## cr17192

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### Macroeconomic outlook and cyclical position
- Real GDP growth:
  - 1.8 percent in 2016; projected 1.8 percent in 2017 and 1.6 percent in 2018.
  - Selected table: 2015: 1.5; 2016: 1.8; 2017: 1.8; 2018: 1.6.
  - Baseline DSA projections (selected): Real GDP growth (percent): 2015: 1.4; 2016: 1.7; 2017: 1.9; 2018: 1.5; 2019: 1.5; 2020: 1.4; 2021: 1.3; 2022: 1.2.
- Output gap:
  - 0.0 percent in 2015; 0.3 percent in 2016; 0.7 percent in 2017; 0.8 percent in 2018.
- Cyclical drivers:
  - Cyclical upswing expected to persist near term supported by rising employment, some fiscal expansion, and continued monetary accommodation.
  - Higher energy costs should curb consumption growth.
- Medium-term risks:
  - Population aging and slow progress on structural reforms expected to weigh on growth.

### Labor market, wages, and inflation
- Unemployment and employment:
  - Unemployment rate (%, ILO): 4.6 in 2015; 4.2 in 2016; 3.9 in 2017; 3.9 in 2018.
  - Employment growth (%): 0.8 in 2015; 2.7 in 2016; 1.1 in 2017; 0.6 in 2018.
- Wages:
  - Nominal wage growth: 2.3 percent in 2016.
  - Minimum wage: raised by 4 percent in January 2017.
- Inflation:
  - Headline inflation averaged 0.5 percent in 2016; temporarily peaked at 2.2 percent in February 2017.
  - Inflation (CPI, table): 0.1 in 2015; 0.4 in 2016; 1.7 in 2017; 1.6 in 2018.
  - Core inflation: remained flat at 1.1 percent (text).
- Outlook:
  - Headline inflation expected to peak in 2017 and recede in 2018 to 1.7 percent.
  - Core inflation and nominal wage growth expected to gradually pick up; core inflation expected to exceed 2 percent beyond 2019.
  - Medium-term annual wage growth expected to reach slightly above 3 percent.

### External sector and current account
- Current account and trade:
  - Current account balance (% of GDP): 8.6 in 2015; 8.3 in 2016; 8.4 in 2017; 8.1 in 2018.
  - Trade balance (% of GDP): 8.0 in 2015; 7.9 in 2016; 7.8 in 2017; 7.6 in 2018.
  - Exports of goods (% of GDP): 38.9 in 2015; 38.1 in 2016; 39.5 in 2017; 40.1 in 2018.
    - Exports volume (% change): 5.0 in 2015; 2.5 in 2016; 5.1 in 2017; 4.0 in 2018.
  - Imports of goods (% of GDP): 30.3 in 2015; 29.5 in 2016; 31.0 in 2017; 31.7 in 2018.
    - Imports volume (% change): 5.6 in 2015; 3.9 in 2016; 5.1 in 2017; 4.6 in 2018.
- Current account assessment:
  - CA surplus averaged 7.5 percent of GDP over the last five years and reached 8.3 percent of GDP in 2016.
  - Cyclically-adjusted CA balance: 8.5 percent of GDP in 2016.
  - Staff assesses CA norm at 2½–5½ percent of GDP; assessed cyclically-adjusted CA is 3–6 percentage points stronger than fundamentals and desirable policy settings.
- REER and NIIP:
  - Staff assessment: REER undervalued by 10–20 percent in 2016.
  - NIIP: approached 52 percent of GDP at end-2016.
    - Gross assets: 251 percent of GDP (end-2016).
    - Net direct investment position: close to 17 percent of GDP (end-2016).
    - Portfolio investments stock rose from 4 to 9 percent of GDP (accounting for full increase in NIIP).
- Capital flows and composition:
  - 2016: net portfolio and other investment flows constituted about ½ and ⅓ of the capital and financial accounts balance, respectively.
  - Regional composition of net outflows: about ⅔ toward European countries and ⅓ toward the Americas (mostly the U.S.).

### Fiscal position, projections, and public investment management
- Fiscal balances and debt:
  - Fiscal balance (% of GDP): 0.7 in 2015; 0.8 in 2016; 0.4 in 2017; 0.5 in 2018.
  - Revenue (% of GDP): 44.7 in 2015; 45.1 in 2016; 45.2 in 2017; 45.2 in 2018.
  - Expenditure (% of GDP): 44.0 in 2015; 44.3 in 2016; 44.8 in 2017; 44.7 in 2018.
  - Public debt (% of GDP): 71.2 in 2015; 68.3 in 2016; 65.8 in 2017; 63.2 in 2018.
  - DSA projections (nominal gross public debt percent of GDP): 2015: 73.3; 2016: 71.2; 2017: 68.3; 2018: 65.8; 2019: 63.2; 2020: 60.5; 2021: 57.6; 2022: 54.8.
- Fiscal planning and headroom:
  - Structural balance: 0.7 percent in 2016.
  - Estimated fiscal headroom: ½ percent of GDP in the short run, rising to 1¼ percent of GDP in 2022.
  - Fiscal plans include income tax relief worth 0.2 percent of GDP and refugee-related expenditures of about ½ percent of GDP throughout the forecast horizon.
- Public investment at local level:
  - Municipal Investment Promotion Fund (MIP): doubled to EUR 7 billion (0.2 percent of GDP).
  - Additional non-earmarked relief to subnational governments: some EUR 19 billion between 2014 and 2018.
  - MIP take-up by mid-2016: less than EUR ½ billion spent and less than EUR 2 billion in commitments.
  - Recommendation: rebuild staffing capacity at local level; broaden scope of MIP (including school infrastructure) to raise take-up.
- Revenue projection methodology:
  - PIT under-estimated in 2011–16 and explains largest share of average forecast errors; recommendation to revise macroeconomic relationships and tax elasticities to improve fiscal planning accuracy.

### Housing market, mortgages, and affordability
- Price and supply dynamics:
  - House prices accelerated further in 2016; regional divergence with falling prices in some rural areas and double-digit growth in large cities and university towns.
  - In certain urban areas, overvaluation may amount to 30 percent according to Bundesbank estimates.
  - Housing completions and building permits increased but new construction remains below estimated requirements.
- Affordability indicators:
  - Aggregate mortgage affordability judged moderate; price-to-rent and price-to-income indicators remain moderate.
  - Mortgage credit growth has stabilized against rising house prices.
- Macroprudential framework and data gaps:
  - New legislation broadens toolkit to include loan-to-value and amortization requirements; omits debt-to-income and debt-service-to-income limits.
  - New law does not provide for a granular loan-by-loan database.
  - Staff recommendation: conduct at minimum a regular (at least annual) survey in hotspots to collect loan-level information.
- Policy measures to boost supply:
  - Stepped-up sales of federally-owned land and properties below market price for affordable projects.
  - More funds for social housing.
  - Promotion of building code harmonization.
  - Staff recommendation: further encourage local authorities to relax zoning and height restrictions; lower effective transaction tax rate on new construction (past recommendation).

### Housing-related macroprudential and regional monitoring
- Risks and supervisory actions:
  - Anecdotal evidence of looser underwriting standards in some areas; no comprehensive regional mortgage-growth data available.
  - New law’s omission of LTI/DSTI and loan-level data limits effective macroprudential operation.
  - Recommendation: expand macroprudential toolkit and supervisory databases; enhance data collection in hotspots.

### Banking and financial sector resilience
- Banking sector structure and profitability:
  - Broad money (M3) end-year % change: 9.2 in 2015; 5.7 in 2016 (reflects Germany's contribution to euro area M3).
  - Credit to private sector (% change): 2.4 in 2015; 3.5 in 2016.
  - 10-year government bond yield (%): 0.6 in 2015; 0.2 in 2016.
  - Negative yields extend to 7-year government securities and bank debt securities to 3-year maturities; one-year term bank deposits yield ¼ of a percentage point.
  - Banks competing for returns: expanding maturity transformation, loosening covenants and collateral, compressing interest margins.
  - Regulatory capital generally comfortable; leverage ratios low internationally, especially for large private banks.
  - Profitability weak due to high operating costs, crisis legacies, and low interest rate environment.
  - Number of banks and branches declined by about 15 percent since the financial crisis.
- Interest-rate risk and supervisory measures:
  - Low and flattening yield curves erode margins; cooperative and savings banks increased fee income and maturity transformation, raising exposure to valuation losses and funding cost increases if rates rise.
  - Supervisory response: regular stress tests and scenario simulations; imposition of Pillar II capital requirements on most exposed banks.
- Crisis coordination:
  - 2016 FSAP noted absence of a formal coordination framework among ECB, SRB, and competent German authorities; recommendation to reinforce contingency planning and test via real simulation exercises; no progress reported.

### Life insurers and insurance sector vulnerabilities
- Profitability and solvency:
  - Average return on investment trending down; gap between return on investment and average technical rate about 50 basis points.
  - Duration of LI sovereign portfolio reached 13.7 years last year.
  - Aggregate SCR for German life insurance industry: 286 percent at beginning of 2016.
  - A 50 basis point fall in long-term rates in first half of 2016 reduced aggregate SCR by 76 percentage points to 210 percent.
  - About 70 percent of German LIs use Solvency II transitional measures.
  - Without transitional measures, about a third of reporting LI companies (26 insurers) would not have reported sufficient own funds in 2016:Q1; associated capital shortfall would have been EUR 12.3 billion (versus EUR 3.5 billion in 2015:Q4 for 16 insurers).
  - Stress tests (2016 FSAP and EIOPA) show severe negative effects in a “low for long” scenario.
- Policy recommendations for insurers:
  - Move away from guaranteed returns toward unit-linked products.
  - Supervisors to monitor poorly capitalized companies and demand early action plans; small to medium firms may need to reduce duration gaps and improve profitability via access to international portfolios and derivatives.

