Luis Ángel Rojo: Presentation of the Annual Report of the Banco de España
Address by Mr Luis Ángel Rojo, Governor of the Banco de España, to the Governing Council of the
Banco de España on the presentation of the Annual Report, Madrid, on 20 June 2000.
* * *
Gentlemen,
When this Governing Council met a year back to examine and publish the Annual Report of the Banco
de España, the international economic setting was substantially different from at present. True, fears of
a forthcoming worldwide contraction had faded. But doubts persisted over the strength of the recovery
in those economies most affected by financial crises in the two preceding years and, therefore, over the
speed with which the world economy would fully overcome the setback resulting from such
disturbances. The doubts were progressively dispelled, however, in the second half of the year. The
recovery firmed with greater speed than initially envisaged and it has led to a phase of expansion with
forecasts for world output growth currently at above 4% for this year and the next, which might yet
run for several years. These highly favourable expectations are, however, clouded by significant
uncertainties which lie at the heart of current international concerns.
Among these concerns are, of course, those relating to the effects of the rise in oil prices since early
1999. This rise has largely involved a recovery in the price of crude from the low levels posted in the
previous months of sluggish demand. But if the current high levels are sustained or rise further, there
could ultimately be a contractionary monetary policy response, with adverse effects for the very
countries regulating the supply of oil.
The greatest worries, however, surround the United States. The US economy has been the linchpin of
the world economy over the past decade, but today it stands at an uncertain juncture. The stabilising
effectiveness of macroeconomic policies, the greater competition resulting from globalisation, and the
deregulation and increased flexibility of labour and product markets have created the conditions for
greater cyclical stability, while moderating the wage rises associated with each level of unemployment
and encouraging investment in new technology. During the 1990s, the US economy has enjoyed a
lengthy expansion with strong job creation, a declining unemployment rate and low inflation. And,
since 1996, when the cyclical upturn was already at an advanced stage and expected shortly to
weaken, the US economy has shown renewed vigour. This fresh momentum has been linked to a surge
in productivity growth, attributed to the more intensive and extensive use of new technology, which
has allowed the unemployment rate to fall to very low levels, without significant increases in the
inflation rate over a considerable period, and has also caused share prices to soar. However, the strong
rise in overall demand in relation to supply (spurred partly by the effects of the sharp increase in share
prices on consumption and investment) could not continue without eventually exacerbating
pre-existing imbalances and causing others to emerge. Thus, the balance of payments deficit on
current account, reflecting the sharp decline in US private-sector saving, has widened to barely
sustainable levels, while the march of the economy at above capacity has led to the appearance of
inflationary pressures on costs and prices in excess of what might be attributable to dearer oil.
The US economy requires an adjustment, and the monetary authorities have registered the fact. While
the virtues of the so-called "new economy" are valid to some extent, they cannot preclude the ultimate
emergence of the problems that have always concerned the old economy. The US Federal Reserve
acknowledges that the explanation of recent economic developments is not satisfactory if no reference
is made to the spur provided by new technology. But, at the same time, it points out that the
productivity gains resulting from this spur have tended to generate even greater increases in aggregate
demand than in potential supply. It concludes, in the words of Chairman Greenspan, that "until market
forces, assisted by a vigilant Federal Reserve, effect the necessary alignment of the growth of
aggregate demand with the growth of potential aggregate supply, the full benefits of innovative
productivity acceleration are at risk of being undermined by financial and economic instability".
Last July, the US authorities duly initiated a tightening of monetary policy pursuing a strategy of
gradual rises in interest rates, only reinforcing this process in May this year in view of the vigorous US
economy's stubbornness to adjust. It is difficult to anticipate whether the economy will move
smoothly onto a sustainable growth path with stability or whether, on the contrary, the persistence of
monetary restrictiveness to overcome the resistance encountered will ultimately lead to a sudden
adjustment whose adverse effects might impact the rest of the world economy. The consequences of
this impending adjustment in the United States are the main factor of uncertainty in the optimistic
outlook for most of the industrialised and emerging countries. Naturally, mention should also be made
of the doubts about the capacity of the Japanese economy to overcome its deep-seated problems in the
short term.
