilateral Surveillance adopted in June this year emphasizes surveillance over policies – particularly exchange rate policies – that influence the stability of a country's external accounts, and the need to deepen further the integration of financial sector issues in surveillance. In the words of the Managing Director's policy agenda report for this meeting, surveillance needs to "characterized by greater clarity, candor, evenhandedness, and accountability" with the concept of external stability serving as an organizing principle. The emphasis on candor and evenhandedness is particularly to be welcomed: surveillance will not be successful in influencing a country's policies if it is not seen to be applied candidly and equally to all countries, large and small, rich and poor. In addition, surveillance needs to be timely. Surveillance matters not only because it helps member governments improve their policies, but no less because it informs a wider public. Therefore publication should be speeded up. In the age of emails and the internet, there is no good reason why Article IV reports should not appear within a month of the conclusion of the staff’s visit to the country. It is also desirable that the Fund increase its use of interim reports, as has been done in the publication of quarterly WEO forecasts. Third, the Fund needs to maintain its financial capacity to help members deal with financial crises. A decade ago we may have thought that financial crises among the industrialized countries were a thing of the past. After the events of this summer, we can no longer think that. We should all be grateful that improvements in economic management and the strengthening of financial systems in emerging market and developing countries have kept this crisis away from them. But we cannot rule out the possibility that the Fund will once again have to lend to member countries facing the threat of serious economic instability, as a result either of their own actions or of contagion. The owners of the Fund need to ensure that it be in a position to help when needed. Fourth: if the Fund is to retain its legitimacy, it needs to reform its governance to give the rising nations a greater share. The problem with percentage shares is that they have to add up to 100. This means that if the emerging and developing nations are to have a larger role, the industrialized nations have to have a lesser role in determining its decisions. It is that simple. It is also clear that the governance/quota problem will not be solved without resolving difficult issues about the representation of Europe in the Fund. For lack of time, I pass over quickly two other issues: the income of the Fund, and the Fund's role in poorer member countries. As emphasized in a recent paper by Jack Boorman, the Fund's income needs to be fitted to its role, and not vice versa. With regard to poorer member countries, the Fund, in close collaboration with the World Bank, needs to continue to be involved in working with them. After all, its claim to legitimacy depends on its being and being seen as a global institution. In this regard, it will probably be necessary to increase the basic vote by more than agreed upon at least year's Singapore meeting. There is much to be done, and we wish incoming Managing Director Strauss-Kahn every success as he takes over leadership of the Fund. 3. The Bank President Zoellick has set out his vision for the Bank in his October 10 speech at the National Press Club and his October 21 Note to the Development Committee. The vision is appropriately ambitious. It deserves the strong support of the membership. The overall vision is to contribute to an inclusive and sustainable globalization – to overcome poverty, enhance growth with care for the environment, and create individual opportunity and hope. To do that, the President sets out six key strategic themes: • Overcoming poverty and spurring sustained growth in the poorest countries, especially in Africa; • Helping rebuild post-conflict and failing states; • Producing an appropriate business model to help middle income countries meet their development goals; • Fostering regional and global public goods; • Promoting development and economic opportunities in the Arab world; • Developing the role of the Bank as “the knowledge bank”, a brains trust of applied experience. As they should, these themes clearly reflect the needs and wishes of a wide range of the developing and emerging market member countries of the Bank. The goals implied by the themes will not be achieved easily. Indeed it is fashionable to emphasize the failures of development over the past fifty years, the many countries where per capita income has declined, the persistence of poverty and of hunger. It is right to emphasize the problems that remain to be solved. But we should also from time to time recognize that this has been a remarkably successful decade for the developing countries, that many African countries are now growing at rapid rates, and that in Asia, nearly 40 percent of the world’s population is seeing sustained growth at unprecedented rates. In the process, the world is being transformed. We wish President Zoellick every success in achieving the goals he has set out for the World Bank – goals that as they are attained will help bring the fruits of economic development to people and to nations who do not yet share in the historic global transformation now under way. Thank you, Mr. Chairman.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Sderot Conference for Society, Sderot, 6 November 2007.
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Stanley Fischer: The growth of the Israeli economy in the long run Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Sderot Conference for Society, Sderot, 6 November 2007. * * * The subject for this evening is "Evaluating the Socio-Economic Situation of Israel in 2008". I prefer, with your permission, to take a longer perspective, and to speak about the growth of the economy in the long run. In this context, I will focus on economic policy, and the importance of sustainable growth. The rate of growth is critical for the future of the economy, and the future of the state. If we manage on average to grow in the next 25 years at a rate of 5 percent a year, in 2032 we will attain a level of GDP of NIS 2,235 billion (in 2007 prices), compared to a GDP of NIS 660 billion in 2007. To compare, if we were to grow by only 3 percent a year, GDP would reach only NIS 1,380 billion. That's an enormous difference, of more than 60 percent. It is important that we understand that if we can achieve persistent high growth, then we will have the necessary resources to address existing problems in critical areas, such as social welfare. With regard to sustainable growth, I will not speak here of the importance of continuing the strategy of macroeconomic stability, free markets, the opening of the economy, and its integration into the global economy. Instead, I will speak today on three structural and no less important issues: education, welfare and investment. I have listed welfare among these three topics, because Israeli society cannot succeed – certainly not in the long term – if there are wide social gaps, and if a large part of the population has to subsist on a very low standard of living. A. Education In principle, we all understand the importance of education in Israel. We have no natural resources but we have human resources, which should be constantly developed in order to maintain and increase the qualitative edge of the State of Israel. Over the years the country has placed great stress over the years on the subject of education, and if this topic does not continue to hold a high enough place in our priorities, then we shall find ourselves in a continually deteriorating situation. And in some ways this erosion has already begun. When looking at our spending on education in international comparison, we find a very interesting and important picture: on average, spending per child in compulsory and tertiary education as a share of GDP is not low by OECD standards, and in some cases is higher. But when we see the decline in pupil achievement over the years, compared to other countries, then we must conclude that the Israeli education system is not effective. To improve the situation, it is important that we examine the reasons for this ineffectiveness and that we act to put it right. Why? Because we are referring to our most important investment, the investment in our young, who are our future source of labor, enterprise and growth. In the field of higher education too there is room for special concern. It is sufficient to see the lists of Israelis on the faculties of the leading universities of the US and other countries. This is a difficult situation to accept. The Shochat Committee, which reported earlier this year, has done sterling work on advancing higher education in Israel and it is important that its recommendations be implemented, including granting wage differentials in order to reward the best academic staffers. Another area that has been neglected in recent years is that of technological education. I hear this from various sources: in the educational system, and from industrialists who need individuals with technological qualifications. This is also a field that needs cultivating and promoting. As is well known, education is the best way of reducing poverty in the long run. And this leads me onto the next topic, that of welfare. B. Welfare A very important way of alleviating poverty is by integrating those who can work into the field of employment, and at the same time raising the compensation that poorly paid people receive. In this context I am delighted that the subject of Earned Income Tax Credits is on the government's socioeconomic agenda and I hope that it will be implemented soon, along with the other subjects found on this important agenda. I will not elaborate today on the ways to integrate the poor into employment and to support those who cannot work. Rather, I would like to refer to the topic of the composition of Israeli society. According to data from the Central Bureau of Statistics, most of the poor in Israel are concentrated in two sectors: the ultra-Orthodox and the Arab. While the incidence of poverty among the non-ultra-Orthodox Jewish population was only 12 percent in 2006, the incidence of poverty among the ultra-Orthodox and Arabs was 57 percent and 58 percent respectively. This is connected to the low rates of employment in these two sectors, particularly among ultra-Orthodox men and Arab women. In 2006 the employment rate among ultra-Orthodox men was 25 percent (compared to 62 percent among the male population overall) and among Arab women it was 17 percent (compared to 53 percent among women in general). If we do not manage to deal with this issue, more and more of the Israeli population are likely to find themselves outside of the labor market and, as a result, poor. It is important that this sensitive and complex topic be addressed, and that appropriate solutions are found based, inter alia, on the right system of incentives. C. Investments Investment is the key to growth, and therefore it is important that the Israeli economy is an attractive place for local and foreign investors. In this context, I will refer to the easing of processes required in order to do business in Israel. There are a number of reports that refer to this topic, such as the World Economic Forum's Global Competitiveness Report. I will concentrate on another important report, the Doing Business Report, published by the World Bank. This report ranks 178 countries measured by parameters that represent the ease (or difficulty) of doing business in each country. Overall, Israel is ranked 29th, which is not bad, and even relatively high. If we examine the parameters of the index more closely, we will find that Israel ranks even higher on some of these: for example, on the strength of minority shareholder protections against misuse of corporate assets by directors for their personal gain, Israel is ranked fifth; or on the legal rights of borrowers and lenders, and the availability and legal framework of credit registries, Israel comes seventh; on the procedures necessary to import and export by sea a standardized cargo of goods, eighth; and on the procedures and costs associated with setting up a business, 17th. However in other parameters Israel ranks very low: for example, on legal procedures relating to the enforcement of contracts (102nd place); on the procedures, time, and costs to build a warehouse (109th place); and on registering property (152nd place). These findings will not surprise any Israeli. It is very important that all the relevant authorities cooperate, to remove these bureaucratic obstacles, and to bring about an improvement in all these fields, especially in those where Israel currently ranks low. It is easy to think that details like these are not important. But we have to contend with competition from all the world, and it is clear that the achievement of sustainable growth depends on our dealing with these barriers to growth. And for the long run, there is nothing more important for the Israeli economy and the economic well-being of Israelis than sustained rapid growth.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Third Annual Jewish-Arab Business Conference, Herzliya, 13 November 2007.
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Stanley Fischer: A brief look at the Israeli economy and the vital importance of employment Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Third Annual Jewish-Arab Business Conference, Herzliya, 13 November 2007. * * * Since 2003 Israel’s economy has been enjoying economic growth, and since 2004 GDP has been rising by more than 5 percent per year. At the same time price stability has been maintained, and the economy has shown impressive financial and economic stability. Israel is well integrated in the global economy, exports are increasing and in the first half of 2007 reached about 45 percent of GDP, and the current account of the balance of payments shows a healthy surplus of about 5 percent of GDP. The economy continues to benefit from the inflow of investments from abroad, which halfway through 2007 had reached some 8 percent of GDP. The fact that the government can obtain Knesset approval for the 2008 budget according to the targets it set, particularly in light of the implications that the credit crisis could have for the global economy, is an auspicious and important achievement. The positive economic developments are reflected in the labor market. The unemployment rate has fallen, and reached 7.6 percent in the second quarter, a far cry from the level of about 11 percent in 2003, and this has occurred in the time when the rate of participation in the labor force rose from 54 percent to 57 percent; a very important development. Employment is of vital importance both economically and socially. Economically, because employment per se contributes to economic growth; socially, since one of the direct ways of dealing with poverty is to place those capable of working in employment. That is because there is a clear negative link between poverty and employment. In 2006, for example, the poverty rate among families with no wage-earner was about 76 percent; among families with one breadwinner, about 37 percent; and among families with two breadwinners, about 4 percent. These figures paint a very clear picture. Poverty in Israel, however, is closely related to Israel’s demographic features. Based on the Central Bureau of Statistics (CBS) Income Survey, the majority of poverty is concentrated in two groups in the population: the Arab sector and the ultra-orthodox sector (Haredi). While the incidence of poverty among the Jewish, non-Haredi population (based on the relative measure of poverty generally used in Israel) in 2006 was only 13 percent, among the Arabs and the ultra-orthodox the rates were 57 percent and 58 percent respectively. This is linked to the low employment rates in those two sectors, mainly among ultra-orthodox men, and Arab women. A closer look at employment among Arabs reveals an even more complex picture. An analysis of the figures in the CBS Income Surveys and the Manpower Surveys reveal several findings worthy of attention: 1) The participation rate among Arab women is rising, but it is still lower than that among Jewish women. Moreover, the rise in their participation rate is reflected mainly in an increase in unemployment among Arab women, with only a moderate increase in their employment. Thus, in 2006 the employment rate among Arab women was about 17 percent, compared with 51 percent among all women in the population. 2) In contrast to Arab women, the participation rate among Arab men is declining, and since the beginning of the decade it has been lower than that among Jewish men. This is most prominent among older men. 3) The Arab labor force has a lower educational level, with most having between nine and twelve years of schooling, compared with the Jewish labor force, the highest proportion of which has more than twelve years of education. 4) The unemployment rate is higher among Arabs than among Jews. 5) Employment among Arabs is concentrated in low-paid industries. 6) On average, the wage of Arab employees, as well as the hourly wage, is lower than that of Jewish employees. Furthermore, many studies highlight employment inequality and wage inequality between the Arab population and the Jewish population. There are several reasons for this, and I will not be revealing any new discovery if I mention the word "discrimination". The picture arising from the integration of the Arab population in the work force in Israel indicates the necessity to pay special attention to this issue and to find appropriate solutions based among other things on a proper system of incentives. The purpose must be to increase the participation rate of the whole Arab population and at the same time to remove the barriers to their absorption in the workplace, and this is of particular relevance to women. At the same time it is essential to place education as a high priority, and I mean particularly education and training in professions and skills that will help the integration of the Arab population into the labor market, especially in those industries and occupations requiring relatively high levels of skill, and which command high pay. I am referring both to technological and non-technological education. In this context I would like to mention that in the last few years technological education has been sorely neglected. I hear this from different sources, both in the education system and industrialists who need workers with technical and technological qualifications. If we, as a society, do not take steps to absorb the Arab population into the labor market, larger segments of the population will be caught up in the poverty situation. It should be noted that Israeli society cannot succeed, certainly not in the long run, if it creates large differentials, with a big sector of the population existing at a very low standard of living. It is clear that we must also relate to the removal of labor market and cultural barriers, including anti-minorities discrimination, anti-Arab employment discrimination at all levels, as well as doing business across the sectors. The Bank of Israel, for example, after years when no Arabs were employed in professional capacities – economists, accountants, lawyers – is currently making genuine efforts to increase their chances of employment in these jobs. We publish tenders for the populations entitled to affirmative action, and in other tenders too the approach to candidates from those sectors is one of affirmative action. Tenders are passed directly to several organizations that represent those populations, and are published also in Arabic. The purpose of all the above is to make the Bank of Israel more accessible to members of the relevant groups in the population and to give them the opportunity to be represented fairly among the Bank’s professional employees. This conference also has an important contribution to make in promoting employment and business between the various sectors of Israel’s population. Employment is not the only issue when dealing with poverty. In the case of extremely lowpaid employees, the solution lies in the system of negative income tax, or earned income tax credit (EITC), which would raise the return on labor. This subject, together with many others, features in the government’s socio-economic agenda. It should be advanced and implemented as quickly as possible, along with the other important issues. At the same time, appropriate support must be provided for those genuinely incapable of working, including the handicapped and the elderly. In a broader perspective, and with a view to the long term, I would like to reiterate the importance of education – which is the key to improving anyone’s chances to integrate into the labor market and to earn a higher wage – and that of sustainable growth. We must face many difficulties, in the area of security, welfare, etc. We will not succeed in overcoming them, especially not in the long term, if we do not manage to grow at a relatively fast rate of over 5 percent a year. The subject of long-term growth is critical, as only that can provide the means required to solve the problems mentioned. Nothing is more important for Israel’s economy and for the welfare of Israeli society, certainly in the long run, than rapid and sustained growth. Hence the importance of creating the conditions required to enable each individual to contribute to the maximum to the economy and society.
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Text by Professor Stanley Fischer, Governor of the Bank of Israel, of the Mundell-Fleming lecture, at the Eighth Annual Jacques Polak Research Conference at the IMF, Washington DC, 15 November 2007.
