Germany: 2008 Article IV Consultation Concluding Statement of IMF Mission
November 24, 2008
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
1. Germany faces the prospect of a sizeable, and possibly extended, economic downturn. Following GDP contraction in the past two quarters, a further four quarters of negative GDP growth and sluggish recovery thereafter now appear likely. In 2009, GDP is projected to fall by 0.8 percent and the 0.5 percent growth in 2010 would be well below the potential of about 1½ percent. The risk is that corporate and financial sector stresses, thus far dissociated from each other in Germany, may become more intertwined. The longer the global shocks persist, the more severe and prolonged would be the weakness.
2. Policy measures to contain the risk of a self-reinforcing and costly slump will, given strong spillovers, achieve more if coordinated internationally. Recognizing the threat to systemic financial stability, Germany, along with other advanced economies, has moved to provide a shield to its financial system. Continued actions to strengthen the financial safety net will buttress the recent initiatives. In this regard, Germany's request for an FSAP update is timely. Similar risk management strategies should apply to economic, especially fiscal, policy. This is so because global impulses are forcefully felt in Germany and, moreover, Germany rapidly transmits these to other economies. An economic slowdown in Germany lowers growth in the rest of Europe, which feeds back to Germany. Moreover, a necessary scaling back of German banks' exposure to emerging markets could generate cascading spillovers. Thus, giving due consideration to its short- and long-term domestic objectives, Germany stands to benefit from an internationally coordinated approach to managing global risks.
3. The Financial Market Stabilization Fund, which has been vital to shielding the financial sector, could be a stepping stone for broader financial reforms. Following the passage of the law authorizing the Fund, the administering agency (SoFFin) was rapidly established and has processed a few transactions. The German approach has differed from that in other countries: it is voluntary and banks may choose from a range of stabilization measures. Given the low absolute level of capital in several banks, a more proactive recapitalization is desirable, particularly in view of expected asset quality deterioration. For this reason, resolving the early inevitable process uncertainties would strengthen the shield. Establishing transparent reporting of the transactions would promote public confidence, assure equitable treatment, and safeguard accountability. Moreover, the authority and procedures being developed under SoFFin could be the basis for enhancing the soundness of the financial sector more broadly, including through the restructuring of Landesbanken and a stronger bank resolution regime.
4. The proactive restructuring of the Landesbanken requires early attention. The economic role of the Landesbanken is in question, highlighted by their investments in imprudent ventures. Moreover, the financial crisis has revealed the serious risks—to their viability and, thereby, to systemic stability—associated with their wholesale funding approach. Downsizing these banks, separating them into "good" banks and "bad" banks, and publicly-listing the "good" banks should be among the options for their restructuring. SoFFin could fruitfully work with the Landesbanken in achieving these goals.
5. The global crisis has emphasized the need for strengthening the financial safety net. Bank resolution and deposit insurance rely largely on cooperative approaches and involve ad hoc arrangements.
• Recognizing the systemic features of the financial system, the authorities should possess the ability to act expeditiously under a special bank resolution regime. A move in that direction has been made for bank recapitalizations under SoFFin allowing dilution of shareholder rights. In this line, further modifications of the legal framework for orderly bank resolutions are warranted.
• Moreover, the multiple deposit protection schemes have typically relied on ex post burden-sharing, which elevates risks in periods of stress. Mandatory deposit insurance—ex ante funded by contributions from all banks—would provide unified terms of protection for depositors and reduce incentives to shift deposits among the existing schemes. The resources could also help finance bank resolutions. Additional voluntary deposit protection could be allowed.
• Evolving European Union rules should provide the appropriate guidance on policies related to deposit insurance.
6. The case for a tighter bank regulatory and supervisory process has become more compelling. To respond promptly to problem situations, supervisors have a heightened need for information on the current status of bank soundness. This implies, first, significantly reduced reliance on external auditors. Additionally, prudential regulation and supervision should be linked to a system of macro-surveillance and stability analysis. As such, greater consolidation of regulatory and supervisory resources could yield significant benefits. Should the authorities wish to place all prudential oversight under the authority of the Bundesbank, as provider of liquidity to the banking sector, it would be necessary to ensure its operational independence. BaFin's role could then be redefined as a market-conduct regulator and consumer protection agency.
7. Additional significant fiscal stimulus that is well targeted and internationally coordinated is necessary. Following sustained fiscal prudence, the authorities have rightly taken steps to stimulate the economy. But their net size, timing, and focus on bolstering private investment imply that the immediate benefit will be limited. Despite relief to consumers from lower energy costs and current labor market conditions, the looming uncertainties create the risk of a self-reinforcing cycle of pessimism, output loss, and financial instability.
• Bringing GDP growth to zero in 2009 would require a fiscal stimulus of 1½ to 2 percent of GDP. Such an effort would be particularly effective if German actions were part of a joint European effort to bolster demand.
• The sizeable German stimulus would likely be most effective if initiated by transfer payments to vulnerable households (to impart an immediate demand impulse), followed by bringing forward the proposed reduction in social security contributions (to lower labor taxation) and accelerating infrastructure projects (possibly through top-up federal payments to local communities). In contrast, a value-added tax rate reduction would be less appropriate.
8. These actions must be accompanied by a credible long-term commitment to fiscal sustainability. This remains a concern, especially with regard to trends in healthcare costs and the debt accumulation by the Länder.
• In addition to cost-saving measures introduced in the 2007 healthcare reform, further rationalization could be achieved in pharmaceutical expenditures. Also, as the OECD recommends, incentives for efficiency-enhancing competition could be strengthened.
• Fundamental reform of the fiscal federalism system is required to improve Länder incentives for fiscal discipline, including more Länder taxation autonomy and a redesign of supplementary federal grants.
• The German authorities aim to amend the Basic Law to establish a rule that limits the structural budget balance to close to zero from 2011. The proposed fiscal rule—which should be applied also to the Länder, backed by a surveillance and enforcement system—would provide the mechanism to regain lost ground and ensure fiscal sustainability.