### Risks to the outlook and scenario quantifications
- Key near-term and long-term risks:
  - Short-term risks broadly balanced; longer-term risks tilted to the downside.
  - Notable risks: retreat from economic integration, Brexit negotiation difficulties, anti-euro sentiment and European banking/fiscal legacy problems, weaker-than-expected euro-area wage/price response (“low for long”), continued rise in German house prices.
- Risk Assessment Matrix highlights (selected):
  - I. Retreat from cross-border integration (Likelihood: H M). Policy response: let automatic stabilizers work; consider discretionary fiscal expansion within rules; consider invoking escape clause under debt brake if needed.
  - V. Low for long (Likelihood: M M). Policy responses: lift inflation expectations through communication; consider fiscal expansion; strengthen macroprudential framework and bank supervision; reduce bank leverage; use early intervention powers for life insurers.
- Public debt stress tests (selected outcomes):
  - Public gross debt at end-2016: 68.3 percent of GDP.
  - Under growth shock (real output growth lower by one standard deviation over 2018–19, i.e. 2.7 percentage points): debt peaks at 70 percent of GDP and gross financing needs at 14 percent of GDP, converging to 61 and 11 percent of GDP by 2022.
  - Under combined macro-fiscal shock: impact slightly worse than growth shock.
  - Under contingent fiscal shock (cumulative 3 percent of GDP additional support to financial sector over 2018–19): convergence to 60 percent achieved in 2021; gross financing needs remain below 15 percent of GDP.
- Baseline macro assumptions (public debt analysis):
  - Inflation (GDP deflator): 1.4 percent in 2017, rising towards 2 percent thereafter.
  - Average interest rates expected to fall from 2 percent in 2016 to 1.2 percent in 2022.

### Policy recommendations and reforms (Executive Board and staff)
- Use available fiscal space to enhance growth potential by expanding public investment in infrastructure, digital infrastructure, childcare, refugee integration, and reducing the tax burden on labor.
- Reexamine fiscal projection methodology to improve fiscal planning given continued fiscal overperformance.
- Reform pensions to raise the effective retirement age:
  - One additional year of effective retirement age estimated to reduce pension bill by 0.7 percent of GDP.
  - Staff estimates pension reforms that achieve a one-year increase could reduce the CA surplus by almost ½ of a percentage point of GDP.
- Encourage sustained rise in wage and price inflation consistent with labor market tightening to lift euro area inflation and facilitate monetary policy normalization; authorities could emphasize importance of robust wage and price growth in public communication while respecting social partners’ wage-setting autonomy.
- Accelerate competition-enhancing reforms in parts of the services sector, speed up digitalization, and enhance venture capital investment to strengthen productivity and business investment.
- Maintain attention to relative poverty risk; ensure anti-poverty measures preserve achievements of past labor market reforms.
- Address housing supply restrictions in pressured areas and fill important data gaps in the mortgage market; enhance macroprudential toolkit and supervisory databases.
- Support the proposed Federal Infrastructure Corporation for Highways to improve transport investment administration.
- Recommendation on Article IV timing: next consultation on regular 12-month cycle.

### Pension, demographics, and long-term fiscal sustainability
- Aging cost projections:
  - Pension outlays rising between 1.9 and 2.7 percentage points of GDP by 2050.
  - Health and long-term care costs adding a further 1.3–2.1 percentage points.
  - Dependency ratios projected to approach 45–50 percent by 2030.
  - Total age-sensitive expenditures projected to climb by ½–3 percent of GDP by 2030 and by 3–6½ p.p. by 2060.
- Long-run debt implications:
  - Official estimates: debt would rise to 75–225 percent of GDP by 2060 absent other adjustments, with fiscal adjustment need of 1¼–4 percent of GDP.
  - To fully close estimated pension gap, average retirement age would need to rise by 3 to 5 years up to 2060 (beyond programmed rise to age 67 by 2030).
  - Alternative to retirement-age reform: a 1.4 percentage point increase in payroll tax/SSC to achieve similar savings.
- Policy implication: making it attractive to extend working lives yields immediate fiscal savings and supports potential growth; once reforms are in place, some relaxation of fiscal rules could be considered.

### Structural reforms, digitalization, and innovation policy
- Digitalization and broadband:
  - Germany ranks twenty fifth in the world in average download speeds.
  - Federal government earmarked EUR 4 billion to support deployment of fast broadband in remote areas through 2020.
  - New initiative “Gigabit Germany” and Digital Networks Act to reduce fiber rollout costs; private telecoms to increase fiber investment until 2025.
- R&D and venture capital:
  - R&D spending in 2015 at around 3 percent of GDP.
  - Venture capital investment remained relatively small.
  - Policy actions: High-Tech Strategy grants and equity instruments; tax rule modification on loss carry-forward; Deutsche Börse “Scale” launched March 2017 to boost IPOs.
  - Recommendation: periodically assess effectiveness of measures to prevent a “small business trap” and address administrative uncertainties.
- Product market reforms:
  - Professional services remain overregulated; European Commission indicators show restrictiveness higher than EU median for lawyers, engineers, architects, and accountants in 2016.
  - Staff recommends greater openness in exclusive rights, compulsory chamber membership, and price/fee regulation.

### Social cohesion, poverty, and refugee integration
- Income distribution and poverty:
  - Gini index of disposable income around 0.29.
  - Share of individuals at risk of poverty rose to about 16 percent by end-2014.
  - In-work at risk of poverty also increased.
  - Recommendation: if poverty risk does not recede, review targeting and effectiveness of existing programs and benefits.
- Refugee integration:
  - Inflow during 2015–16: around 1.2 million (1½ percent of population).
  - By March 2017: about 0.5 million asylum seekers and refugees had completed initial integration stages and registered as jobseekers; employment rate about 12 percent.
  - Authorities view: employment rate of 50 percent five years after arrival is achievable.
  - Recommendation: create new vocational training paths more suitable for refugees.

### FSAP follow-up, data, and AML/CFT actions
- Macroprudential and data initiatives:
  - Bundesbank building “house of microdata”; to be supplemented by AnaCredit when available.
  - Legislation enacted (Bundesrat, May 12, 2017) introducing LTV and amortization instruments; omitted DTI/DSTI and loan-level data access.
- Supervisory and reporting improvements:
  - FINREP reporting by all LSIs begins June 2017.
  - BaFin added 30 staff to AML Department as of 1 January 2017; on-site inspections rose from 80 in 2014 to 102 in 2016.
  - Draft law for beneficial ownership register scheduled to enter into force in June 2017; register accessible by competent authorities in December 2017.
- Insurance supervision:
  - BaFin extending recovery plan requirements to two other groups; participating in EIOPA stress tests; developing BSM—Branchensimulationsmodell for internal model review.

*IMF Staff Report for the 2017 Article IV Consultation (cr17192).*

### 8.3 percent in 2016, due to the deterioration of the income and services balance. The fiscal policy

### cr17192 - 8.3 percent in 2016, due to the deterioration of the income and services balance. The fiscal policy

### Macroeconomic outlook and cyclical position
- Real GDP growth: 1.8 percent in 2016; projected 1.8 percent in 2017 and 1.6 percent in 2018.
- Cyclical outlook: cyclical upswing expected to persist near term supported by rising employment, some fiscal expansion, and continued monetary accommodation; higher energy costs should curb consumption growth.
- Output gap: 0.0 percent in 2015; 0.3 percent in 2016; 0.7 percent in 2017; 0.8 percent in 2018.
- Medium-term risks: population aging and slow progress on structural reforms expected to weigh on growth.

### Labor market, wages, and inflation
- Employment and unemployment:
  - Unemployment rate (%, ILO): 4.6 in 2015; 4.2 in 2016; 3.9 in 2017; 3.9 in 2018.
  - Employment growth (%): 0.8 in 2015; 2.7 in 2016; 1.1 in 2017; 0.6 in 2018.
- Inflation:
  - Headline inflation averaged 0.5 percent in 2016; temporarily peaked at 2.2 percent in February 2017.
  - Inflation (CPI, table): 0.1 in 2015; 0.4 in 2016; 1.7 in 2017; 1.6 in 2018.
  - Core inflation remained flat at 1.1 percent (text).
- Wages:
  - Nominal wage growth: 2.3 percent in 2016.
  - Minimum wage: raised by 4 percent in January 2017 (first regular review after two years of implementation).

### External sector and current account
- Current account balance (% of GDP): 8.6 in 2015; 8.3 in 2016; 8.4 in 2017; 8.1 in 2018.
- Trade balance (% of GDP): 8.0 in 2015; 7.9 in 2016; 7.8 in 2017; 7.6 in 2018.
- Exports of goods (% of GDP): 38.9 in 2015; 38.1 in 2016; 39.5 in 2017; 40.1 in 2018.
  - Exports volume (% change): 5.0 in 2015; 2.5 in 2016; 5.1 in 2017; 4.0 in 2018.
- Imports of goods (% of GDP): 30.3 in 2015; 29.5 in 2016; 31.0 in 2017; 31.7 in 2018.
  - Imports volume (% change): 5.6 in 2015; 3.9 in 2016; 5.1 in 2017; 4.6 in 2018.
- Net International Investment Position (NIIP): approached 52 percent of GDP at end-2016.
  - Gross assets: 251 percent of GDP (end-2016).
  - Net direct investment position: close to 17 percent of GDP (end-2016).
  - Portfolio investments stock rose from 4 to 9 percent of GDP (accounting for full increase in NIIP).
- External exposures:
  - Claims of German banks on non-residents: declined from 63 to 61 percent of GDP in 2016.
  - Germany’s exposure to the Eurosystem: 27 percent of GDP (post-ECB QE widening).

### Fiscal position
- Fiscal balance (% of GDP): 0.7 in 2015; 0.8 in 2016; 0.4 in 2017; 0.5 in 2018.
- Revenue (% of GDP): 44.7 in 2015; 45.1 in 2016; 45.2 in 2017; 45.2 in 2018.
- Expenditure (% of GDP): 44.0 in 2015; 44.3 in 2016; 44.8 in 2017; 44.7 in 2018.
- Public debt (% of GDP): 71.2 in 2015; 68.3 in 2016; 65.8 in 2017; 63.2 in 2018.
- Fiscal stance: neutral in 2016 with general government posting its third consecutive yearly surplus; structural balance 0.7 percent in 2016.
- Drivers: favorable labor market and buoyant corporate tax receipts explain bulk of 0.5 percentage points increase in revenue-to-GDP ratio; decline in interest bill and 0.5 percent of GDP rise in primary spending (4 percent in real terms).