In the euro area, the hesitant recovery embarked upon in the spring of 1999 progressively firmed in the
second half of the year. Indeed, it has made way for an expansion underpinned by the strength of
domestic demand and higher exports, which promises growth rates of more than 3% this year and
next, and which might run on into the following years. The fears of recession surrounding the start-up
of Monetary Union gradually gave way to concern to ensure stability in an upturn. As demand
increased and growth expectations were revised upwards, the area began to experience price pressures,
compounded by dearer oil, and it became evident that the low interest rate monetary policy adopted in
the early months of EMU was progressively proving inadequate. The strong growth of the money
supply and of credit, low real short-term interest rates and the weakness of the euro all portrayed an
overly lax monetary policy that could fuel inflation pressures in the longer term. Consequently, the
European Central Bank adopted last November a somewhat tighter policy stance which it has
sustained with five increases in its intervention rates as the expansion has taken root.
The European Central Bank is an important and newly founded institution whose decisions are
scrutinised by economists, markets and the media. Such close attention is to be welcomed and can
contribute positively to the development of the common monetary policy. Inevitably though, as the
institution takes its first steps, its decisions often give rise to confused and divergent interpretations.
Sometimes this is because the transmission of intentions leaves something to be desired, and other
times because observers pass the expression of such intentions through the prism of their prejudices.
But the constant here is that monetary policy is not an exact science and it can be judged from a
plethora of different positions. That said, the 18 months in which the common monetary policy has
operated to date should suffice to bring observers round to the idea that the decisions of the European
Central Bank have been geared to its primary goal of maintaining price stability in the area over the
medium and long term. These decisions have been underpinned by inflation forecasts based on a broad
range of indicators, among which those of a monetary nature are logically given privileged attention,
especially the money stock. Of course, it can always be debated whether the decisions adopted with
this basic aim and founded on the interpretation of the information available are appropriate or not.
But it is much more difficult to maintain, for example, that such decisions have been deeply affected
by the behaviour of the euro to the point of introducing confusion into the objectives pursued.
The European Central Bank does not, as it is sometimes claimed, practise "benign neglect" in respect
of the euro. The euro may act as a generator of inflationary pressures and, as such, is an important
element in the definition of the area's monetary conditions. Moreover, it is important for a new
currency to have the public's confidence as regards its future capacity to retain its value. It is my view,
however, that the euro cannot be the decisive factor in monetary decision-making. The successive rises
in the European Central Bank's intervention interest rates over the past eight months have sought to
adapt monetary conditions to the growing expansion while attempting to prevent the emergence of
price pressures from harming durable growth in the area in future. Admittedly, the strong differentials
(favourable to the dollar) in short- and long-term interest rates and expectations about their course
have been one of the immediate determinants of the euro's weakness. But the European Central Bank
has, fortunately, not been tempted to narrow spreads which are the result of different growth rates in
the United States and in the euro area and of the efforts by the US authorities to realign overall
demand and supply in the United States.
The euro area members are currently enjoying a most favourable economic situation. The expansion is
running at a high rate overall and now extends to all the countries in the area (including Germany). It
promises to continue narrowing the growth gap between the euro area and the United States given the
high business and consumer confidence levels prevailing. The current inflation rate in the area is very
moderate, both in relation to the US situation and to Europe's past experience, and the balance of
payments on current account is running a surplus, in contrast to the burgeoning US deficit. The
foreseeable continuation of this situation, assisted by a monetary policy firmly focused on price
stability, will be propitious to the euro strengthening, although the rate at which this occurs will hinge
decisively on how the adjustment sought by the US monetary authorities unfolds.
It is my belief that the common monetary policy, taken overall and with a perspective of 18 months,
may be said to have been satisfactory. Its main problems have been its different significance and effect
in the various countries of the area and, regarding implementation, those of the arrangements for
liquidity allotment via regular tenders for euro area credit institutions.
