## cr18223 ## Source details **Canonical URL:** [cr18223](https://www.imf.org/-/media/files/publications/cr/2018/cr18223.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18223.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18223.pdf.json) --- ### Macroeconomic Impacts of Brexit - Strength of EU–U.K. links - The United Kingdom accounted for 13 percent of euro area trade in goods and nonfactor services. - Bilateral capital flows (FDI, portfolio investments, bank claims) amounted to some 55 percent of euro area GDP in 2016. - Bilateral migration links particularly important for Cyprus, Ireland, and Malta. - Aggregate EU-27 impact estimates (staff empirical analysis) - Standard FTA scenario: EU-27 real GDP would fall by up to 0.8 percent in the long run relative to the baseline. - WTO rules scenario: EU-27 real GDP would fall by up to 1.5 percent in the long run relative to the baseline. - “Norway” scenario (single market access preserved, customs union membership lost): estimated loss of output is negligible. - Multi-country general equilibrium model (direct and indirect trade effects) - Euro area long-run real output decline: - Standard FTA scenario: -0.3 percent. - “Hard Brexit” (WTO) scenario: -0.5 percent. - Country-level impacts (examples): - Ireland: long-run decline of about 2 percent under standard FTA; up to 4 percent under “hard Brexit” (WTO) scenario. - Other adversely affected countries: Belgium, Luxembourg, Malta, the Netherlands. - Distributional conclusion - No winners from Brexit: higher barriers to trade, capital, and labor mobility produce negative long-term effects on output and employment throughout the EU-27. - Policy-relevant implications - Losses concentrated in countries with strong ties to the United Kingdom (notably Ireland, the Netherlands, and Belgium). - Transmission channels: increased trade barriers, reduced capital flows, diminished labor mobility, supply-chain and indirect trade link effects. - Monetary policy expected to provide demand support; limited fiscal space in high-debt countries may constrain offsetting via investment or stimulus. - Lack of progress in negotiations raises risk of a disruptive exit that would weigh on confidence and investment. ### Euro Area Macroeconomic Context and Outlook - Recovery and labor market - Euro area in its fifth year of recovery with steady job creation. - Overall unemployment fell to 8½ percent in April 2018. - Youth unemployment remains above 20 percent in several countries. - Inflation and wages - Headline inflation spiked to 1.9 percent in May 2018. - Core inflation rose from 0.9 percent in early 2017 to 1.3 percent in May 2018. - Wage growth below 2 percent for most of last six years; latest reading 1.8 percent in Q1 2018. - Among four largest economies, Germany wage growth 2.2 percent in 2017; Italy 0.4 percent in 2017. - Financial sector and credit - Aggregate euro area risk-based tier 1 capital ratio: 15.8 percent as of Q4 2017. - Average return on equity: 5.6 percent (Q4 2017). - NPL ratios averaged about 5 percent; double digits in Greece, Cyprus, Portugal, and Italy. - Bank credit growth: 1.7 percent in 2017. - Short-term outlook and projections - Q1 2018 growth provisional 0.4 percent q/q versus 0.7 percent average quarterly rate in 2017. - Staff growth projections: 2.2 percent for 2018 (revised down by 0.2 percentage points between April and July 2018 WEOs) and 1.9 percent for 2019 (revised down by 0.1 percentage points). - Aggregate output gap projected to close in 2018 and turn positive in 2019. - Medium-term outlook - Potential growth seen settling at around 1½ percent, down from about 2 percent pre-crisis. - Drag factors: demographic changes, weak productivity growth, crisis legacies including ongoing private sector deleveraging. ### Monetary Policy, Inflation Dynamics, and ECB Guidance - Monetary policy guidance - Strong monetary accommodation should be maintained until inflation convincingly converges to objective; premature hikes damaging. - Clear communication and data dependence emphasized. - ECB policy stance and timing - Commitment to keep policy rates at current low levels at least through next summer described as vital. - Ending net asset purchases at end-2018—subject to incoming data confirming medium-term inflation outlook—is warranted. - Governing Council expects key ECB interest rates to remain at present levels at least through the summer of 2019. - Inflation dynamics (Box 2) - Preferred Phillips curve specification includes domestic slack, lagged inflation, and long-term inflation expectations. - Domestic factors dominate global factors; euro area inflation markedly backward looking compared with U.S. - Persistence delays transmission of improving labor markets to prices. - QE wind-down and reinvestments - Forward guidance importance grows as QE is wound down. - Reinvestment strategy should remain anchored to the capital key but calibrated flexibly. - Reinvestment of maturing principal will continue for an extended period after end of net asset purchases at end-2018. ### Financial Vulnerabilities, NPLs, and Supervisory Actions - Banks’ profitability and internal capital generation - Returns on equity remain far below pre-crisis levels. - FSAP analysis: even if real GDP growth in 2016 had been 1 percentage point higher, it would not have restored the least profitable banks (group with €5½ trillion in assets) to healthy profitability without aggressive NPL reductions. - Legacy asset clean-up (NPLs) - NPLs fell by €145 billion in 2017, to near €842 billion; €70 billion reduction in Italy largely from proactive NPL sales by two large banks. - ECB guideline: cover full value of unsecured loans no later than two years, secured loans no later than seven years, after default. - Commission proposal: new unsecured loans fully provisioned no later than two years, new secured loans no later than eight years after nonperforming, with pillar 1 deductions. - Sovereign home bias and diversification - Almost 60 percent of French, German, Italian, and Spanish banking groups’ exposure to euro area sovereigns concentrated in home sovereign securities. - 60–80 percent of French, Italian, and Spanish insurance companies’ investments in sovereign debt are in home-country bonds. - Liability-side resilience and MREL - Minimum burden sharing of 8 percent of total liabilities and equity required before a bank in resolution may receive resolution funds. - Single Resolution Board setting binding MREL requirements; process slow—call for largest banks to issue more capital and junior debt now. - Localized risks and macroprudential stance - ESRB warned Austria, Belgium, Finland, Luxembourg, and the Netherlands about potential housing market overvaluation and pickup in household indebtedness. - Macroprudential recommendations: increase national flexibility, legislate borrower-based tools, strengthen reciprocity arrangements, close data gaps. ### Banking Union, Resolution, and AML - Architectural reforms needed: complete the banking union, advance capital markets union, and create a central fiscal capacity to improve macro stabilization. - Remaining challenges: - Incomplete banking union and fragmentation; national ring-fencing of capital and liquidity persists. - Need for shared financial safety net: staff urges swift progress on creating an ESM credit line to backstop the SRF. - Resolution and crisis management proposals: - Indemnity to protect Eurosystem from credit losses on liquidity to new banks post-resolution. - Harmonize emergency liquidity assistance arrangements; adopt common creditor hierarchy; add administrative liquidation tool; consider financial stability exemption from minimum bail-in for extreme circumstances with strict governance. - AML supervision - Inadequate AML oversight can result in bank failures; FSAP recommends considering an EU-level institution for AML supervision to enhance convergence. ### Capital Markets Union (Box 6) - Objectives - Adopted in 2015; goal to reach completion by 2019. - Core objective: mobilize capital for financial integration complementary to the banking union. - Specific aims: market-based financing for firms including SMEs; regulatory environment for infrastructure; increase investment choices; support securitization; reduce cross-border barriers. - Progress and regulatory measures - More than half of Action Plan items implemented as of mid-point review. - Key developments: new EU Prospectus Regulation (take effect 2019); European Venture Capital Funds Regulation; agreement in principle on a standard for simple, transparent, and standardized securitization. - New action items: framework for covered bonds; reduce regulatory barriers to cross-border fund distribution; action plans on fintech and green finance. - Brexit implications and FSAP recommendations - Brexit adds urgency; migration of nonbank finance to the continent requires upgraded regulatory and supervisory capacity. - FSAP proposals: central warehousing of firms’ financial data, common collateral conventions, steps to minimize double counting on withholding taxes. ### Common Fiscal Capacity (CFC) and EU Budget Issues - Commission CFC proposal: €30 billion (about 0.2 percent of euro area GDP in 2021) central scheme to help protect public investment in face of large asymmetric shocks. - Support modalities: back-to-back loans under EU budget; subsidy to cover interest financed by contributions proportionate to national central banks’ monetary income. - Access conditional on eligibility criteria. - Authorities’ view: back-to-back borrowing–lending scheme prevents permanent transfers more easily than Fund staff’s contribution–transfer scheme, but provides less stabilization. - EU budget considerations - Brexit prompts overhaul of EU budget; 2021–27 proposal envisages streamlining policies to fund new priorities and paring back some agricultural and cohesion outlays. - Revenue mobilization via modernizing and diversifying sources and eliminating rebates to net contributors proposed. - Fiscal guidance - With growth vigorous, opportunity to rebuild buffers; high-debt countries should adjust now. - Large countries with ample fiscal space (notably Germany and the Netherlands) should invest more in infrastructure, education, and R&D. - Commission projections based on unchanged policies indicate slight deterioration in composite structural balance in 2018 and 2019. - Public debt ratios projected to remain above 90 percent of GDP in more than one-third of euro area countries at end-2019. ### Key Macroeconomic and Fiscal Statistics (selected series, exact values) - Real GDP: 2015 2.1, 2016 1.8, 2017 2.4, 2018 2.2, 2019 1.9, 2020 1.7, 2021 1.5, 2022 1.5, 2023 1.4 - Private consumption: 2015 1.8, 2016 2.0, 2017 1.6, 2018 1.5, 2019 1.7, 2020 1.5, 2021 1.5, 2022 1.4, 2023 1.3 - Gross fixed investment: 2015 3.3, 2016 4.6, 2017 3.2, 2018 3.9, 2019 3.6, 2020 2.9, 2021 2.5, 2022 2.3, 2023 2.2 - Exports 3/: 2015 6.4, 2016 3.3, 2017 5.3, 2018 4.7, 2019 4.4, 2020 3.8, 2021 3.6, 2022 3.4, 2023 3.3 - Imports 3/: 2015 6.7, 2016 4.6, 2017 4.3, 2018 4.6, 2019 4.7, 2020 4.2, 2021 3.9, 2022 3.6, 2023 3.6 - Potential GDP: 2015 1.5, 2016 1.3, 2017 1.4, 2018 1.6, 2019 1.6, 2020 1.6, 2021 1.6, 2022 1.5, 2023 1.5 - Output gap: 2015 -1.6, 2016 -1.2, 2017 -0.2, 2018 0.4, 2019 0.8, 2020 0.8, 2021 0.8, 2022 0.7, 2023 0.6 - Unemployment rate 4/: 2015 10.9, 2016 10.0, 2017 9.1, 2018 8.4, 2019 8.0, 2020 7.8, 2021 7.6, 2022 7.5, 2023 7.4 - Consumer prices: 2015 0.0, 2016 0.2, 2017 1.5, 2018 1.7, 2019 1.7, 2020 1.8, 2021 2.0, 2022 2.1, 2023 2.1 - General government balance (percent of GDP): 2015 -2.0, 2016 -1.5, 2017 -0.9, 2018 -0.6, 2019 -0.6, 2020 -0.5, 2021 -0.7, 2022 -0.7, 2023 -0.8 - General government gross debt (percent of GDP): 2015 89.9, 2016 89.0, 2017 86.7, 2018 84.3, 2019 81.8, 2020 79.8, 2021 77.9, 2022 76.1, 2023 74.5 - Current account balance (percent of GDP): 2015 3.2, 2016 3.6, 2017 3.5, 2018 3.2, 2019 3.1, 2020 3.1, 2021 3.0, 2022 3.0, 2023 2.9 - Commission CFC proposal size: €30 billion (about 0.2 percent of euro area GDP in 2021). - NPL stock: near €842 billion at end-2017; reduction of €145 billion in 2017 (including €70 billion in Italy). ### External Sector, REER, and Current Account Assessments - Consolidated current account surplus edged up to 3½ percent of euro area GDP in 2017. - Staff assesses the euro area 2017 average REER gap of -8 to 0 percent. - Flow REER model implies an overvaluation of 2.2 percent in 2017; level REER model suggests an undervaluation of about 2.9 percent. - Country heterogeneity: - Germany: undervaluation of 10–20 percent. - Several small to mid-sized member states: overvaluations of 0–10 percent. - Policy recommendation: net creditor countries should limit excessive surpluses—Germany’s surplus 8 percent of GDP in 2017; the Netherlands’ surplus almost 10 percent of GDP in 2017. ### Risk Assessment Matrix — Selected Risks and Policy Responses - Retreat from cross border integration - Likelihood: Medium; Expected impact: High. - Policy responses: support multilateral rules-based trading system; secure smooth predictable transition to new U.K.