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Stanley Fischer: Exchange rate systems, surveillance, and advice Text by Professor Stanley Fischer, Governor of the Bank of Israel, of the Mundell-Fleming lecture, at the Eighth Annual Jacques Polak Research Conference at the IMF, Washington DC, 15 November 2007. I am grateful to Thierry Tressel, Cigdem Akin, Meital Gram, Prachi Mishra, and Inci Otker-Robe for essential assistance, and to Mark Allen, Jeff Frankel, Morris Goldstein, Ken Rogoff, and Shakour Shaalan for helpful discussions. * * * The IMF Executive Board's adoption on June 15 this year of the new Decision on Bilateral Surveillance over Members' Policies puts exchange rate policies at the center of the surveillance process. The Fund's description of the new decision and the differences between it and the 1977 Decision notes that • "the new Decision introduces a concept of external stability as an organizing principle for bilateral surveillance", where external stability "refers to a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements"; • Article IV's prohibition of exchange rate manipulation relates to policies directed at affecting the level of the exchange rate "in order to prevent effective balance of payments adjustment, or to gain an unfair competitive advantage over other members". A member will be considered to be manipulating the exchange rate to gain an unfair competitive advantage if the Fund determines that the country is trying to increase net exports by promoting an undervalued exchange rate; and • members should "avoid exchange rate policies that result in external instability, regardless of their purpose …" A little over a month earlier, the Board had discussed the Independent Evaluation Office's Report "IMF Exchange Rate Advice", which presented a critical view of the advice the Fund had offered in the period 1999-2005 on exchange rate systems, on the level of the exchange rate, and on the mechanics of exchange markets and of intervention. While the criticisms are forceful and in many cases appear appropriate, they suffer from the lack of professional consensus on what the right advice should be. The IEO Evaluation Report struggles with this issue, but does not adequately resolve it, for example when noting (p.28): "…Of course, when there is little academic consensus on many points, the problem of distilling and establishing operational guidance is more challenging, but management oversight and the right internal structure are therefore all the more critical." Similarly, in Chapter 5 on "Findings and Recommendations", the Report states (p.37): "68. To improve assessments of the exchange rate level, the IMF should be at the forefront of developing the needed analytic framework … The genuine difficulty in doing this is no excuse for not making more progress." (italics in original) In this lecture, I will try to draw together some lessons and questions about exchange rate systems, and attempt to state what is known and what is not known about them. I will also comment on problems of IMF surveillance. I start in Section I by revisiting the bipolar issue with regard to exchange rates, restating the hypothesis and updating it in light of events of this decade. I will argue that the bipolar view is fundamentally correct for emerging market and industrialized countries with open capital accounts –a qualification that was stated in Fischer (2001), but that was perhaps not adequately stressed. In Section II I discuss managed floating regimes and exchange market intervention, for countries with open capital accounts. Section III is devoted to the choice of exchange rate regime for countries whose capital account is not open; and I conclude with comments on IMF surveillance and advice. I. The bipolar hypothesis The bipolar hypothesis about exchange rates has come in for serious criticism. For example, Jeffrey Frankel (2004) argues that there is no analytic rationale for the argument of the disappearing intermediate regime. The usual justification is the impossible trinity, but Frankel suggests that a variety of managed floats are fully consistent with the impossible trinity – that one can have half-stability and half-independence. In my 2001 article on the bipolar exchange rate approach, I tried to clarify the hypothesis, and I shall have to quote extensively (Fischer, 2004, p.229): "… proponents of what is now known as the bipolar view – myself included – probably have exaggerated their point for dramatic effect. The right statement is that for countries open to international capital flows: (i) soft exchange rate pegs are not sustainable; but (ii) a wide variety of flexible rate regimes remain possible; and (iii) it is to be expected that policy in most countries will not be indifferent to exchange rate movements. To put the point graphically, if exchange rate arrangements lie along a line connecting hard pegs like currency unions, currency boards, and dollarization on the left, with free floating on the right, the intent of the bipolar view is not to rule out everything but the two corners, but rather to pronounce as unsustainable a segment of that line representing a variety of soft pegging exchange rate arrangements. [italics in the original] … For countries open to international capital flows, it [the bipolar view] includes as sustainable regimes both very hard pegs and a variety of floating rate arrangements, including managed floats. For countries not yet open to international capital flows, it includes the full gamut of exchange rate arrangements. The question that then arises is what exchange rate arrangements are excluded by the bipolar view. The answer is: for countries open to international capital flows, exchange rate systems in which the government is viewed as being committed to defending a particular value of the exchange rate, or a narrow range of exchange rates, but has not made the institutional commitments that both constrain and enable monetary policy to be devoted to the sole goal of defending the parity. …" During the decade of the 1990s, it seemed that exchange rate systems were becoming bipolar in the sense defined above, as can be seen in the comparison for developed and emerging market countries 1 between the data for 1991 and 1999 in Figure 1. 2 Figure 1 also shows what has happened since then for the group of developed and emerging market countries. In brief, the shift towards bipolarity that was evident in the data for 1991-1999, has continued, but at a reduced pace. The major changes in the distribution between 1991 and I use the "Developed and emerging market countries" category as an approximation to countries whose capital accounts are open, though in fact that is not true for all the countries listed as emerging (see Table 2), among them China. The data in this paper differ somewhat from those in Fischer (2001), because in the former the exchange rate regimes as of each year relate to countries that were members of the Fund in that particular year, whereas in this paper the data for each year are those for countries that were Fund members in 2006. 1999 were due to the introduction of the Euro and the emerging market financial crises of that decade. Nothing on a similar scale has happened in this decade, although the number of countries in EMU continues to grow, albeit slowly. As a reminder, the classification of exchange rate systems used in Figure 1, and in my previous paper, is that of the staff of the IMF, based on their evaluation of the de facto exchange rate arrangement in place at the time. 3 Table 1 lists the categories of exchange rate regimes, with the intermediate grouping consisting of varieties of less than very hard pegs, include crawling pegs and bands. The floating category consists of "managed float" and "independent float", the latter less managed than the former. Figure 2 breaks the "Advanced and emerging market countries" grouping down into its two parts – for advanced (Figure 2a) and emerging market (Figure 2b) countries respectively. Among the 25 advanced countries, bipolarity is almost complete, with only Denmark, which shadows EMU monetary policy, in the intermediate category. Among the 39 emerging market countries, a considerable number still remains in the intermediate category. Tables 2a and 2b list the advanced and emerging market countries and their exchange rate regimes. Note that the intermediate category for the emerging market countries includes five countries that are in the process of joining EMU, so that the shift to bipolarity for this country grouping is likely to continue in the coming years. It thus appears that the bipolarity view is broadly consistent with recent exchange rate regime developments, for the advanced and emerging market countries grouping. I should though emphasize two qualifications. First, the bipolarity hypothesis is about countries open to international capital flows, which is why the data examined in Figures 1 and 2 are for the advanced and emerging market group – though, to be sure, some of the countries listed as "emerging market" have significant capital controls. Second, the "floating" group does not consist only of freely or almost freely floating exchange rate regimes, for it includes managed floats: indeed, for both the emerging market and "other" categories, there are more "managed" than "independent" floaters among the countries listed as having floating exchange rates. ; Further even among the "independent" emerging market floaters, there are several countries that intervene frequently and significantly. The well-known difficult of classifying exchange rate systems has led to a considerable literature, including articles by Levy-Yeyati and Sturzenegger (2000), Reinhart and Rogoff (2004), Frankel (2004), 4 Eichengreen and Razo-Garcia (2006), Tavlas, Dellas and Stockman (2006), and others. The fundamental issue in the classification discussion relates to how to classify countries whose policies appear to be different than they are declared to be by the country (or by someone else's classification scheme). For instance, how should one classify countries that declare they have a pegged exchange rate but that in practice change the peg frequently? Or, as in the case of the "freely falling" category of Reinhart and Rogoff, how should one classify rates that are flexible only because extremely high inflation prevents their being anything other than flexible? And most important from the viewpoint of this paper, how The approach is described in Bubula and Otker-Robe (2002). See also, IMF (2003). As of the time of writing of this paper, the staff of the IMF is preparing a new classification of exchange rate regimes that will make more use of quantitative information on exchange rate behaviors and reserves, instead of qualitative information as in the current de facto exchange rate classification. This new classification will change how currency unions are treated, for example EMU countries will be classified as "independently floating". Moreover, a new category of "tightly managed float" is being introduced. This new de facto classification, however, will not be retroactive, so there will be a break in the series in 2007. It is clear that for a member of the EMU, the exchange rate of the currency it uses is independently floating. But it is also clear that for almost all or all EMU members, the exchange rate of the currency they use is absolutely fixed against the currencies of the countries that account for the great bulk of their trade. This suggests a note of caution about the reclassification of these countries' currency regimes. Frankel (2004) notes: "Placing actual countries into … categories is far more difficult than one who has never tried it would guess". should one classify heavily managed exchange rate regimes that are in principle flexible, but where the authorities intervene frequently and extensively? 5 While this discussion is important, I believe the essential question is whether the authorities are committed to defending a particular exchange rate or narrow range of exchange rates, for these are the unstable exchange rate regimes when the capital account is open. Further, while there are countries whose currencies float freely, as noted in the quote from my 2001 paper above I do not regard intervention per se as being inconsistent with an exchange rate that is defined as flexible. The data presented thus far relate to the proposition that as countries become more advanced and open their capital accounts, they also tend to leave the middle ground of soft pegs, and move towards either a hard peg or a floating (including managed floating) regime. 6 Another way of examining this proposition is to focus on the empirical relationship between countries' choice of exchange rate regime and the extent of their capital controls. The IMF has an index of capital controls for which the latest year is 2005. 7 It is available for only 90 of the 186 countries for which exchange rate regime data are available. A probit regression was run of the exchange rate regime (coded 1 if an intermediate regime, 0 otherwise) on the extent of capital controls, an index that runs from zero to one (e.g. Japan and the UK are zero, the United States is 0.2, and India is 0.95). The estimated relationship is positive but weak, 8 and significant only at the 15% level. On further examination of the data, it appears that there might be a bias with regard to the countries for which capital controls data are available: among the advanced countries, the capital controls index is available for 23 out of 25 countries; for the emerging market countries, the capital controls variable is available for 32 out of 39 countries; and for the "other" category (data on which are presented in Table 3 below), capital controls data are available for only 35 of 118 countries. It is quite likely that the extent of capital controls among the countries in the "other" group for whom the capital controls index is not available, is significantly higher than in the advanced and emerging market groupings. The frequency of intermediate regimes is also higher in the "other" group (47.5% versus 4% for advanced countries and 35.9% for emerging market countries). I would like here to make two comments on the impossible trinity, in relation to Jeff Frankel's statement that one can have half stability and half independence of monetary policy. In the first instance, while the impossible trinity is usually stated in terms of an independent monetary policy, it should more accurately be stated in terms of independent macroeconomic policy, for when a currency comes under serious pressure, typically both monetary and fiscal policy have to adjust if the exchange rate is to be maintained. This was, for instance, clear in the collapse of the Argentine currency peg. Second, an "independent" monetary policy in this context is one that is targeted at something other than the exchange rate. For many countries that have given up exchange rate pegging, the monetary regime switches to inflation targeting, in practice typically flexible inflation targeting. For others, monetary policy is directed to a range of targets, including inflation and growth, sometimes also the real exchange rate, with tradeoffs among them to be determined by the policymakers. Once the goals of monetary policy have been specified, monetary From the viewpoint of this paper, I should add that the grouping of countries into "advanced", "emerging market", and "other" categories is also not entirely obvious ex ante. While this is a statement about facts, I also believe – for reasons that will be explained below – that countries should move away from the soft center as they remove capital controls. The capital controls data are from the AREAER database. The coefficient on the capital controls variable is 0.20, implying that a one point increase in the capital controls variable – which runs from zero to one – increases the probability that the exchange rate regime is intermediate only by 20 percent. policy is no longer independent of the factors that move the economic variables that it is targeting. For instance, in setting the policy interest rate, the Bank of Israel, an inflation targeter, has to take into account changes in foreign interest rates that affect the exchange rate and through it the inflation rate. Thus in practice by giving up exchange rate pegging and shifting to inflation targeting, a central bank does not gain monetary independence in the sense that its monetary policy becomes independent of monetary policy – more generally of economic developments – in other countries. Rather it has switched from targeting one economic variable – the exchange rate – to another, namely the inflation rate, both of which depend to differing extents on economic developments abroad and at home. This may be the meaning of Jeff Frankel's statement that a country can have half stability and half monetary policy independence [of the exchange rate]. Why then the general recommendation to countries to avoid the intermediate regimes if they are open to capital movements? Primarily because such regimes are crisis prone, in part because their policy dynamics are unstable: we are all familiar with the syndrome in which when the exchange rate is not under pressure, the country sees no need to change the regime; and when it is under pressure the country is reluctant to change it because it is unclear by how much it will have to change if it is repegged, or where it will go if it is allowed to find its own level. As they develop and open their capital accounts, some countries, who have good reasons to do so – for instance those who meet the conditions for being part of an optimum currency area, or who expect to meet those conditions after joining the hard currency grouping – will choose to move towards harder pegs. Others will move towards more flexible exchange rates. As noted by Rogoff et al (2003), for advanced countries "free floats register faster growth than other regimes without incurring higher inflation". II. Managed floating As is evident from the fact that there are more managed than independent floaters among the floating group for the emerging market and "other" countries, very few countries, if any, are indifferent to the behavior of the exchange rate. For a strict inflation targeting country, the behavior of the exchange rate matters, but only to the extent that it affects inflation. For other countries the nominal exchange rate may matter because changes in the nominal rate also lead to (partially or wholly temporary) changes in the real exchange rate and thus in net exports, which are targets of policy. Interest rate and/or fiscal policy can be used to try to affect the exchange rate; for instance the Taylor Rule for a central bank that is also targeting the exchange rate can include an additional term in which the interest rate responds to deviations of the real exchange rate from its target level. Monetary policy effects on the real exchange rate are likely to be temporary, but may be of sufficient duration to have a transitional effect on exports and imports. More fundamentally, changes in fiscal policy can be deployed to affect the real exchange rate over a longer period: by tightening fiscal policy and increasing national saving, the government can expect to generate a real depreciation and increase net exports. There is also the option of foreign exchange market intervention, which can be seen as introducing an extra policy instrument to deal with an extra target of policy. 9 Some countries, such as the United States, Chile, and Israel and more recently Japan – as well as the ECB – do not intervene in the exchange markets, or intervene very rarely. Even these central banks have not totally foresworn intervention; rather they reserve the right to intervene if market conditions become disorderly, or in other extreme or emergency situations. If they intended The early work on targets and instruments suggested the need for as many instruments as targets. In the presence of uncertainty, having an extra instrument could be useful even if there were not an extra target. never to intervene then they would presumably not hold foreign exchange reserves. 10 In the Israeli case we have not intervened since 1997, and Chile has not intervened since 1998. New Zealand had not intervened since 1985, but did so in 2007. A policy of non-intervention is however rare among emerging market countries, even those with flexible rates. Among countries listed as having flexible rates in Table 2, Japan ($544 billion), Russia ($263 billion), Korea ($136 billion), and India ($125 billion) have each accumulated over $100 billion in reserves since the start of 2001 – and these numbers pale by comparison with the accumulation of over a trillion dollars of reserves by China during that period. Countries may intervene to build up their reserves, as many did after the crises of the 1990s. But just as clearly, and as is well known, the great bulk of the accumulation of reserves during the last few years is a result of the desire to prevent exchange rate appreciation. Ishii et al (2006) identify four circumstances under which countries intervene in the foreign exchange market: 11 (i) to correct misalignments or to stabilize the exchange rate at a predetermined level – in other words, to try to set the exchange rate at a desired level, e.g. one which will encourage exports; (ii) to calm disorderly markets; (iii) to accumulate reserves; and (iv) to supply foreign exchange to the market – this occurs when the government is a major recipient of foreign exchange (e.g. through royalty payments for mineral extraction), and will not be discussed further. 12 With regard to (ii), the stabilization of disorderly markets: in extremis, the central bank may have to intervene to stabilize a disorderly market, but it needs to be aware that the more frequently and easily it intervenes, the more it will impede the development of a deep and robust market, in which it is possible to hedge against exchange rate changes without having to rely on government intervention. 