The latter problem - to some extent a secondary one for monetary policy but an important one from the
standpoint of the terms of access to liquidity for credit institutions - has arisen from the liquidity
allotment system used in the regular (normally weekly) tenders. This system was based on a fixed
interest rate at which the amounts bid by the institutions were satisfied according to a uniform
percentage based on the total volume of funds that the European Central Bank wished to provide at
each tender. Since the funds supplied had to be fully collateralised by the recipient institutions, and
since the collateral volumes available varied greatly from one institution to another and from one
country to another owing to the differing features of national financial systems, the amounts allotted
and the rationing of funds at the fixed interest rate gave rise to a distribution of liquidity among
institutions and among the Eurosystem countries that owed more to the relative volumes of collateral
available than to actual liquidity requirements. When the European Central Bank judged that the
volume of collateral required was only that needed to cover the liquidity allotted to each institution,
overbidding by institutions became a structural feature of the system, becoming accentuated with time
and increasing strongly in periods in which there were expectations of interest rate rises. In parallel,
the fund rationing percentages applied in tenders declined and became more volatile, thereby
heightening banks' difficulty in deciding on the size of their bids. Recently, the European Central
Bank has decided to change to a regular tender system based on a variable interest rate (as hitherto
applied in the fortnightly tenders) which, it is expected, will resolve the above-mentioned difficulties.
The first of the above problems is more important and is, moreover, inevitable. The single monetary
policy is common to the entire euro area and is defined having regard to the situation and outlook for
the countries of the area as a whole. Since cyclical positions and the transmission mechanisms for
monetary measures vary from one country to another, the common or single monetary policy will
never have the same significance (as regards its being more or less expansionary or contractionary) for
all the economies of the area. When the common monetary policy adapted to the area's overall
situation proves too expansionary or contractionary for a country in the area, that country has to offset
this accordingly with a contractionary or expansionary fiscal policy, respectively, and, in the former
case, pursue policies that increase flexibility and competition in the economy.
This problem, which is unavoidable in any monetary union, has been quite considerable in the first
year and a half of Stage Three of EMU. The common monetary policy began at a time when external
demand in the Eurosystem economies was weak owing to the international financial disturbances of
the two previous years. Likewise, domestic demand was sluggish in some member states while surging
in others, fuelled by strong interest rate cuts and the improved outlook resulting from the
macroeconomic policies pursued to join EMU. Hence, the relatively accommodating common
monetary policy adopted by the European Central Bank in view of the overall conditions of and
outlook for the area was perhaps insufficient for some countries while excessively loose for those
others (Spain among them) where demand and activity were advancing robustly. Later came the
improvement in the world economy, the pickup in exports and the gradual strengthening of domestic
demand across the area. And the European Central Bank, given the clearly expansionary climate
taking hold, began the course of intervention interest rate rises it has followed to date. However, the
recovery of exports and the strengthening of domestic demand have also spread to the countries in the
area - including Spain - whose economies were already growing forcefully and have stepped up in
pace in the closing months of 1999 and the opening months of the present year. Consequently, the
common monetary policy has been tightened, but it is perhaps still too relaxed for the latter countries.
These situations of relative monetary easiness are unimportant if temporary. But if they persist over
time and are not sufficiently offset, they may ultimately generate demand pressures on supply in the
countries affected. That may lead to losses in competitiveness the correction of which would exact a
reduction in the growth rate of output and a fall in the level of employment.