### Housing, credit, and financial sector
- Housing:
  - Housing prices have been trending up, especially in urban areas, driven by rising immigration, continuing urbanization, inelastic housing supply, and easy financing conditions.
  - Despite rapidly rising prices, housing judged affordable in aggregate, but regional differences and hot spots warrant close monitoring.
  - New legislation introduced additional macroprudential instruments for the real estate market; further strengthening of toolkit and enhancement of supervisory database on real estate credit recommended.
- Credit and monetary environment:
  - Broad money (M3) (end of year, % change): 9.2 in 2015; 5.7 in 2016 (table note: reflects Germany's contribution to M3 of the euro area).
  - Credit to private sector (% change): 2.4 in 2015; 3.5 in 2016.
  - 10-year government bond yield (%): 0.6 in 2015; 0.2 in 2016.
  - Low/negative yields: negative yields on government securities extend to 7-year maturities; bank debt securities to 3-year maturities; one-year term bank deposits yield ¼ of a percentage point.
  - Credit growth: loans to non-financial corporations accelerated in 2016; banks competing for returns, expanding maturity transformation, loosening covenants and collateral requirements, and compressing interest margins.
- Banking and insurance profitability:
  - Regulatory capital adequate, but profitability remains weak due to structural factors, crisis legacies, and low interest rate environment.
  - Low interest rates, if prolonged, would negatively affect life insurers given reliance on guaranteed products.
  - Supervisory attention to interest rate risk welcomed; continued restructuring efforts in bank and life insurance sectors recommended.

### Executive Board and staff recommendations (key policy recommendations)
- Use available fiscal space to enhance growth potential by expanding public investment in infrastructure, digital infrastructure, childcare, refugee integration, and reducing the tax burden on labor.
- Reexamine fiscal projection methodology to improve fiscal planning given continued fiscal overperformance.
- Reform pensions to raise the effective retirement age to increase potential growth, reduce the need to save for retirement, and strengthen the fiscal position.
- Encourage a sustained rise in wage and price inflation (consistent with labor market tightening) to lift euro area inflation, facilitate monetary policy normalization, and promote competitiveness realignment within the monetary union; authorities could emphasize importance of robust wage and price growth in public communication while respecting social partners’ wage-setting autonomy.
- Accelerate competition-enhancing reforms in parts of the services sector, speed up digitalization, and enhance venture capital investment to strengthen productivity and business investment.
- Maintain attention to relative poverty risk; ensure anti-poverty measures preserve achievements of past labor market reforms.
- Address housing supply restrictions in pressured areas and fill important data gaps in the mortgage market; enhance macroprudential toolkit and supervisory databases.

### Selected illustrative table values (from "Germany: Selected Economic Indicators, 2015–18")
- Real GDP growth (%): 1.5 (2015); 1.8 (2016); 1.8 (2017); 1.6 (2018).
- Total domestic demand growth (%): 1.5 (2015); 2.2 (2016); 1.6 (2017); 1.7 (2018).
- Employment growth (%): 0.8 (2015); 2.7 (2016); 1.1 (2017); 0.6 (2018).
- Inflation (%): 0.1 (2015); 0.4 (2016); 1.7 (2017); 1.6 (2018).
- Public debt (% of GDP): 71.2 (2015); 68.3 (2016); 65.8 (2017); 63.2 (2018).
- Current account balance (% of GDP): 8.6 (2015); 8.3 (2016); 8.4 (2017); 8.1 (2018).

*IMF Staff Report for the 2017 Article IV Consultation (cr17192).*

### 7.      Mortgage credit growth has stabilized against the backdrop of rising house prices.

### 7.      Mortgage credit growth has stabilized against the backdrop of rising house prices.

### Mortgage, housing supply, and prices
- House prices accelerated further in 2016, reflecting continued migration to urban centers, an inelastic housing supply, and easy financial conditions as banks and other financial institutions compete for mortgage business in a low interest rate environment.
- Housing completions and residential building permits have increased further over the past year, but new residential construction has remained below estimates of the amount required to balance the market, suggesting that the backlog is still building up.

### Outlook, key macro projections, and external assessment
- Real GDP is expected to grow by 1.8 percent in 2017 and 1.6 percent in 2018, increasing the positive output gap slightly.
- Headline inflation is expected to peak in 2017 and recede somewhat in 2018 (to 1.7 percent) as the effect of higher commodity prices wanes.
- Core inflation and nominal wage growth are expected to gradually pick up; core inflation is expected to exceed 2 percent beyond 2019.
- In the medium term, in a context of growth slightly above potential and still accommodative monetary policy, annual wage growth is expected to reach slightly above 3 percent.
- The cyclically adjusted current account surplus reached 8.5 percent of GDP in 2016.
- The norm for the current account is assessed at 2½–5½ of GDP, implying a gap of 3–6 percent of GDP relative to fundamentals and desirable policy settings.
- The real effective exchange rate (REER) is assessed to be undervalued by 10–20 percent in 2016.
- Staff projects a gradual rebalancing, but the current account surplus is expected to remain large, at 7.5 percent of GDP in 2022—still 2 percent of GDP above the upper bound of the norm’s confidence interval.
- Germany accounts for 28 percent of the euro area.

### Fiscal position, plans, and headroom
- Based on the 2017–20 financial plan, staff forecasts that the government should register a surplus (0.4 percent of GDP) in the year of the report and meet the political commitment of no new net borrowing (black zero) throughout the current legislature.
- The structural balance is expected to fall by 0.6 percent of GDP.
- The stimulus is underpinned by income tax relief worth 0.2 percent of GDP—in the form of a higher basic tax allowance, more generous child-related tax credits, and a correction of the bracket creep—as well as higher social benefits, including pensions, and some increase in public investment.
- Refugee-related expenditures are expected to remain at about ½ percent of GDP throughout the forecast horizon.
- Consequentially, the fiscal buffer in relation to the SGP’s MTO and national debt brake is set to rise from ½ percent of GDP in 2017–18 to 1¼ percent of GDP in 2022.
- Public gross debt (Maastricht definition): 71.2 68.3 65.8 63.2 52.0

### Risks to the outlook
- Short-term risks are broadly balanced; longer-term risks are tilted to the downside.
- Key risks include:
  - A global retreat from economic integration prompted by anti-globalization sentiment, which would hurt Germany’s exporting industries and deter domestic investment.
  - Brexit negotiation difficulties increasing uncertainty and holding back investment.
  - Anti-euro sentiment, stalled structural reforms, and banking sector and fiscal legacy problems in parts of Europe reigniting sovereign bond market tensions and triggering asset market corrections and financial turbulence in Germany.
  - A weaker-than-expected response of prices and wages in the euro area leading to a prolonged period of exceptionally low interest rates, with associated financial stability risks.
  - A continued rise in house prices in Germany, supported by expansionary monetary conditions, potentially lifting investment and consumption more rapidly than anticipated and strengthening cyclical growth.

### Policy discussions: wages, prices, and communication
- A sustained rise in wage and price inflation in Germany is needed to lift inflation in the euro area and help open the way to the normalization of monetary policy.
- In the staff’s medium-term forecast, headline inflation is expected to rise and slightly exceed 2 percent by 2019 in Germany, underpinned by rising core inflation and wage growth.
- Model simulations suggest that a failure of German wage and price inflation to pick up could:
  - Translate into higher real interest rates and lower wage dynamics,
  - Depreciate the REER,
  - Depress domestic demand in the short term,
  - Raise external imbalances and lower GDP and inflation in the euro area, delaying monetary policy normalization.
- Staff recommendation: The authorities could usefully emphasize in public communication the importance of robust wage and price growth to lift inflation expectations and wage growth, speed-up ECB policy normalization, and reduce risks associated with rates being “low for long.”
- Policies that promote sustainable and higher long-term growth while stimulating aggregate demand in the short run would support these objectives.

### Fiscal policy recommendations for growth and rebalancing
- Germany has created substantial fiscal space through consolidation and should use the room within fiscal rules to finance growth-friendly policies in the medium term—estimated headroom is ½ percent of GDP in the short run, rising steadily to 1¼ p.p. by 2022.
- Recommended uses of fiscal headroom:
  - More infrastructure investment,
  - High-quality child care and aftercare programs,
  - Training and integration efforts for refugees,
  - Permanent reductions in the labor tax burden to support labor supply among secondary earners and low-to-medium income households.
- Under the baseline projections and full use of fiscal leeway, public debt would continue to fall and cross below the 60 percent of GDP benchmark by 2021/2022, even under plausible macroeconomic and fiscal shocks (fan-chart analysis under alternative structural balance paths).

### Authorities’ views (summary)
- Authorities broadly agreed with staff on the positive macroeconomic outlook and emphasized the dominant role of domestic demand and the labor market in supporting consumption and the housing market.
- Authorities expected wage dynamics to remain more moderate than staff, noting wage bargaining is decentralized and influenced by immigration.
- Authorities viewed the current account surplus as reflecting private sector decisions and temporary factors; the Bundesbank assessed REER undervaluation at around 6 percent—smaller than staff’s assessment.

*Source: IMF staff report excerpt from the Germany consultations chapter.*

### 21.      The government’s agenda to improve public investment management at the local level

### 21.      The government’s agenda to improve public investment management at the local level

### Local public investment management and Municipal Investment Promotion Fund (MIP)
- Investment needs are concentrated at the municipal level.
- The federal government doubled the size of the Municipal Investment Promotion Fund (MIP) created in 2015, to a total of EUR 7 billion (0.2 percent of GDP).
- Additional, non-earmarked, financial relief to subnational governments amounted to some EUR 19 billion between 2014 and 2018.
- MIP take-up has been disappointing to date:
  - less than EUR ½ billion spent by mid-2016
  - less than EUR 2 billion in commitments by mid-2016
- Primary reasons for low take-up: administrative constraints, including a steady reduction in specialized personnel over the years.
- Scope for MIP usage was expanded to include school infrastructure, which should help raise take-up.
- Other measures to reduce public investment bottlenecks (medium term):
  - A recent fiscal equalization agreement between the states and the federal government foresees a transfer of investment competencies to the latter and paves the way for the creation of an infrastructure entity responsible for the administration of highways.
  - Germany’s former PPP agency (Partnerschaft Deutschland) has been reformed to improve its accessibility and extend its support to normal procurement.
  - New measures have been introduced to expand high-speed broadband networks and provide schools with access to fast internet.

### Staffing and capacity
- Rebuilding staffing capacity at the local level is necessary to bolster the government’s agenda to improve public investment management.

### Fiscal planning and revenue projection models
- Conservatism in revenue projections has led to a tighter fiscal stance than intended by the government.
- Persistent bias derives in part from under-estimation of employment growth, resulting in higher-than-expected outturns for the personal income tax (PIT).
- The PIT was the only main tax category to be consistently underestimated in 2011–16, and explains the largest share of average forecast errors in that period.
- Recommendation: Revise both the macroeconomic relationships underlying revenue projections and estimated tax elasticities to improve fiscal planning accuracy.

