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IMF Concludes UK's Article IV Consultation

by Robin Pilgrim,, London

22 December 2006

The International Monetary Fund (IMF) on Wednesday published the conclusions reached in the course of its United Kingdom 2006 Article IV Consultation.

The IMF mission stated that:

"This year, there has been a relatively high convergence between our and the authorities' views on central projections for the economy for the near and medium terms, and related demands on macroeconomic policies. Given this agreement, good structural policies, and the IMF's efforts to better focus surveillance, we have centered our discussions on the risks -- upside and downside -- to the UK economy from globalization. This statement, which experiments with a new format, covers the central outlook briefly before turning to this risk assessment."

The report commenced by stating that macroeconomic performance in the United Kingdom remains impressive, with the growth of investment, productivity, and output rebounding from a softer 2005.

The IMF also observed that GDP growth had picked up in 2006 and is expected to remain robust, announcing that:

"We see growth at about 2¾ percent in each of the next two years, broadly in line with potential and close to the forecasts in the Pre Budget Report and the latest Inflation Report. Business investment is being boosted by healthy corporate balance sheets and the low cost of capital. "

It suggested:

"Consistent with this favorable outlook, financial sector prospects are strong. Net exports of financial services have risen steadily over the past decade and increased sharply in recent years. UK banks are among the most profitable in the G7 and ratings agencies rank the UK banking system as one of the strongest in the world."

"The strength of the banking system reflects effective financial regulation and supervision in the context of improved risk management, geographical diversification, and the growth of new business activities. In particular, the development of financial markets has allowed banks to transfer some of the risk that they traditionally held on their own balance sheets. The insurance sector has returned to a more stable outlook. And the ongoing shift from negotiated, bilateral banking finance to arms-length finance through asset markets has facilitated consumption smoothing. "

However, it warned the UK government that: "Continued fiscal restraint is also essential given the still sizable overall deficit."

Looking to the possible impact of external events on the UK economy, the IMF observed that:

"Openness and flexibility continue to position the United Kingdom to benefit from the opportunities of globalization and absorb shocks. The recent rapid growth of the world economy has boosted demand for exports, especially of financial services, and allowed the United Kingdom to source goods from the lowest cost global producers."

"The combination of benign global financial conditions and openness to capital flows has contributed to record levels of foreign direct investment inflows, while allowing the United Kingdom to earn substantial net investment income. The decision to admit workers from the new EU member states has boosted the flow of immigrants and helped to fill skills gaps. While openness may increase exposure to downside global risks, it also contributes to the flexibility that allows the economy to respond to adverse developments quickly. However, this flexibility alone would not be sufficient to smooth developments in the face of some major international shocks."

It concluded:

"The financial sector starts from a position of strength, and the authorities continue to promote the system's resilience. The key concerns are low-probability events with potentially severe consequences. In addition to global risks, vulnerabilities include high and rising household debt, increasing exposure to complex and potentially illiquid instruments, and growing reliance by banks on wholesale funding, which raises liquidity risk."

"In addressing these risks, the authorities are, appropriately, aiming to balance the costs and benefits of regulation. We support the authorities' efforts to identify and encourage best practices in stress-testing. Given the growing cross-country linkages between financial systems, the authorities' plans to further enhance international crisis prevention and management arrangements are welcome."

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