Over the past three years Spain has run high GDP growth and job creation rates clearly above those in
the euro area as a whole. And although the economic recovery in the euro area will lead to a narrowing
of these differences this year and next, our economy will continue to experience high rates of
expansion in this period. The government has pursued a fiscal policy which has lowered the general
government deficit to 1.1% of GDP in 1999 (down from 5% in 1996), and promises to place it at 0.4%
of GDP this year. It has further applied a deregulation and competition-enhancing policy of
undoubtedly favourable effects for the price level and, in the short run, for the inflation rate. However,
against a background of highly optimistic expectations, monetary conditions remain lax, as testified by
the growth of the main monetary aggregates and the low level of real interest rates. Further, credit
continues to rise at very high rates. The overall result is thus a heightening of demand pressure on
trend output, with worrying effects. On one hand, the consumer price index has undergone a rise
which, though largely attributable to exogenous factors (higher prices of oil and other commodities on
international markets, the depreciation of the euro and bad weather), and despite the moderate
behaviour of wages, also reflects the effects of demand pressure. This has taken the Spanish CPI to
somewhat more than 1 percentage point higher than the average for the area. On the other, the
resilience of demand has led to a very high growth rate of imports in real terms. And this, along with
the rise in the prices of imported goods, has tipped the balance of payments on current account into
deficit. Under these conditions, the Spanish economy needs to restrain the expansion of demand and
increase the degree of flexibility in labour and product markets in order to sustain high, stable growth
rates in the future. Specifically, it requires a policy to further reinforce fiscal consolidation, to push
through greater labour market flexibility in industrial relations bargaining and to forcefully pursue
deregulation and the infusion of greater competition in product and service markets. The
Government's announcement that it intends to act firmly along all these lines is thus to be welcomed
and encouraged.
This desirable Spanish economic policy stance for circumstantial reasons has the advantage of
coinciding with that required, to differing degrees, in most Eurosystem countries to overcome the
structural problems that are at the very core of current difficulties. The United States is faced with a
thorny issue of cyclical adjustment. But the euro area economies have a worrying point of reference in
the US economy as regards matters such as the capacity to generate employment, the development and
application of new technology and productivity growth. The euro area, in order to maintain and
strengthen its position in the world economy, needs to increase employment among its population of
working age and productivity so that its current expansion, exceeding its cyclical component, may lead
to intense and sustained growth. That will require greater dynamism than the area has shown in recent
years.
Winds of change are, of course, blowing across Europe. Corporate mergers and acquisitions have
intensified of late and industrial restructuring is much more frequent than in the past. There are several
forces behind this process. First, the heightened competition arising from the expansion of global trade
in goods and services, which leads to size and strategy reviews and to cost-cutting drives. Adding to
this in the euro area are the effects of the introduction of the single currency; this heightens
competition in the area, highlights the industrial fragmentation of Europe and leads to the search for
competitive edge through greater size. Privatisation and deregulation are also forcing former
monopolies or oligopolies to shake off inertia, to compete and to restructure. Moreover, major
European companies have tended to replace bank finance by resorting more to bond and equity
markets. That has led them to pay greater heed to the requirements of stock market investors, moving
closer to the Anglo-Saxon model of capitalism, to be more mindful of profits and to serve
shareholders' interests more. In turn, they have been led to undertake restructuring with a view to
enhancing their effectiveness and cutting their costs.
Governments, for their part, have in recent years adopted a stance more favourable to fostering
competition and limiting intervention, to assisting the creation of companies and to reducing a tax
burden that is a deterrent to risk-taking. They are convinced that if they fail to do this, companies will,
under the pressure of markets, emigrate to less regulated and lower-cost regions outside the euro area.
Despite these signs of greater dynamism, much remains to be done in the euro area in terms of
increasing competition, reducing intervention, promoting innovation, boosting public and private
research, and overcoming a nationalist bias which sees only a minor portion of corporate mergers
cross borders and witnesses others being supported by governments to create dominant corporations of
their nationality in the area.
The recent extraordinary European Council in Lisbon has highlighted Europe's backwardness in
developing and applying new technology. This is not the only area where Europe lags behind,
although it does appears to offer an explanation, at present, for the gap between the results achieved by
the US economy and the European economies in recent years. Reflection on the range of factors and
conditions bearing upon the progress and the absorption of the transforming effects that the new
technology heralds leads inevitably to the general matter of the context in which economic activity
unfolds and which encourages or hampers dynamic growth in Europe. Indeed, the shortcomings in
research, education and technical and professional training which hinder scientific and technological
progress, the inadequate levels of competition which hold back the introduction of new technology
and the rigidities which prevent the replacement and reallocation of productive factors that are
normally associated with technological innovation are problems no different from those that generally
stifle productivity and job creation in Europe.