13 With regard to (iii), the accumulation of reserves, the question is how best to do this. A variety of approaches has been used, including buying preannounced amounts of foreign exchange at a steady rate over a period of months. Other central banks have added to reserves on an opportunistic basis. Case (i) is most significant from the viewpoint of the new Decision on Bilateral Surveillance, for it relates to exchange rate manipulation. Why might such intervention work? Here the authors identify three channels: (i) a signaling channel – where the signal is one about future monetary policy or more generally the authorities' preferences about the desired range of values of the exchange rate; (ii) a portfolio balance channel – where the central bank is a sufficiently large player in the foreign exchange market to affect the exchange rate; and (iii) a microstructure channel – where the central bank has sufficient information about the A few years ago the Reserve Bank of New Zealand considered whether to stop holding reserves. This would have sent a powerful though not totally convincing signal that there would be no intervention, because intervention can also be financed by borrowing. Included in Ishii et al (2006) is material on the mechanics of foreign exchange intervention, which can be seen as providing a partial answer to the IEO's concerns that Fund staff are not equipped to give practical advice on intervention and other practical exchange rate issues, including how to develop the needed market infrastructure. In any case, it is not entirely clear that the staff should be experts in the nitty-gritty of exchange rate intervention, which is highly country and institution dependent. It is probably better in this area for the Fund to help the central bank of the concerned country to obtain technical assistance from a central bank that is or has been in a similar situation. This was attempted in the Indonesian program in 1997, but it became clear there that the forces moving the exchange rate were too powerful to be stemmed by intervention alone, however sophisticated it might be. I have avoided using the Calvo-Reinhart term "fear of floating", preferring rather to try to explain why countries often intervene. Ishii et al (2006) describe the approach of the Mexican authorities, which involved selling options to sell foreign exchange if the exchange rate depreciated to a specified value. This approach may have encouraged the development of hedging instruments by the private sector. operation of the market and the forces active in it to be able to intervene in particular ways or at a particular time such that it can move the rate. In the face of significant capital flows, these channels are unlikely to be able to influence the rate for very long without supportive macroeconomic policy. That is why it has been so hard to find major effects of intervention per se on the exchange rates of the major industrialized countries. However, where capital flows are controlled or the country is not yet well integrated into the global capital markets, and provided policymakers are willing to intervene on a sufficiently large scale, the portfolio balance channel can operate to enable the country to have a sustained effect on the exchange rate, as the Chinese and the Russian cases illustrate. Interventions are not costless. Unless they are sterilized they are likely to have an inflationary effect, and as they become larger, they become harder to sterilize. If domestic interest rates are higher than those abroad, monetary sterilization is expensive for the central bank; and if in any case the exchange rate will eventually have to appreciate against the currency in which the reserves are held, there will also be potentially large capital losses on the reserves on that account. Clearly though, some countries regard the growth- and export-promoting effects of such actions as worth the cost, for the cost issues are well understood by the countries accumulating reserves on a massive scale. In cases where the export proceeds accrue to the government, they can be sterilized by being reinvested abroad through a sterilization fund. They can also be sterilized through running a larger fiscal surplus, and building up a stabilization fund that may also invest abroad. Russia has used exchange market intervention and fiscal policy in the form of building up a stabilization fund, but nonetheless is paying a price for its sterilization in terms of inflation that is above the desired level. Why despite the many reasons central banks may want to intervene in the foreign exchange markets do some central banks do their best not to intervene? In the case of Israel, where there are essentially no capital controls, the non-intervention policy is based on the view that intervention is unlikely to have a sustained effect on the exchange rate, and that monetary policy decisions are more fundamental. Further, we believe that the foreign exchange market works better when market participants do not expect the central bank to intervene except in extreme circumstances, and thus have to focus in their decisions on the underlying forces that determine the exchange rate. The passthrough from the exchange rate to prices is large and rapid in Israel – close to 0.3 within a quarter – and exchange rate movements are therefore taken into account in predicting inflation and the effects of interest rate decisions on prices. But this connection has not led us to want to intervene in the foreign exchange market, a decision that we believe – in IMF language – has served the economy well. III. Other countries Turning to countries other than those defined as developed or emerging market countries, Figure 3 shows that while the evolution of exchange rate regimes between 1991 and 1999 was consistent with the bipolar hypothesis, the evolution of exchange rate regimes for this group of countries since 1999 is not. Rather on balance there has been a move from the floating rate to the intermediate regimes. There has been a considerable amount of movement among exchange rate regimes in Figure 3. Fifteen countries moved into the intermediate regime from the floating regime and six moved from the intermediate regime to floating. El Salvador moved from an intermediate regime to dollarization. Table 3 lists the countries in this group along with their exchange rate regimes; asterisks indicate changes in the exchange rate regime (including shifts among subcategories within the three major categories) between 1999 and 2006, with asterisked numbers in brackets indicating the number of countries in each of the seven categories in the table that were not in that category in 1999. The economics literature has not yet developed a strong position on which exchange rate system developing countries should adopt. Frankel (1999 and 2004) and Mussa et al emphasize that "no single currency regime is right for all countries or at all times". Nonetheless, Rogoff et al (2003) summarize their review of the evidence of the impact of the exchange rate regime on developing countries' economic performance thus: "relatively rigid regimes – pegs and intermediate flexibility arrangements – appear to have enhanced policy credibility and thus helped achieve lower inflation at little apparent cost in terms of lost growth, higher growth volatility, or more frequent crises." Mussa et al (2000) provide a list of factors that would favor a country pegging its rate: (i) low capital mobility; (ii) a high share of trade with the country to which it is pegged; (iii) the shocks it faces are similar to those facing the country to which it pegs; (iv) it already relies extensively on its partners' currency; (v) fiscal policy is flexible and sustainable; (vi) its labor markets are flexible; (vii) it has high international reserves. In other words, to sustain a pegged rate a developing economy should have the capacity to perform well and flexibly, and maintain low inflation. Otherwise it would be advised to adopt a floating exchange rate regime, thereby allowing the exchange rate to act as an extra shock absorber. Of course, the requirements listed by Mussa et al are also those that, together with a strong financial system, would enable the country successfully to maintain a flexible exchange rate system. Mussa et al also note that as countries develop and become more financially sophisticated and more integrated into global markets, they should consider more flexible exchange rate regimes. This is far from a detailed manual or formula that tells each country what exchange rate system to adopt. Indeed, if the Fund were to develop a detailed manual it would be accused of having a cookie cutter approach to the issue. It is not surprising that there is no such manual, for there is no way of specifying the right exchange rate system for a country without a careful analysis of its circumstances – and there is no question that among those circumstances is its exchange rate regime history. "If it ain't broke – or likely to break soon, or being held together only with the help of economically distortionary and costly measures – don't fix it" is good advice in this area too. The general presumption then is that as countries become more developed, they should be moving away from intermediate regimes, towards greater flexibility of the exchange rate – or in some cases towards a hard peg. IV. Exchange rate surveillance and advice To return now to the new Decision on Bilateral Surveillance, the quotes with which this paper opens raise two questions. First, there seems to be a tension between the focus on an unsustainable balance of payments position, and that on exchange rate manipulation, which relates to an undervalued exchange rate. From the viewpoint of what types of situation might give rise to disruptive exchange rate movements, a currency that is overvalued, or a balance of payments deficit that is so large as to be unsustainable, can give rise to rapid exchange rate movements. One example is the current account deficit of the United States in recent years. There was no exchange rate manipulation; nonetheless by most measures the currency was overvalued. Possibly the overvaluation could be offset – though not fully, so long as other countries maintained their dollar pegs – through fiscal policy, thereby reducing the underlying threat to stability of the global exchange rate system. Which takes us to the second question: why does the decision relate to "exchange rate policies that result in external instability, regardless of their purpose …" (underlining added) rather than to "policies that result in external instability, regardless of their purpose"? The failure to use fiscal policy to deal with an unsustainable current account deficit would be as deserving of staff and Board censure as would policies – such as sustained intervention – to manipulate the exchange rate to increase net exports. Presumably the emphasis on exchange rate policies was included to deal with the difficulty that if other countries peg to the dollar, then a significant part of the normal adjustment mechanism is neutralized – and that the pegging decision was not that of the United States. That is understandable, but should not have led to what appears to be a too narrow focus on exchange rate policies rather than overall economic policy. As a central banker from a small economy, I am also concerned that the new decision may focus too narrowly on external stability. For many countries, the Article IV report is the most thorough and professional evaluation of the country's economy and economic policies. As such, it provides a valuable service for the smaller members of the Fund. I hope the new decision does not significantly reduce the scope and depth of Article IV reports for such countries. There has been a great deal of criticism of the Fund for failing to censure the Chinese authorities more seriously over their exchange rate policies and huge and growing current account surplus. There are two questions to answer here. First, why are the Chinese pursuing these policies? The answer is that the undervaluation and export promotion strategy has been a highly successful growth strategy, not only for China but also for other countries. The policy works, spectacularly so in the case of China. Second, why have the world's entreaties and pressures – bilateral from the United States, in European-Chinese meetings, and via the Fund's surveillance – to revalue not had a substantial impact on Chinese policies? Presumably for the same reason, that the present policies have worked spectacularly, for China. The standard analysis of the costs and dangers to China and to the world economy of its massive rate of reserve accumulation is correct. So what should the Fund – newly equipped with the new decision on surveillance – be doing with its analysis? Mussa (2007) asserts that the Fund's management should have taken an increasingly tough stand, mentioning "the possibility of formal censure of a country's policies by the Executive Board as a final resort for those rare and highly regrettable cases where all vigorous but less extreme efforts at persuasion have failed". There is no question that the Fund staff should state its professional judgment clearly and unambiguously in all surveillance reports. There is also no question that in contacts with the authorities, the staff should be explaining its professional judgments and giving its advice more frankly than is possible in written reports. I am sure that at present, as in the past, very frank but confidential policy discussions take place at all levels with the authorities of member countries. I also believe that these discussions have an impact. But of course, the Fund's capacity to influence a member's policies is greater in the context of a program than in the context of consultations. One of my mentors once asked me: "Who do you listen to, your friends or your enemies?" The answer is that it is easier to accept advice from friends, whom you believe support your objectives. But it is also necessary to listen to your enemies – sometimes they are right. Thus the Fund should be working very hard to gain the trust of its member countries (something that a cooperative organization should be doing in any case), should state its views firmly at all times, should press for policy changes that it believes are important through every effective channel, and reserve for very rare occasions a decision to enter into open conflict with a member. A final word – or rather two final stories – about advice. I was struck by the emphasis the IEO report on IMF exchange rate advice put on country's responses to questions about the quality of the advice they receive from the Fund. The mentor mentioned above used to say when asked for advice "Tell me what advice you would like me to give you." And I fondly remember an aunt who lived in a small town in Zambia who twice a year used to visit my parents in the bigger town in Zimbabwe in which we lived. She had a significant weight problem. Before each visit she would ask my parents to arrange for her to see a doctor. They would ask whether she would like to see the same doctor as last time. She gave the same answer each time: "No, I need a different doctor, that doctor was no good, he told me to eat less." Sometimes advice is valued less for its quality and more for its agreeableness, and that is simply a fact of life with which the Fund has to contend. References Bubula, Andrea and Inci Otker-Robe (2002). "The Evolution of Exchange Rate Regimes Since 1990: Evidence from De Facto Policies", IMF Staff Working Paper, WP/02/155. Eichengreen, Barry and Raul Razo-Garcia (2006). "The Evolution of Exchange Rate Regimes", Economic Policy, July, 393-442. Fischer, Stanley (2001). "Exchange Rate Regimes: Is the Bipolar View Correct?" Journal of Economic Perspectives, 15, 2 (Spring), 3-24. (Reprinted in Stanley Fischer, IMF Essays from A Time of Crisis, MIT Press, 2004.) Frankel, Jeffrey (1999). "No Single Currency Regime Is Right for All Countries or at All Times". Princeton Essays in International Finance, number 215. Princeton: Princeton University. ------- (2004). "Experience of and Lessons from Exchange Rate Regimes in Emerging Economies", in Monetary and Financial Integration in East Asia: The Way Ahead, Vol. 2, edited by Asian Development Bank. New York: Palgrave Macmillan Press, 91-138. Independent Evaluation Office of the IMF (2007). IMF Exchange Rate Policy Advice. Washington DC: IMF International Monetary Fund (2003). "Developments and Issues in Exchange Rate Regimes, in Exchange Arrangements and Foreign Exchange Markets – Developments and Issues", World Economic and Financial Surveys Series, 2003 Ishii, Shogo, Jorge Canales Kriljenko, Roberto Guimaraes, and Cem Karacadag (2006). Official Foreign Exchange Intervention. IMF Occasional Paper 249. Mussa, Michael (2007). "IMF Surveillance over China's Exchange Rate Policy", Peterson Institute for International Economics, Washington, DC. --------, Paul Masson, Alexander Swoboda, Esteban Jadresic, Paulo Mauro, and Andrew Berg (2000). Exchange Rate Regimes in an Increasingly Integrated World Economy. IMF Occasional Paper 193. Reinhart, Carmen, and Kenneth Rogoff (2004). "The Modern History of Exchange Rate Arrangements: A Reinterpretation", Quarterly Journal of Economics, 119, 1-48. Rogoff, Kenneth, Aasim Husain, Ashoka Mody, Robin Brooks, and Nienke Oomes (2003). "Evolution and Performance of Exchange Rate Regimes", IMF Working Paper WP/03/243 Tavlas, George, Harris Dellas and Alan Stockman (2006). "The Classification and Performance of Alternate Exchange-Rate Systems", (March), Bank of Greece. 59% 44% 30% 28% 47% 33% 28% (18) 23% 8% Hard Peg Intermediate Float Figure 2a: Developed Countries: Exchange Rate Regimes, 1991, 1999 and 2006 Number of countries as a percentage of total Number of countries as a percentage of total Figure 1: Developed and Emerging Market Countries: Exchange Rate Regimes, 1991, 1999 and 2006 64% 52% 52% (13) 40% 28% 44% 8% 8% 4% Hard Peg Intermediate Float Number of countries as a percentage of total Figure 2b: Emerging Market Countries: Exchange Rate Regimes,1991, 1999 and 2006 56% 46% 41% (16) 36% 49% 36% 8% 13% 15% Hard Peg Intermediate Float Number of countries as a percentage of total Figure 3: All Other Countries: Exchange Rate Regimes,1991, 1999 and 2006 53% 39% 46% 39% 31% 26% (32) 22% 23% (27) 20% Hard Peg Intermediate Float Table 1: De Facto Exchange Rate Classification Category Consists of No separate legal tender Hard Peg Currency Board Other fixed pegs Intermediate Pegged rate in horizontal band Crawling peg Rates within crawling bands Managed float Float Independent float Table 2a: Advanced Countries Grouped by Exchange Rate Arrangement, (as of December 31,2006 Exchange Rate Regime (Number of Countries) No separate legal tender/currency board tender/currency Countries Austria, Belgium, Finland, France, Germany, Hong-Kong, Ireland, Italy, Luxembourg, Netherlands, Portugal, San Marino, Spain Other fixed pegs Pegged rate in horizontal band Denmark Crawling peg Rates within crawling bands Managed float Independent float (10) (*2) Singapore Australia, Canada, Iceland(*), Japan, New Zealand, Norway(*), Sweden, Switzerland, United Kingdom, United States Table 2b: Emerging Markets Countries Grouped by Exchange Rate Arrangement, (as of December 31,2006) Exchange Rate Regime (Number of Countries) Countries No separate legal tender/currency board (6) (*2) Bulgaria, Ecuador (*), Estonia, Greece (*), Lithuania, Panama Other fixed pegs (10) (*5) Argentina (*), Egypt (*), Jordan, Latvia, Morocco, Nigeria (*), Pakistan, Qatar, Slovenia (*), Venezuela (*) Pegged rate in horizontal band (3) (*2) Crawling peg (*1) Cyprus, Hungary (*), Slovak Republic (*) China (*) Rates within crawling bands Managed float (10) (*6) Colombia (*), Czech Republic, India, Malaysia (*), Peru (*), Philippines, Romania (*), Russia, Sri Lanka (*), Thailand (*) Independent float (9) (*3) Brazil, Chile, Indonesia, Israel (*), Korea, Mexico, Poland (*), South Africa, Turkey (*) Note: * indicates country whose exchange rate regime has changed since 1999 Source: IMF AREAER database. Table 3: Other Countries Grouped by Exchange Rate Arrangement, (as of December 31,2006) Exchange Rate Regime (Number of Countries) No separate legal tender/currency board (28) (*1) Other fixed pegs (51) (*20) Pegged rate in horizontal band Crawling peg (4) (*3) Countries Antigua and Barbuda, Benin, Bosnia, Brunei Darussalem, Burkina Faso, Cameroon, Central African Republic, Chad, Congo, Rep of, Cote d'Ivoire, Djibouti, Dominica, El Salvador (*), Equatorial Guinea, Gabon, Grenada, Guinea-Bissaeu, Kiribati, Mali, Marshall Islands, Micronesia, Niger, Palau, Senegal, St Kitts and Nevis, St Lucia, St VIncent and the Grenadines, Togo Afghanistan (*), Angola (*), Aruba, Bahamas, Bahrain, Barbados, Belarus (*), Belize, Bhutan, Bolivia (*), Cape Verde, Comoros, Costa Rica (*), Eritrea (*), Ethiopia (*), Fiji, Ghana (*), Guyana (*), Honduras (*), Iran, Kuwait, Lebanon, Lesotho, Libya, Macedonia, Maldives, Malta, Mauritania (*), Mongolia (*), Namibia, Nepal, Netherlands Antilles, Oman, Rwanda (*), Samoa, Saudi Arabia, Sierra Leone (*), Solomon Islands (*), Suriname, Swaziland, Syria, Trinidad and Tobago, Tunisia (*), Turkmenistan, Ukraine (*), United Arab Emirates, Uzbekistan (*), Vanuatu, Vietnam (*), Yemen R. (*), Zimbabwe Tonga Azerbaijan (*), Botswana (*), Iraq (*), Nicaragua Rates within crawling bands Managed float (33) (*13) Algeria, Armenia, Bangladesh (*), Burundi, Cambodia, Croatia, Dominican Republic, Gambia (*), Georgia, Guatemala, Guinea, Haiti (*), Jamaica, Kazakhstan, Kenya, Kyrgyz Republic, Lao PDR, Liberia (*), Madagascar (*), Malawi, Mauritius, Moldova (*), Mozambique (*), Myanmar, Papua New Guinea (*), Paraguay, Sao Tome and Principe, Serbia (*), Seychelles (*), Sudan (*), Tajikistan, Uruguay (*), Zambia (*) Independent float (5) (*1) Albania, Congo Democratic Republic (*), Somalia, Tanzania, Uganda Note: * indicates country whose exchange rate regime has changed since 1999 Source: IMF AREAER database.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Business Conference, Tel Aviv, 10 December 2007.