–EU relationship. - Policy and geopolitical uncertainties - Likelihood: Medium; Expected impact: High. - Policy responses: rapid refugee integration, temporary costs accommodated within fiscal targets case-by-case, new relocation system for refugees. - Tighter global financial conditions - Likelihood: High; Expected impact: High. - Policy responses: build buffers via structural reforms, balance sheet repair, fiscal consolidation; maintain accommodative ECB stance. - Further pressure on traditional bank business models - Likelihood: Medium; Expected impact: Medium. - Policy responses: strict supervisory monitoring of NPL management, insolvency reform, develop distressed debt markets, consolidation. - Structurally weak growth in key advanced economies; slowdown in China - Likelihood: High; Expected impact: High. - Policy responses: accelerate structural reforms, continue accommodative monetary policy. ### Structural Reforms, Country Highlights, and Staff Recommendations - Reform priorities across countries concentrate on product market reforms, labor market reforms, governance and institutional improvements. - Country highlights (selected recommendations) - France: finalize apprenticeship and professional training reforms; pursue product and service market reforms; reduce public spending and improve efficiency. - Germany: increase labor force participation of women, older workers, and refugees; lower tax wedge for low skilled and women; advance digitalization. - Greece: preserve labor market flexibility; accelerate opening regulated professions; finalize investment licensing overhaul. - Italy: increase competition in product and services markets; implement insolvency and civil justice reforms; align wages with productivity. - Portugal: improve competitiveness and judicial efficiency; link minimum wage increases to productivity growth. - Spain: reduce labor market segmentation; improve ALMPs; foster competition and innovation; strengthen access to finance for start-ups. ### Data, Statistics, and Eurostat/ECB Initiatives - G20 Data Gaps Initiative (DGI-2): work on 20 recommendations; target full implementation by 2021. - SDDS Plus: by April 2018, seven EA countries (and 11 EU Member States overall) adhered. - Timeliness and quality improvements: - Preliminary (T+30) GDP flash estimates introduced April 2016. - EA quarterly sector accounts timeliness improved to around T+94 in 2017. - HICP flash estimates available since January 2017. - AnaCredit first reporting: mid-November 2018 based on data as of September 2018. - New ECB regulation on pension funds statistics: Regulation (EU) 2018/231 (ECB/2018/2), OJ L 45, 17.2.2018; first PF data reporting start by end-2019. - Payment statistics enhancement and other statistical modernization projects underway. *Source: International Monetary Fund — cr18223 (Euro Area Policies and related chapters, excerpts).* ### 1. Macroeconomic Impacts of Brexit _______________________________________________________________7 ### 1. Macroeconomic Impacts of Brexit ### Overview of macroeconomic context (pre-Brexit analysis) - Recovery status and labor market - The euro area is in its fifth year of recovery, with broad-based growth and steady job creation. - Overall unemployment fell to 8½ percent in April 2018, the lowest level since early 2009. - Youth unemployment remains above 20 percent in several countries; net job creation for young adults has been much slower than the overall rate. - Inflation and wages - Headline inflation spiked to 1.9 percent in May 2018 (driven by higher world oil prices). - Core inflation rose from 0.9 percent in early 2017 to 1.3 percent in May 2018. - Wage growth has been below 2 percent for most of the last six years; latest reading was 1.8 percent in Q1 2018. - Among the four largest economies, Germany recorded wage growth of 2.2 percent in 2017; Italy recorded 0.4 percent in 2017. - Financial sector and credit - Aggregate euro area risk-based tier 1 capital ratio was 15.8 percent as of Q4 2017. - Average return on equity was 5.6 percent (Q4 2017). - Non-performing loan (NPL) ratios averaged about 5 percent at present but remain in double digits in Greece, Cyprus, Portugal, and Italy. - Bank credit growth picked up to 1.7 percent in 2017, still below nominal GDP growth. - Short-term outlook - Q1 2018 growth was a provisional 0.4 percent q/q versus an average quarterly rate of 0.7 percent in 2017. - Staff growth projections: 2.2 percent for 2018 (revised down by 0.2 percentage points between April and July 2018 WEOs) and 1.9 percent for 2019 (revised down by 0.1 percentage points). - The aggregate output gap is projected to close in 2018 and turn positive in 2019. - Medium-term outlook - Once cyclical upswing runs its course, growth is expected to ease to an annual rate near 1½ percent. - Drag factors: demographic changes, weak productivity growth, crisis legacies (including ongoing private sector deleveraging in some countries). - Key risks - Domestic: policy inaction on fiscal adjustment and structural reform; political shocks raising sovereign spreads and causing contagion. - Global: rising protectionism and trade tensions with risk of a full-blown trade war; policy cycle mismatches (for example, U.S. monetary normalization). ### Findings specific to Brexit and its macroeconomic impacts - Strength of EU–U.K. links - The United Kingdom accounted for 13 percent of euro area trade in goods and nonfactor services. - Bilateral capital flows (FDI, portfolio investments, bank claims) amounted to some 55 percent of euro area GDP in 2016. - Bilateral migration links are particularly important for Cyprus, Ireland, and Malta. - Aggregate EU-27 impact estimates (staff empirical analysis) - Under a standard free trade agreement (FTA) scenario, EU-27 real GDP would fall by up to 0.8 percent in the long run relative to the baseline. - Under a default to World Trade Organization (WTO) rules scenario, EU-27 real GDP would fall by up to 1.5 percent in the long run relative to the baseline. - Under a “Norway” scenario (single market access preserved, customs union membership lost), the estimated loss of output is negligible. - Multi-country general equilibrium model results (direct and indirect trade effects) - Euro area long-run real output decline: - Standard FTA scenario: -0.3 percent. - “Hard Brexit” (WTO) scenario: -0.5 percent. - Country-level impacts (examples): - Ireland: long-run decline of about 2 percent under standard FTA; up to 4 percent under “hard Brexit” (WTO) scenario. - Other adversely affected countries: Belgium, Luxembourg, Malta, the Netherlands (variable but notable declines). - Distributional conclusion - There are no winners from Brexit: higher barriers to trade, capital, and labor mobility produce negative long-term effects on output and employment throughout the EU-27. ### Scenarios and comparative outcomes - Norway scenario - If access to the single market is preserved while losing customs union membership, estimated output loss is negligible. - FTA scenario - EU-27 real GDP long-run decline: up to 0.8 percent (staff empirical analysis); euro area model: -0.3 percent. - WTO (“hard Brexit”) scenario - EU-27 real GDP long-run decline: up to 1.5 percent (staff empirical analysis); euro area model: -0.5 percent. - Ireland could experience up to a 4 percent decline in output in this scenario. ### Policy-relevant analysis and implications - Concentration of losses - Brexit-related dislocations will cause output and job losses concentrated disproportionately in countries with strong direct and indirect ties to the United Kingdom, notably Ireland, the Netherlands, and Belgium. - Transmission channels - Losses operate through increased trade barriers, reduced capital flows, and diminished labor mobility, plus supply-chain and indirect trade link effects. - Monetary and fiscal context - Monetary policy is expected to continue to provide strong demand support for some time, helping soften the near-term impact. - Limited fiscal space in high-debt countries may constrain capacity to offset Brexit-related shocks via investment or stimulus, especially for productivity-enhancing infrastructure. - Risk management - Given the nontrivial downside scenarios, the report highlights that lack of progress in Brexit negotiations raises the risk of a disruptive exit which would weigh on confidence and investment. - Policy inaction and political shocks could amplify vulnerabilities, including abrupt sovereign spread widening with contagion across the euro area. *International Monetary Fund (chapter content).* ### 17. Potential growth is seen settling at around 1½ percent, down from about 2 percent ### 17. Potential growth is seen settling at around 1½ percent, down from about 2 percent ### Potential growth and drivers - Potential growth is seen settling at around 1½ percent, down from about 2 percent pre-crisis. - Authorities identify weaker contributions from labor supply and capital formation as main culprits. - Population aging is cited as a drag despite rising labor force participation among older segments. - Technological developments such as digitalization and automation add uncertainty to medium-term growth prospects. ### Monetary policy guidance - Strong monetary accommodation should be maintained until inflation is convincingly converging to objective, which could take time given a strong backward-looking element in the euro area inflation process; premature interest rate hikes would be damaging. - Clear communication will be central. Vigilance is needed to ensure that financial stability risks do not begin to take root. ### ECB policy stance and timing - The ECB’s commitment to keep policy rates at their current, extraordinarily low levels at least through next summer is described as vital. - Ending net asset purchases at the end of 2018—subject to incoming data confirming the medium-term inflation outlook—is warranted given strong demand conditions and the dissipation of deflation risks. - Slow progress toward self-sustaining convergence of inflation to the medium-term objective underscores the need for patience, persistence, and prudence. - Raising rates too early could be a costly error—for the euro area, and for the rest of the world, through unwanted demand spillovers. ### Inflation dynamics (Box 2: Understanding Euro Area Inflation Dynamics) - Staff used a Phillips curve framework augmented with global factors; preferred specification includes domestic slack, lagged inflation, and long-term inflation expectations. - Domestic factors dominate global factors in explaining recent inflation dynamics. - Global factors contribute less to inflation developments than domestic factors and did not consistently push inflation down during the "missing inflation" episode. - The domestic Phillips curve still holds; inflation persistence is identified as the main factor behind recent low inflation. - Euro area inflation is found to be markedly backward looking compared with U.S. inflation; persistence delays transmission of improving labor markets to prices. - Potential causes for persistence include long-duration contracts, prevalence of SMEs that are backward looking in wage and price setting, and product market features such as sector-specific regulations and long-term customer relationships. ### Forward guidance and quantitative easing (QE) wind-down - The importance of forward guidance will grow as quantitative easing is wound down; clear communication is essential to anchoring interest rate expectations. - Episodes of volatility in 2017 highlighted sensitivity of financial markets to perceived policy direction changes and the relatively rapid pass-through of short rates to corporate and household borrowing costs. - Future policy actions should be well-telegraphed and gradual to avoid destabilizing surprises. ### Reinvestment strategy and market considerations - The reinvestment strategy should remain anchored to the capital key but can be calibrated flexibly. - The path of reinvestments offers another lever of monetary policy and can help reduce uncertainties arising from changing supplies of sovereign securities across jurisdictions. - Flexibility in reinvestment is advised given unpredictable changes in financial conditions; clear communication will be essential. ### Financial vulnerabilities and macroprudential stance - Emerging pockets of financial vulnerabilities are noted (examples cited: Luxembourg, some German cities, some areas in Portugal and the Netherlands) where demand-supply mismatches drive strong residential or commercial real estate price appreciation. - Corporate debt is outpacing GDP in a few countries, including France, where steps to limit banks’ exposures to highly indebted corporations have been taken. - Various financial conditions indices confirm euro area conditions remain less loose than the global average and within one standard deviation of historical levels. - Policymakers should remain vigilant and move decisively with targeted macroprudential actions where necessary; excesses remain the exception rather than the rule, so the single monetary policy should stay focused on area-wide inflation. ### ECB views on data dependence and balance sheet - The ECB emphasized that future monetary policy will remain data dependent. - The Governing Council expects key ECB interest rates to remain at present levels at least through the summer of 2019 and in any case for as long as necessary to ensure inflation evolution aligns with expectations of sustained convergence toward the ECB’s aim. - ECB staff noted market expectations that first rate hikes could precede balance sheet unwind, with strong transmission through conventional instruments; clear communication is critical. - Reinvestment of maturing principal will continue for an extended period after the end of net asset purchases at the end of 2018; current reinvestment modalities contemplate a relatively neutral approach without willful changes to public-vs.