### Pension reforms and long-term fiscal sustainability
- Rising aging costs expected to burden public accounts:
  - pension outlays in relation to GDP rising between 1.9 and 2.7 percentage points by 2050
  - health and long-term care costs adding a further 1.3–2.1 percentage points
- Without further reforms, the government will need to:
  - raise taxes and/or social security contributions (staff estimates that a 2 percent increase in payroll tax/contribution rates is necessary to finance a 1 percent of GDP rise in aging costs), or
  - generate substantial upfront fiscal savings to avoid a large increase in public debt when aging costs rise sharply.
- Pension reform benefits:
  - Making it attractive to extend working lives would directly reduce the pension bill by an estimated 0.7 percent of GDP per additional year of effective retirement age, assuming unchanged individual pension benefits, and would positively affect growth.
  - Reforms encouraging female labor supply and promoting integration of refugees into the labor market would help fiscal sustainability through increased employment, though with a lower quantitative impact.
- Policy implication: Once such reforms are in place, some relaxation of Germany’s fiscal rules could be considered in the future.

### Authorities’ views on fiscal stance, investment, and pension reform
- Authorities emphasize that:
  - the output gap is closed and public debt is still above the limit set by fiscal rules, so fiscal policy should be prudent and oriented toward improving fiscal sustainability.
  - further steps to reform pensions in the future are needed and reducing the tax wedge on labor is desirable.
  - the Ministry of Finance sees scope for further tax relief of ½ percent of GDP per year in the next legislature, mainly in income taxation.
  - public investment has accelerated at the federal level and financial support has been extended to subnational governments; a Federal Infrastructure Corporation for Highways is proposed.
  - capacity constraints limit the scope and desirability of a faster spending increase than currently envisaged.
  - increasing effective retirement age is desirable, but the Ministry of Finance does not see merit in discussing new fiscal targets given long-run fiscal sustainability challenges and views a government debt level of 60 percent of GDP as a ceiling and not a target.
  - risk of negative euro-area spillovers through higher borrowing costs if Germany’s fiscal policy loses credibility.

### Income distribution and relative poverty
- Wage inequality in Germany rose gradually but the trend has stopped over the past few years.
- Wage distributions for full-time and part-time employees widened from the mid-1990s.
- Since 2010, both wage and labor earnings inequality have been broadly stable.
- The new statutory minimum wage announced in late 2013 and introduced in January 2015 provided a higher floor to hourly wages without significantly harming employment.
- Inequality of disposable income has been broadly flat over the past ten years; Gini index of disposable income is around 0.29.
- Relative poverty risk has crept up:
  - share of individuals at risk of poverty rose to about 16 percent by end-2014
  - in-work at risk of poverty also increased
- Causes and policy considerations:
  - Weak disposable income growth in the left tail of the income distribution is behind the rise in poverty risk.
  - The federal government’s Fifth Poverty and Wealth Report lists measures taken: statutory minimum wage, reform to reduce abuse in temporary employment, new/revamped training for long-term unemployed or workers lacking formal vocational training, higher tax allowance for single parents, and significant increases in some social transfers (such as housing benefits or supplementary child benefits) in 2016–17.
  - If poverty risk does not recede, review of targeting and effectiveness of existing programs and benefits should be considered.
  - Anti-poverty policies should preserve gains in labor force participation and employment; evidence shows satisfaction with household income is strongly negatively correlated with the unemployment rate.
  - Policies to increase equality of opportunities and social mobility would help address poverty over the longer term.

### Refugee integration
- Asylum seeker and refugee inflows:
  - Exceptionally large inflow during 2015–16: around 1.2 million, or 1½ percent of the country’s population.
  - By March 2017, about 0.5 million asylum seekers and refugees had completed initial integration stages and registered as jobseekers.
  - Their employment rate remains low at about 12 percent.
- Integration measures:
  - The Integration Law (entered into force in August last year) introduced enhanced integration and language courses, specific language instruction targeted to vocational training, and increased legal security to refugees.
  - The law temporarily suspended the priority review for employers.
  - Recommendation: Create new paths to vocational training more suitable for refugees to enhance labor market integration prospects.
- Authorities view: Pace of integration is picking up; an employment rate of 50 percent five years after arrival is viewed as achievable.

### Product market reforms, competition, and innovation
- Competition-enhancing reforms in professional services and network industries should be pursued more vigorously.
- Productivity growth in services has remained low.
- Recent law (implementing an EU directive) boosts railways sector efficiency and strengthens regulator power; likely to make freight transportation relatively more attractive but little effect on long-distance passenger segment.
- No competition-enhancing measures taken in postal services; incumbent’s dominant position largely unchanged.
- The European Commission’s indicator shows restrictiveness higher than the EU median for lawyers, engineers, architects, and accountants in 2016.
- Ongoing infringement procedures by the EC regarding minimum compulsory tariffs of architects and engineers.
- Staff view: professional services remain overregulated; greater openness recommended in exclusive rights, compulsory chamber membership, and regulation on prices and fees.

### Digitalization, broadband, and venture capital
- Digitalization strategy and infrastructure:
  - “DIGITAL Economy 2016” monitoring report indicates corporate-sector digitalization is gaining momentum.
  - Obstacles: network infrastructure and shortage of skilled labor.
  - Germany ranks twenty fifth in the world in terms of average download speeds.
  - Federal government earmarked EUR 4 billion to support deployment of fast broadband in remote areas through 2020.
  - New initiative “Gigabit Germany” launched in cooperation with private companies; private telecommunication companies significantly increase fiber optic network investment until 2025.
  - The Digital Networks Act will reduce the cost of rollout of optical fiber cables; competition and business regulatory frameworks are being updated.
- R&D and venture capital:
  - R&D spending in 2015 at around 3 percent of GDP.
  - Venture capital investment remained relatively small.
  - Government measures under “High-Tech Strategy” include grants, equity financing instruments, and preferential tax treatment for seed and growth phases.
  - Late 2016: tax rule modification of loss carry-forward regime in case of change in company ownership to be friendlier to young innovative firms.
  - March 2017: Deutsche Börse launched “Scale” to boost IPOs of young, fast-growing companies; Scale replaces “Entry Standard” with stricter admission criteria and follow-up obligations, with part of the cost covered by Deutsche Börse.
  - Recommendation: Periodically assess effectiveness of measures to prevent a “small business trap” and address administrative uncertainties (e.g., VAT treatment on management fees for venture capital).

### Authorities’ views on digitalization and innovation policy
- Authorities emphasize progress on the Digital Agenda and promotion of venture capital investment.
- Acknowledge cross-country ICT indicators show Germany is not a top performer but argue comparisons may be misleading due to product sophistication differences.
- Highlighted policy initiatives: promotion of digitalization and ICT competence in SMEs, modern regulatory framework for the digital world, launch of digitalization of the energy transition.
- Recognized reforms have been slow in some professional services deregulation; cautioned that E.U. principle of mutual recognition should not dilute quality and consumer protection standards.
- Argued no de jure obstacles to greater competition in long-distance railways transportation and noted international evidence on benefits of separating infrastructure from incumbent operators is ambiguous.
- Noted most government-supported equity funds are managed on commercial terms, implying limited risk of perpetuating nonprofitable start-ups; agreed on importance of periodic review of instruments supporting innovation and venture capital.

*IMF staff summary of chapter 21 of the IMF Country Report*

### 34.      At the aggregate level, housing

### 34.      At the aggregate level, housing

### Housing market developments and affordability
- House prices have continued to accelerate but their level remains moderate, as do various indicators of mortgage affordability (price-to-rent, price-to-income).
- Regional divergence:
  - House prices continue to fall in some rural areas.
  - Price growth has reached double-digits in large cities and university towns.
  - In certain urban areas, overvaluation may amount to 30 percent according to the Bundesbank’s latest estimates.
  - Anecdotal evidence of looser underwriting standards in some areas; no comprehensive regional mortgage-growth data available.

### Supply-side policy measures and recommendations
- Recent government package to address supply shortages and improve affordability includes:
  - Stepping up the sales of federally-owned land and properties below market price for affordable housing projects.
  - More funds for social housing.
  - Promotion of building code harmonization.
- Authorities estimate that the supply of new housing units remained below demand in 2016.
- Staff recommendations to significantly boost short-term supply:
  - Further encourage local authorities to relax zoning and height restrictions in areas under pressure.
  - Lower the effective transaction tax rate on new construction (as recommended by staff in the past).

### Macroprudential framework for real estate
- New legislation broadens the macroprudential toolkit to include:
  - Loan-to-value requirements.
  - Amortization requirements.
- Not included in new law:
  - Debt-to-income limits.
  - Debt-service-to-income limits.
- Important data gaps remain:
  - New law does not provide for a granular, loan-by-loan database.
  - Staff recommendation: at minimum, conduct a regular (at least annual) survey in hotspots to collect information on individual loans and assess household leverage, loan affordability and the concentration of banks’ exposure.

### Banking sector profitability, structure, and interest-rate risk
- Banking sector status and challenges:
  - Banks are generally well capitalized in risk-weighted terms, but leverage ratios are low in international comparison, especially for large private banks.
  - Profitability is weak due to high operating costs, competition from within and outside the banking sector, and slow development in non-interest revenues.
  - Poorly performing legacy shipping loan portfolios are weighing on some banks and may lead to increased provisioning costs in coming years.
  - Restructuring is ongoing but progress is slow.
  - Fee-based income has increased recently, including at savings banks.
  - Number of banks and branches has declined by about 15 percent since the financial crisis; trend set to continue as the cost-to-income ratio remains on an uptrend in recent years—partially reflecting higher regulatory costs.
  - Following a second year of large losses, Germany’s G-SIB substantially increased capital in March–April 2017 and announced a new restructuring strategy; decline in the bank’s CDS spreads noted, but too early to assess sustainability of profitability recovery.
- Interest-rate risk:
  - Low and flattening yield curves are eroding margins as assets reprice and banks find it difficult to pass negative rates to depositors.
  - Cooperative and savings banks have increased fee income and expanded maturity transformation, raising exposure to:
    - Large valuation losses on the assets side if interest rates rise rapidly.
    - Increased funding costs on the liability side.
  - Supervisory response:
    - Regular stress tests and scenario simulations (including ‘low for long’ scenarios).
    - Imposition of Pillar II capital requirements on the most exposed banks.