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Stanley Fischer: Tomorrow’s economic agenda Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Israel Business Conference, Tel Aviv, 10 December 2007. * * * The announcement in the newspapers about the Israel Business Conference bears the slogan “Come and join us, so that you’ll be part of tomorrow’s economic agenda”. And that is what I would like to talk about today, “Tomorrow’s economic agenda.” The objective of such an agenda should be rapid and sustained growth, the benefits of which would be enjoyed by the whole population. Such growth is critical for the future of the economy, the future of the society, and the future of the country. The reason is simple, and is like the effect of compound interest: if, for example, we manage to grow during the next 25 years at an average rate of 6 percent a year, in the year 2032 Israel’s GDP will reach NIS 2,830 billion (at 2007 prices), compared with about NIS 660 billion in 2007. If on the other hand the economy grows at only 3 percent a year over the same period, GDP will reach NIS 1,380 billion. That is a huge difference of more than 100 percent, and proves what my late friend Professor Herbert Stein used to say: “The difference between 3 percent growth and 6 percent growth is 100 percent.” If we succeed in traveling along the path of rapid, sustained growth, we will have the means available to deal with the various problems confronting us – in the fields of education, the economy, the social fabric, security, etc. Failure to do so will cost the country and society dearly. Today I will speak about two important aspects of growth: (1) the fact that actual economic growth permeates the whole population; (2) the need to maintain fiscal discipline. Actual economic growth permeates the whole population Growth of more than 5 percent a year, which the economy has been enjoying since 2003, significantly improves the standard of living of the whole population. a) In 2006 the rate of poverty, based on the relative measure that relates mainly to income differentials, stopped rising. Moreover, if we use the absolute measure of poverty, i.e., the ability to purchase a basket of basic goods, the rate of poverty actually declined in 2005 as well as in 2006. b) The decline in unemployment since 2003 can be seen at all educational levels, including the lowest. c) The increased rate of participation in the labor market is evident in all parts of the country, including outlying areas (the northern and southern districts). d) The rate of employment of Israelis is rising in all industries, including the lowtechnology ones (such as construction, agriculture, hotels and catering, and electricity and water). e) The average real wage is rising in all industries, including the low-technology industries. What conclusion do we draw from this? It’s very simple: the longer we stick to the path of rapid growth, the more people will be absorbed in the labor market, and the standard of living of all segments of the population will rise. Hence the importance of rapid and continuous growth to the economy, society, and the country, as everyone enjoys its benefits. The need to maintain fiscal discipline In order to achieve rapid and continuous growth, the government’s strategy – which enables the economy to continue to grow and economic and financial stability to be maintained – must be adhered to. The essence of this strategy is fiscal discipline, alongside the Bank of Israel’s interest rate policy, and the continued process of structural reforms in areas that promote growth and improve the country’s social fabric. One such area, possibly the most important, is without doubt education; hence the vital importance of a comprehensive reform in this field. I turn now to fiscal discipline. In order to escape from the recession that gripped the economy in the early 2000s, the government adopted a fiscal strategy aimed at reducing both the share of its expenditure in GDP, which had reached 52 percent, and also the budget deficit. There were two good reasons for doing so: the need to free resources for the private sector, which is the main source of growth, and the need to reduce the debt burden, which in 2003 had reached 102 percent of GDP and was threatening to undermine economic stability. The situation was so serious that we had to obtain US government guarantees so that we could borrow on the international markets. As a result of that policy, and with the extra advantage of global economic growth, since mid2003 the economy has been growing at an impressive pace of more than 5 percent a year, the debt burden has been reduced to 82 percent of GDP, the government’s interest payments on its debt fell by more than NIS 10 billion, the government’s share of GDP has fallen to below 45 percent, exports are expanding swiftly, the current account of the balance of payments is showing a surplus of more than 5 percent of GDP, the unemployment rate has dropped by about 4 percentage points, the rate of poverty is declining (based on the absolute measure), and so are tax rates. This is a huge success, which must be protected. At present, when uncertainty about global growth has risen, it is even more important for Israel to maintain fiscal discipline. What is the government’s fiscal strategy? It set a rigid framework of discipline based on budget targets for its expenditure and the budget deficit, and it makes sure that it adheres to them. This greatly enhanced its credibility in the eyes of investors and in the domestic and international financial markets. The high level of the government’s credibility, combined with the success of its policy, led to the reduction of Israel’s sovereign risk premium, the improvement of its credit rating, the OECD decision to invite Israel to start the process of joining the organization, and the agreement of the US government to extend the guarantees. The result of the above is that the government and the business sector can borrow at reasonable cost. Thus, yields to maturity on indexed government bonds have fallen from about 5 percent in 2003 to about 3 percent today. Households, too, pay lower interest on their loans. For example, indexed interests on mortgages have fallen from an average of about 6 percent in 2003 to an average of about 4 percent currently. Now, just prior to the approval of the 2008 budget by the Knesset, and just after the government set its budget targets for next year, proposals are being made to abandon those targets. It would be very dangerous to accept these proposals. Abandoning the targets set by the government itself is likely to severely undermine its credibility, and will cancel much of the progress that has been made. Just now, when uncertainty about continued global growth has increased, we must not go back on our undertakings. I support the efforts of the Minister of Finance, with the backing of the Prime Minister, to ensure that the framework of the budget for 2008, based on the expenditure and deficit targets set by the government, will soon receive Knesset approval. These efforts were certainly an important consideration that led to Israel’s recently improved credit rating, and we should help the Minister and the government as much as we can to make sure that their undertaking is implemented. The responsible way to increase expenditure on certain items is to alter the order of priorities in the budget, within the framework of the targets that have been set, and to implement them in conjunction with reforms that would boost efficiency. The budget for 2008 already reflects changed priorities, with increased expenditure on defense and education. It is obvious that education is one of the most important subjects, for the future of the economy, the society, and the country. Human capital is Israel’s main natural resource. It is therefore vital to invest in education and promote the reform that will raise the level of youngsters’ achievements, while remaining within the budget framework. Maintaining the budget framework, and growth-inducing reforms such as the education reform constitute a very important contribution by the government to the achievement of the goal of tomorrow’s economic agenda – rapid and sustained growth which benefits the entire population. Such growth is critical for the future of the economy, society, and the country.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Conference of the Association of Banks, Tel Aviv, 25 December 2007.
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Stanley Fischer: The Israeli economy, its banking system and Basel II Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Conference of the Association of Banks, Tel Aviv, 25 December 2007. * * * Today I will first speak about the state of the economy in Israel, and about the banking system as an important part of the economy; then I will talk of the Bank of Israel’s activity regarding competition in the banking system; and finally I will turn to Basel II. 1. The state of the economy Israel’s economy is in a very good situation, and growth this year is expected to be 5.4 percent, or even slightly higher. Exports have risen rapidly, the current account of the balance of payments is showing a surplus of 4 percent of GDP, the debt/GDP ratio has fallen to about 82 percent of GDP, compared with about 102 percent in 2003, the strong inflow of foreign investment in Israel is continuing, unemployment is declining, and according to quarterly figures has already reached 7.3 percent, down from about 11 percent in 2003, the rate of participation in the labor market is rising, price stability has been maintained, and both financial and economic stability have been preserved. At the present time, the inflation rate is slightly higher than the upper bound of the target range, but it is expected to return to the target by around the middle of next year. The Bank of Israel, for its part, will make every effort to ensure this outcome. The auspicious state of the economy is reflected in the OECD’s invitation to Israel to start the process of joining the organization, the improved credit rating granted to Israel, the agreement of the US government to continue providing us with loan guarantees, and the report of the IMF delegation that visited Israel this month. Nevertheless, the future looks less rosy: it appears that the financial crisis in the US and Europe will become more severe. The central banks are searching for the right tools to deal with the problems of liquidity, and as a result of the difficulties in the financial markets the gaps between central banks’ interest rates and market rates are widening. The first signs of the fruits of the central banks’ efforts are becoming visible. If this continues, the interest rate gaps will again become more reasonable, but even then the problem of the collapse of the US housing market and its implications for the economy will remain. Till now there has been no evidence of a slowdown in the US economy. However, a slowdown is expected, and the financial crisis is likely to exacerbate the situation. Israel’s banks were hardly exposed to the situation that developed in the international financial markets. Nevertheless, Israel’s interest spreads have widened, and if a serious slowdown in the US occurs, it is bound to affect Israel’s economy too. The intensity of the potential impact on Israel depends on us. Therefore, it is imperative that the government continue to observe fiscal discipline, that the Bank of Israel continue to maintain price stability and to support financial stability, and that the banks continue with prudent, and particularly with cautious risk management. If all the above fulfill their functions properly, and if concurrently the business sector continues to display enterprise and to thrive, we will be able to continue to grow at a good pace, even against the background of some economic slowdown in the advanced economies. In the context of this strategy, our chances of achieving the main objective of economic policy will improve – to convert a high rate of growth into sustainable growth. Such growth is vital to the future of the country, society, and the economy. Growth has already improved the standard of living of the whole population in Israel and of all its strata. As a result, the rise in the poverty rate halted in 2006, based on the relative measure of poverty (which relates mainly to income differentials); based on the absolute measure of poverty (with relates to the ability to purchase a basket of basic goods), poverty actually declined in 2005 and 2006. In addition, unemployment has fallen from its peak in 2003 at all educational levels, including the lowest, the rate of participation in the labor market has risen in all parts of the country, including the outlying ones, and the rate of employment of Israelis and the average real wage has risen in all industries, including the low-technology ones. 2. The Israeli banks What does this mean for Israel’s banks? It is clear that economic buoyancy affects the banks. The financial position of the banks in Israel has improved during the last few years, with regard to their profits, capital ratio, and the drop in the proportion of problem loans. Israel’s economy needs the banking system to remain strong and robust. However, it was not only correct management that contributed to their success – the improved economic situation also played a part. Therefore, I repeat the message that I delivered in my address last year (it sounds better in Yiddish): “Bad loans are made in good times.” This is an important thing to say at any time but particularly at the present time, in view of expectations of a growth slowdown in the global economy and, especially, the US economy, in 2008. On this point, an important aspect is the process in which the banks are currently engaged, with the support of the Supervisor of Banks – of raising the capital ratio. This process should be followed through to its completion. Before I turn to the subject of competition in the banking system, I would like to emphasize one especially important point. The banks have recently been subjected to a wave of attacks in the name of competition and customers’ wellbeing, and I too have leveled criticism with regard to one aspect, and that is bank fees. Sometimes the banks themselves take steps that seem to invite such attacks, but we must be extremely careful. A strong and stable banking system, as I have already stated, is vital to the robustness of the economy, and we must not weaken it. Although nearly all proposed legislation regarding banks purports to protect depositors, in certain cases it would harm the banks and the desire of other entities to act as competitors to the banks, and in the final analysis, the depositors themselves. It is thus essential that any initiative concerning the banking system be undertaken in full cooperation with the banking supervision. 3. Competition in the banking system Competition in the banking system has been a focus of attention in the Bank of Israel and among the public for many years. There is a reasonable degree of competition in the area of banking services for the business sector, and the Bachar Committee dealt with competition in the credit and capital markets. This year bank fees were the focus of a great deal of attention. The Banking Supervision Department was deeply involved in the subject this year. Firstly, the Supervisor of Banks, together with the Knesset Economics Committee, successfully promoted the Bank Fees Law. Following that, the Banking Supervision Department, after investing a great deal of effort, drew up a new schedule of bank fees for households and small businesses. The new schedule is standard for all banks, and contains 68 fees, still not a small number, but significantly fewer than the 198 fees currently listed. The new schedule will make it easier for customers to know how much they will have to pay, and for what. This enables customers to compare the fees charged by the different banks, and to decide which offers the cheapest rates for which services. We hope that when the degree of competition has increased we will no longer have to supervise bank fees. The best supervision is that exercised by consumers and the markets. In addition to the work invested in the subject of bank fees, the Bank of Israel was also very busy with many aspects of increasing the level of competition long term in banking services for households and small businesses. The underlying approach to this topic is to create sources of competition not only from within the banking system but also from outside it. The aim is to offer the Israeli consumer alternatives for certain services currently provided by the banks. In some areas this requires cooperation with other institutions, such as the Ministry of Finance (and specifically with the Commissioner of the Capital Market, Insurance and Savings), the Ministry of Justice, the Securities Authority, the Tel Aviv Stock Exchange, the Anti-Trust Authority, and the Government Companies Authority. What are the main potential sources of competition for the banking system from without? 1. Money market funds. These are likely to compete for short-term local-currency deposits in banks. We hope that in due course they will be able to offer additional cash management services, such as drawing checks. 2. Commercial paper. These are likely to compete for short-term local-currency deposits in banks. 3. Repo-type transactions. These are likely to compete against short-term bank credit. 4. Securitization. This should contribute to the general development of the credit market, including nonbank credit. 5. A platform for online distribution of mutual funds. This may compete with the banks in their distribution of mutual funds. In addition to the above, there are other possible sources of competition from within the banking system: 1. Simplification of switching from bank to bank. This a very important step in encouraging competition within the banking system, and several significant measures have already been introduced by the Banking Supervision Department: banks need to provide customers with relevant information before customers close accounts and the process of switching banks has been simplified; the transfer of the account is handled by the bank to which the customer is moving; customers now have the possibility of transferring some of their activities; and the costs of transferring to another bank have been reduced. The Banking Supervision Department intends to tighten the enforcement of its directives in this regard and to increase customers’ awareness of it. The power to supervise bank fees will also enable steps to be taken as necessary to reduce the costs of switching between banks. 2. Increasing the transparency of banking activity for customers. The Banking Supervision Department intends to take further steps towards the uniformity and simplification of reports to customers on their banking and credit-card activities, and the provision of information about a given banking service before the customer commits him/herself by signing a contract The new fee schedule is an important move in this direction. 3. Increasing the chances of other banks entering the banking system. The more banks there are in Israel, the greater the choice facing customers, and the greater the competition. On this point there is a trade-off between the number of banks in the system—the more banks, the more competition – on the one hand, and their efficiency and robustness, on the other, and the latter is certainly a relevant consideration for the supervisory authorities This trade-off is a focal consideration when it comes to decisions on mergers between banks. The Banking Supervision Department is already taking steps to remove barriers to increase the chances of an internet bank operating in Israel, to advance the privatization of the Postal Bank and to regularize its banking activity, and to bring about the entry of a foreign bank into the field of retail banking in Israel. All of which, without waiving considerations of bankingsystem stability. Here it is important to stress the following two points: 1. The size of Israel’s economy, the high technological level of its banking system, and Israel’s geopolitical situation all play a part in foreign banks’ considerations about entering Israel’s retail banking market. 2. As I mentioned before, the attacks on banks, and I include in that the extensive legislative activity regarding banking, is likely to deter anyone, including foreign banks, from starting to operate in Israel. Some of the points made above are already being dealt with by the Bank of Israel, and others will be discussed by the Ariav Committee set up by the Minister of Finance and myself. The committee consists of the appropriate people in the relevant authorities and external experts in the field. The establishment of the committee signifies the importance that the Ministry of Finance and the Bank of Israel, among others, attribute to the development of Israel’s financial system. Now we must allow the committee to get on with its work and to present its conclusions in due course. I now turn to my last subject for today: 4. Basel II The adoption of the Basel II principles is one of the most important tasks being tackled by the Banking Supervision Department, and hence, by the banking system as a whole. Basel II is an advanced approach to bank management and supervision, based on the establishment of risk-management systems rather than detailed rules. This requires the banks to invest much effort in setting up sophisticated information and management systems and an extensive database. The Banking Supervision Department is devoting many resources to this subject. The Supervisor of Banks has already published a schedule and delineated the path to be followed in preparing for and completing the adoption of Basel II. This is an ambitious project, and it is very important that we succeed in implementing it. Adopting the Basel II principles and those of SOX 404 will improve overall management – and in particular risk management – and banks’ control, and will institute the highest international standards in Israel’s banking system. I hope that next year we will be able to stand on this platform and look back and see how much we have progressed in this vital aspect of banking, and in particular with regard to the competitiveness, efficiency, and robustness of the banking system. Thank you.