-private composition or active duration management. - Even after net asset purchases end, stock effects would continue to matter. ### Risk reduction and structural resilience - Time to strengthen resilience of the euro area and its growth potential through rebuilding fiscal buffers, improving productivity, addressing external imbalances while maintaining trade openness, and enhancing resilience in banking and finance. - Insufficient policy buffers and deep structural challenges create fragility and stifle opportunity; determined national-level responses are required. ### Fiscal policy findings and recommendations - The sum of 19 projected national fiscal stances suggests a modestly expansionary aggregate impulse this year. - Distribution of national impulses differs from staff advice: countries with ample fiscal space and excessive external surpluses run tighter-than-advised policies, while most high-debt countries postpone adjustment or contemplate expansion as growth stays firm. - With growth remaining vigorous, this is an excellent time to rebuild buffers where lacking; high-debt countries should use the opportunity to adjust now to avoid sharper adjustments later. - Large countries with ample fiscal space (notably Germany and the Netherlands) should invest more in infrastructure, education, and research and development to lift labor force participation and potential growth, incentivize private investment at home, and contribute to external rebalancing. - National budgetary plans are doing too little or moving in the wrong direction; several high-debt countries including Italy, Portugal, and Spain will adjust only slightly or not at all despite closing or positive output gaps. - Better compliance with and enforcement of fiscal rules is needed; the EU’s CSRs for 2018 did not specify required fiscal effort consistent with the SGP and the Commission intends to use a “margin of discretion” in 2018 compliance assessments, which could hurt SGP credibility. - The European Fiscal Board (EFB) recommends simplifying rules to focus on a single operational target and a single fiscal anchor and strengthening incentives by raising reputational costs of noncompliance, including ensuring strong funding, autonomy, and voice for national fiscal councils and the EFB. ### EU budget, corporate taxation, and authorities’ views - Brexit prompts an overhaul of the EU budget; the 2021–27 proposal envisages streamlining existing policies to fund new priority areas (border control, defense, research and innovation, digital economy) and paring back common agricultural and cohesion policy outlays; revenue mobilization via modernizing and diversifying sources and eliminating rebates to net contributors is proposed. - Corporate tax issues are gaining prominence; steps to limit arbitrage (transfer pricing, relocation of intellectual property) are best taken at an international level as digitalization blurs residence concepts. - The Commission has proposed an EU-wide corporate tax base and a digital sales tax; staff view interim and partial solutions as distortionary and prefer an internationally coordinated comprehensive solution. - Commission urges more effort by high-debt countries to rebuild buffers given closing output gaps and continued strong growth; on aggregate this would be consistent with a moderate structural tightening in 2018–19 for the euro area as a whole. - Commission projections based on unchanged policies indicate a slight deterioration in the composite structural balance in both 2018 and 2019, reflecting expected easing in Germany and the Netherlands and little or no adjustment in Belgium, France, Italy, Portugal, and Spain. - Several estimated national budgetary outturns for 2018 (including Belgium, France, Latvia, Italy, Portugal, Slovakia, and Slovenia) risk falling short of SGP requirements. - Public debt ratios are projected to remain above 90 percent of GDP in more than one-third of euro area countries at end-2019. *International Monetary Fund — Euro Area Policies (excerpt).* ### 33. The Commission argued that the available flexibility under the SGP had allowed it to ### cr18223 - 33. The Commission argued that the available flexibility under the SGP had allowed it to ### Stability and Growth Pact (SGP) flexibility and fiscal guidance - The Commission argued that the available flexibility under the SGP had allowed it to strike a good balance between macroeconomic stabilization and debt sustainability. - Its matrix-based approach under the preventive arm considers the cyclical and debt position of each economy and "had served well." - Commission staff noted that all countries could come under the preventive arm by 2019, when Spain is expected to exit the excessive deficit procedure. - Staff added that, over the next two years, cyclical considerations would call for sustained fiscal efforts toward the medium-term objectives. - The Commission agreed SGP compliance and enforcement can be improved, including by simplifying the rules. - For 2019, the CSRs set explicit structural adjustment floors and do not use the margin of discretion. - For countries that have not yet reached their medium-term objective, the CSRs introduce a ceiling on nominal primary expenditure growth consistent with the required minimum structural adjustment—shifting the focus to a simple, transparent benchmark. ### EU budget and tax policy developments - The draft EU budget proposed by the Commission: - Entails more resources for key priorities. - Relies on an increased share of own resources. - Envisages significant savings and efficiency gains. - Budget negotiations will likely take time, with approval requiring unanimity among the EU-27; leaders hope to agree on the main issues before the European Parliament elections in 2019. - On corporate taxation: - Commission staff saw the consolidated tax base as a potentially path-breaking advance. - The digital sales tax is defended as a reasonable interim step ahead of more permanent solutions. ### Structural policies — productivity gaps and reform priorities - Finding: Productivity gaps across countries remain a fundamental threat to euro area cohesion. - Consequences include stalled convergence of per capita incomes, high structural unemployment in some countries, and external imbalances. - Structural reforms are critical to lifting productivity and closing the gaps; staff analysis suggests larger reform gains for countries with lower initial productivity levels (see IMF, 2017). - Strong productivity growth—in excess of nominal wage growth—is needed in lagging economies to reduce unit labor costs and close the competitiveness gap. - Reform focus areas (efforts should concentrate on three areas): - Product market reforms: - Reduce regulatory burden on firms, remove barriers to entry in service markets, encourage innovation and technology diffusion. - Further progress in implementing the EU single market strategy in services, energy, the digital market, and transportation is important. - Shield the vulnerable from transition costs and ensure inclusiveness of reform benefits. - Properly done, product market reforms can help generate national fiscal space. - Labor market reforms: - High youth unemployment remains an issue (see companion chapter “Youth Unemployment during the Euro Area Economic Recovery”). - Shift taxes away from labor, encourage apprenticeship programs, implement well-designed active labor market policies. - Better align wages with productivity; ensure quality education and training are accessible and well-tailored. - Modernize social safety nets to reduce disincentives to work and help adaptation to globalization, technology, and a shift from tangibles to intangibles. - Governance and institutions: - Enhance public administrative capacity, procurement frameworks, and the effectiveness of justice systems to increase reform benefits. ### Reform delivery, progress, and incentives - Regrettably, structural reform delivery has been uneven: - In France, last year’s labor market and tax reforms are expected to boost employment, investment and growth; the policy agenda remains ambitious. - In several other countries, reform implementation has slowed; progress on implementing CSRs has slipped, with product market reforms being an area of especially poor delivery. - National implementation of the 2015 EU single market strategy remains halting. - Some progress in the energy union project and the digital single market (e.g., elimination of roaming charges and geo-blocking) but limited progress on EU standardization policy in IT. - Linking EU financial support to reform implementation could improve incentives: - The Commission proposed a new reform delivery tool to bring direct financial support to national reform efforts. - More funding for standing technical assistance under the Structural Reform Support Program is mooted. ### Capitalizing on knowledge-based capital (Box 4) - Investment in intangibles has risen: - Share of investment in intangibles in Europe increased from about 10 percent of gross fixed capital formation in the early 1990s to close to 20 percent in more recent years. - The bulk of the increase took place in the manufacturing and service trade sectors. - The gap with the U.S. remains substantial. - Empirical findings: - Intangible capital is strongly and positively correlated with sectoral productivity. - Intangible capital is negatively correlated with employment, suggesting substitution effects and potential efficiency-driven employment losses. - Policy implications: - Remove structural impediments in labor and product markets and broaden access to finance (for instance, via the capital markets union initiative) to sustain productivity and benefit job creation. - Focus on education and adult learning policies and strengthen social safety nets to alleviate adjustment burdens on vulnerable groups and help capitalize on knowledge-based capital without fueling social discontent and populism. ### Authorities’ views on structural reform - Authorities agreed on the pressing need to step up structural reforms. - Commission staff noted that despite streamlining CSRs starting in 2011, implementation continues to fall short: - Some or substantial progress was made on only about half of the 2017 CSRs. - A multi-annual assessment covering 2011–17 found that more than two-thirds of the CSRs have seen at least some progress. - For 2018–19, the Commission has sought to streamline CSRs further, focus on medium-term challenges, and step up dialogue with stakeholders. - The proposed reform delivery tool aims to cushion short-term costs, build country ownership, and link financial support closely to milestones and targets laid out in countries’ reform proposals. - The Commission is working closely with national productivity boards to build consensus for reforms. ### External sector policies and current account positions - 2017 external position summary: - The consolidated current account surplus edged up to 3½ percent of euro area GDP. - The real effective exchange rate (REER) appreciated modestly, by about 1.6 percent. - The cyclically adjusted current account balance for 2017 is estimated at 3.4 percent of GDP, yielding a gap of 1.3 percent of GDP relative to staff’s estimated “norm.” - The REER was assessed to be broadly in line with fundamentals in 2017, exhibiting a small undervaluation of about 4 percent. - Policy recommendation: - Net creditor countries should take steps to limit excessive current account surpluses. - Germany’s surplus reached 8 percent of GDP in 2017. - The Netherlands’ surplus was almost 10 percent of GDP. - Main causes: excess savings relative to investment in the nonfinancial corporate and household sectors; government balances play a relatively smaller role. - Net creditor countries should use some of their ample fiscal space to finance well-targeted reforms and investments and gear public communications toward encouraging more rapid wage growth to facilitate relative price adjustment. - Trade and multilateralism: - The EU should stay committed to free trade and the rules-based global trading system. - The U.S. imposed tariffs on steel and aluminum from the EU on June 1, 2018; the EU requested a WTO dispute settlement consultation on June 1 and on June 20 adopted rebalancing measures targeting U.S. products with additional duties. - Staff cautions against further escalation and deviations from the rules-based system; EU and partners should work constructively to reduce trade barriers and resolve disagreements through the WTO. - Policies to spread trade gains: - Upgrade education systems, provide vocational training, assist with job search. - Help hard-hit regions and communities; strengthen safety nets including unemployment insurance, health benefits, and portable pensions. ### Authorities’ views on external sector and trade - Authorities stressed the centrality of national actions to tackle external imbalances. - The ECB assesses the consolidated external position of the euro area and the REER as broadly in line with fundamentals in 2017. - The Commission considers the current account surplus as being stronger than implied by fundamentals. - Authorities emphasized corrective policies by large net external creditor countries and further competitiveness efforts by net debtor countries. - Authorities reiterated commitment to free trade and the rules-based system, calling for modernization of WTO rules to address non-market distortions and protesting unilateral measures that jeopardize the system. - Commission staff assess the EU response to U.S. steel and aluminum tariffs to be WTO compliant; any further measures would likewise remain within the rules. - The EU plans to use initiatives such as the European Pillar of Social Rights, the European Globalization Adjustment Fund, and the Structural and Cohesion Fund—supported by pro-growth and pro-jobs national policies—to spread trade benefits more equally. ### Financial sector policies and banking health - Health of SSM-supervised banks: - The subset of SSM-supervised “significant institutions” still beset by double-digit NPL ratios, price-to-book ratios below 0.5, or both accounts for a fifth of significant institutions’ aggregate assets, down from over a quarter in 2016. - FSAP findings: - A stress test of 29 large SSM-supervised banks conducted as part of the first FSAP exercise for the euro area suggests both credit and market risk factors remain significant, with some banks more vulnerable than others. - The FSAP calls for closer inter-agency coordination and data sharing, including to facilitate earlier intervention in problem banks. *International Monetary Fund (content unit cr18223).