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2015 Article IV Consultation with the Euro Area Concluding Statement of IMF Mission
June 18, 2015
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. 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, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
A Collective Concerted Commitment to Lasting Growth
A cyclical recovery is underway, supported by policy actions that have improved confidence and reduced deflation risks. But the medium-term outlook remains subdued, calling for a comprehensive policy response to secure lasting growth. A concerted commitment should build on four key pillars: continuing demand support, cleaning up bank balance sheets, accelerating structural reforms, and strengthening further the economic governance framework to better incentivize reforms.
1. The cyclical recovery is underway, reflecting lower oil prices, a weaker euro, the ECB’s quantitative easing (QE) and a broadly neutral fiscal stance. Inflation has picked up and the decline in inflation expectations has been arrested. Improving sentiment and easing credit conditions suggest that the recovery is likely to continue in the near term. Risks to the outlook are now balanced, with a potential slowdown in emerging market economies or geopolitical events offset by a possible stronger lift from rising confidence and a quicker pass through of QE to the real economy.
2. Provided there is a timely and effective policy response, the near-term risks from uncertainty surrounding Greece appear manageable. The immediate risks of market contagion have been much reduced by the policy instruments available in the euro area, including QE, and the European firewalls. Beyond the near term, the risks surrounding Greece can be managed as long as there are concerted efforts to accelerate and deepen integration within the monetary union to make it more resilient.
3. But the medium-term outlook is subdued. Recent policy actions are supporting growth and have reduced the material risk of deflation. Nevertheless, the medium-term outlook is still fragile, as a chronic lack of demand, impaired balance sheets, and slow progress in structural reforms continue to hold back employment and investment. Potential growth, estimated at around 1 percent on average over the medium term, is well below what is needed to reduce unemployment to acceptable levels in many countries. As the one-off factors driving the cyclical recovery fade, the risk remains that the economy will return to low growth and be vulnerable to shocks given the limited policy space.
4. A stronger collective push is urgently needed to consolidate the recovery, raise trend growth and deepen integration. Demand support from an accommodative monetary stance should be reinforced by an aggressive clean-up of bank balance sheets to promote new lending and an acceleration of structural reforms to boost investment and productivity. A more balanced policy mix would not only generate a larger growth dividend for Europe, but also create positive spillovers for the global economy. The euro’s depreciation so far in 2015 has been beneficial given the economic cycle but the currency is now moderately weaker than the level consistent with medium-term fundamentals. Along with counter-cyclical monetary policy, a broader reform agenda would secure more durable growth and contribute to a gradual strengthening of the euro over the medium term.
Supportive macro policies to boost demand
5. Stay the course on QE. The ECB’s policies have helped lower term premia, boosted asset prices, and weakened the euro. International experience with QE suggests that the impact on bank lending will take longer to materialize, especially if bank balance sheets remain impaired. The ECB’s firm communication of its intent to stay the course on QE, looking through temporary episodes of volatility, until inflation is on a sustained adjustment path, will help anchor inflation expectations.
6. Preempt scarcity of sovereign bonds. The Eurosystem’s large asset purchases have raised concerns about possible shortages of sovereign bonds and their availability as collateral, especially given stricter liquidity standards for banks. While there are few signs of scarcity currently, the ECB should preemptively harmonize procedures for securities lending across national central banks to expand and facilitate market access to their sovereign bond holdings.
7. Monitor financial stability risks. There is little evidence so far of excessive risk-taking and asset price bubbles. But the ECB should remain vigilant and coordinate macro-prudential policies as the first line of defense, should risks emerge. In addition, a stronger common European fiscal backstop is needed to fully sever bank-sovereign links. Lowering the threshold for direct bank recapitalization by the ESM, while accelerating the planned funding of the Single Resolution Fund (SRF) would ensure that member states have access to emergency tools if needed in a crisis. Low interest rates have also led to significant asset-liability mismatches for many life insurance firms. This could be mitigated by restricting the use of guarantee-based products, for example, by bringing minimum returns in line with current interest rates, and encouraging alternative long-term investments to spur diversification subject to proper supervision.