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Remarks by Professor Stanley Fischer, Governor of the Bank of Israel, at the 2007 HIAS Scholarship Award Ceremony, Jerusalem, 28 December 2007.
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Stanley Fischer: Education, ‘aliya, and the young generation in Israel Remarks by Professor Stanley Fischer, Governor of the Bank of Israel, at the 2007 HIAS Scholarship Award Ceremony, Jerusalem, 28 December 2007. * * * Mr. Neil Grungras, Director General of HIAS Israel, Europe, and the Middle East; Mr. Danny Adamaso, Director General of the Israel Association for Ethiopian Jews; HIAS referees; HIAS staff members and volunteers; students; and esteemed guests: It is a great honor for me to be here with you at the 2007 HIAS scholarship award ceremony. This event concerns itself with three domains that I consider very important for the future of the State of Israel and its society: education, ‘aliya, and the young generation. It’s also a very important day for you personally – you are at the beginning of your path to higher education and independent life. The topic of education is very important in Israel, since the country is almost totally lacking in natural resources apart from human capital. And human capital is a natural resource that has to be developed constantly, in order to maintain and widen Israel’s qualitative edge. For many years, Israel placed a great deal of emphasis on education. I’ll illustrate this with three examples from international comparisons in education that were performed in 2005: a. 46 percent of Israelis aged 25–64 had post-secondary schooling, as against 26 percent on average in the OECD countries. b. R&D expenditure in Israel was 4.4 percent of GDP, as against 2 percent on average in the OECD countries. c. Per-pupil government expenditure relative to per-capita GDP was similar in Israel to the OECD average at the prekindergarten and secondary levels of education and surpassed the OECD average at the primary and higher-education levels. This favorable picture, however, stands in stark contrast to the relatively poor achievements of Israel’s student relative to other countries, for example, in the sciences, according to the OECD’s PISA exams. Thus, the government in Israel is relatively lavish in its education spending but the country’s students are not achieving well. This state of affairs leads us to one conclusion: Israel’s education system is inefficient. There are several possible reasons for this: a. Israel does not have one education system but at least four separate systems – some of which do not impart basic schooling in math, science, and English. b. At the individual school level, there is less administrative flexibility than should be desired. c. Between 1995 and 2005, per-pupil expenditure at the primary, secondary, and postsecondary levels of education was significantly lower than the OECD average. Therefore, our trend is negative. Education, like defense, should remain at the very top of our scale of priorities. Otherwise, we will find ourselves in a situation of steady and continual decline – which, to a large extent, has already begun. Therefore, it is important to examine in depth the problems that afflict education in Israel and to formulate – and implement – a solution. The need to promote education is especially important because it is an investment in the thing that counts most for the country’s future: the young population. The young generation, like the audience seated here, is our future labor force and our future source of entrepreneurship and growth. Investment in education is important from the economic and social standpoints in the long run: a. From the economic standpoint – education is an infrastructure for rapid and protracted economic growth. b. From the social standpoint – education is the key to social mobility. This is sometimes critical for the ability of every individual to improve his or her situation in life. Precisely because education is immensely important for the long term, it already should be encouraged at the present time. Today more than ever, it is clear that higher education is another field that needs a rethinking. It suffices to see the Israeli names that appear on the rosters of academic faculty at prominent universities in the United States and other countries. This is a situation that is hard to accept with equanimity. The Shohat Committee did excellent work and formulated important recommendations for the advancement of higher education in Israel. It is important to apply the committee’s conclusions – including the introduction of differential wages in order to reward the finest members of the academic faculty. Another field that we have been neglecting in recent years is technological education. Fewer students are applying for this form of education and, for this reason, fewer and fewer people are proficient in the technological trades. Skilled personnel are needed in this field – for example, in industry. Here is another domain in need of re-examination. Finally, I would like to say a word about ‘aliya and then conclude on a personal note. Recent immigrants from many countries are with us here: from Ethiopia, Russia, Ukraine, Belarus, Lithuania, Moldova, Bulgaria, Kazakhstan, Turkmenistan, Azerbaijan, Uzbekistan, Iran, Australia, the UK, Germany, France, the U.S., Argentina, Uruguay, and Brazil. I, too, am an ‘oleh. It makes me proud, as an Israeli and as a recent immigrant, to see the young immigrants integrating beautifully in Israel and doing well in their fields of study. The more able Israel is to grow over time, and the better its education system, the more successful we will be in attracting immigration that attracts immigration – because of Zionism, yes, but also because it’s a country that is worth living in. Thus far, I’ve spoken about the social and national levels. But this event is above all an important one at the personal level. Each of you has reached at a critical phase in your lives. The path you choose to follow in the coming years will affect your future. It sounds very important, and indeed it is. But student life may also be very enjoyable. It is my wish that each of you should seize firmly the opportunities that lie ahead. Enjoy yourselves, and, the main thing, be successful! Thank you. May you succeed.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the conference in memory of the late Amnon Ben-Natan, Tel Aviv, 3 January 2008.
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Stanley Fischer: Main aspects of the new law for the Bank of Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the conference in memory of the late Amnon Ben-Natan, Tel Aviv, 3 January 2008. * * * In the course of the last 25 years central banking has undergone a significant change, partly in reaction to the inflation of the 1970s and 1980s. These changes had a marked effect on Israel’s central bank too. This evening I would like to speak about the main aspects of the new central bank law on which we are working with the government; we hope that in the near future a new bill will be submitted to the Knesset, which will become a modern law governing the Bank of Israel. Before speaking about the law, I will describe two basic changes in the attitude towards central banking that have taken place over the last decades: first, the emphasis placed on the independence of the central bank as a major factor in the successful fulfillment of its functions and achievement of its objectives; second, the need for central bank transparency and accountability relating to its monetary policy, regarding both the analysis of the data underlying its decisions and the results of the policy. 1. Central bank independence In the 1990s researchers began to examine the link between central bank independence, inflation and economic growth, and to make international comparisons. Professor Cukierman was among the pioneers in this field. The meaning of independence in the case of a central bank refers to its authority to make decisions without having to obtain approval for them from sources outside the bank. The findings of the research were clear: a country that strengthens the independence of its central bank can expect lower inflation at no cost in terms of growth. This lesson, and experience gained in countries with independent central banks, especially Germany, also had an effect on decision makers. With the establishment of the European Monetary Union, the formation of the new republics following the break-up of the Soviet Union, and the democratization process in Latin America, new laws were passed for many central banks, and in all cases the emphasis was on their independence. The most wellknown and notable instance is the United Kingdom: the first economic decision of the Blair government elected in 1997 on taking office was to grant independence to the Bank of England. Till then it had not been independent, and interest rate decisions were taken by the Treasury. In light of the significant improvement in the economy in the last ten years, particularly with regard to inflation and steady growth, it is clear that that government decision proved to be a very wise one. The independence of central banks is vital for their success in carrying out their functions and achieving their goals. Why is that? The answer is that democracies have an inflationary bias. There are two reasons for this: The first is that an expansionary interest rate policy, i.e., a reduction in the interest rate, tends to have a positive effect, mainly on GDP, and only later does it lead to inflation, and since governments in democracies generally have a short-term horizon, this leads to a preference for interest rate reductions. This tendency is most marked in the approach to elections. An independent central bank can make decisions with a view to the long term, and can ignore political pressures. The second reason is that the central bank can finance government activity by printing money, which results in inflation. It is very easy/convenient for the government to request financing from the central bank, instead of imposing taxes or trying to raise money by issuing bonds on the financial markets. In the well-known words of Keynes in the period of hyperinflation in Europe after World War I: “A government can live for a long time, even the German Government or the Russian Government, by printing paper money… A government can live by this means when it can live by no other. It is the form of taxation which the public finds it hardest to evade and even the weakest government can enforce.” This situation was a familiar one in Israel in the early 1980s, until an end was put to it in 1985, when as part of the Economic Stabilization Program the law known as the “No Printing Law” was passed. This law prohibited the central bank from providing loans to the government, and in practice was the first step towards the independence of the Bank of Israel. Unfortunately, no progress was made since then with regard to the Bank’s independence. This did not happen only in Israel. Throughout the world, in the course of the last 25 years central banks have been granted independence. Why did governments give independence to their central banks and relinquish the ability to obtain finance from them and to influence their interest rate policy? a. Governments understood that without giving their central banks independence, they would probably find themselves in situations of high inflation, as happened in the 1970s and 1980s. b. They also realized that the economy performs better with an independent central bank. c. A by-product of the above was that globalization had the effect of increasing the importance of central bank independence, in light of the importance that domestic and foreign investors afford to that factor as a major consideration in their decisions about the countries in which to invest. This was supported by the findings of the 2005 study by Professor Alex Cukierman, which confirmed his earlier results: the independence of central banks and price stability are positively correlated. Over and beyond that, central bank independence is positively correlated with high, steady growth, price stability and low rates of interest. There are two types of central bank independence: a. Target independence: this is the case with central banks such as the European Central Bank (ECB) that set their own monetary policy targets, such as the inflation target. These central banks also have the resources with which to achieve their targets. b. Tool independence: this is the situation in which the government determines the targets for the central bank, e.g., the inflation target, and it is up to the central bank to employ the tools available, generally the interest rate, to achieve those objectives. Most central banks have this independence, and in practice so does the Bank of Israel. In my opinion, this is the preferred and proper situation for democracies. I would like to stress a very important point: an integral feature of central banks’ independence throughout the world is their administrative independence. This is a vital condition, as it prevents external and interested parties from obtaining the means that they could use to try to undermine the ability of the central bank to make its decisions independently. 2. Central bank transparency and accountability The independence of a central bank, especially in democracies, must be accompanied by the bank’s responsibility to account for its policies and the achievement of its objectives. For that purpose it is necessary to provide it with clearly defined targets against which its performance can be measured. It is thus important that the central bank submit a regular report to the legislature, government and public on its policy and the achievement of its goals. The report should describe the decisions made and the reasons behind them, the instruments employed and how they were operated, the resources employed and how they were used, etc. Thus, for example, with regard to interest rate policy, central banks, including the Bank of Israel, usually publish annual reports, economic forecasts, periodic inflation reports, minutes of interest rate discussions, press releases on decisions taken, etc. This framework of transparency and accountability ensures an open channel of communication between the central bank and the public in general, and the financial markets in particular, and constitutes an important mechanism of control over the central bank, its management and its policies. It enables the central bank to stay attuned to public criticism, and it enables the public to better understand the functions, policy, decisions and achievements of the central bank. The two subjects I have spoken about so far, central bank independence and the requirement for transparency and accountability incumbent on the central bank lead me to my main subject this evening. 3. The new law for the Bank of Israel The current Bank of Israel Law dates back to 1954, and is not appropriate either to the current reality of Israel’s modern economy, or to the global economy. Although amendments have been introduced into the law that grant the Bank of Israel a greater measure of independence, in particular the “No Printing Law”, the Bank’s de jure independence is more restricted than its de facto independence. It is therefore important to bridge the gap by passing a new law that will provide a proper legal basis for the reality that has been created. The new law will clearly define the independence of the Bank, its goals, and the mechanisms for decision making, and should impose on the Bank a comprehensive framework of transparency and accountability. The new law should thus contain the correct mixture of independence, transparency and control mechanisms for the Bank of Israel, according to the generally accepted standards in the advanced economies. In my first few months as Governor of the Bank we cooperated with the Ministry of Finance, the Prime Minister’s Office and the Ministry of Justice in producing a bill. We made good progress, but decided to shelve the matter until a new Bank of Israel wage agreement was reached, and that took longer than we had anticipated. We are now reverting to this issue, and I hope that we will soon have a final version. a. Independence The new law will give the Bank of Israel instrumental independence, i.e., independence in making the decisions on the interest rate as needed to perform its functions and reach its goals. And as I stated above, this independence must also be reflected in the management of the Bank. b. Defining the targets The new law should clearly define the Bank of Israel’s targets, along the lines of the targets of other modern central banks. The modern approach, and that adopted in the major central banks such as the Bank of England and the ECB, generally define three targets, and determines their order of priorities. The targets, I order of their importance in the proposed law, are: 1) the achievement and maintenance of price stability; 2) subject to that, support for the government’s other economic objectives, headed by growth and employment; and 3) support for the economy’s financial stability. c. Decision making This divides into two subjects – decisions on interest rate policy and decisions on the management of the Bank. i. Monetary policy – the Monetary Committee In a small number of countries, including New Zealand, Canada and Israel, the governor of the central bank makes the decision on the interest rate. In most countries that decision is made by a monetary committee that operates in the central bank. Generally the monetary committee has some members from outside the central bank and some from within, with the governor of the bank heading the committee. This is the preferred model, as has been shown in many studies, because decisions reached by a committee are on average better than those made by one person. In addition, the participation of external members, who are not beholden to the central bank or its governor but are committed to the attainment of the target set for the bank, is an important part of the mechanism of external control over the bank’s policy. ii. Management of the Bank – the Administrative Council The new Bank of Israel Law will specify an administrative council alongside the monetary committee, with an absolute majority of external members, one of whom will serve as chair of the council. The Governor and Deputy Governor will serve as members. This model is the one followed in several central banks in the advanced economies, including the Bank of England. The role of the council will be to make decisions related to the management of the Bank, such as approving work plans, the Bank’s budget and wages. The council will also appoint an audit committee from among its external members. All this is intended to provide another system of external control over the activities of the Bank. To adhere to the principle of the Bank’s independence, and its professional expertise, it is essential that the external members of the monetary committee and the administrative council, who will be appointed by the government, should be experts in the relevant fields, free of conflict of interests, and independent of the government and political institutions. d. Transparency and accountability The new Bank of Israel Law will require the Bank to account for its decisions, policies and achievements in a clear, ordered fashion, by means of reports to the Knesset, the government and the public, in line with the practice in the leading central banks. This is part of the gamut of the areas of the Bank’s responsibilities that includes the Monetary Committee, the Administrative Council, and the Governor. In its reports the Bank will explain the considerations underlying its decisions, including the relevant information available at the time, economic forecasts, and how it views expected economic developments. The reports will include inflation reports and periodic reports, minutes of the discussions of the Monetary Committee, press releases, etc. The Bank of Israel, even prior to the enactment of the new law, already publishes an extensive range of reports as per the list above. The issue of new and modern legislation for the Bank of Israel has been on the public agenda since the beginning of the 1990s. At the end of 1998 the public committee headed by the late Judge Dov Levin – whose members, including Professor Alex Cukierman and Professor Haim Ben-Shahar, were experts on the subject – submitted very precise proposals. The proposals were made following an extensive professional review based inter alia on developments in this field throughout the world, particularly in the advanced economies. In addition, after I took office as Governor of the Bank, the government made a decision adopting the principles that would be incorporated in the new Bank of Israel Law, and this in the spirit of the recommendations of the Levin Committee and developments in this area around the world. All that remains now is to complete the legislative process as quickly as possible.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the 2008 Herzliya Conference, Herzliya, 21 January 2008.