It is to be hoped that the course of action agreed upon in Lisbon will not be hamstrung by dissenting
voices in the complex world of European politics and that the guiding principles of such action will
extend beyond the field of new technology. It is also to be trusted that these programmes of action are
structured around the goals, likewise formulated in Lisbon, of strongly increasing employment during
this decade and of finding sound, viable social welfare systems in Europe. Such goals need not be
eroded by greater economic and technological drive; rather, they should be tackled bearing in mind the
likely technological future and the reality of population trends and of the resulting conditions, so as to
design appropriate, sustainable social protection systems in the area. The European economies'
apparent impending boom provides them with the opportunity to address a set of decisions geared to
ensuring firmer and stable growth in the long run. Spain should participate purposefully in such
reforming policies, which are currently the main challenge facing the euro area economies.
* * *
Following the introduction of the euro, European financial markets have witnessed an acceleration of
the trends discernible in the years prior to monetary union. These have been induced by growing
deregulation, the introduction of remote access further to banking and investment services directives
and the ongoing process of globalisation in economic and financial relations. The changes are
introducing growing measures of consolidation and integration in European financial markets and
paving the way for a more appropriate framework in which these markets may rapidly assimilate the
effects of developments in information and communications technology.
The most rapid and direct effects of the introduction of the euro have been on the degree of integration
of money markets, especially in the interbank deposit and derivatives (including most notably interest
rate swaps) segments. This has been a consequence of the implementation of the single monetary
policy and the sound functioning of the TARGET system.
In the market for fixed income securities, the defining characteristic of the year has been the strong
growth of issues by non-financial private firms, which have resorted to the primary markets in many
cases to finance mergers and acquisitions. The success of these placements has been assisted by
investors' desire to diversify their portfolios and purchase the higher-yield instruments offered by
private companies following the process of convergence in interest rates on European public debt.
Further, the demand for bonds has benefited from the expansion of pension and mutual funds.
On the equity markets there has been a fresh increase in stock market capitalisation. This has come
about due both to rising prices and a greater number of companies accessing the market. A key
development in this area has been the establishment in the main European stock markets of a "new
market" for technology or high-growth companies. The reporting, listing and trading rules of this
market differ from those prevailing on the traditional markets.
Following the changes on derivative markets, equity markets are witnessing a deep-seated
transformation, especially as regards trading. The construction of new electronic trading platforms has
established a more competitive environment, characterised by a wealth of information, lower
transaction costs and the elimination of entry barriers, all of which provides direct market access to a
broader range of investors. This innovative process has prompted adaptation by the traditional market
members. They have likewise offered electronic options for trading, and amended their governing
structures, characterised to date by mutualism, which offered privileges to market members, through
whom all transactions had to pass. As part of this process of adaptation to what will be a broader and
less segmented market territorially, mention may likewise be made of the increasingly prominent role
of strategic mergers and alliances between traditional market participants.
EMU has also led to advances in the consolidation of clearing and settlement systems. Nonetheless, it
is premature as yet to talk of the speed or outcome of this integration process, which will probably
lead to one or two major pan-European platforms being established.
Spanish financial markets have largely moved in step with other European markets following the
introduction of the euro. They have also been influenced by the entry into force of the reform of the
Securities Market Act and by the changes in the taxation of a good number of financial instruments.
These events have generally tended to heighten competition in the markets and they have given extra
momentum to financial disintermediation and to the internationalisation both of investor portfolios and
end borrowers' sources of financing.
The high degree of integration attained in the biggest segments of the euro area money market has
allowed Spanish deposit money institutions, as a whole, to offset the decline in financing extended by
the central bank with interbank loans obtained from the rest of the area. The system of periodic
liquidity injections by the Eurosystem via fixed rate tenders and rationing (now under change) and the
relatively modest volume of assets usable by Spanish banks as collateral for the liquidity received
have adversely affected our institutions' capacity to receive funds directly from the central bank; as a
portion of what were previously domestic transactions are now cross-border ones, the domestic
interbank market has shrunk considerably. At the same time, the integration of the money market has
affected foreign banks with a presence in Spain: some such institutions have withdrawn or cut back
their activity as their main source of business has disappeared.