### Crisis coordination and contingency planning
- Limited progress on formalizing a coordination mechanism for addressing systemic crises:
  - 2016 Germany FSAP noted absence of a formal coordination framework among authorities involved in crisis management (the ECB, the Systemic Risk Board, and competent German authorities).
  - FSAP recommended reinforcing contingency planning and testing via real simulation exercises; no progress reported.

### Life insurers (LIs): profitability and solvency
- Profitability pressures:
  - Persistent low interest rate environment is weighing on LI profitability.
  - Average return on investment has been trending down and is getting closer to the average technical rate.
  - The gap between return on investment and average technical rate is now about 50 basis points, or 80 basis point lower than in 2008, and at an all-time low.
  - Insurers have extended portfolio duration and held foreign sovereign debt (including U.S. debt); duration of the LI sector sovereign portfolio reached a peak of 13.7 years last year.
  - Limits to this strategy exist: further extension of asset duration risks locking in low long-term yields; potential policyholder surrenders if rates rise.
- Solvency measures and vulnerabilities:
  - Aggregate solvency capital requirement ratio (SCR) for German life insurance industry was 286 percent at the beginning of 2016, above the required 100 percent and among the highest in Europe.
  - Sensitivity to interest rates:
    - A 50 basis point fall in long-term interest rates in the first half of 2016 reduced aggregate SCR by 76 percentage points to 210 percent.
  - Transitional measures:
    - About 70 percent of German LIs are making use of Solvency II transitional measures.
    - Without transitional measures, about a third of reporting LI companies (26 insurers) would not have reported sufficient own funds in 2016:Q1; associated capital shortfall would have been EUR 12.3 billion (versus EUR 3.5 billion in 2015:Q4 for 16 insurers).
  - Stress-test findings:
    - 2016 FSAP and recent EIOPA stress tests showed severe negative effects in a “low for long” scenario due to large negative duration gaps and prevalence of guaranteed returns products.
  - Policy recommendations for LIs:
    - Move away from guaranteed returns and towards unit-linked products.
    - Supervisors should closely monitor poorly capitalized companies and demand early action plans—emphasizing changes in business models when necessary.
    - Small to medium firms may need to reduce duration gaps and improve profitability through access to international investment portfolios and derivative products.

### Authorities’ views (summarized)
- Authorities stressed that banking and insurance sectors needed to accelerate review and development of business models; many institutions must shore up profitability and resilience.
- Confidence expressed that adjustment will be smooth due to comfortable capital buffers in both sectors.
- Not overly concerned by rapid house price increases in hotspots given moderate credit growth and high credit standards; agreed that mortgage data gaps must be remedied for effective macroprudential surveillance.
- Highlighted the role of demographics for house prices and substantial regional differences.
- Strong commitment to the new EU bank resolution framework and the concept of bail-in.
- Shared staff’s concerns about operational readiness in a systemic crisis; noted coordination among national and European authorities still needs to be tested in real-time simulation exercises.

### Staff appraisal: outlook, risks, and policy priorities
- Near-term cyclical outlook:
  - Cyclical upswing expected to continue in the near term.
  - In 2017, growth should remain stable as foreign demand is expected to strengthen and consumption to soften as higher commodity prices will curb real income growth.
  - Medium term: continuing growth slightly above potential should result in a widening of the output gap and further tightening of labor market conditions.
  - Risks: balanced in the short term; predominantly tilted to the downside in the longer run (e.g., anti-globalization policies abroad, insufficient euro-area reform progress).
- Labor market and wages:
  - Labor market continues to perform strongly following the Hartz reforms: rising labor force participation and falling unemployment, large employment gains, also fed by immigration.
  - Wage and labor earnings inequality broadly stable since 2010.
  - Average wage gains have been subdued despite increasing signs of labor market tightness.
  - Policy communication recommendation: emphasize the importance of robust wage and price growth while respecting social partners’ autonomy in wage setting.
- Inflation and monetary-normalization implications:
  - Baseline forecast envisages a gradual demand-driven rise in wage, core, and headline inflation consistent with tight labor market conditions.
  - Risk that wages may not respond sufficiently, leading to protracted low inflation and slower normalization of monetary conditions in the euro area; this would increase financial stability risks associated with ‘low for long’ interest rates and delay competitiveness rebalancing.
- External position and rebalancing:
  - Germany’s external position substantially stronger than implied by medium-term fundamentals.
  - Surplus expected to narrow slowly over the medium term as energy and other import prices recover, private investment strengthens, and wage growth supports domestic demand and competitiveness realignment.
  - Under current policies, projected adjustment is limited.
  - Policy recommendations to accelerate external rebalancing:
    - Boost public and private investment.
    - Reduce need for private saving (for example, by promoting longer working lives).
- Fiscal position and recommendations:
  - Fiscal position continues to strengthen; protracted reduction in debt-to-GDP ratio after the crisis.
  - 2016: primary spending rose (including for refugees) but offset by higher tax revenues and a decline in the interest bill.
  - Current fiscal plans preserve a comfortable buffer above European and national fiscal rules; staff forecasts this buffer to rise.
  - Fiscal policy advice:
    - Use fiscal space to raise growth potential by encouraging investment, promoting labor supply, and boosting productivity.
    - Revenue side: scope to reduce Germany’s large and increasing tax burden on labor to support labor supply.
    - Expenditure side: overcome barriers to expanding investment in public infrastructure; rebuild staffing capacity at the local level for planning and administration of investment projects.
    - Support for the proposed Federal Infrastructure Corporation for Highways as a means to ensure a more stable and efficient framework for transport investment.
    - Expand labor supply via enhanced childcare and after-school programs and provide vocational training to refugees; foster digitalization and innovation.
- Fiscal planning improvement:
  - Reexamination of revenue projection models warranted:
    - Tax revenue projections (especially for personal income taxes) have proven overly conservative post-crisis, partly due to underestimation of employment growth.
- Pension reform:
  - Further pension reforms to prolong working lives would foster long-term fiscal sustainability and help external rebalancing by lowering the pension bill, raising growth, and reducing household saving needs.
  - Sustainability gains could facilitate some relaxation of fiscal targets in the medium and long term.
- Social cohesion and poverty risk:
  - Despite strong employment gains, relative poverty risk warrants continued attention.
  - Disposable income inequality (Gini coefficient) broadly stable and near the European median, but slow secular rise in the at-risk-of-poverty rate.
  - New social cohesion measures have been put in place; too early to assess impact.
  - If poverty risk does not recede, consider reviewing targeting and effectiveness of some social benefits.
  - Anti-poverty policies should preserve achievements of past labor market reforms and enhance labor force participation of women with children and facilitate refugee integration.
- Competition, network industries, and professional services:
  - New law to boost railways efficiency and regulator power is a step in the right direction but may have little effect on long-distance passenger segment where competition is lacking.
  - No new competition-enhancing measures in postal services; regulator should avoid discrimination against smaller competitors and new entrants.
  - 2016 National Action Plan on regulated professions contains only a limited number of policy measures; some professions remain overregulated.
- Digitalization and venture capital:
  - Measures to speed up digitalization and stimulate venture capital investment are welcome.
  - Germany: innovation leader in Europe, but network infrastructure and skilled-labor shortages hold back progress.
  - Average stock of capital per worker in ICT is low in international comparison; Germany ranks only twenty fifth in the world in average download speeds.
  - Federal government initiatives to accelerate broadband deployment, adapt regulatory frameworks, and foster venture capital are welcome and momentum should be sustained.

*Source: IMF staff, Germany country report excerpt (cr17192).*

### 54.      Housing prices remain in line with fundamentals at the aggregate level although some

### 54.      Housing prices remain in line with fundamentals at the aggregate level although some

### Housing market assessment and government measures
- Housing prices remain in line with fundamentals at the aggregate level although some hot spots are developing as prices continue to accelerate.
- Government measures adopted to help balance supply and demand and maintain affordability:
  - stepped-up sales of federally-owned land and properties below market price for affordable housing projects
  - more funds for social housing
  - promotion of building code harmonization
- Policy gap identified:
  - To significantly boost supply in the short term, these measures must be complemented by further encouragement for local authorities to relax zoning and height restrictions.

### Macroprudential legislation and data issues for the real estate market
- New legislation will introduce:
  - loan-to-value ratios
  - amortization requirements
- Important omissions in the new toolkit:
  - debt-to-income and debt-service-to-income ratios are not included
  - supervisors are not granted the power to request access to loan-level data
- Consequences and interim mitigation:
  - Debt-to-income and debt-service-to-income ratios are important to limit borrower vulnerability to income and interest rate shocks.
  - Lack of loan-level data is a key pre-requisite shortfall for effective implementation of macroprudential instruments.
  - To partially overcome data gaps, a regular (at least annual) survey could be conducted in the country’s hotspots to assess households’ leverage, loan affordability, and the concentration of bank exposure.

### Banking and life insurance sectors: vulnerabilities and recommended directions
- Banking sector:
  - Regulatory capital is generally comfortable.
  - Cost-to-income and leverage remain high.
  - Restructuring efforts are ongoing.
  - Low profitability reflects:
    - structural inefficiencies
    - persistent crisis legacy issues
    - provisions for compliance violations
    - the need to adjust to the new regulatory environment
  - Lower and flatter yield curves are gradually eroding margins, especially in smaller retail banks.
- Life insurance sector:
  - Low interest rates hurt solvency ratios.
  - Large duration gaps must be reduced through changes in investment strategy and less reliance on guaranteed return products.
- Supervisory response:
  - Recent supervisory attention to interest risk both in banking and insurance is welcomed.

### Institutional timing recommendation
- It is recommended that the next Article IV consultation take place on the regular 12-month cycle.

*GERMANY 24 INTERNATIONAL MONETARY FUND*

### Box 1. How Can Germany’s Current Account Gap Be Closed?

### Box 1. How Can Germany’s Current Account Gap Be Closed?

### Assessment of the current account gap
- Current account gap: 2.5 to 5.5 percent of GDP.
- The adjustment under the baseline together with the elimination of policy gaps in trading partners would result in an estimated reduction of Germany’s surplus of some 1.7 percent of GDP.
- Without nominal exchange rate flexibility, stronger wage growth relative to euro area trading partners is expected to contribute to realign price competitiveness within the monetary union, but at a slow pace. The projected adjustment is partial and additional policy actions will be necessary to fully rebalance the economy.