* ### 49. Supervisory actions can and should push ### 49. Supervisory actions can and should push ### Banks’ profitability and internal capital generation - Banks’ returns on equity remain far below pre-crisis levels, reflecting deep structural issues including overbanking (staff numbers and branch networks) and unviable business models in some cases. - In some countries, low profitability also reflects still-high NPL burdens. - An FSAP empirical analysis of 109 SSM-supervised banks finds that even if real GDP growth in 2016 had been 1 percentage point higher than the actual outturn, it would not have restored the least profitable banks (a group with €5½ trillion in assets) to healthy profitability without aggressive reductions in NPLs. - Finding underscores the role of NPL reduction and the need for strong supervision to improve internal capital generation. ### Legacy asset clean-up (NPLs) - NPLs fell by €145 billion in 2017, to near €842 billion, with a €70 billion reduction in Italy largely reflecting proactive NPL sales by two large banks. - Many banks still have double-digit NPL ratios and low provisioning coverage by international standards, necessitating intense supervisory pressure. - FSAP recommendations to energize NPL restructuring and disposal: - Set demanding timelines for provisioning and charge-off. - Impose stricter valuation rules for immovable collateral. - Support more consistent reporting. - Pursue parallel efforts to set minimum standards for national insolvency laws and creditor rights regimes. - ECB’s supervisory addendum on provisioning expectations and the Commission’s policy package on NPLs (including measures to develop a pan-European secondary market) are steps in the right direction. ### Recent policy proposals on NPLs (Box 5) - Commission proposals: - Amend the Capital Requirements Regulation: require that new unsecured loans be fully provisioned no later than two years, and new secured loans no later than eight years, after they become nonperforming, with concomitant pillar 1 deductions from banks’ own funds. - Directive on credit servicers, credit purchasers, and collateral recovery to provide efficient out-of-court value recovery mechanisms and push development of distressed debt markets. - Guide EU member states on national asset management companies, clarifying that under exceptional circumstances, state aid may be permissible. - ECB guideline: - Sets provisioning expectations for all loans that become nonperforming going forward. - Expectation as part of supervisory dialogue: cover full value of unsecured loans no later than two years, and secured loans no later than seven years, after default, with more ambitious interim expectations than the Commission’s binding requirements. - Provisioning shortfalls could incur pillar 2 add-ons from 2021 onward. - FSAP recommendation: give the ECB broad powers to adjust loan classification rules and regulatory provisioning requirements. ### Sovereign home bias and diversification - Almost 60 percent of French, German, Italian, and Spanish banking groups’ exposure to euro area sovereigns is concentrated in securities issued by the home sovereign. - Similarly, 60–80 percent of French, Italian, and Spanish insurance companies’ investments in sovereign debt are in home-country bonds. - Proposals to reduce home bias (examples): - Concentration charges. - Sovereign risk weights. - Risk-based premia for common deposit insurance. - Such proposals warrant careful consideration with attention to transition risks. ### Safe asset and sovereign bond-backed securities - A euro area safe asset could, in principle, help intermediaries diversify balance sheets. - One proposal by an ESRB high-level task force: sovereign bond-backed securities—collateralized debt obligations backed by a portfolio of sovereign bonds of all euro area member states, issued in three tranches. - Proposal depends on harmonization of regulatory capital treatment of banks’ exposures to these asset-backed securities vis-à-vis sovereign debt, which the Commission is proposing. - Viability and market uptake of the three tranches remain to be seen. ### Liability-side resilience: MREL and bail-in-able debt - New EU bank resolution framework requires minimum burden sharing of 8 percent of total liabilities and equity before a bank in resolution may receive any resolution funds. - Single Resolution Board is setting binding minimum requirements for own funds and eligible liabilities (MREL), initially as “external MREL” at ultimate parent level and later including “internal MREL” at subsidiary level. - Process of setting requirements is slow; supervisors and resolution authorities should push the largest banks to issue more capital and junior debt now given supportive financial conditions, while remaining alert to cross holdings of MREL among banks and uneven profitability impacts. ### Localized financial stability risks and macroprudential policy - ESRB warned Austria, Belgium, Finland, Luxembourg, and the Netherlands about potential housing market overvaluation and recent pick-up in household indebtedness. - Several countries have tightened bank- or borrower-based tools in response. - Risks in nonbank financial intermediaries warrant careful monitoring, especially where there is leveraged maturity transformation; significant data gaps remain. - FSAP recommendations on macroprudential framework include: - Increase national authorities’ flexibility. - Improve transparency of ESRB warnings and ECB decisions on top-ups. - Legislate borrower-based tools. - Strengthen reciprocity arrangements. - Close data gaps in commercial real estate and shadow banking. ### Authorities’ views (supervision, NPLs, safe asset, MREL, macroprudential) - ECB supervisory approach: - Pushes banks to improve profitability; supervisory pressure complements market discipline. - Tools include onsite inspections assessing profit sources and product pricing, public communications on SSM stance, offsite monitoring scoring profitability prospects, and pillar 2 requirements reflecting business model challenges. - ECB view on NPLs: - Many banks’ NPL reduction strategies are not ambitious enough. - Aggregate NPL ratio for the euro area is declining but projected not to reach 3½ percent until 2026. - Many banks may face NPL sales receipts below net book value and under-provisioning; many lack adequate workout capacity, leaving disposals as the main clean-up plank. - Safe asset: - Authorities cautious about raising expectations; Commission’s legislative proposal seeks to remove regulatory impediments to origination of sovereign bond-backed securities and address regulatory capital treatment. - Both Commission and ECB agree a true euro area safe asset is desirable but will require more work and market testing. - MREL issuance: - Broad support for accelerating MREL issuance by the largest banks. - Commission legislative proposal to harmonize MREL norms with the international standard for total loss absorbing capacity, and to embed them in pillar 1 for G-SIIs; draft rules in negotiation propose similar treatment, with lower calibration, for other top-tier banks above a certain size. - Authorities agree MREL issuance should be expedited with transition periods reflecting market access and market capacity challenges. - Macroprudential deployment: - ESRB flagged overheating risks in 15 EU countries (corporate debt, real estate prices, or both); only France has deployed macroprudential tools to curb corporate credit. - Data paucity on commercial real estate is a major challenge likely to take years to close. ### Banking union and broader architecture - Architectural reforms needed: complete the banking union, advance capital markets union, and create a central fiscal capacity to improve macro stabilization—each to combine risk sharing and risk reduction. - Progress to date: - Considerable risk reduction achieved: improvements in capital levels and quality, reductions in legacy assets, some efficiency gains. - Banking supervision quality improved with creation of the SSM. - Remaining challenges: - Incomplete banking union and fragmentation: national authorities still favor ring-fencing of capital and liquidity; national legal provisions fragment centralized supervision in areas where SSM/SRM directives are weak or silent (examples: related party lending limits, loan classification and provisioning, corporate governance oversight, sanctions). - Need for a shared financial safety net: staff urges swift progress on creating an ESM credit line to backstop the Single Resolution Fund (SRF), which even at steady state in 2024 will not be sufficient for serious systemic disturbances. - Staff urges agreement on a risk-reduction roadmap to common deposit insurance with possible targets for banks’ capital, junior debt, and NPLs, and regulations on banks’ sovereign bond holdings. - Resolution and crisis management improvements proposed: - Establish an indemnity to protect the Eurosystem from credit losses on liquidity provision to new banks post-resolution. - Harmonize and centralize arrangements for emergency liquidity assistance. - Adopt a common creditor hierarchy for bank liquidation. - Align loss-sharing requirements so no creditor is better off in liquidation than in resolution. - Add an administrative liquidation tool to the resolution toolkit. - Create a financial stability exemption from minimum bail-in for extreme circumstances, with stringent governance to prevent misuse. - Anti-money laundering (AML) supervision: - Recent experience in Latvia shows inadequate or uneven AML oversight can result in bank failures. - FSAP recommends considering an EU-level institution responsible for aspects of AML supervision to enhance convergence. *Source: IMF staff report (cr18223 - 49. Supervisory actions can and should push).* ### Box 6. Specific Steps Toward Capital Markets Union ### Box 6. Specific Steps Toward Capital Markets Union ### Objectives of the Capital Markets Union Action Plan - Adopted in 2015; goal to reach completion by 2019. - Core objective: help mobilize capital for financial integration in the EU as a complement to the banking union. - Specific aims: - (i) provide more market-based financing options for firms, including SMEs, to gradually reduce dependence on loans from banks and nonbank financial intermediaries; - (ii) ensure an appropriate regulatory environment for long-term infrastructure investment; - (iii) increase investment choices for retail and institutional investors; - (iv) support securitization markets; and - (v) reduce cross border barriers to a unified EU capital market. ### Progress to date and recent regulatory measures - Last year’s mid-point review found that more than half of the Action Plan’s individual items had been implemented. - Key developments: - A new EU Prospectus Regulation, to take effect in 2019, enhances cross border comparability of firms’ financial statements, with ESMA planning to set up an EU-wide online prospectus database. - The European Venture Capital Funds Regulation supports financing for start-ups. - Agreement in principle by the European Parliament and the EU Council on a standard for simple, transparent, and standardized securitization could help SMEs tap market financing. - New action items (proposals floated in early 2018) include: - an enabling framework for covered bonds; - measures to reduce regulatory barriers to the cross border distribution of investment funds in the EU; and - action plans on fintech and green finance. - Intersection with NPLs: steps to develop distressed debt markets and strengthen secured lenders’ ability to attach collateral are being pursued in coordination with the EU Council’s Action Plan on NPLs. ### Brexit implications and FSAP recommendations - Brexit adds urgency and a slew of new priorities to the capital markets project; to the extent nonbank finance migrates to the continent, an upgrade of regulatory and supervisory resources and capacities will be essential for the EU-27. - The FSAP recommends the EU-27 anchor its strategy on investor needs, including by addressing: - national variations in financial reports that impede comparability; - barriers to accessing collateral that hurt secured funding; and - procedures for withholding tax refunds that deter cross border investment. - Specific measures proposed by FSAP: - central warehousing of firms’ financial data with some smoothing of accounting differences; - common collateral conventions; and - steps to minimize double counting on withholding taxes. - On withholding taxes, the European Commission has recently released new guidelines that aim to reduce costs and simplify procedures for cross border investors in the EU. ### Key policy implications and priorities - Complete remaining Action Plan items to expand market-based financing alternatives for firms, especially SMEs. - Strengthen regulatory infrastructure to support cross border investment, including data comparability, collateral frameworks, and tax refund procedures. - Coordinate new initiatives (covered bonds framework, cross border fund distribution, fintech, green finance) with broader efforts to reduce NPLs and develop distressed debt markets. - Prepare supervisory and regulatory capacity enhancements across the EU-27 to manage migration of financial activity post-Brexit. *International Monetary Fund — Box 6. Specific Steps Toward Capital Markets Union* ### 78. The authorities agreed that a CFC would complement national fiscal policies in ### cr18223 - 78. The authorities agreed that a CFC would complement national fiscal policies in ### Common Fiscal Capacity (CFC) proposal and design - Commission proposal as part of the EU budget for 2021–27: a €30 billion (about 0.2 percent of euro area GDP in 2021) central scheme to help countries protect public investment in the face of large asymmetric shocks. - Support modalities: - Back-to-back loans under the EU budget. - A subsidy to cover interest, financed by contributions from member states proportionate to their national central banks’ monetary income. - Access conditional on a number of eligibility criteria. - Possible complement over time by additional means outside the EU budget, including: - A possible role for the ESM loans. - A possible insurance mechanism to be set up by member states. - Authorities’ view: their borrowing–lending scheme would prevent permanent transfers more easily than Fund staff’s proposed contribution–transfer scheme, while providing less stabilization given its smaller size. ### ESM reform and institutional context - ESM reform is under active discussion; the Commission has proposed how to create a European Monetary Fund. - No consensus yet among member states to integrate the ESM into the EU framework. - Targeted reform of the ESM’s role would require changes to the ESM Treaty and national parliament ratifications. - Commission reminder: Treaties’ attribution of competences and tasks to EU institutions (the EU Council and the Commission), including for economic surveillance, needs to be respected. - On debt sustainability: the Commission rejected any automatic or mechanical approach to its assessments and consequent decisions, given the repercussions on financial stability. ### Staff appraisal — macroeconomic context and policy priorities (paragraphs 80–89) - Overall opportunity: - The continuing expansion offers a good opportunity to build resilience, lift growth potential, and deepen the currency union. - Despite signs that growth has peaked, the recovery remains strong. - Countries should tackle structural challenges, build buffers, and rebalance externally. - Respecting shared fiscal rules and pursuing structural reforms is central to cohesion, trust, and further architectural advances. - Key risks: - Ascendance of trade protectionism is deeply worrisome. - Policy complacency and the risk of political shocks could hurt debt sustainability and push up borrowing costs across the union. - Lack of progress in Brexit negotiations raises risk of a disruptive exit. - Monetary policy guidance: - Monetary policy needs to stay accommodative until inflation is convincingly converging to objective. - Positive output gaps and tightening labor markets will eventually lift inflation; this will take time given a strong backward-looking element in the euro area inflation process. - The ECB’s commitment to keep policy rates low through mid-2019, and beyond if necessary, is vital. - Clear communication is becoming ever more important. - Fiscal policy guidance: - National fiscal policies must be tailored to rebuilding buffers or boosting investment as country-specific conditions require. - High-debt countries must ramp up fiscal efforts while conditions remain supportive. - Large net external creditor countries with ample fiscal space and excessive current account surpluses should increase public investment in infrastructure, education, and innovation to incentivize more private investment at home. - Fiscal rules and enforcement: - Better compliance with and enforcement of the fiscal rules is needed; enforcement by responsible EU institutions has been too lenient. - As output gaps close, the case for a flexible interpretation of the fiscal rules weakens. - Strict compliance with the SGP will help rebuild buffers and ensure debt sustainability. - Simplifying the rules would support discipline in both compliance and enforcement. - Structural reforms: - Critical to lifting productivity and creating job opportunities in many countries. - Product and labor market reforms should be energized to improve resilience, boost potential growth, and close competitiveness gaps. - Linking EU financial and technical support to structural reform implementation can improve incentives. - External rebalancing and trade openness: - Policy response should center on fiscal policy actions—especially measures that would raise the returns to private investment at home—in large net creditor countries where current account surpluses are persistently excessive. - Architectural advances that support credit flows and investment are also part of the remedy. - Trade openness must be preserved, with unwavering commitment to the rules-based global trading system. - Banking and finance: - Risk reduction momentum should be maintained. - FSAP finds resilience of large euro area banks has improved, albeit with some banks vulnerable to credit, market, or liquidity risks. - Low profitability remains a serious challenge, calling for sustained supervisory pressure. - Legacy asset clean-up should be taken to the finish line; MREL issuance needs to be stepped up at the largest banks. - Consider steps to encourage reduction of home bias in banks’ sovereign exposures, with attention to transition risks. - Architectural reforms for collective resilience: - Focus on completing the banking union, advancing the capital markets union, and building consensus for meaningful public risk sharing. - Creating a borderless banking market requires less legal fragmentation, an improved resolution framework, and a shared financial safety net with common deposit insurance and a backstop to the SRF. - Brexit increases the urgency of capital markets union and cross-border regulatory cooperation. - Better macro stabilization calls for a well-designed CFC, with strong safeguards against permanent transfers and moral hazard. - Process note: - Proposed next consultation on euro area policies in the context of Article IV obligations to follow the standard 12-month cycle. ### Key statistics and indicators (as reported) - Commission CFC proposal size: €30 billion (about 0.2 percent of euro area GDP in 2021). - Table highlights (selected series, exact values preserved from source): - Real GDP: 2015 2.1, 2016 1.8, 2017 2.4, 2018 2.2, 2019 1.9, 2020 1.7, 2021 1.5, 2022 1.5, 2023 1.4 - Private consumption: 2015 1.8, 2016 2.0, 2017 1.6, 2018 1.5, 2019 1.7, 2020 1.5, 2021 1.5, 2022 1.4, 2023 1.3 - Gross fixed investment: 2015 3.3, 2016 4.6, 2017 3.2, 2018 3.9, 2019 3.6, 2020 2.9, 2021 2.5, 2022 2.3, 2023 2.2 - Exports 3/: 2015 6.4, 2016 3.3, 2017 5.3, 2018 4.7, 2019 4.4, 2020 3.8, 2021 3.6, 2022 3.4, 2023 3.3 - Imports 3/: 2015 6.7, 2016 4.6, 2017 4.3, 2018 4.6, 2019 4.7, 2020 4.2, 2021 3.9, 2022 3.6, 2023 3.6 - Potential GDP: 2015 1.5, 2016 1.3, 2017 1.4, 2018 1.6, 2019 1.6, 2020 1.6, 2021 1.6, 2022 1.5, 2023 1.5 - Output gap: 2015 -1.6, 2016 -1.2, 2017 -0.2, 2018 0.4, 2019 0.8, 2020 0.8, 2021 0.8, 2022 0.7, 2023 0.6 - Unemployment rate 4/: 2015 10.9, 2016 10.0, 2017 9.1, 2018 8.4, 2019 8.0, 2020 7.8, 2021 7.6, 2022 7.5, 2023 7.4 - Consumer prices: 2015 0.0, 2016 0.2, 2017 1.5, 2018 1.7, 2019 1.7, 2020 1.8, 2021 2.0, 2022 2.1, 2023 2.1 - General government balance (percent of GDP): 2015 -2.0, 2016 -1.5, 2017 -0.9, 2018 -0.6, 2019 -0.6, 2020 -0.5, 2021 -0.7, 2022 -0.7, 2023 -0.8 - General government gross debt (percent of GDP): 2015 89.9, 2016 89.0, 2017 86.7, 2018 84.3, 2019 81.8, 2020 79.8, 2021 77.9, 2022 76.1, 2023 74.5 - Current account balance (percent of GDP): 2015 3.2, 2016 3.6, 2017 3.5, 2018 3.2, 2019 3.1, 2020 3.1, 2021 3.0, 2022 3.0, 2023 2.9 - External sector assessments and current account details: - NIIP recovered from about -18 percent of GDP by end-2008 to around -1 percent by end-2017. - Gross foreign positions in 2017: assets about 221 percent of GDP, liabilities about 222 percent of GDP. - Current account (CA) 2017: Actual CA 3.5 (percent of GDP); Cycl. Adj. CA 3.4; EBA CA Norm 1.5; EBA CA Gap 1.9. - Staff assessment: Staff Adj. 0.6; Staff CA Gap 1.3; staff assess the CA gap to be 1.3 percent, with a range of 0.6 to 2.0 percent of GDP for 2017. - Real exchange rate movements: - CPI-based REER appreciated by about 1.6 percent from 2016 to 2017. - Nominal appreciation about 2.1 percent. - Estimates through May 2018 show REER has appreciated by 2.2 percent relative to the 2017 average. *Source: IMF staff report (Euro Area Policies section, excerpts as provided).* ### 2.2 percent in 2017, while the level REER model ### 2.2 percent in 2017, while the level REER model ### Aggregate REER and Current Account (CA) assessment - Staff assesses the euro area 2017 average real exchange rate gap of -8 to 0 percent. - The flow REER model implies an overvaluation of 2.2 percent in 2017, while the level REER model suggests an undervaluation of about 2.9 percent. - The aggregate masks large heterogeneity in REER gaps across euro area member states: - Germany: undervaluation of 10–20 percent. - Several small to mid-sized euro area member states: overvaluations of 0–10 percent. - Policy implication: continuing need for net debtor countries to improve external competitiveness and for net creditor countries to boost domestic demand. ### Capital and financial accounts: flows and policy drivers - Background: - Mirroring the 2017 CA surplus, the euro area experienced net capital outflows, largely driven by portfolio debt and FDI outflows. - Outflows were somewhat tempered by inflows into portfolio equity and loans and other bank-related instruments. - The geography of gross capital inflows shifted with the global financial and sovereign debt crises, with inflows from the core euro area economies into the rest of the euro area diminishing. - Assessment: - Capital outflows in portfolio debt and inflows into portfolio equity over the past couple years likely arose in large part from the ECB’s monetary accommodation through its asset purchase program, which has lowered yields on debt and spurred interest in equity. ### FX intervention and reserves level - Background: - The euro has the status of a global reserve currency. - Assessment: - Reserves held by euro area economies are typically low relative to standard metrics, but the currency is free floating. ### Technical background notes - The IMF EBA analysis for the euro area covers 11 euro area members, which are Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain. - The assessments of CA and REER gaps for the euro area are derived from GDP-weighted averages of the assessments of the individual countries listed above. - When applying GDP-weighted aggregation for the euro area, the CA is corrected for reporting discrepancies in intra-area transactions, as the CA of the entire euro area is about ½ percent of GDP less than the sum of the individual 11 countries' CA balances. ### Risk Assessment Matrix — selected risks, impacts, and policy responses - Retreat from cross border integration - Likelihood: Medium - Expected impact: High - Expected effects: - A retaliatory cycle of trade restrictions; undermining of the rules-based international trading system. - Lower growth due to trade barriers. - Increased investor uncertainty, exacerbating low investment and weak productivity. - Rise in euro skepticism, leading to less cooperation and a reversal of integration. - Policy responses: - Continued support for the multilateral rules-based trading system, trade liberalization and free trade agreements. - Re-double efforts to secure the benefits of economic integration and cooperation across the EU. - Strong collaboration to ensure smooth and predictable transition to a new economic relationship between the U.K. and the EU. - Policy and geopolitical uncertainties - Likelihood: Medium - Expected impact: High - Expected effects: - Global spillovers from two-sided risks to U.S. growth; uncertainties about the impact of the tax bill; uncertainty associated with negotiating post-Brexit arrangements and evolving political processes in some European countries. - Intensification of security dislocation could lead to sharp rise in migrant flows into Europe. - New geopolitical flashpoints could lead to socio-economic disruptions. - Policy responses: - Rapid integration of refugees into host country labor markets. - Temporary costs related to refugee expenditures should be accommodated within current fiscal targets on a case-by-case basis. - A new system to relocate refugees is needed to reduce the burden on frontline countries. - Tighter global financial conditions - Likelihood: High - Expected impact: High - Expected effects: - An abrupt change in global risk appetite could lead to sudden, sharp increases in interest rates and associated tightening of financial conditions. - Highly indebted countries could face higher borrowing costs. - Loss of market confidence, negative shocks to growth, worsening an already weak growth outlook. - Policy responses: - To build buffers against adverse shocks, structural reforms, balance sheet repair and fiscal consolidation are needed in high-debt countries. - The ECB’s monetary policy stance should remain accommodative and remain focused on its euro area-wide medium-term price stability objective. - Further pressure on traditional bank business models - Likelihood: Medium - Expected impact: Medium - Expected effects: - Legacy problems and potential competition from nonbanks curtail banks’ profitability, which could lead to financial distress in one or more major banks. - Such an event could reverberate through the entire financial sector and widen sovereign yields spreads within the banking union. - Policy responses: - The ECB’s new guidance on NPL management should be followed with strict supervisory monitoring of all banks. - Insolvency reform, further development of distressed debt markets, cost cutting, and banking system consolidation would facilitate the sector’s adjustment. - Euro area insurance sector stress from low interest rates - Likelihood: Low - Expected impact: Low - Expected effects: - Stress on life insurer balance sheets due to investment returns falling below minimum return guarantees. - Absent a unified supervisory or resolution regime, the failure of a number of mid-size insurers could be a funding risk for domestic sovereigns in some countries. - Policy responses: - Restrict use of new guarantee-based products, review rates on existing products, and transition to unit-linked instruments, review business models or consolidate through M&As. - Some insurers may need additional capital based on EONIA stress tests. Transition to Solvency II framework requires periodic review and regular system-wide stress testing. - Structurally weak growth in key advanced economies; significant slowdown in China and its spillovers - Likelihood: High - Expected impact: High - Expected effects: - Low productivity growth, failure to fully address crisis legacies and undertake structural reforms, and persistently low inflation undermine medium-term growth. - Too fast an adjustment and improper sequencing of actions in China to “de-risk” the financial system may weigh on near-term growth (Low). Over the medium term, overly ambitious growth targets lead to unsustainable policies and a sharp adjustment would weaken demand with adverse international spillovers (Medium). - Lower growth potential and higher output gaps compared to baseline; further deterioration in public debt sustainability and private balance sheets; intra-euro area rebalancing. - Policy responses: - Accelerate structural reforms to spur investment, productivity and competitiveness, advance rebalancing of bank, corporate, and household balance sheets