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Stanley Fischer: Challenges facing the Israeli economy in the globalisation era Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the 2008 Herzliya Conference, Herzliya, 21 January 2008. * * * The topic of this session relates to the challenges that our economy faces in the globalization era. Indeed, since the early 1990s the Israeli economy has undergone a successful process of integrating into the global economy, and today we are already a part – albeit a small part – of it. As part of this integration, the Bank of Israel headed a campaign of liberalization of capital flows and disinflation until price stability was obtained. The various governments adopted, and have been practicing to this day, an approach of budget discipline and pushed through a series of structural reforms. Israel’s successful integration into the global economy is manifested, among other things, in rapid growth; in exports, which reached about 45 percent of GDP; foreign investment; a flow of foreign investments into Israel; a high credit rating; favorable evaluations by international financial institutions; and an invitation from the OECD to begin the process of joining. These important achievements are contributing to the strong growth and stability of our economy. In one important field in the process of globalizing our economy, however, little has been done thus far: passing a new and modern Bank of Israel Law. The Law in effect today was passed in 1954; it is antiquated and does not meet the accepted norms in the advanced economies. Various governments in Israel and the Bank of Israel have done a great deal of work on the new Bank of Israel Law. In this context, two important milestones are noteworthy: 1. In late 1998, a committee under the late Justice Dov Levin presented the government with recommendations for a new Bank of Israel Law. This was the aftermath of professional work based on other countries’ efforts in this field, among other things. The members of the commission included Prof. Haim Ben-Shahar and Prof. Alex Cukierman, and several noteworthy personalities appeared before it, including the former President of the Bundesbank, Hans Tietmeyer; the Deputy Governor of the Bank of England, Mervyn King (today the Governor); and even myself. 2. On October 2, 2005, shortly after I took up office as Governor, the government resolved to adopt the principles of the new Bank of Israel Law in the spirit of the Levin Committee’s recommendations and developments in this field abroad. Before turning to the new law, I will mention two basic changes in central bank thinking over the last twenty years: (1) the emphasis on the independence of the central bank as a major component of its success in fulfilling its functions and achieving its targets; and (2) the need for central bank transparency and accountability in its interest rate policy, including the analysis of the information it had available that provided the basis for its decision, and the results of its interest policy. I. Central bank independence Studies were carried out in the 1990s, among others by Prof. Cukierman, to examine and make international comparisons regarding the link between central bank independence, inflation, and economic growth. The significance of the concept of independence in the context of a central bank is that it has the authority to make its decisions without needing to obtain any external confirmation or approval. The research findings were clear: the relation between central bank independence and inflation is a negative one, and this, without paying a price in terms of growth. In other words, countries that reinforce their central banks’ independence attain low inflation with no impairment to growth. This lesson and experience gained in countries with independent central banks, particularly in Germany, also influenced decision makers. With the establishment of the European Monetary Union, the founding of the new republics following the collapse of the Soviet Union, and the process of democratization in Latin America, new laws were enacted relating to many central banks, and in all cases, the emphasis was on their independence. The best known and most impressive instance is that of the Bank of England: the first economic decision taken by the new Labour Government after the election in 1997 was to grant independence to the Bank of England. Till then the central bank had not been independent, and decisions on the interest rate were taken by the Treasury. It is clear from the marked improvement in the performance of the UK economy over the last ten years, with regard to both inflation and steady growth, that the decision was wise and justified. The independence of a central bank is very important for its success in performing its functions and achieving its objectives. This is because democratic governments have an “inflation bias,” for two main reasons: a. Since an expansionary interest rate policy, i.e., lowering the interest rate, tends to have a positive effect on GDP and only later does it contribute to higher inflation, and since democratic governments generally have a short horizon, they prefer to reduce interest rates, particularly when there are elections looming. An independent central bank can make decisions with a view to the long term and without paying regard to political timetables. b. Governments find it more convenient to ask the central bank to print money in order to finance their activities than to impose taxes or raise capital in the financial markets. Such behavior, however, ultimately leads to higher inflation. Here I would like to quote the well-known words of Keynes in the period of hyperinflation in Europe after World War I: A government can live for a long time… by printing paper money… It is the form of taxation which the public finds it hardest to evade and even the weakest government can enforce. This scenario was highly typical of Israel of the early 1980s, until it was put to an end in 1985 when as part of the Economic Stabilization Program, a law known as the “No Printing Law” was enacted, which prohibited the Bank of Israel from granting loans to the government. This was in effect the first step toward the independence of the Bank of Israel. In the past twenty-five years many central banks around the world have been granted independence, and governments thus relinquished the ability to obtain finance from the central bank and to influence interest rate policy. They did so because they realized that (a) without giving their central banks independence, they would probably find themselves in situations of high inflation, as happened in the 1970s and 1980s; (b) the economy performs better with an independent central bank; and (c) as a by-product of the above, globalization had the effect of increasing the importance of central bank independence, in light of the weight that domestic and foreign investors give to that factor as a major consideration in their decisions about the countries in which to invest. This approach received further support from a 1995 study that examined data covering fifteen years and found that central bank independence and price stability are positively correlated. Central bank independence was also found to be positively correlated with high, stable growth and low rates of interest. I would like to stress: an integral feature of central banks’ independence throughout the world is their administrative independence. This is a vital condition, as it determines the resources required for the bank to fulfill its functions. II. Central bank transparency and accountability The independence of a central bank, especially in democracies, must be accompanied by the bank’s responsibility to account for its policies and the achievement of its objectives. For that purpose it is necessary to provide it with clearly defined targets against which its performance can be measured. It is thus important that the central bank submit a regular report to the legislature, government and public on its policy and the achievement of its goals. The report should describe the decisions made and the reasons behind them, the instruments employed and how they were operated, the resources employed and how they were used, etc. Thus, for example, with regard to interest rate policy, central banks, including the Bank of Israel, usually publish annual reports, economic forecasts, periodic inflation reports, minutes of interest rate discussions, press releases on decisions taken, etc. This framework of transparency and accountability ensures an open channel of communication between the central bank and the public in general, and the financial markets in particular, and constitutes an important mechanism of control over the central bank, its management and its policies. It enables the central bank to stay attuned to public criticism, and it enables the public to better understand the functions, policy, decisions and achievements of the central bank. The two subjects I have spoken about so far, central bank independence and the requirement for transparency and accountability incumbent on the central bank lead me to my main subject this evening. III. The new Bank of Israel Law The new law will clearly define the independence of the Bank, its goals, and the mechanisms for decision making, and should impose on the Bank a comprehensive framework of transparency and accountability. The new law should thus contain the correct mixture of independence, transparency and control mechanisms for the Bank of Israel, all, of course, according to the generally accepted standards in the advanced economies. In my first few months as Governor of the Bank we cooperated with the Ministry of Finance, the Prime Minister’s Office and the Ministry of Justice in drafting a bill. We decided to shelve the matter temporarily until a wage accord at the Bank was concluded, but now we are taking it up again. I hope that we will soon work out a final draft. 1. Independence of the Bank of Israel The new law will give the Bank of Israel independence in making decisions about the interest rate as needed to perform its functions and reach its goals. This independence must also be reflected in the management of the Bank, as that is the means by which it creates the instruments required to meet its goals. 2. Definition of the objectives of the Bank of Israel The new law will clearly define the Bank of Israel’s targets, along the lines of the targets of other modern central banks. The modern approach, and that adopted in the major central banks such as the Bank of England and the ECB, generally define three targets: 1) the achievement and maintenance of price stability; 2) subject to that, support for the government’s other economic objectives, headed by growth and employment; and 3) support for the economy’s financial stability. 3. Decision-making mechanisms at the Bank of Israel The law will establish new decision-making mechanisms for the Bank. In Israel today, as in a few other countries including New Zealand and Canada, the Governor makes the interest decisions alone, under law. He also runs the Bank, and is responsible for all administrative decisions. Research has shown that decisions made by committees of experts are, on average, better than those made by one expert acting alone. The new Bank of Israel Law will establish two decision-making mechanisms – one in the policy area, and the other in the area of management of the Bank. a) Interest rate policy – the Monetary Committee In most countries decisions on the interest rate are made by a monetary committee that operates in the central bank. Generally the monetary committee has some members from outside the central bank and some from within, with the governor of the bank heading the committee. This is the preferred model, which will be specified in the new law. The participation of external members, who are not beholden to the central bank or its governor but are committed to the attainment of the target set for the bank, is an important part of the mechanism of external control over the Bank’s policy. (b) Management of the Bank – the Administrative Council The new Bank of Israel Law will specify an Administrative Council alongside the Monetary Committee, with an absolute majority of external members, one of whom will serve as chair of the council. The Governor and Deputy Governor will serve as members. This model is the one followed in several central banks in the advanced economies, including the Bank of England. The role of the council will be to make decisions related to the management of the Bank, such as approving work plans, the Bank’s budget and wages. The council will also appoint an audit committee from among its external members. All this is intended to provide another system of external control over the activities of the Bank. To adhere to the principle of the Bank’s independence, and its professional expertise, it is essential that the external members of the Monetary Committee and the Administrative Council, who will be appointed by the government, should be experts in the relevant fields, free of conflict of interests, and independent of the government and political institutions. 4. Transparency and accountability The new Bank of Israel Law will require the Bank to account for its decisions, policies and achievements to the Knesset, the government and the public. In this context the Bank will have to explain the considerations underlying its decisions, including the relevant information available at the time, economic forecasts, and how it views expected economic developments. The reports will include inflation reports and other periodic reports, summaries of the discussions of the Monetary Committee, fundamental decisions by the Administrative Council, press releases, etc. In light of the importance of transparency and accountability, The Bank of Israel, even prior to the enactment of the new law, has already adopted a level of transparency and accountability that is broader than current law requires. However, this should be enshrined in new legislation. Allow me to conclude. There is nothing to gain by wasting time talking about the new Bank of Israel Law. The time has come to roll up our sleeves and get to work on completing the bill and passing it into law promptly. By so doing, we will have completed the final and most important stage in the global integration of Israel’s economy. It will be an important achievement and a badge of maturity for Israel’s economy.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Forbes Conference, Ramat Gan, 14 April 2008.
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Stanley Fischer: A salute to the country on its 60th birthday Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Forbes Conference, Ramat Gan, 14 April 2008. * * * In my remarks today, I would like to speak about the special period the Israeli economy is currently passing through and what is required from policymakers and the business sector to get through this period of the slowdown in global growth relatively unscathed. The Israeli economy is presently confronting a very complex situation. The Western world, and especially the United States, is in the throes of a serious financial crisis, which is causing a significant slowdown in growth in the United States, and hence also in Europe, and a decrease in the volume of world trade. The Israeli economy will also certainly be affected by the slowdown in global growth. This will probably come from two directions: a) Through the influence of the financial markets. Even though the financial crisis hardly touched the Israeli financial system, it is having an impact. This is seen in price falls in the share market and a rise in the risk premium on the bond market. We can thus expect a reduction in consumer demand due to the “wealth effect” – the effect of a fall in the value of households’ assets on their purchases – and a decline in real investments resulting from the increase in firms' costs of borrowing in the capital market. b) Through the slowdown in Israeli exports, in the context of the decrease in worldwide demand, particularly in the United States, and the strengthening of the shekel against the dollar. Taking the above into account, the Bank of Israel's forecast of the rate of growth in 2008 is 3.2 percent. Although this is lower than the rate we have been accustomed to since the middle of 2003, it is similar to the average growth rate recorded in Israel over the past 25 years, and is higher than that expected in the developed countries – particularly the United States and Europe. In other words, the Bank’s forecast, in line with that of nearly all forecasters, is that Israel’s economy will continue to grow at a good pace, despite the difficult times in which the advanced economies find themselves. The question thus arises what the policymakers – i.e., the government, especially the Ministry of Finance, and the Bank of Israel – and the business sector should be doing to minimize the harm to the economy. We should emphasize that whatever is done has to be consistent with the macroeconomic policy we have adopted in recent years and to which we have committed ourselves. This policy has been fundamental to the impressive success of the economy in the last few years. If we continue with this macroeconomic policy, we can rest assured that the confidence in the economy of the business sectors in Israel and abroad and of Israeli households will be maintained. In that situation Israeli and foreign investors will continue to invest in the economy, and households will continue to consume. Together with this, the business sector needs to organize itself in advance to cope better with the changing conditions – I mean by searching for new markets, streamlining procedures etc. The data relating to 2007 indicate that exporters have indeed made a start in this direction, and exports to Europe and the East have risen faster than those to the US. This macroeconomic policy rests on two major pillars: a) Continuation of the budgetary policy based on the expenditure targets and deficit that were determined – the aim of which is to continue to reduce the high government debt/GDP ratio. This policy contributes to the activity of the business sector as the engine of economic growth, which helps to boost Israeli and foreign investors' confidence in the economy and thereby also to support financial stability. As far as the budget is concerned, the correct approach at this stage is to allow the automatic stabilizers to function. This means that even if tax revenues this year fall below the level forecast in the budget due the slowdown in growth, it will not be necessary to raise tax rates or to cut expenditure, even if this results in a certain rise in the budget deficit. On the other hand, reducing taxes beyond this and beyond the path to which we have committed ourselves is liable to undermine the credibility of the economic policy. The last thing the economy needs, particularly now, is a loss of credibility in the government's macroeconomic policy. This would cost us dear, through a rise in the interest rates determined by the capital markets, which would ultimately deal a further blow to growth and employment. The step currently taken by the Ministry of Finance regarding accelerated depreciation as an incentive to companies to invest now rather than wait till the end of the slowdown in growth is a good move that will help the economy get through this period successfully. I would like to point out that the Ministry of Finance does not have an easy job at this time, in light of the pressures exerted to undertake weird and wonderful measures, which do not always contribute to the achievement of the policy goals. These pressures notwithstanding, the Ministry of Finance is adhering to the correct and prudent policy without yielding to demands for unproductive hyperactive steps. b) Continuation of the Bank of Israel's interest policy, aimed essentially at maintaining price stability. In this respect there has not been, there is not, and there will not be any change in the Bank's view of the maintenance of price stability as its major objective. At the same time, the Bank will continue to contribute to the government's other economic goals, especially growth and employment, as long as doing so does not adversely impact on the objective of price stability. The Bank will also continue to support financial stability. This issue, the Bank of Israel’s objectives, leads me to the Bank’s role in the economy. The perception of the Bank of Israel's policy objectives is expressed in the modern approach to central banking, according to which the central bank is an independent institution, with clear division of labor and responsibility between the government, and especially the Ministry of Finance, on the one hand, and the central bank on the other. The independence of the central bank is vital for the success of the economy. This is because of the irresistible temptation for governments to ask their central banks to print money to finance their activities, rather than imposing taxes on the population. The request to print money can take on different guises, such as a request to cut the interest rate – which initially, under certain circumstances and in the short run may boost growth, but which eventually, after what may be a very short period, leads to inflation. Other examples could include a request to finance a particular industry, or to purchase government bonds, or to write off government debts. This danger is particularly acute in democracies, because democratic governments – in all countries and at all times – generally have a short horizon, especially when elections are approaching. Hence, despite the fact that printing money ultimately brings inflation, it is not the focus of their concern, despite the destructive impact it has on the economy and the society. In other words, governments in democratic countries have an inflationary tendency. Some of us well remember Israel’s economy thirty years ago, and the crises that resulted from that tendency. Price stability should thus be placed in the hands of a professional independent institution that is free of any political consideration and involvement, and that will operate with a longterm perspective. The political systems in advanced countries understood how important this is, and granted independence to their central banks. There is a vast amount of research showing that an economy performs better when the central bank is independent. Central bank independence is thus important for the achievement of sustainable growth, price stability, and financial stability. Hence, central bank independence is one of the considerations of domestic and foreign investors in deciding where to invest. This consideration is expressed, among other things, in the country's rating and in the costs incurred by the government and the private sector in raising capital. It is also important that the independence of the central bank be accompanied by fruitful cooperation between it and the government, including the Ministry of Finance. On this point I would like to mention the excellent cooperation between the Minister of Finance and me, and between the senior personnel in the Ministry of Finance and the Bank. The modern approach to central bank independence is expressed in the laws relating to modern central banks in advanced countries worldwide. This is also the approach underlying the new Bank of Israel bill which we are drafting in conjunction with the Ministry of Finance and with the support of the Prime Minister. This law will comply with the accepted standards of central banks in advanced countries, and will also, and mainly, serve the economy, the state and its citizens in the best possible way. I hope that the government will present the new bill to the Knesset in the very near future. This will be a further milestone in building the foundations of an advanced and modern economy in Israel. That will be an achievement the State of Israel and its citizens can be proud of as the country celebrates its 60th anniversary.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to 'TheMarker' Capital Markets Conference, Tel Aviv, 21 May 2008.