### Quantified adjustment scenarios (staff estimates and model results)
- Medium-term adjustment under the baseline forecast: -0.8 percent of GDP
- Fiscal adjustment by trading partners: -0.9 percent of GDP
- Using all the fiscal room in relation to the fiscal rules: -0.5 to -0.75 percent of GDP
- Pension reform: -0.4 percent of GDP per additional year of effective retirement age
- Staff estimates suggest that pension reforms that achieve a one-year increase in the effective retirement age could reduce the surplus by almost ½ of a percentage point of GDP.

### Policy levers in Germany to promote rebalancing
- Use fiscal space to finance higher public investment in infrastructure, as well as initiatives that promote higher labor supply and innovation:
  - These policies would reduce public sector savings and stimulate private sector investment, thereby reducing the CA surplus while also lifting potential growth.
  - If fiscal room is used primarily for initiatives that stimulate private investment (for example, public infrastructure or pro-innovation policies), the external rebalancing effect would be reinforced due to larger external spillovers.
- Pension reforms to encourage longer working lives as life expectancy rises:
  - Would reduce households’ need to save for retirement, thereby reducing private savings and the CA surplus.
  - Would also raise future potential output by mitigating the effect of aging on labor supply and help reduce the fiscal cost of population aging.
- Policies to boost labor supply:
  - Additional spending on childcare and afterschool care that encourages women to work longer hours would lower the CA surplus by encouraging private investment even if budget neutral.
  - Incentivizing female labor force participation through targeted tax relief would have similar effects.
  - Stepped up vocational training to accelerate refugee job market integration would support labor supply and investment.
- Faster wage and price growth would also speed up the rebalancing process.

### Interaction with external policies and baseline dynamics
- The baseline adjustment combined with fiscal adjustments by trading partners yields an estimated reduction of some 1.7 percent of GDP in Germany’s surplus.
- Elimination of policy gaps in trading partners is part of the quantified adjustment (-0.9 percent of GDP attribution).
- Model-based quantification (EBA model and staff analysis) is uncertain but indicates feasible paths to eliminate Germany’s external imbalance in the medium term through policies that also strengthen economic potential.

### Conclusion and policy implications
- Rebalancing is possible through a mixture of policy adjustment in Germany and abroad.
- Policies that simultaneously reduce savings and raise investment (fiscally financed public investment, pension reforms, labor supply measures, pro-innovation measures, and faster wage growth) can shrink the CA surplus while boosting potential growth.
- Even though quantification relies on uncertain model estimates, staff analysis demonstrates credible policy paths to bring the CA surplus comfortably within the norm interval.

*Source: Box 1, "How Can Germany’s Current Account Gap Be Closed?" (cr17192).*

### 7.5 percent of GDP over the last five years and reached

### 7.5 percent of GDP over the last five years and reached

### Current Account (CA) — levels, composition, and assessment
- CA surplus averaged 7.5 percent of GDP over the last five years and reached 8.3 percent of GDP in 2016, a 0.3 p.p. decline relative to 2015, while the nominal balance remained virtually unchanged.
- The increase in net exports in 2016 was roughly equally split between euro area and non-euro area trade partners.
- The bulk of the CA surplus reflects large saving-investment surpluses of non-financial corporations and households, with rising net savings of non-financial corporations and fiscal consolidation accounting for the upward trend.
- Cyclically-adjusted CA balance reached 8.5 percent of GDP in 2016, slightly below the 2015 level.
- Staff assesses the CA norm at 2½–5½ percent of GDP, with a midpoint slightly lower than the CA norm implied by the EBA model of 4½ percent.
- The assessed cyclically-adjusted CA is 3–6 percentage points of GDP stronger than the value implied by fundamentals and desirable policies.
- Technical note: Rapid aging contributes 3 percentage points to the EBA CA norm of 4½ percent of GDP; staff judges EBA demographic projections somewhat pessimistic, accounting for a -0.5 percentage point difference between the EBA norm and the staff midpoint.

### Real exchange rate (REER) — background and assessment
- Yearly average CPI-based REER was broadly unchanged relative to 2015; nominal effective exchange rate and ULC-based REER were also broadly unchanged.
- The euro remained stable vis-à-vis the U.S. dollar, but appreciated relative to the sterling and the renminbi.
- REER through March 2017 showed a very minor depreciation relative to the 2016 average.
- Staff assessment for 2016: REER undervaluation of 10–20 percent.
- Model estimates:
  - EBA REER Level model yields an undervaluation of about 19 percent.
  - CA regression model using standard trade elasticities implies an undervaluation of 10–15 percent.
- Technical note: The EBA REER Index model has an unusually poor fit for Germany; its 2016 estimate of overvaluation (4 percent) was discarded as implausible.

### Capital and financial accounts — flows and regional composition
- In 2016, net portfolio and other investment flows constituted about ½ and ⅓ of the capital and financial accounts balance, respectively.
- On a regional basis, about ⅔ of the net outflows were toward European countries and ⅓ toward the Americas (mostly the U.S.), with small net inflows from emerging countries and offshore centers.
- Net direct foreign investment declined reflecting both a decrease in outward investment and an increase in flows into Germany.
- Assessment: Safe haven status and the strength of Germany’s current external position limit risks.

### FX intervention and reserves
- Background: The euro has the status of global reserve currency.
- Assessment: Reserves held by Euro area countries are typically low relative to standard metrics. The currency is freely floating.

### Risks to the economic outlook and policy responses (Risk Assessment Matrix highlights)
- I. Retreat from cross-border integration (Likelihood: H M). Policy response: Let automatic stabilizers work. Consider discretionary fiscal expansion to the extent allowed by the fiscal rules. If output gap widens significantly, invoking the escape clause under the national debt brake rule could be appropriate.
- II. Policy uncertainty and divergence (Likelihood: H M). Vulnerability: high degree of trade openness; fiscal buffers comfortable.
- III. Reassessment of regional sovereign risk (Likelihood: H H). Financial stress in the euro area could re-emerge.
- IV. Structurally weak growth in key advanced economies (Likelihood: H M).
- V. Low for long (failure of wage and price inflation to pick up) (Likelihood: M M). Policy responses: Lift inflation expectations through consistent communication; consider discretionary fiscal expansion; strengthen macroprudential framework and bank supervision; reduce bank leverage; use early intervention powers for life insurers.
- VI. European bank distress (Likelihood: M H). Policy responses: Ensure adequate liquidity buffers, engage in contingency planning, coordinate relevant authorities.

### Public Debt Sustainability — baseline and key projections
- Public gross debt at end-2016: 68.3 percent of GDP.
- Public gross debt peaked at 82.5 percent of GDP in 2009–10.
- Public debt-to-GDP ratio should cross the 60 percent mark by 2020 under the baseline.
- Baseline macro assumptions:
  - Real GDP growth: about 1½ percent over the next three years; medium-run potential 1.2 percent per year.
  - Inflation (GDP deflator): 1.4 percent in 2017, steadily rising thereafter towards 2 percent.
  - Average interest rates expected to fall from 2 percent in 2016 to 1.2 percent in 2022.
- At 68.3 percent of GDP in end 2016, Germany falls under the higher scrutiny framework (threshold: 60 percent of GDP).
- Median forecast errors and biases (historical):
  - Median forecast error for real GDP growth during 2007–15: -0.11 percent.
  - Median forecast error for inflation (GDP deflator): 0.54 percent.
  - Median forecast bias for the primary balance: 1.16 percent of GDP.

### Public Debt Stress Tests — scenarios and outcomes
- Under plausible macro-fiscal shocks, government debt should remain below 70 percent of GDP and gross financing needs remain below 14 percent of GDP.
- List of shocks and main results:
  - Growth shock: real output growth rates lower by one standard deviation over 2018–19, i.e. 2.7 percentage points; debt peaks at 70 percent of GDP and gross financing needs at 14 percent of GDP, converging to 61 and 11 percent of GDP by 2022.
  - Primary balance shock: cumulative 1.4 percent deterioration in the primary balance over 2018–19; modest deterioration in debt dynamics.
  - Interest rate shock: 400 basis points increase in debt servicing costs throughout the forecast horizon; relatively modest effect on public debt and gross financing needs.
  - Combined macro-fiscal shock: combines growth, interest rate, and primary balance shocks; impact slightly worse than growth shock.
  - Contingent fiscal shock: cumulative 3 percent of GDP (about 90 billion euros) additional support to the financial sector over 2018–19 (55 billion euros bank recapitalization, 25 billion euros call on half of capital shield guarantees, 10 billion euros worse-than-expected performance of winding-down institutions). Impact on debt ratio relatively limited; convergence to 60 percent achieved in 2021. Gross financing needs remain below 15 percent of GDP.

### Selected baseline projection numbers (from DSA tables and figures)
- Nominal gross public debt projections (percent of GDP): 2015: 73.3; 2016: 71.2; 2017: 68.3; 2018: 65.8; 2019: 63.2; 2020: 60.5; 2021: 57.6; 2022: 54.8.
- Public gross financing needs (percent of GDP): 2015: 16.1; 2016: 13.8; 2017: 13.1; 2018: 11.9; 2019: 11.2; 2020: 9.3; 2021: 9.7; 2022: 8.5.
- Real GDP growth (percent): 2015: 1.4; 2016: 1.7; 2017: 1.9; 2018: 1.5; 2019: 1.5; 2020: 1.4; 2021: 1.3; 2022: 1.2.
- Inflation (GDP deflator, percent): 2015: 1.3; 2016: 2.0; 2017: 1.4; 2018: 1.1; 2019: 1.4; 2020: 1.5; 2021: 1.7; 2022: 1.9.
- Effective interest rate (percent): 2016: 2.2; 2017: 2.0; 2018: 1.8; 2019: 1.5; 2020: 1.3; 2021: 1.2; 2022: 1.2.
- Change in gross public sector debt (percent of GDP): 2015: 0.9; 2016: -3.7; 2017: -2.9; 2018: -2.5; 2019: -2.6; 2020: -2.7; 2021: -2.9; 2022: -2.8; cumulative 2015–2022: -16.3.
- Identified debt-creating flows cumulative (2015–2022): -13.9.
- Primary (noninterest) revenue and grants (percent of GDP) cumulative: 270.4.
- Primary (noninterest) expenditure (percent of GDP) cumulative: 262.0.
- Automatic debt dynamics contribution cumulative: -5.5.
- Residual, including asset changes cumulative: -2.4.