to enhance monetary transmission. - Continue accommodative monetary policy to raise inflation and support demand. - Note on likelihood labels: “Low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more. ### Structural reform plans and progress — selected country highlights and staff recommendations - France - Reform priorities: Improve functioning of the labor market, improve business environment and competition in service sectors, reform government spending to put debt on a firm downward path and attain MTO. - Recent progress: - Key reforms of the labor code in 2017 (limiting automatic extension of branch-level agreements; reducing judicial uncertainty surrounding dismissals; simplifying social dialogue). - 2018 budget tax reforms supporting investment and job creation, lowering the tax wedge in a budget-neutral way, reducing the CIT gradually, simplifying capital taxation. - Previous reforms (2015–16) include liberalization measures and expansion of Competition Authority competencies. - Staff recommendations: - Finalize and implement planned reforms of apprenticeship and professional training systems; consider (i) expanding firm-level flexibility in setting base wages, (ii) reforming minimum wage mechanism, (iii) improving professional high-schools and pre-apprenticeship programs, (iv) strengthening unemployment insurance incentives to work. - Pursue product and service market reforms (open railway sector, reduce administrative burden, liberalize regulated professions). - Provide specific plans to reduce public spending while increasing efficiency (target social transfers, improve health spending efficiency, rationalize tax expenditures, simplify pensions and raise effective retirement age, reform public administration, limit local government spending, merge municipalities). - Germany - Reform priorities: Increase labor force participation of women, older workers, and refugees; facilitate immigration of qualified workers; increase productivity and competition, especially services; advance digitalization; support innovation and venture capital; reduce administrative burden. - Recent progress: - Extended child care provision; 2016 law reducing disincentives to work after pensionable age; measures to broaden access to training and employment services for refugees; action plan on professional regulations; measures to improve venture capital environment; December 2016 law allowing more corporations to deduct past tax losses; plans to roll out gigabit networks by 2025 with 10–12 billion euro coalition plan and Gigabit Investment Fund. - Staff recommendations: - Lower the tax wedge, particularly for the low skilled and women. - Improve child care provision; increase retirement ages; facilitate labor market integration of low-skilled migrants. - Further deregulate professional services; strengthen regulator powers to curb incumbent discrimination in railways and postal services. - Continue policy focus on innovation and digital economy; reduce administrative uncertainties for venture capital. - Greece - Reform priorities: Preserve and expand labor market flexibility; foster competition in services and product markets; improve business environment. - Recent progress: - Reversals of the 2011 collective bargaining reform beginning September 2018; reform of collective dismissal framework legislated; raised quorum threshold to vote on strikes. - Removal of restrictions on dockworkers; streamlining medical code; steps to remove restrictions on engineering profession and public work registries; streamlining regulations for private clinics. - Some liberalizations (OTC trade of pharmaceuticals, Sunday trade) though Sunday trade reform constrained by Constitution. - Investment licensing reform largely completed; moves most sectors from authorization to notification and risk-based ex-post inspections. - Staff recommendations: - Preserve recent labor market reforms, adopt legislative changes to align collective dismissals and industrial action with EU best practices. - Accelerate opening up of regulated professions, prioritizing macro-critical professions. - Implement pending OECD recommendations to reduce barriers to competition. - Finalize overhaul of investment licensing, address remaining 24 sectors, finalize pending secondary legislation on environmental activities, harmonize nuisance categorization with updated environmental classification. - Italy - Reform priorities: Increase competition in product and services markets; raise public sector efficiency; labor market reform; civil justice and insolvency reform. - Recent progress: - August 2017 Annual Competition Law approved (weakened from original provisions). - 2014 Jobs Act overhauled labor market; progress uneven (delays in ALMPs); some elements revised in April 2017. - October 2017 framework law to modernize insolvency regime; government has up to one year to issue implementing decrees. - Implementing decrees on public administration reform were issued, but other critical reforms remain. - Staff recommendations: - Ensure annual adoption of pro-competition laws; enhance competition in local public service provision, transport, legal and professional services; fully implement existing legislation. - Align wages with productivity at the firm level; give primacy to firm-level contracts and consider differentiated minimum wage across regions; strengthen ALMPs and extend Jobs Act contracts to all open-ended private sector contracts. - Swift passage of implementing decrees for insolvency reform; improve efficiency of civil justice to reduce trial lengths and backlog. - Portugal - Reform priorities: Alleviate impediments to external competitiveness and potential growth; continue to improve labor and product markets; improve judicial sector efficiency. - Recent progress: - Public transport concessions halted; privatization of national airline TAP renegotiated to retain a 50 percent stake. - One-time levy on GALP imposed and paid in May 2015, lowering gas prices for end users by an estimated 7–12 percent in the next three years. - New Budgetary Framework Law adopted in 2015 to reduce budget fragmentation and improve transparency, but implementation delayed. - National Reform Program for 2017–21 focuses on public sector modernization and managerial training to improve labor force skills. - Discrepancy between official data showing more efficient resolution of debt enforcement and insolvency cases and anecdotal evidence of persistent delays and low payouts. - Staff recommendations: - Revisit reforms that have not yielded expected results; fully implement initiated reforms and address remaining bottlenecks. - Preserve recent labor market reforms; promote managerial skills; link minimum wage increases to productivity growth; reduce duality by making permanent contracts more flexible. - Upgrade quality of public services and policies; raise effectiveness of public administration; increase payment discipline of public sector entities. - Continue reducing energy costs and make no new investments in energy infrastructure until energy sector debt is paid off; strengthen market integration at the European level. - Commission an in-depth survey on judicial system efficiency by an outside firm. - Spain - Reform priorities: Address labor market duality; improve employability of long-term unemployed and unskilled youth; enhance competition and facilitate innovation and firm growth; strengthen access to finance for young firms and innovative start-ups. - Recent progress: - Limited overall progress toward raising efficiency and effectiveness of ALMPs; authorities published multi-year strategy on employment activation and plan external evaluation in 2018. - Eligibility for the Youth Guarantee scheme relaxed; new apprenticeship bonus introduced; intensified inspections and increased sanctions to reduce abuse of temporary contracts. - Slow implementation of the Market Unity Law (MUL); Constitutional Court decision finding one principle of the MUL in violation of the constitution could delay implementation. - No actions to liberalize professional services or reduce non-tax size-related disincentives; access to credit, including for SMEs, has improved. - Staff recommendations: - Reduce labor market segmentation by improving attractiveness of open-ended contracts and reducing administrative and legal obstacles that add to cost. - Ensure ALMPs are better targeted, evaluated, and coordinated; increase capacity of public employment services; improve education and training quality. - Foster competition by swiftly implementing the MUL and liberalizing professional services. - Stimulate firm growth and productivity by tackling remaining size-related rules and regulations on reporting, auditing, and labor regulation. - Enhance innovation capacity by increasing efficiency of public R&D, improving public-private cooperation, and enhancing private R&D investment. - Strengthen access to finance for young and innovative start-ups by enhancing market-based financing via alternative exchanges, venture capital, and securitization, and promote judicious use of direct financing and guarantees through ICO. *Source: IMF country teams.* ### Annex I. Progress Against IMF Recommendations ### Annex I. Progress Against IMF Recommendations ### Structural Policies - Recommendation: Use the window provided by the cyclical recovery to undertake ambitious structural reforms that boost productivity and foster income convergence. - Actions since 2017 Article IV: - Compliance with the 2017 Country-Specific Recommendations (CSR) under the European Semester has been uneven. - Reference to Table 4 for country-specific information on reform progress. - Recommendation: Instruments at the EU level should be used more effectively to incentivize reforms. - Actions since 2017 Article IV: - The European Commission has proposed a new reform delivery tool to bring direct financial support to national reform efforts, while also mooting more funding for its standing Structural Reform Support Program. - Recommendation: Progress in completing the single market in services, energy, digital commerce, and transport, as well as ambitious trade agreements, would increase competition and boost growth potential. - Actions since 2017 Article IV: - Some progress in the energy union project, including regional market integration and infrastructure development. - Movement on the EU’s digital single market initiative, including the elimination of roaming charges and of geographic discrimination in electronic commerce (“geo-blocking”). - The EU’s free trade agreement with Canada provisionally entered into force in 2017. - Trade negotiations concluded with Singapore and Vietnam; advanced with Japan, Mercosur, and Indonesia. ### Fiscal Policies - Recommendation: Countries with fiscal space should use it to promote public investment and structural reforms, while high-debt countries should adjust now to rebuild buffers. - Actions since 2017 Article IV: - Policy actions have been mixed: some countries with fiscal space eased their fiscal stance while others tightened; some high-debt countries made progress on fiscal adjustment, while others did not. - Recommendation: Better compliance with the rules is essential to ensuring the credibility of the fiscal framework; consider simplifying the fiscal framework and making enforcement more automatic; consider central fiscal capacity (CFC). - Actions since 2017 Article IV: - There have been a number of proposals for greater fiscal risk sharing. - The latest from the EC would establish a euro area stabilization budget line in the next EU budget. - Compliance with the fiscal rules has been weak and enforcement has become increasingly discretionary, exemplified by the lack of quantitative targets in CSRs for 2018. - There are currently no proposals to reform the fiscal rules. - The European Fiscal Board, in its first annual report, made some suggestions, in line with past Fund advice, on how to improve the rules. ### Monetary Policies - Recommendation: Monetary policy should remain accommodative until there is a sustained upward adjustment of euro area-wide inflation. - Actions since 2017 Article IV: - In October 2017, the ECB extended the asset purchase program (APP) to September 2018 (from December 2017), or beyond, if necessary, and in any case until a sustained adjustment in the inflation path is achieved. - The monthly net asset purchases between January and September 2018 were set at €30 billion (down from €60 billion). - Recommendation: Develop a common securities-lending framework for national central banks to facilitate access to high-quality collateral. - Actions since 2017 Article IV: - In December 2016, the ECB introduced cash collateral in the PSPP securities lending. - The overall limit for securities lending against cash collateral was set at €50 billion for the Eurosystem. - The cash collateral option will be offered at a rate equal to the lower of the rate of the deposit facility minus 30 basis points and the prevailing market repo rate. ### Financial Policies (NPLs, Bank Profitability, Banking Union, CMU) - Recommendation: The ECB’s guidance on NPLs needs strong follow up. Agree ambitious reduction targets with vigorous supervisory follow up. Modernize and harmonize foreclosure and corporate insolvency frameworks; consider an EU-wide NPL clearing house; national AMCs guided by an EC “blueprint” likely more useful than a pan-European AMC. - Actions since 2017 Article IV: - In March 2018, both the European Commission and the ECB proposed new risk reduction measures. - The Commission’s package includes changes to the Capital Requirements Regulation requiring for new unsecured loans to be fully provisioned no later than two years, and new secured loans no later than eight years, after they become nonperforming, with concomitant pillar 1 deductions from banks’ own funds. - The Commission seeks to provide banks with efficient out-of-court mechanisms for value recovery on secured loans while pushing development of distressed debt markets supported by specialized credit servicers. - A national blueprint for AMCs clarifies that, under exceptional circumstances, state aid may be