In 1999, and generally in parallel with developments in the euro area, there was a slowdown in net
issuance of public fixed income (reflecting the Treasury's lower borrowing requirements) and a strong
expansion of net issuance of private fixed income on the bond markets.
In the public fixed income segment, which remains the biggest and predominant one in total trading,
there were several notable developments. First, reforms have been made to the group of
marketmakers, giving access to new non-resident market-makers without a presence in Spain. Further, an
electronic public debt trading platform has been created, and the trading of public debt derivatives has
fallen sharply as a result of the high substitutability between the products offered by various European
centres following the launch of the euro, making for a strong concentration of these operations in the
British (for short-dated terms) and German (for medium- and long-term maturities) markets. As to
public debt clearing and settlement systems, the Spanish Public Debt Book-Entry System (CADE by
its Spanish abbreviation) has established links with other central securities depositories and embarked
on a venture to join forces with the Securities Clearing and Settlement Service (SCLV), which will be
open to other systems. In this connection, the entity promoting the venture has been incorporated as a
private company for the ultimate purpose of unifying the registration, clearing and settlement systems
and thus improving the Spanish position vis-à-vis the foreseeable concentration into one or two
European central depositories.
Private fixed income dominated the scene in 1999. Issuance increased fivefold on the previous year,
although this figure should be interpreted bearing in mind the low starting level. The reasons for such
a strong expansion in issues are to be found in the finance sought on this market by financial and
non-financial corporations to fund their expansion; in the placing of private fixed income on the same
tax footing as public debt for legal entities; and in the rapid advance of portfolio securitisation to
convert holdings into assets that may be used as collateral for monetary policy and payment system
operations. Private fixed income trading is still very modest in relation to total trading, but AIAF (the
Spanish association of securities dealers) dealing doubled last year and it would be desirable if its
initiative to link up to the Electronic Public Debt Platform were to prosper so that both public and
private fixed income could be commonly traded. Both public and private debt could find a single
clearing and settlement platform under the roof of a future union between CADE and SCLV.
Compared with the strong volumes of previous years, equity issues in 1999 were affected by the
decline in privatisations. If this effect is stripped out, equity issues were up by over 50%, while trading
increased moderately. Equity derivatives withstood the integration of European financial markets
better than their fixed income counterparts, and held at positive growth rates. There were some
significant structural innovations on equity markets. First, a market for Latin American companies
called LATIBEX has been created, allowing the listing of certain companies from Latin American
countries which are quoted in euro via the Spanish stock markets' electronic system and settled via
SCLV. And more recently, the New Market has been instituted. The eligibility, listing and disclosure
requirements of this market are better adapted to the particular features of technology and high-growth
firms, whose financing requirements are also better served. Finally, the Spanish stock markets reached
an agreement with seven other European exchanges to form a single pan-European trading platform,
although little headway has been made given the difficulties of harmonising criteria and procedures
and the new stock market merger plans in Europe.
Generally, the organised financial markets may be said to be undergoing a process of accelerated
change and ongoing reforms under the pressure of the trend towards integration, accentuated by the
introduction of the euro, and of technological innovation. Uncertainty persists over the foreseeably
significant effects all this will have on the location of financial business in Europe. In any event, the
process will lead to greater competition, cheaper operating costs in markets, greater diversification in
investor portfolios and improved financing possibilities for companies. It is important that the
institutional structure of our markets should be reformed with a view to increasing negotiating power
vis-à-vis the mergers that will, no doubt, ultimately take place in the euro area.
Turning to financial intermediaries, and commencing with institutional investors, mention should be
made of the modest increase in the net asset value of mutual funds, following the very strong increase
in previous years, and the considerable growth in pension funds and insurance products. The lesser
increase in the net asset value of mutual funds was due to the lower rise in the value of their holdings
and to the