_International Monetary Fund: Annex I–III, Germany, External Sector Report and Public Debt Sustainability Analysis (excerpts) contained in cr17192._

### Annex IV. Authorities’ Response to Past IMF Policy

### Annex IV. Authorities’ Response to Past IMF Policy

### Fiscal Policy
- IMF recommendations:
  - Step up investment addressing weaknesses in public infrastructure to strengthen potential output and domestic demand; put in place new institutions that enable better planning and coordination of public investment at the local level.
  - Reduce labor tax wedge for lower income households.
  - Promote longer working lives, indexing the statutory retirement age to life expectancy.
- Authorities’ responses / outcomes:
  - Plans for additional public investment (excluding military investment) of some €25.5 billion (0.8 percent of GDP) through 2019 have been announced so far over the past three years, of which €3.5 billion since the publication of the 2016 Article IV Staff Report.
  - Germany’s former PPP advisory agency Partnerschaft Deutschland has been restructured to provide advisory support for municipal investment, both for PPP and conventional procurement, as a public entity.
  - A fiscal equalization agreement has paved the way for some centralization of investment competencies in the medium term. Discussions are ongoing to create a Federal Infrastructure Corporation for Highways, but it would be operational only in the medium term.
  - An update of the basic income allowance has safeguarded the minimum subsistence income and compensated for the fiscal drag from inflation (bracket creep).
  - New legislation (Flexirentengesetz), implemented in December 2016, raises incentives to continue working beyond the current statutory retirement age.

### Financial Sector Policy
- IMF recommendations:
  - Expand the macroprudential toolkit to better address potential future excesses in the housing sector.
  - Ensure that life insurance companies maintain sufficient capital buffers to withstand a prolonged period of low interest rates.
- Authorities’ responses / outcomes:
  - New regulation passed that introduced new instruments that allow LTV and amortization requirements in relation to real estate borrowing, but omits complementary LTI/DSTI instruments. The law also does not address important data requirements for the effective operation of these macroprudential instruments.
  - Supervisors have intensified the monitoring of vulnerable life insurers.
  - For progress on the implementation of outstanding FSAP recommendations see Annex VI.

### Structural Reforms and Housing Supply
- IMF recommendations:
  - Spur competition to increase productivity in the services sector.
  - Reduce disincentives for women to work full time as a way to mitigate the adverse effects of an aging population on labor supply.
  - Remove impediments to housing supply expansion to relieve pressure on house prices.
- Authorities’ responses / outcomes:
  - A new law was passed to strengthen the powers of the railways regulator, and boost the attractiveness and efficiency of the sector. However, the law has been criticized by the EC for likely leading to increases in access charges in the long-distance passenger segment, which is precisely the segment where competition is most limited.
  - No competition-enhancing measures have been taken in postal services, and the incumbent’s dominant position is largely unchanged.
  - The government’s 2016 National Action Plan on access to and practice of regulated professions, produced in the context of a pan-EU EC-led initiative, contains only a limited number of policy measures. Infringement procedures by the EC are still ongoing regarding the minimum compulsory tariffs of architects and engineers.
  - Federal government’s financial support to the regions for the expansion of childcare more than doubled since 2015 (+€1.5 billion).
  - The government’s action plan to address supply shortages (particularly in the affordable segment) adopted last year is progressing in coordination with the responsible regional authorities. However, no action has been taken towards the loosening of height and zoning restrictions in areas under pressure.

### Long-term fiscal sustainability (summary findings from Annex V cited in Annex IV)
- Demographics and projected fiscal impact:
  - Dependency ratios are projected to approach 45–50 percent by 2030 and continue to rise thereafter.
  - Total age-sensitive expenditures are projected to climb by ½–3 percent of GDP by 2030 and by 3–6½ p.p. by 2060.
  - Main upward contributions: pension outlays, 2¼–3½ p.p.; health and long term care expenditures, 1–2¼ p.p.
- Debt and adjustment projections:
  - Recent official estimates show that debt would rise to 75–225 percent of GDP by 2060, with an associated fiscal adjustment need of 1¼–4 percent of GDP, if other expenditures and the revenue ratio stay constant.
- Policy implications and targets:
  - A structural balance of -1.5 percent of GDP (1 p.p. below the current MTO) would still be consistent with a declining debt path in the absence of macro-fiscal shocks; a more conservative minimum fiscal target of -1 percent of GDP (the minimum floor foreseen by the European SGP) is justified by macroeconomic uncertainty.
  - Probabilities that debt remains structurally above the SGP debt ceiling of 60 percent of GDP are: higher than 25 (15) percent in the next 8 (12) years when running larger structural deficits; these probabilities drop to 5 (<1) percent when the structural deficit stays at 1 percent of GDP.
- Role of retirement-age reforms:
  - Staff analysis suggests that a one-year increase in the effective retirement age (with no accompanying increase in the annual benefit accrual) would yield a 0.7 p.p. in pension savings.
  - To fully close the estimated pension gap, the average retirement age would have to rise by 3 to 5 years up to 2060, beyond the already programed rise to age 67 by 2030.
  - To achieve similar savings via payroll-related taxes or social security contributions (SSC) instead of raising the retirement age would require a 1.4 percentage point increase in the tax/SSC rate.
- Caveats:
  - Several reforms have already been implemented in the past to curb health and long-term care spending, limiting the scope for easy savings going forward.
  - Retaining the deficit limits currently foreseen in the national debt brake rule—close to that of the current MTO—is appropriate without further reforms, although accumulating buffers can only delay, not resolve, the long-term sustainability problem.

*Source: Annex IV. Authorities’ Response to Past IMF Policy, cr17192.*

### Annex VI. Authorities’ Response to FSAP 2016 Recommendations

### Annex VI. Authorities’ Response to FSAP 2016 Recommendations

### Financial stability policy framework
- Establish a core set of readily-available, consistent data for banks and non-banks to strengthen financial stability and macroprudential policy analysis. (Short term)
  - The Bundesbank is integrating selected granular supervisory and statistical data of banks, insurance companies and investment funds to build a “house of microdata” that will be used for financial stability and macroprudential policy analysis.
  - The “house of microdata” will be supplemented by AnaCredit data when available.
- Develop the legal basis for real estate-related macroprudential tools. (Short term)
  - The German government passed legislation (Bundesrat, May 12, 2017) that implements part of the FSC’s recommendation of January 2015.
  - The law introduces new instruments for capping LTV ratios and setting amortization requirements, if necessary, for financial stability purposes.
  - The minimum requirements are meant to apply to all financial institutions.
  - The law omits complementary DTI and DSTI ratio instruments and does not address important data requirements for the effective operation of the real estate-related macroprudential instruments.

### Banking oversight
- Implement measures to strengthen the oversight role of the banks’ supervisory board. (Short term)
  - Within the German two-tier system, the supervisory board’s role is passive and restricted to a pure control function.
  - There is no indication that the legislator intends to amend the legal framework.
- Provide guidance on risk management and other supervisory requirements, e.g. regarding loan portfolio management, concentration and related party risk, and operational risk. (Short term)
  - Bundesbank and BaFin are currently following-up on the 2016 FSAP recommendations when reviewing relevant provisions in MaRisk.
  - The authorities consider that concentration risk is sufficiently covered by MaRisk, and further guidance has not been issued.
- Increase granularity and coverage of bank supervisory data. (Short term)
  - Starting in June 2017, all LSIs will report using FINREP templates, increasing the granularity and comprehensiveness of the information available to supervisors.
  - The new reporting standard will also allow to access data at a consolidated level (e.g., NPLs).
  - The requirements have been set on a harmonised basis throughout the SSM-covered countries.
  - National regulatory reporting will remain in place as a necessary complement from a German banking supervisory perspective.
- Increase the effectiveness of the AML/CFT supervisory framework over cross-border banks. (Short term)
  - As of 1 January 2017, BaFin’s AML Department added 30 additional staff (two new divisions for AML/CFT banking supervision).
  - In ongoing AML/CFT supervision BaFin asked banks with cross-border correspondent banking relationships to give more emphasis to this issue in their own risk assessments to avoid that the required enhanced Customer Due Diligence measures lead to a termination of the relevant relationships.
  - A sub-working group of the European Banking Authority ́s AMLC has been set up to work out a framework for future AML/CFT supervisor colleges on all banks with cross-border activities.

### Insurance oversight
- Prepare a communication strategy ahead of the publication of Solvency II indicators. (Short term)
  - BaFin conducted bilateral discussions with LI companies ahead of the publication date of May 21, 2017, but no common communication strategy was decided.
- Extend the application of G-SII toolkit on a risk-based basis to other large groups, including recovery and resolution planning, enhanced supervision and regular stress tests. (Medium term)
  - BaFin has extended the requirement for recovery plans to two other groups headquartered in Germany, beyond the country’s single G-SII.
  - Supervisory teams responsible for the respective groups are in the process of defining the elements of the plans and will review them once they are finalized.
  - BaFin does currently not intend to further extend this requirement to other LI groups.
  - Germany participates in the EIOPA stress testing exercises. In 2016, 20 life insurers covering three quarters of the market participated.
  - Insurers are required to perform additional stress tests as part of their risk and solvency analysis (Insurance Supervision Act, section 27); results are part of narrative reporting to BaFin.
- Communicate supervisory expectations based on the ORSA review more systematically; use Solvency II framework to impose capital add-ons. (Medium term)
  - BaFin gives feedback to LI undertakings following the ORSA review, especially when those do not seem to hold sufficient own funds over and above the SCR.
  - Capital add-ons are not a first resort measure, but the supervisor is ready to set capital add-ons on a case by case basis when pre-conditions are found to be in place under Solvency II.
- Require action plans for companies facing difficulties in meeting Solvency II requirements, including stress testing to ensure that they would be met even after a plausible shock. (Medium term)
  - BaFin monitors progress towards compliance with solvency capital requirements without transition measures and assesses the plausibility and appropriateness of the companies’ plans on a yearly basis.
  - BaFin is thoroughly reviewing internal models, including by developing a new stochastic approach (BSM—Branchensimulationsmodell) that better accounts for embedded options and guarantees of typical LI products.

### Asset management oversight
- Intensify frequency of on-site inspections and enhance risk classification methodology. (Short term)
  - BaFin revised the risk classification methodology for supervised asset managers, and, starting in 2018, will use improved impact criteria.
  - BaFin increased the frequency of on-site inspections from 80 in 2014, to 102 in 2016.
- Introduce stronger rules on reporting of pricing errors and investor compensation rules. (Short term)
  - BaFin published the “Mindestanforderungen an das Risikomanagement von Kapitalverwaltungsgesellschaften” (KAMaRisk) in January 2017.
  - According to chapter 6, no. 3 v) and w) of the KAMaRisk, asset management companies are required to have policies in place (1) to inform depositaries of material pricing errors and (2) to compensate investors in the event of material pricing errors.