permissible. - The ECB’s guideline sets provisioning expectations for all loans, new or existing, that become nonperforming going forward: banks will be expected to cover the full value of unsecured loans no later than two years, and secured loans no later than seven years, after default, with more ambitious interim expectations than the binding requirements proposed by the Commission. - Recommendation: Bank profitability needs to be enhanced; banks supervised by the Single Supervisory Mechanism (SSM) may require greater supervisory efforts to adapt and consolidate. - Actions since 2017 Article IV: - Profitability continues to improve. - The SSM notes that changes to business models need to be market based. - Business models are part of the attributes that determine the SSM’s SREP/Pillar 2 capital requirements. - FSAP analysis suggests the stock of NPLs is a robust determinant of profitability, especially for the least profitable banks. - The SSM’s new NPL guidance and the EC’s proposals will help address both the stock and flow of NPLs, which should improve profitability over time. - Recommendation: Completing the banking union by establishing a common deposit insurance scheme with a common fiscal backstop would foster liquidity flows and sever the bank-sovereign link; harmonize insolvency and foreclosure frameworks; speed implementation of MREL and resolution planning. - Actions since 2017 Article IV: - Political support for instituting a standing ESM credit line to backstop the Single Resolution Fund is building, and technical work is underway. - Discussions on common deposit insurance are likely to continue, focusing on agreeing a roadmap for risk reduction. - The Single Resolution Board is setting binding minimum requirements for own funds and eligible liabilities (MREL) for banks under its purview, initially comprising “external MREL” at the level of ultimate parents of banking groups, later including “internal MREL” at the level of subsidiary banks within groups. - The process of setting these requirements, based on detailed resolution planning, is slow. - Recommendation: Faster progress on the capital markets union (CMU) action plan would foster greater international private risk sharing. - Actions since 2017 Article IV: - More than half of CMU Action Plan items have been implemented. - Progress includes agreement on a standard for simple, transparent, and standardized securitization aimed at diversifying funding options for SMEs. - A new Prospectus Regulation has been issued to streamline issuance norms and make it easier and cheaper for SMEs to raise funds. - Pending elements of the Plan—such as harmonized insolvency laws—would also support the banking union. ### Annex II. Statistical Issues (excerpt) - European statistics are developed, produced, and disseminated by the European Statistical System (ESS) and the European System of Central Banks (ESCB); the ESS is composed of Eurostat and the national statistical institutes (NSIs), and the ESCB is composed of the European Central Bank (ECB) and the national central banks (NCBs). - The European statistics produced by the two statistical systems are of sufficient coverage, quality, and timeliness for effective macroeconomic surveillance. - Transition to the new international statistical standards is complete but minor enhancements are still expected. - With regard to data availability, most countries received derogations from the European System of National and Regional Accounts (ESA) 2010 data transmission requirements up to 2020 based on justified requests. - A review of the justifications of the derogations took place in 2018, which showed that data availability improved significantly between October 2015 and January 2018. - In most cases, Member States have resolved the issues that gave rise to the derogations; a significant number of Member States have started providing (part of) the data covered by derogations even before the first expected transmission date. - Strong effort on ensuring that globalization-related issues are properly reflected in the statistics; a number of work streams are progressing. *Source: cr18223 - Annex I. Progress Against IMF Recommendations* ### 2. Eurostat and the ECB continued working in 2017 on the 20 recommendations of the ### 2. Eurostat and the ECB continued working in 2017 on the 20 recommendations of the ### G20 Data Gaps Initiative — DGI-2 - Eurostat and the ECB, as members of the Inter-Agency Group (IAG) on Economic and Financial Statistics, continued work in 2017 on the 20 recommendations of the second phase of the G20 Data Gaps Initiative (DGI-2). - Objective: implement the regular collection and dissemination of reliable and timely statistics for policy use and address evolving policymaker needs. - The 20 recommendations are clustered under three headings: - (i) monitoring risk in the financial sector; - (ii) vulnerabilities, interconnections and spillovers; - (iii) data sharing and communication of official statistics. - Progress and commitments: - Substantial progress achieved despite implementation challenges for some recommendations. - Recommendation II. 7 on securities statistics (BIS-ECB): all G20 and almost all non-G20 economies provided self-commitments on reporting specific datasets on debt securities. - The 2018 DGI-2 work program will include further thematic workshops to support participating economies. - It is intended that all DGI-2 recommendations are fully implemented by 2021. ### SDDS Plus and data standards - Eurostat and the ECB jointly support the Special Data Dissemination Standard Plus (SDDS Plus), the third and highest tier of the IMF’s Data Standards Initiatives launched in November 2014. - By April 2018, seven EA countries (and 11 European Union (EU) Member States overall) have adhered to the SDDS Plus. ### Macroeconomic Imbalance Procedure (MIP) statistics and quality assurance - Eurostat publishes annually the indicators for the MIP Scoreboard, together with auxiliary indicators; the Scoreboard provides the statistical basis for the annual Alert Mechanism Report by the European Commission. - November 2017: the ESS-ESCB quality assessment report on statistics underlying the MIP was published. - Implementation of the Memorandum of Understanding (MoU) on quality assurance of statistics underlying the MIP (signed November 2016) in 2017: - ECB/DG-Statistics ran a quality assurance procedure on datasets reported by NCBs and transmitted a brief metadata report to Eurostat explaining major events and revisions. - Pilot visits to Greece and Belgium took place in November and December 2017. - Terms of reference for future visits finalized. - In 2018 the ECB and Eurostat will start publishing harmonized domain specific quality reports for balance of payments (BOP) and international investment position statistics (IIP). ### Broader improvements in timeliness, coverage, and quality (selected developments) - 5.1 Streamlining flash releases of key national accounts (NA) indicators: - Preliminary (T+30) GDP flash estimates for the EU and the EA introduced in April 2016; Eurostat continued to monitor quality. - Mid-term strategy agreed to move to a regular estimation schedule based on country estimates available after 30, 60 and 90 days. - Possible publication of an employment flash estimate currently under tests. - 5.2 Quarterly BOP and IIP improvements via amendment of ECB Guideline on External Statistics (ECB Guideline ECB/2011/23): - Changes will bring in 2021, among others: - (i) more detailed information by sector, including distinction between households and non-financial corporations and more granular presentation of the financial sector; - (ii) a comprehensive breakdown of the IIP by currency of denomination; - (iii) bilateral data vis-à-vis all G20 countries for the main accounting entries; - (iv) a complete instrument breakdown of the BOP and IIP to facilitate the link with NA. - 5.3 Timeliness of integrated sector accounts: - EA quarterly sector accounts timeliness: around T+120 days in 2016, improved to around T+102 in 2016, and further accelerated in 2017 to around T+94. - New first aggregated release of non-financial sector accounts based on preliminary data transmitted by EA Member States by T+85 days after the reference period. - 5.4 First reporting exercise on quality of ESA 2010 data transmitted by Member States: - Introduced in 2017 concerning 2016 data transmissions. - National quality reports completed in October 2017. - Eurostat assessment report prepared in December 2017; under consultation and to be published around July 2018. - Assessment findings: 2016 quarterly and annual NA mandatory data had high completeness; punctuality of quarterly NA transmission relatively high; punctuality of annual data transmission needs improvement. - Online documentation on methodology, metadata and implemented major revisions can be further enriched. - 5.5 Task Force on recording illegal economic activities (IEAs) in NA and BOP: - Task Force published results in a Handbook in March 2018 providing a comprehensive overview of conceptual and practical issues related to compilation of statistics on IEAs in accounting frameworks. - Handbook purpose: provide a common definition of IEAs and guidance for collecting and compiling IEA statistics consistently and coordinated. - Contributors included experts from the European Commission, European national statistical institutes and central banks, UNODC, ECB, OECD and European Parliament–European Parliamentary Research Service. - Handbook provides input to forthcoming work of the UNODC-UNCTAD Expert Group on the SDG Indicator on Illicit financial flows and the IMF Task Force on Informal Economy. - 5.6 Harmonized Indices of Consumer Prices (HICP) flash estimates: - Following entry into force of new basic legal act on HICP, all EA Member States transmit HICP flash estimates starting with January 2017 index. - EA flash estimates now based on aggregating country data; Eurostat stopped using a model for estimating missing countries. - Since March 2017, Eurostat publishes the HICP all-items flash estimate rate of change by country for those countries that agreed to dissemination. Currently released countries: Cyprus, Germany, Spain, France, Lithuania, Latvia, Italy, Malta, Poland, Slovakia and Slovenia. - 5.7 More granular inflation data: - Since 2016 indices at new sub-class level of ECOICOP available at country level. - In 2018 these data will be complemented with European aggregates. - 5.8 Commercial real estate indicators and AnaCredit: - ECB and Eurostat established a joint expert group (JEG) in 2017 to explore development of commercial real estate indicators related to the physical market. - JEG conducted stock-taking of variables existing or being developed in Member States and sketched a way forward; submitted report to the Economic and Financial Committee (EFC) in autumn 2017 advocating an evolutionary approach. - ESCB Statistics Committee’s Real Estate Task Force (RETF) analyzed the role of the AnaCredit dataset to provide comparable data for bank financing of commercial real estate. - Eurostat published in December 2017 a Statistical Report: "Commercial Property Price Indicators (CPPI): sources, methods and issues". - 5.9 EuroGroup Register (EGR) and RIAD: - EGR: the central European register for multinational enterprise groups managed by Eurostat; based on microdata sent by NSIs, around 100,000 enterprise groups active in the EU with a unique identifier are part of the register. Production of the 2016 EGR data finalized and output increasingly used for statistical production. - RIAD (Register of Institutions and Affiliates Data) supports statistics and other activities of European central banks and supervisors; a fourth generation of the RIAD system delivered in March 2018 to support AnaCredit counterparts with data to be frontloaded in 2018 Q2–Q3. - RIAD will record more than 15 million entities and be updated at high frequency. - 5.10 Modernization of intra-EU trade in goods statistics (Intrastat Modernization): - Based on SIMSTAT and REDESIGN projects; EU Member States provided strategic orientation in May 2016. - Deployment project spanning 2017–2020 set up to implement modernization. - Work in 2017–2018 focused on preparing European legal provisions and technical implementation, including exchange of micro-data on intra-EU exports. - New legal provisions incorporated in the Framework Regulation on Integrated Business Statistics (FRIBS) under discussion at European Council and Parliament. - 5.11 Government finance statistics (GFS) developments: - Annual and quarterly ESA 2010-based GFS time series continue to be available for all countries. - For most countries, data are mapped to GFSM 2014 framework and reported to STA with additional country information. - Quarterly non-financial accounts data by subsectors of general government are collected under ESA; all countries supply detailed COFOG data. - Progress in national publication of monthly fiscal data based on public accounts as required by Stability and Growth Pact measures (the “Six-Pack”). - Eurostat publishes data on contingent liabilities and non-performing loans of the government; contingent liabilities include government guarantees, liabilities related to public-private partnerships recorded off government balance sheets, and liabilities of government-controlled entities classified outside general government (public corporations). - 5.12 European-level supply and use tables — FIGARO project: - FIGARO aims to establish annual production of EU multi-country input-output tables and five-yearly production of EU multi-country supply, use, and input-output tables. - First deliverables are experimental EU inter-country supply-use and input-output tables (EU-IC-SUIOT) for the year 2010, which will be available shortly. - 5.13 ECB regulation on statistical reporting requirements for pension funds (PF): - New regulation published on 19 February 2018 (ECB Regulation on pension funds statistics Regulation (EU) 2018/231 of the ECB of 26 January 2018 on statistical reporting requirements for pension funds (ECB/2018/2), OJ L 45, 17.2.2018, p. 3). - Aims to increase transparency and