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Stanley Fischer: Remarks about financial supervision authorities Address by Professor Stanley Fischer, Governor of the Bank of Israel, to “TheMarker” Capital Markets Conference, Tel Aviv, 21 May 2008. * * * The Capital Markets Conference is taking place this year during one of the most fascinating periods as far as the situation in the global financial markets is concerned. I am referring of course to the global financial crisis. Although the crisis is not yet over, it has already confronted the authorities, particularly the supervisory authorities, with important questions. I would like to exploit this platform to make some remarks about the financial supervision authorities. It is important, right at the outset, to distinguish between two main aspects of financial supervision: A) The first aspect relates to the difference between sectorial supervision and functional supervision. The traditional approach is the sectorial one. In this approach separate authorities supervise different sectors: the banks, insurance companies, provident and pension funds, and also a securities authority. That is the current approach in Israel, with banking supervision on one side, and supervision of insurance and provident funds and pension funds on another. The main drawback of this approach is the existence of separate, and sometimes dissimilar, supervision of different financial institutions that may in fact engage in similar activities, such as giving credit. A clear example of this in Israel is the fact that both banks, supervised by the Supervisor of Banks, and also insurance companies, supervised by the Capital Markets, Insurance and Savings Division of the Ministry of Finance, offer credit to businesses. Clearly, risk management in these entities should be subject to the same standards of supervision. This problem can be solved simply, by merging, partially or totally, the various supervisory authorities. The best known example of such unification is that of the Financial Services Authority (FSA) established in the UK, which regulates the entire financial system in the UK. Other models exist, too, in different countries, such as partial mergers of financial supervision. In Israel’s case, the solution to the problem of lack of uniformity in supervision of financial institutions that engage in similar activities is to unify the supervision of banks with the supervision of insurance, provident funds and pension funds, with the Securities Authority continuing as a separate entity. This solution can be implemented relatively simply, and requires fewer resources and changes than would full unification, which is why this model is more appropriate for small, open economies such as Israel’s. B) The second aspect of financial supervision is the location of the financial supervision authority. In this context, a key question is the relationship between the supervisory authority or authorities and the central bank. First, it is important that the financial supervision authority operate as an independent entity free from political considerations. Second, an important lesson to be learned from the current financial crisis is that it is essential for the central bank to be very closely involved in the supervision of the financial institutions. This is the present situation in nearly all countries, with the central banks bearing the responsibility for the economy’s financial stability, and having the unique capacity of being able to inject liquidity into the financial markets as necessary, and of being able to act as the “lender of last resort” in a financial crisis. It is thus essential that the central bank be able to make decisions quickly in, and before, a financial crisis, based on comprehensive and detailed information, and in real time. This is of special importance due to the risks to which financial institutions are exposed, against the background of the development of new, sophisticated, and sometimes unfamiliar, financial instruments. The implications of these risks are evident in the current crisis. The need for a very close connection between the central bank and the supervision of banks features in an important report issued in April this year by the Financial Stability Forum (FSF) entitled “Enhancing Market and Institutional Resilience”. The conclusion in the report – stressing the need for central bank involvement in the supervision of banks and other financial institutions with similar impact on financial stability – receives strong support from the current crisis. Thus, for example, the US Department of the Treasury has proposed that the Fed should be granted greater responsibility for financial stability, including the authority to supervise important financial institutions not currently subject to its supervision. In the UK too the current strict separation of the FSA from the central bank is being reconsidered in light of the Northern Rock episode. To summarize: the conclusion drawn from the current financial crisis by nearly all those who have analyzed the situation is that the involvement of the central bank in the supervision of financial institutions should be extended and enhanced. In Israel’s case, the conclusion is that supervision of financial institutions, i.e., the banks, and insurance, provident and pension funds should be brought together in the Bank of Israel. I return now to the distinction between sectorial and functional supervision. A notable example of the functional approach to financial supervision is the model adopted in the Netherlands, known as the twin peaks model. This model separates the two functions of financial supervision: i. Supervision of financial institutions’ risk management (prudential supervision); ii. Supervision of conduct of business, covering such subjects as transparency and full disclosure by institutions, fair relations between them and their customers, and consumer protection. In the Netherlands, the supervision of financial institutions’ risk management is the responsibility of the central bank, while supervision of business conduct is performed by a separate authority. Another model is the Irish one, where the central bank supervises both financial institutions’ risk management and their business conduct. In Australia, in contrast, the central bank is not responsible for either supervision of risk management by financial institutions or their business conduct. If the Bank of Israel is given the responsibility for the supervision of financial institutions, it would be advisable to adopt the functional supervision approach, in other words, to separate the two supervisory functions – the supervision of financial institutions’ risk management and the supervision of their business conduct. Later, after some years’ experience, the situation can be reviewed, and the question considered of whether supervision of business conduct should be transferred from the Bank of Israel to a new authority that would be established specifically for that purpose. To conclude: financial supervision is one of the most important issues affecting the functioning and development of the financial markets and the economy as a whole. In Israel the issue assumed even greater import with the implementation of the recommendations of the Bachar Committee, and at this time it has come to the fore again in light of the implications of the global financial crisis. After examining the question very closely, and taking into consideration the conclusions being drawn in the major financial institutions around the world, we recommend that the supervision of banks be merged with the supervision of insurance, provident funds and pension funds, within the Bank of Israel. It is advisable to switch then to the functional supervision approach, i.e., to distinguish between the supervision of risk management in financial institutions and supervision of their business conduct. At a later stage, after some years, we can examine the question of whether the supervision of business conduct should be transferred from the Bank of Israel to another authority.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Degree Presentation Ceremony of the Open University of Israel, Raanana, 21 May 2008.
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Stanley Fischer: Education and Israel’s future Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the Degree Presentation Ceremony of the Open University of Israel, Raanana, 21 May 2008. * * * It gives me special pleasure to participate in this degree presentation ceremony of the Open University, because nothing is more crucial to Israel’s future than education. In the long run, education is as important as the country’s security and geopolitical situation. The reasons are well known. Israel has hardly any natural resources, apart from human capital, i.e., its citizens’ talents and initiative, and these must be nurtured constantly. Thus, and only thus, will be able to maintain and increase Israel’s qualitative advantage. The State of Israel, and before its establishment the Yishuv (the pre-State Jewish population in Palestine), long placed great emphasis on education. This can be seen in various figures relating to the position in Israel in 2005 compared with that in other countries: A. Forty-six percent of those aged 25-64 years in Israel had post-high-school education, compared with an average of 26 percent in the OECD countries. B. The ratio of government expenditure per student on pre-school, elementary and secondary education to GDP per capita in Israel was similar to that in the OECD, and in tertiary education the ratio was higher in Israel than in the OECD. C. As early as at the establishment of the State, Israel had two universities of internationally recognized standing – the Hebrew University of Jerusalem, and the Technion, the Israel Institute of Technology, in Haifa. This was an impressive achievement for a population of less than a million. And today we have a broad network of higher-education institutions, including the Open University, which provides an opportunity to tens of thousands of Israelis to realize their potential. However, as is well known, the situation in the education system in Israel no longer occupies the exalted position it held in the past. For example, the low position in the scale of achievements attained by students of schools in Israel, e.g., in science, compared with other countries – based on the PISA (Programme for International Student Assessment) tests coordinated by the OECD – stands out like a sore thumb. Thus, despite the fact that the government spends a relatively large amount on education, students’ achievements are relatively poor. In other words, Israel’s education system is not efficient. Various reasons may be put forward to explain this: A. Israel does not have one education system, but several, including among others Hebrew state education, Arab state education, state religious, and a number of ultraorthodox streams, and some of them do not include basics such as mathematics, sciences and English in their curricula. B. These education systems do not have enough management flexibility, certainly at the school level. C. Between 1995 and 2005 expenditure per student on elementary, secondary and tertiary education rose more slowly in Israel than in the OECD countries. It is clear that a fresh approach is needed also in the field of higher education. In this context Israel’s brain drain gives particular cause for concern. We need only look at the number of Israelis in the faculties of the leading universities in the US and other countries. We must not sit back as passive observers of this trend, but should take steps aimed at changing this situation. Promoting education should be high on Israel’s list of priorities. If not, we will find our relative position deteriorating, and indeed, there are signs that this has started. This is one of the few subjects on which there is a consensus; but the fact there is a consensus does not itself solve the problem. Two committees have examined the issue and formulated comprehensive proposals – the Dovrat Committee in 2005, and the Shochat Committee in 2007. The implementation of their recommendations – including the introduction of differential pay for lecturers based on their achievements – should be advanced. Investment in education is vital in the long term, economically, socially and culturally, and even from the security aspect: A. Economically – education provides the infrastructure for rapid and sustained economic growth; B. Socially and culturally – formal and informal education is the key to the realization of individuals’ potential, and also contributes to social mobility; C. Security – without good education to help boost and sustain growth, and without maintaining our technological edge, we will be unable to preserve our advantage in the field of security. It is because of the immense importance of education to Israel’s long-term future that now is the time to push ahead with the implementation of the recommendations of the Dovrat and Shochat Committees. Nothing is more important for Israel and its citizens, and that includes you and the coming generations. I congratulate you on your achievements and wish you every success in the future.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Economic Affairs Committee, Jerusalem, 15 July 2008.
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Stanley Fischer: Challenges for Israel’s banking system Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Knesset Economic Affairs Committee, Jerusalem, 15 July 2008. * * * Today I would like to talk about four issues: competition in Israel’s banking system; the importance to banks’ customers and the whole economy of a robust banking system; the danger to banks’ customers in the proposal to separate credit cards from the banks; and the importance of the reform in bank fees. 1. Competition in the banking industry This is a subject that has occupied the Bank of Israel for a long time. It is important for the banks’ customers, as it lowers the cost of the services they receive from the banks, improves their quality, and broadens their range; and it is important for the banking system, as it is the most effective way of making it more efficient. 2. The importance of a robust banking system for its customers and for the whole economy It is of the utmost importance that customers depositing their money and savings in banks feel confident that their funds are being well managed by the bank, and that they can withdraw them whenever they wish. Especially now, when banking systems around the world are confronting a serious financial crisis – which apparently is entering another very serious stage – it would be very dangerous to weaken Israel’s banking system, which as a result of prudent management has not run into serious problems, despite the crisis. If we weaken Israel’s banking system, its customers will be the first to pay the price. We must bear in mind, when dealing with the banks, that a robust banking system is essential for customers, normal economic activity, and growth. 3. The danger to customers in the suggestion to separate the credit cards from the banks This is an example of a proposal currently being formulated that at the end of the day would harm the banks’ customers. It is a dangerous proposal. Separating the credit cards from the banks would not necessarily increase competition in the credit card markets, retail credit or retail banking, and in fact would probably have an adverse impact on consumers. Based on research we have carried out and experience abroad, it is clear that separating credit cards from the banks entails a high risk that it would increase the price of credit given via credit cards. Today the interest on credit via credit cards in Israel is significantly lower than on such credit abroad. In addition to which, as I mentioned, there is the risk that a further weakening of the banks would have both a direct adverse impact on customers and an indirect effect that would result from its negative impact on economic growth. 4. The importance of the reform in bank fees I am in favor of this important reform, because it is likely to increase competition in the banking industry, to the benefit of its customers. The reform was the outcome of the intense efforts by the Knesset, mainly by Member of Knesset (MK) Moshe Kahlon, MK Gilad Ardan, the entire Economic Affairs Committee, and the Supervisor of Banks. Here I would like to compliment the staff of the Banking Supervision Department on the efforts they invested in this area, which resulted in a necessary and wellplanned reform. I would also like to mention the Ministry of Finance, the Director-General of the Anti-Trust Authority, expert advisers and consumer organizations, all of whom cooperated on this issue and supported the reform. The aim of this reform, which will affect us all, is to lower the costs paid by banks’ customers. There are two ways of achieving this: one is by imposing wide-ranging supervision on bank fees, and the other is by increasing competition in the banking system, and lowering prices via market forces. The first method gives immediate results, but brings in its wake much damage, which I will describe later. The second approach is the right one, which will yield long-term gains to consumers and to the economy as a whole. The reform has increased the level of transparency with regard to fees, and transparency is essential to the development of competition. Thus, the reform reduced the oversized list of bank fees, gave them uniform names, and created the current situation in which, for the first time, customers know the prices they are asked to pay for banking services. As a result of these changes, consumers can compare prices and make informed decisions – just as we all do when we go shopping. This has revolutionized the pricing of banking services, and customers can see what they would be charged for various services in each of the banks, and they can then make rational decisions. To help customers, the Bank shows on its website the fee tariffs of the banks, tables and calculators enabling customers to compare the costs of managing their current accounts, and other detailed relevant information. All these have created a new situation in Israel: for the first time customers are well aware of the full implications of the bank fees and have become more actively involved in this issue. The reform also abolished fees in the retail segment wherever there is interest: credit arrangements, retail loans and deposits. This change results in significant savings in costs for a large proportion of banks’ customers, an important point that should be brought to the attention of the public, most of whom were previously unaware that these charges were being made. The reform has already proved itself, and has started a positive trend in fees. Even before the reform went into effect, there was a saving of about 80 percent in the cost to customers of handling their current accounts, which is likely to amount to half a billion shekel. And already now, just two weeks after the reform started, we can see cuts in fee tariffs on various bank services, and reductions offered to certain groups in the population. Thus, with the publication of their new tariffs in the middle of June, even before the reform had gone into effect, banks announced more than twenty reductions in the cost of various current account transactions, reductions for pensioners and other groups, plus another forty reductions following measures taken by the Banking Supervision Department – a total of more than sixty reductions in fees. In addition, there is at last evidence of variation in prices, in contrast to the uniformity that prevailed in the past, and it is the large banks, which in the past generally led the field in raising their fees, that are offering lower prices. This last point is particularly important not only because it is an indication of competition, but also because of the large banks’ wider spread network of branches that also covers outlying areas. The Bank of Israel is well aware of the special needs of the elderly and the weaker sections of the population, whose banking activity typically involves many over-the-counter transactions in branches. The reform has already made banking services via tellers more accessible to them at the lower price charged for online services As mentioned, the Bank of Israel publishes a list comparing banks’ fees, both on its website and via press releases, and provides other means which enable customers to compare costs. The Banking Supervision Department is closely monitoring the implementation of the reform, and will not hesitate to take any steps needed, within its mandate, to protect customers in general or certain sections of the population if it sees their interests are being harmed. In the next few days the Banking Supervision Department is launching a large publicity campaign to increase the public’s awareness of the new situation resulting from the reform, and to provide the means and information necessary to make the best decisions regarding the management of current accounts. It would be inadvisable to opt at this stage for simpler, “instant” solutions, such as imposing wide-ranging supervision over bank fees, or forbidding banks to charge fees at all. We must give the new system time to operate properly, and to allow the Banking Supervision Department to deal with flaws that may come to light. Supervision must be the last step, not the first, and even then only if there is absolutely no alternative. Sweeping supervision is not advisable, is unacceptable around the world, will take us back to somewhere we do not want to be, and is likely to have an adverse effect on competition which we all favor so highly, and thus, in the final analysis, on consumers. This would probably occur because supervision is likely to result in the banks setting uniform fees, at the exact level determined, and the quality of service to customers would be impaired. Moreover, and certainly no less important, it would probably deter potential competitors, particularly foreign banks, from entering the field of banking in Israel, meaning that competition would remain at its low level. Clearly we must give the reform a chance; it has been in effect just two weeks. It is also important that we all support the Supervisor of Banks in advancing the reform, and he, on his part, will do what is necessary to correct any flaws and to speed up the whole process.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the General Assembly of the Association of Publicly Traded Companies, Jerusalem, 8 December 2008.