8. Deliver fiscal support within the fiscal rules... The neutral fiscal stance strikes a better balance between supporting the recovery and promoting sustainability. Countries with limited fiscal space should use their interest savings from the lower borrowing costs due to the ECB’s QE to reduce debt and meet their fiscal targets. Within the SGP, countries with fiscal space should use it to support investment and structural reforms. Doing so now, in the context of low interest rates, can have a powerful growth impact. And all countries need to pursue more growth-friendly fiscal rebalancing by lowering taxes on labor and capital financed by cuts to unproductive spending and a broadening of the tax base.
9. …while expediting a centralized boost for investment. Rapid implementation of the European Fund for Strategic Investment (EFSI) would help support the recovery, especially in countries with limited fiscal space. Particular attention should be paid to project selection to support new investment and to removing regulatory barriers.
Stronger bank balance sheets would support lending
10. High nonperforming loans (NPLs) are constraining credit. The 2014 Comprehensive Assessment was successful in enhancing transparency and strengthening bank capital, but NPLs continue to rise and have reached systemic levels in some economies. For the euro area as whole, NPLs as a share of total loans stand at around 7 percent, more than three times higher than in the United States, where banks were more aggressive in writing off bad loans after the crisis. High NPLs erode bank profitability and hold back new lending, limiting the effectiveness of monetary policy.
11. Complementary policy actions are needed to remove bad loans quickly. First, prudential supervision should be strengthened. The SSM has taken appropriate steps to place banks with high NPLs under enhanced monitoring and should continue to work with national regulators to enforce stricter accounting practices on provisioning and collateral valuation. Second, in many countries, insolvency reforms to accelerate court procedures and facilitate out-of-court workouts would provide banks with better tools to resolve bad loans. Third, a market for NPLs should be developed to assist in corporate restructuring. Asset management companies (AMCs) could help banks to work with investors to offload NPLs. In some cases, public sector involvement in AMCs may be beneficial, subject to EU State aid rules.
Structural reforms to boost productivity, employment and investment
12. Accelerate labor and product market reforms to boost productivity... Faster progress in structural reforms is urgently needed to raise potential growth, improve investor confidence and jumpstart investment. At the national level, labor market reforms should aim to reduce duality and increase employment opportunities, especially for the youth, while product market and service sector reforms should enhance the business climate and increase competition.
13. …and deepen integration within the monetary union. At the regional level, priority should be given to faster implementation of the Services Directive to phase out long-held national barriers; further improvements in insolvency regimes; and a greater push towards a single market in capital, transport, energy and the digital economy. A capital markets union (CMU) would permit more efficient matching of savings and investment across the euro area, while allowing firms to diversify away from bank lending. The Commission’s recent Green Paper on the CMU contains many worthwhile proposals, especially for securitizing SME loans. Priority should be given to promoting so-called “high quality” securitization, comprising simple, transparent, and efficient market structures through preferential regulatory treatment and standardized credit reporting. Progress on the Transatlantic Trade and Investment Partnership (TTIP) would also support greater integration.
Better economic governance in the euro area
14. Benchmark structural reforms to improve incentives for implementation... As highlighted in the 2012 Four President’s Report, stronger mechanisms for ensuring sound policies among member states are needed to enhance the benefits and resilience of the EMU. In the near term, a more effective governance framework to incentivize, implement and monitor structural reforms could support national efforts and foster convergence towards best practices. Shifting to “outcome-based” structural reform benchmarks would enhance policy coordination and implementation by increasing transparency and accountability. Facilitating the use of SGP flexibility and support from EU funds could help incentivize reforms. To strengthen accountability and ownership, an independent EU-level “structural council” could monitor ex-post the governance of reforms, while productivity councils at the national level could help translate area-wide reform targets into national action plans.
15. …and simplify the fiscal framework to improve enforcement. Successive reforms have improved the fiscal framework but increased its complexity. To strengthen its effectiveness, the framework could be simplified by focusing on two main pillars: a single fiscal anchor (public debt-to-GDP) and a single operational target (an expenditure growth rule, possibly with a debt correction mechanism). These could be combined with more automatic enforcement. A European fiscal council could also assess the enforcement of the SGP rules and improve the coordination of fiscal policy.
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