### AML/CFT (broader context)
- Recent reforms and supervisory improvements
  - Germany was last assessed against the previous AML/CFT standard in 2009; some shortcomings were identified then.
  - Reforms include criminalizing self-laundering, immobilizing bearer shares, enhanced domestic cooperation, improved supervisory framework for DNFBPs, and improved risk analysis model applied by BaFin for AML/CFT supervision.
  - Onsite visits to financial institutions and DNFBPs have increased.
  - BaFin increased by 30 the staff devoted to AML/CFT supervision and established new units specifically dedicated to the supervision of major banks with cross-border activities.
  - BaFin has started to establish its own audit teams (along external audit teams), increased the number of its onsite inspections of banks, and is planning on-site inspections to be carried out by BaFin-only teams in the medium term.
  - BaFin is adjusting its AML/CFT supervisory framework in line with the European Supervisory Authorities’ joint November 2016 guidelines on risk-based supervision.
  - Germany is working on implementing the Fourth EU AML Directive requirement to establish a register containing information on beneficial ownership of corporate and other legal entities, and of express trusts and legal arrangements having a structure or functions similar to trusts.
  - A draft law implementing this requirement is scheduled to enter into force in June 2017, and to allow for the register to be accessible by competent authorities in December 2017.
  - The next assessment of Germany’s AML/CFT framework is tentatively scheduled to take place in 2021.

### Statistical issues and data adequacy
- General assessment
  - The economic database is generally comprehensive and of high quality, and data provision is adequate for surveillance.
- National Accounts
  - Germany adopted the European System of Accounts 2010 (ESA2010) in September 2014.
  - Sources for estimating value added for a few categories of service industries could be improved.
  - A direct source for quarterly changes in inventories is lacking; extrapolations are based on the difference between the monthly production index and turnover index in manufacturing.
- Government Finance Statistics
  - Comprehensive data reporting systems support accuracy and reliability; however, data are based on cash accounting systems.
  - Documentation exists to explain differences between ESA2010 (noncash) classification and general cash data on an administrative basis.
  - Germany publishes general government revenue, expenditure, and balances on a noncash/accrual basis on a quarterly basis (ESA2010) through Eurostat.
  - These data are presented in GFSM 2001 format in International Financial Statistics, albeit with delay.
  - Monthly data are only disseminated on a cash-basis and are reported to STA.
- Monetary and Financial Statistics
  - The ECB reporting framework is used and data are reported to the IMF through a “gateway” arrangement with the ECB.
  - Monetary statistics for Germany published in the IFS cover data on central bank and other depository corporations (ODCs) using Euro Area wide residency criterion; data based on national residency criterion are published as memorandum items.
- Financial Sector Surveillance
  - Germany participates in the IMF’s CDIS, CPIS and FSI databases.
  - Of the 40 FSIs, Germany reports all except net foreign exchange exposure to equity (I31).
  - Germany reports all 12 core FSIs, but six FSIs are reported on an annual basis only: (i) NPL Net of Provisions to Capital, (ii) NPL to Total Gross Loans, (iii) Return on Assets, (iv) Return on Equity, (v) Interest Margin to Gross Income, and (vi) Non-Interest Expense to Gross Income.
  - Plans are underway to change the legal basis for the periodicity of deposit taking institutions’ reporting requirements.
  - The quality of data on bank exposures submitted to the BIS needs to be improved, including provision of the data on ultimate risk basis for advanced countries.
- External Sector Statistics
  - The Bundesbank compiles the balance of payments in close cooperation with the Federal Statistical Office.
  - Balance of payments, International Investment Position statistics, and related cross-border statistics are compiled according to BPM6 and the legal requirements of the ECB and Eurostat.
- Data standards and quality
  - Adherent to the Special Data Dissemination Standards Plus (SDDS Plus) since February 2015.
  - Currently disseminates a residential property price index and a commercial property price index.
  - Data ROSC from 2006 is available.

### Key procedural and contextual facts
- BaFin added 30 additional staff to its AML Department as of 1 January 2017.
- BaFin increased on-site inspections from 80 in 2014 to 102 in 2016.
- Legislation implementing part of FSC’s recommendation enacted at Bundesrat on May 12, 2017.
- FINREP reporting by all LSIs begins in June 2017.
- Solvency II publication date referenced: May 21, 2017.
- BSM—Branchensimulationsmodell referenced as a new stochastic approach under development.

*Annex VI. Authorities’ Response to FSAP 2016 Recommendations — cr17192*

### introduction of programs to support workers after periods of caring for children or

### introduction of programs to support workers after periods of caring for children or

### Social policies, family support, and labor market activation
- Introduction of programs to support workers after periods of caring for children or relatives as well as the parental allowance with a partnership bonus.
- The supplementary child allowance has been increased.
- Targeted benefits to stabilize the financial position of single parents were introduced.
- Housing benefits reformed in line with the trend in rent and incomes.
- Tackling long-term unemployment has been another priority:
  - Efforts were made to intensify job coaching.
  - Efforts were made to improve wage subsidies.
  - Support was provided for workers who require special support due to health impairments or are living with children in a community of need.

### Education, refugee integration, and digitalization
- Going forward, the authorities recognize that a well-funded education system and the integration of refugees into the labor market are the major challenges for inclusive growth and mitigating relative poverty risks.
- Continued progress is being made on digitalization with several policy initiatives:
  - Promotion of digitization and competence in SMEs.
  - Development of a modern regulatory framework for the digital world.
  - Instruments to support innovation and venture capital, such as the High-Tech Start-up Fund and the INVEST program, are evaluated on a regular basis by external institutions; they certify that measures are successful and funds are used adequately.
- Authorities agree that reducing the regulatory burden in the services sector may lead to an increase in productivity and are scrutinizing regulations for potential productivity gains and for protection of health, safety and consumer interests.

### Fiscal policy, sustainability, and investment
- Fiscal policies will remain growth-friendly and an anchor of stability in the euro area.
- As public debt is gradually approaching the debt ceiling, supporting the sustainability of public finances in the face of demographic challenges and rebuilding buffers for unforeseen developments deserve high priority.
- With a view to long-term demographic challenges it is key to look beyond 2030, as adverse dynamics will accelerate considerably with “baby boomers” entering retirement.
- The national debt brake, which essentially prescribes a close-to-balanced budget, was geared to frontload required consolidation by bringing the debt ratio well below the ceiling of 60 % of GDP.
- It will be important for the aging German society to keep this strategy over the long term.
- The current fiscal stance reflects the favorable cyclical position and growth outlook for Germany.
- Public investment and priority expenditures have been increased substantially in recent years.
- Recent initiatives to address capacity constraints include:
  - Creation of a Federal Infrastructure Corporation for Highways and other Federal Trunk Roads.
  - Greater financial support to subnational governments to allow for better project selection and investment planning going forward.

### Revenue forecasts and institutional framework
- Regarding the Fund’s recommendation towards improved revenue forecasts, several caveats apply:
  - For the long run, empirical evidence indicates that the conditional tax revenue forecasts are not systematically downward biased.
  - There are episodes in which revenue forecasts show upward (early 2000s) or downward bias (recent years); unexpected revenue shortfalls or windfalls play a role.
  - It is not reasonable to project high revenue growth due to windfalls into future years.
  - The methodology is being constantly evaluated and – if possible – improved.
  - Recently, the forecast of the assessed income tax (fraction of PIT) has been augmented by better taking into account the effects of increasing taxation of pensions, which plays an increasing role in the coming years and should lead to higher revenue growth in this tax category.
- Institutional setting for tax revenue forecasts:
  - The working group on tax revenue forecasts is an independent technical working group.
  - Based on individual forecasts by the Ministry of Finance, Deutsche Bundesbank, Research Institutes, Council of Economic Advisers, and Länder the working group decides on a consensual revenue forecast.
  - Forecasters are free in their choice of forecast models.

### External sector, wages, and monetary-normalization implications
- The external sector in Germany remains strong as a result of private demand and supply decisions in international trade and investment.
- The authorities closely observe the high current account surplus.
- Except for a small fiscal policy gap, there are no deviations from desirable policies identified in the EBA exercise for Germany.
- Some additional loosening of fiscal policies is currently being discussed in the run up to the general election in September 2017:
  - Steps to reform pensions as well as reducing the tax burden on labor are envisaged as priorities for the next election period.
- Transitory effects from lower commodity prices and a favorable euro exchange rate will soon cease; these factors as well as brisk domestic demand support the expectation of a reduced external balance in the years to come.
- The sustained increase in investment income reflected in the BoP is fundamentally justified by a rapidly aging population in Germany and greater returns on job-rich investments outside of Germany.
- Continued robust wage and price growth will further strengthen domestic sources of growth:
  - Looking at OECD data, average wages (USD PPPs) in Germany have increased already more strongly than in any other major advanced economy since 2010.
  - Real wage growth has accelerated over the last three years with annual increases close to or above two percent which are the strongest wage gains in over two decades.
  - While wage setting is left to social partners, these developments are likely to persist for the foreseeable future and will support growth and the normalization of monetary policy in the euro area.
  - Staff’s suggestion for a more proactive public communication on wages is not supported by past experience; the decentralized process for wage bargaining is highly valued in Germany and communication by officials has generally been seen as unhelpful interference or a politicizing of negotiations by social partners.

### Housing market, mortgages, and financial sector resilience
- Concurrence with staff report findings on housing market and financial sector assessment:
  - The banking and insurance sectors have to shore up profitability and resilience in a challenging environment with low interest rates and a new regulatory framework.
  - Increases in house prices appear to be driven mainly by fundamentals and the extraordinarily low level of mortgage rates.
  - Continued vigilance is needed especially for certain regional markets that are experiencing rapid price growth.
  - Vigilance is also needed as regards the growth of loans for house purchases, which have picked up in recent months driven by very favorable financing conditions as well as buoyant household demand.
- Commitment to tackle and overcome significant data gaps in the mortgage sector in particular.
- Preference has been given to existing initiatives on the European level, reflecting subsequent efforts following the recommendation of the European Systemic Risk Board in October of 2016 on closing real estate data gaps.

*Source: cr17192 - introduction of programs to support workers after periods of caring for children or*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17192.pdf_