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Stanley Fischer: Impact of the global financial crisis on Israel’s economy Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the General Assembly of the Association of Publicly Traded Companies, Jerusalem, 8 December 2008. * * * For more than a year the world has been confronting one of the worst financial crises in over seventy years. This crisis has two phases: the first, financial, and the second, real, in other words a significant slowdown, and possibly even a global recession. Both the financial and real effects of the global financial crisis on Israel's economy are clearly evident. I would like to stress, however, that Israel entered this period in a more favorable state than that in most other countries. On the financial side the crisis is reflected in Israel mainly by the fall in prices of shares and corporate bonds, unlike in the advanced and other economies. In addition, the rate of growth declined to 2.3 percent (annual rate) in the third quarter, and it is expected that the slowdown in Israel's growth rate will continue, i.e., growth will remain positive, but will slow further, (to 1.5 percent in 2009), as opposed to a more significant slowdown, or even a recession, in the advanced economies. Israel's relatively favorable situation is due to several factors: 1) The government's fiscal policy in the last few years was a responsible one. 2) The Bank of Israel’s interest rate policy supported financial stability and the ability of the economy to deal successfully with the effects of the slowdown in growth. This, without acting counter to the return of inflation to within the target range. 3) A surplus has been created in the current account of the balance of payments. 4) Israel's foreign exchange reserves are high and rising, as a result of the Bank of Israel's plan to increase them. 5) The levels of growth and employment were high at the onset of the crisis. 6) Israel's banking system is strong and stable compared with those of the advanced economies. 7) Israel's capital market did not develop advanced, complex financial instruments whose inherent risk levels are difficult to assess. 8) The average debt burden of companies and households is relatively low. The challenge at present is to preserve the economy's relatively favorable position, to take advantage of it to deal with the new situation, and to introduce the measures needed to escape from the period of slowdown without harming the economy's ability to return to the path of rapid and sustained growth. All this, despite the forthcoming elections and the fact that the 2009 budget has not been approved yet. At this stage the Bank of Israel, in the framework of its powers and the instruments available, is taking the following steps: 1) It is conducting an active interest rate policy intended to strengthen the economy's ability to handle the crisis. 2) The Bank Supervision Department has intensified its regular monitoring of developments in the banking system. In addition, the Bank announced that it was ready to help the banks with all the means at its disposal, as necessary, in order to support depositors. 3) The Bank's program to buy foreign currency will continue until the forex reserves reach the level considered appropriate under the current circumstances – between $40 billion and $44 billion. What do we still have to do? 1) A cautious fiscal policy should be pursued. Thus, assuming a growth rate of 1.5 percent in 2009, the budget deficit is expected to reach about 3 percent of GDP, based on the automatic stabilizers, i.e., the expected drop in tax revenues resulting from the slowdown in growth, on the one hand, and a certain rise in government expenditure arising, for example, from an increase in unemployment, on the other. It would not be advisable to allow the deficit to rise much beyond that; in other words, our ability to embark on an expansionary fiscal policy is limited. Nevertheless, the tax cuts planned for 2009 should proceed, in a manner consistent with the automatic stabilizers. 2) The measures formulated by the Ministry of Finance in cooperation with the Securities Authority and the Bank of Israel should be implemented. This program should help the economy weather the storm. 3) It is essential, and I would place the emphasis on this aspect, to introduce measures on the financial side, particularly steps intended to increase the sources of bank and nonbank credit for the business sector, including small and medium-sized businesses, and to stimulate foreign investment in Israel's capital market. Yesterday the Prime Minister decided to support the proposal put forward by the work teams of the Ministry of Finance, the Bank of Israel and the Prime Minister's Office, regarding a "safety net" for savers close to retirement age. The Bank is in favor of the proposal and its immediate implementation. However, we view the safety net as a temporary measure for this particular time. It is important to start thinking about changes to the structure of the pensions system in Israel, to ensure that those paying into funded pension schemes, as opposed to those covered by unfunded schemes, are not placed in a situation in which, close to retirement age, they are likely to lose a significant part of their savings. It is important that the pension system be structured such that when the time arrives savers can receive a reasonable pension for the rest of their lives. One possible pension scheme structure that could be adopted is the Sicilian model, in which the savings of those close to retirement age are transferred to relatively low-risk channels. To my great regret, the other steps formulated by the Ministry of Finance, although approved by the Prime Minister, are making little or no progress vis-à-vis the Knesset, and are not being implemented. Thus, valuable time that could be used to the benefit of the economy is being wasted, particularly regarding measures relating to the financial side. Further delay in applying these measures is likely to erode the economic achievements of the last few years and our ability successfully to meet the challenges facing us. This is not the time, therefore, to postpone decision making. The financial crisis is here, and is not waiting for us. The measures have been planned, and all that remains is to start with the none-too-simple task of making decisions and implementing them. It is essential that at this time, in the approach to the elections to the Knesset, we persist in being focused, and act with a view to the medium and long term. Failure to do so will cost us dear.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Annual Conference of the Association of Banks, Tel Aviv, 23 December 2008.
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Stanley Fischer: Israel’s banking system and economy Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Annual Conference of the Association of Banks, Tel Aviv, 23 December 2008. * * * The Annual Conference of the Association of Banks is taking place this year while we are experiencing one of the worst financial crises in modern times. The global banking system is at the center of the crisis, and it is reflected in the advanced economies not only in sharp falls in prices of shares and private bonds, but also in shocks to the banking system, to the extent that more than few commercial banks and investment banks have actually collapsed. Our situation is different. Israel's banking system is strong, and depositors can continue to have confidence in Israel's banks. The global financial crisis is not leaving Israel's banking system entirely unscathed, however, and its effects are being felt, among other things, in the area of risks confronting the economy and the banks. One of the salient risks is that of a possible increase in problem loans, a characteristic feature in periods of slowdown in economic growth. That said, the stability of the banking system is being maintained, and so far its exposure to the financial storm has been relatively limited. That may be attributed to the high level of professionalism of the Supervisor of Banks and his staff, and the welcomely high degree of conservatism of Israeli banks, relative to that in many other countries. It is due to that conservatism that the dangerous developments that occurred in the area of mortgages in the US and other countries have hardly been seen here. In light of the crisis the Bank Supervision Department is making every effort to intensify and extend its regular monitoring of developments in each and every bank and in the banking system as a whole. You, the banks, are certainly conscious of the Supervisor's hand on your pulse all the time, and certainly appreciate the expediency of that intensive activity vis-à-vis the banking system and the whole economy. In addition, the Bank announced that it is ready to help the banks with all the means at its disposal, as necessary, in order to support depositors. At the same time the government announced that out of concern for the public's deposits and to ensure the public's confidence in the financial system, it will stand behind the stability of the financial system. It went on to emphasize that for sixty years depositor holders have not been harmed, and the government will continue to follow that path in the future too. The challenge confronting us at this time is to preserve the relatively good situation in the banking system and to take the steps necessary to enable the economy to emerge from the current period in the best way possible. This is our main objective, and by "our" I mean the government, the Bank of Israel, and mainly the Bank Supervision, but it is surely also an important objective for you, the banks. There is another goal, in the main for the policymakers, and that is to make the period of the slowdown in growth as short as possible, to keep any damage to a minimum, and to return quickly to the path of rapid, sustainable growth – essential not just to the economy, but to Israel's overall strength. One of the most important aspects of this is the accessibility of the private sector – particularly the business sector, including medium sized and small businesses – to sources of credit, to enable it to continue producing and developing. At this time, in the shadow of the crisis, accessibility to nonbank credit and to credit from abroad is very restricted. Bank credit, on the other hand, continues to expand. The steps formulated by the Ministry of Finance with the Securities Authority, and with the cooperation of the Bank of Israel, give a partial but significant answer to the question of credit sources. 1. With regard to nonbank credit measures have been formulated to arrange debts to holders of corporate bonds via credit officers, the establishment of funds to deal with nonbank credit jointly with the financial institutions, and making credit funds available to exporters and medium sized and small businesses. 2. With regard to bank credit, steps have been designed to give state guarantees for the issue of subordinated notes by the banks, which means increasing their sources for advancing credit. This program is an important means of strengthening the economy's ability to deal with the shocks emanating from the global economy. Israel's banking system has an important function to fulfill with regard to the second point I mentioned above, i.e., increasing the sources of bank credit, and generally in all matters related to making credit available to the economy. The banking system cannot allow itself to ignore this important role. This is especially the case bearing in mind that unlike other sections of the business sector the banks enjoy the benefit of the safety net spread by the government and the Bank of Israel in the form of their commitment to maintain the strength and stability of the financial system, of which the banks are a central component. It is natural that in a time of crisis and uncertainty, such as the present, the banks should exercise special caution in their credit policy. Moreover, the Supervisor of Banks and I encourage the banks to be more careful and not to take unnecessary risks––but this too must be to the right degree. Hence it is essential that the banks, which are one of the most crucial elements in the economy's ability to continue to grow, strike the correct balance between their credit policies, which at this time must be cautious, and the needs of the economy, particularly the business sector, for finance. I am not speaking only about the supply of bank credit, but also about its cost. Recently the Bank of Israel reduced the interest rate sharply, with the purpose of helping to lower the cost of credit to the business sector and households. In practice the banks hardly reflected these cuts in the cost of credit they offered. And here again, although in this special period spreads are expected to increase, it is important to maintain a sense of proportion and not act excessively. To put it another way, I repeat what I said to you in previous years, "Good bankers can make good loans in bad times," and I have every confidence that in this hall we have good bankers. As an economist, I would like to explain this issue by noting that this relates to externalities. Thus, if all banks significantly tighten their credit policy the economy will grow more slowly, thereby retrospectively justifying the step they took. On the other hand, if every bank takes into account that even slight easing of its credit policy in its marginal decisions will make the economy grow faster, this will retrospectively justify their decision. One of the Bank of Israel's roles is to help to achieve the right balance. To do this we will, monitor the amount of credit each bank gives, among other things. We see no conflict between our responsibility to support the return of the economy to rapid, sustainable growth, and our responsibility to support the stability and strength of the whole financial system, and specifically of the banking system. The financial crisis is still with us, and is too soon to predict when it will end. We do know, however, that it will end, and the economy will return to growth rates similar to those of the last few years. Hence the importance of not wasting valuable time. And I am saying this when the steps formulated and approved by the government have not yet been implemented. It is thus important and urgent that all of us, including the banks, join in the efforts to achieve the important objectives before us. I therefore expect the banks to play their part by finding the correct balance between the need to operate a cautious and prudent policy, essential in itself, and their responsibility as one of the main tollgates along the road towards the economy's medium- and long-term growth. Failure to strike the right balance will cost the economy very dearly. The Bank of Israel will do everything within its authority, in its role as interest rate policymaker and as Supervisor of Banks, to help steer the economy back onto the path of healthy and rapid growth. I am sure that the government will also play its part. It is vital that the banks, on their part, continue to manage their business while maintaining their robustness, and take full account of the implications of their decisions on economic growth. Israel's economy has what it needs to grow.
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Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Annual Conference of the Institute for National Security Studies, Tel Aviv, 23 December 2008.
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Stanley Fischer: The global financial crisis – challenges confronting Israel Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the Annual Conference of the Institute for National Security Studies, Tel Aviv, 23 December 2008. * * * For more than a year the world has been confronting one of the worst financial crises in over seventy years. This crisis has two components: the first, financial, and the second, real – i.e., a significant slowdown, and possibly even a global recession. Both the financial and real effects of the global financial crisis on Israel's economy are clearly evident. I would like to stress, however, that Israel's state at the outbreak of the crisis was more favorable than that in most other countries. On the financial side the crisis is reflected in Israel not by problems in the banking system, as is the case in the advanced economies, but mainly by the fall in prices of shares and corporate bonds. At the same time, on the real side the rate of growth declined to 2.3 percent (annual rate) in the third quarter, and it is expected that the significant slowdown in Israel's growth rate will continue; according to the Bank of Israel forecast, the rate of growth will slow further in 2009 to 1.5 percent, or even lower in one or two quarters. Israel's relatively favorable situation at the outbreak of the crisis was due to responsible and credible fiscal and monetary policies, the economy's low foreign currency exposure, the surplus in the current account of the balance of payments, the relatively high level of the foreign exchange reserves, and, worthy of special emphasis, the strength of the banking system. Now, however, three months after the further intensification of the crisis, the challenges confronting the policymakers on both the real side and the financial side have become much more difficult. The policymakers face the task of maintaining the economy's relatively favorable position and taking advantage of it to deal with the new situation. To that purpose it is essential that they introduce the measures needed to ensure that the economy emerges from the period of slowdown strengthened, and with the ability to return to the path of rapid and sustained growth. All this, despite the forthcoming elections and the fact that the 2009 budget has not been approved yet. At this stage the Bank of Israel is taking the following steps within the realm of its responsibility: 1. It is conducting an active interest rate policy intended to strengthen the economy's ability to handle the effects of the crisis. 2. The Bank Supervision Department is intensifying and extending its regular monitoring of developments in the banking system, with regard to both the robustness of the system and the role of the banks as a major source of credit. From the beginning of 2008 to the end of October bank credit to the public increased by 9.4 percent, i.e., at an annual rate of 12.5 percent. In the months August–October the rate accelerated to an annual 15 percent. 3. In addition, the Bank announced that it was ready to help the banks with all the means at its disposal, as necessary, in order to support depositors. 4. The Bank's program to buy foreign currency will continue until the forex reserves reach the level considered appropriate under the current circumstances – between $40 billion and $44 billion. These measures are wanting, however, and we must act determinedly in the following areas too: 1. A cautious but in a certain sense expansionary fiscal policy should be pursued. Thus in 2009, assuming a growth rate of 1.5 percent, the budget deficit is expected to reach about 3 percent of GDP, based on the automatic stabilizers, i.e., the expected drop in tax revenues resulting from the slowdown in growth, on the one hand, and a certain rise in government expenditure arising, for example, from an increase in unemployment, on the other. It would not be advisable to allow the deficit to rise much beyond that, because our ability to embark on an expansionary fiscal policy is very limited – our debt/GDP ratio is high, and the interest that the government would have to pay would rise significantly if its increased its borrowing. Nevertheless, the tax cuts planned for 2009 should proceed, in a manner consistent with the automatic stabilizers. 2. The measures formulated by the Ministry of Finance and the Securities Authority, in cooperation with the Bank of Israel, should be implemented without delay. This program should help the economy to weather the storm. On the real side this includes increasing the rate of investment in the infrastructure, increasing credit to small and medium businesses, investing in R&D, and dealing with the labor market. On the financial side this includes provision of State guarantees for borrowing by the banking system to increase credit, the establishment of investment funds jointly with financial institutions to turn over nonbank credit, the establishment of credit officers to improve the credit turnover arrangement between bondholders and bond issuers, and tax incentives on investment in Israel. 3. I would to stress the measures already approved directed at dealing with the financial side – steps intended to increase the sources of bank and nonbank credit for the business sector, including small and medium-sized businesses, and steps to stimulate foreign investment in Israel's capital market. On Sunday 14 December the government made a decision to support the proposal put forward by the joint work teams of the Ministry of Finance, the Bank of Israel and the Prime Minister's Office, regarding a "safety net" for savers close to retirement age. The Bank is in favor of the proposal and its immediate implementation. However, despite the measures approved to handle the expected economic slowdown, we must make even greater efforts to deal with the crisis. Unfortunately, it took us, the State of Israel, about three months from the sharp deterioration in the global financial crisis, when Lehman brothers collapsed, to formulate the actions to be taken and their approval by the government and the Knesset. And they have still not been implemented. Thus, valuable time that could have been used to the benefit of the economy has been wasted. It is of particular importance to proceed with the implementation of the steps on the financial side. I hope there will be no further delays and that we can start making progress. This is essential to avoid eroding the economic achievements of the last few years and to enable us successfully to meet the challenges facing us. Hence, following the approval of the Ministry of Finance program last Monday (15 December), we must immediately enter the implementation stage. The financial crisis is here, and is not waiting for us. Particularly at this time, in the approach to the elections to the Knesset, we must deal with the challenges now confronting us in accordance with the guidelines we have followed hitherto – a credible macroeconomic policy, effective cooperation, focusing on the target, and determination. This we must do, to ensure that Israel's economy comes through the current crisis in a good condition.
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bank of israel
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