improve data comparability in the pension fund sector. - Harmonizes and completes quarterly statistics on pension funds published since June 2011, including transactions, security-by-security reporting, individual country counterparty data, investment fund data by investment asset classes, data on pension fund entitlements (by defined contribution and defined benefit & hybrid schemes), and alignment with ESA 2010 and BPM6. - Pension funds will also report to EIOPA. - EIOPA and ECB cooperated to minimize reporting burden and set definitions, methodological framework and transmission format for ESCB statistics and supervisory reporting. - Reporting of the first PF data under the new regulation will start by end-2019. - 5.14 Financial Corporations engaged in Lending (FCLs): - ECB published new annual data on FCLs in September 2017. - FCLs: financial intermediaries specialized in asset financing for households and non-financial corporations (financial leasing, factoring, mortgage lending, consumer lending). - Balance sheet statistics on FCLs provided to ECB by NCBs on a best efforts basis; currently cover the euro area except Finland, Ireland and Luxembourg. - 5.15 Supervisory Banking Statistics dataset: - November 2016: ECB started publishing a new dataset covering quarterly data on the financial soundness of significant banks directly supervised by the ECB. - Based on standardized information submitted by significant institutions within the Single Supervisory Mechanism (SSM). - Dataset includes balance sheet items, profitability, capital adequacy, leverage, asset quality, and information on funding and liquidity; presented by country, income sources, geographical diversification, size, sovereign exposures and overall assessment of banks’ riskiness. - Publication complemented by collection of solvency and leverage ratios as disclosed annually pursuant to Part Eight of Regulation (EU) No 575/2013. - Planned enhancements: provide a view based on business models and disclose an aggregate score on overall data quality. - Dataset reviewed regularly to reflect regulatory and reporting framework changes (e.g., IFRS 9 introduction). - Dataset offers supervisors and the public information on compliance, complementary views for analysts and market participants, and easy access to relevant Pillar 3 disclosures via links. - 5.16 Payment statistics enhancement: - ECB initiated work to enhance statistics on payment instruments and systems collected annually under Regulation ECB/2014/43. - Rapid changes in the payment landscape and regulatory changes created new data requirements to support Eurosystem’s role in market integration and oversight. - Payment data may be required for ECB economic forecasting and for BOP and IIP statistics. - A merits and costs procedure launched to finalize update of the ECB Regulation during 2019 so that data can be collected from 2020. _Prepared jointly by the European Department (EUR) and the Statistics Departments (STA) of the IMF in consultation with Eurostat and the ECB._ ### 6. The ECB continued working on several projects to enhance the availability and quality ### 6. The ECB continued working on several projects to enhance the availability and quality ### ECB statistical projects and data initiatives - Money Market Statistical Reporting (MMSR) - Regular publication of aggregated indicators on the unsecured market was started in November 2017; further segments will follow in 2018. - Unsecured overnight interest rate - The Governing Council of the ECB decided to develop a euro unsecured overnight interest rate based on MMSR data. - The interest rate, which would be produced before 2020, would complement existing benchmark rates produced by the private sector and serve as a backstop reference rate. - Securities holdings statistics - As of October 2018, the list of reporting banking groups will be extended to cover all significant groups directly supervised by the ECB. - Analytical credit datasets (AnaCredit Project) - In May 2016, the ECB adopted the new legal act enabling the ESCB to collect granular information on credit granted from banks to financial and non-financial corporations and other legal persons based on a core set of harmonized concepts and definitions. - A Manual was published in three Parts, the last one by May 2017, still a year and a half prior to data delivery. - Q&As and Validation Checks are published to ensure effective communication. - The endeavor aims to support monetary policy analysis and operations, risk management, financial stability surveillance, and macro-prudential policy. - The first reporting will take place in mid-November 2018 based on data as of September 2018. ### Cooperation on income, consumption, and wealth (ICW) and linking macro–micro household data - The ECB, Eurostat and the OECD actively cooperate on statistics and research concerning the joint distribution of income, consumptions and wealth (ICW) as well as linking macro and micro data on household wealth. - Key activities and milestones - The first meeting of the OECD/Eurostat Expert Group on Disparities in National Accounts took place in March 2018. - Experimental results were presented and a work plan by end-2019 was discussed. - Results from the second phase of the ECB Expert Group Linking Macro and Micro data were presented in the March 2018 meeting of the Household Finance and Consumption Network. - The 2017 biennial conference on household finance and consumption (jointly organized by the ECB and Banque de France) focused on household heterogeneity effects on asset and debt accumulation, consumption and saving behavior, and monetary policy transmission. ### Eurostat work on EPSAS (European Public Sector Accounting Standards) - Technical work ongoing to modernize and harmonize public sector accounting standards in the context of EPSAS. - EPSAS objectives and approach - EPSAS would provide high quality and harmonized source data to benefit all statistical domains drawing on public sector data. - Six EPSAS Working Group meetings took place since September 2015. - A two-phase approach is followed: (1) increasing fiscal transparency in the short to medium term, and (2) working towards comparability in the medium to the longer term. - Current EPSAS work program components - (a) developing of the EPSAS framework (i.e., EPSAS governance, accounting principles and standards) and collection of information for impact considerations, - (b) supporting the modernization of public accounting systems in the EU Member States, - (c) widening stakeholder engagement. - Technical issues under construction and study - Accounting treatment of discount rates, grants and other transfers, loans and borrowings, concession arrangements, provisions, contingent assets and liabilities, financial guarantees. - Impact studies such as on the opportunity cost of non-EPSAS, lessons learned from experiences of accruals implementations, skills and training issues related to the reform. - How EPSAS can support financial audit and control, including a tool for monitoring transparency of public sector financial reporting. ### Statement by Steffen Meyer, Executive Director for Germany — summary of authorities’ views (July 16, 2018) - General - Statement reflects common view of Member States of the euro area and relevant EU Institutions. - Authorities are broadly in agreement with findings and recommendations in the Article IV staff report and Financial System Stability Assessment (FSSA). - Authorities welcome acknowledgement of progress in institutional and risk-reduction reforms, while noting risks have heightened recently. - Economic outlook - Authorities concur that economic growth remains strong, broad based and job friendly, even though underlying inflation has been subdued. - Steady job creation underpins the robustness of the recovery while wage growth remained below 2 percent for most of the last six years. - Recent readings suggest the recovery has passed its peak. - Real GDP growth projections for 2018 and 2019 are very much aligned with staff projections. - Authorities agree downside risks have heightened significantly since last year but believe staff’s assessment understates the euro area's achievements and commitment to reforms. - On Brexit: uncertainty over final outcome represents a downside risk; negotiators need to progress faster; impossible to maintain all current benefits while leaving the EU regulatory, supervisory, enforcement and judiciary framework. - Authorities caution that staff estimates of Brexit impacts are highly speculative and suffer from important modeling limitations. - Medium-term growth prospects: potential growth expected to ease amid demographic changes, weak productivity growth and crisis legacies, including ongoing private sector deleveraging in some countries. - Policy implications: responsible and growth-friendly fiscal policies, rebuilding buffers, prioritizing investment, improving quality of public expenditure and revenues, and stepping up structural reforms. - Monetary policy and inflation outlook - With longer-term inflation expectations well anchored, the ECB’s monetary accommodation and underlying strength of the economy provide grounds for confidence that convergence of inflation towards ECB’s inflation aim will continue. - Underlying inflation has been increasing from earlier lows. - Further build-up of domestic price pressures and headline inflation over the medium term is conditional on support of a sizeable amount of monetary policy stimulus. - Support will continue to be provided by the net asset purchases until the year end, by the large stock of acquired assets and associated reinvestments, and by enhanced forward guidance on key ECB interest rates. - Fiscal policies - Authorities agree distribution of national fiscal policies differs from staff recommendations. - Member States with high public debts need to increase efforts to improve sustainability while strengthening growth potential. - Member States with stronger fiscal positions and external surpluses could prioritize investments to boost potential growth while preserving long-term sustainability. - Consistent application of fiscal rules continues to be warranted. - With negative output gaps finally closed according to most estimates, there may no longer be the same need—ceteris paribus—to use the flexibility provided by the fiscal rules as done in 2018. - Authorities note public finances compare very favorably to those of other major jurisdictions, in aggregate. - External sector policies - Authorities take note of staff's assessment of the euro area's external position, which is in line with the European Commission's. - While progress has been achieved among net debtor countries in correcting external imbalances, large current account surpluses remain in some creditor countries. - Policy levers affecting the current account are mainly at the national level; drivers include savings relative to investment in the non-financial corporate and household sectors, with government balances also playing a role. - Further integration of financial markets and the broader EU single market, in the context of deepening EMU, will help reduce imbalances among Member States. - Paragraph 43 in the staff report singled out external surpluses as potentially fueling protectionism; authorities warn this message could be misused and stress the EU’s commitment to free and fair trade and multilateral rules. - Deepening of the Economic and Monetary Union (EMU) - Euro Summit agreed in June to progress towards completion of the banking union, to strengthen the European Stability Mechanism (ESM) and to discuss other relevant items. - Following the agreement on 25 May, adoption of a package of measures aimed at reducing risk in the banking industry is expected before the end of the year. - The ESM will provide the common backstop to the Single Resolution Fund (SRF) and will be strengthened. - Differences of views remain on the issue of a common fiscal capacity; discussions will continue on the European Commission proposal and other recent ideas. - Euro Summit to return to these issues in December 2018, including on terms of reference for the common backstop and a terms sheet for further development of the ESM. - Work should start on a roadmap for political negotiations on the European Deposit Insurance Scheme (EDIS), while adhering to all elements of the 2016 Council roadmap. ### Financial System Stability Assessment (FSSA) — authorities’ comments and priorities - General stance - Authorities welcome and broadly concur with staff’s analysis and recommendations; emphasis on anti-money laundering and cybersecurity is welcome. - Some report recommendations are already covered in existing Union legislation. - Central counterparties (CCP) - Authorities do not concur with statements referring to mandatory relocation of CCPs; European Commission proposal refers to ability to provide clearing services within the EU, not relocation. - CCP supervision proposal aims to strengthen the EU regime for third countries generally and is not solely driven by Brexit. - Capital Markets Union and macro-prudential supervision - Authorities welcome recognition of Capital Markets Union importance; progress has been made through many legislative and non-legislative initiatives not covered in the FSSA. - Agree with main messages on macro-prudential supervision; development of new instruments for the non-banking sector is at a preliminary stage. - Crisis management and bank resolution - Authorities concur with the criticality of sufficient MREL for effective resolution and welcome progress in completing crisis management infrastructure. - Recommendation to proceed quickly with build-up of external and internal MREL should account for diversity of banking groups and recognize transitional periods, though authorities urge banks to build up needed MREL buffers without delay. - Authorities welcome staff’s recommendation to establish the ESM as a common backstop for the SRF. - Treaty change to grant SRB status of an "institution" may not be feasible in short term; SRB is already an independent agency in line with the Key Attributes. - Endorsement of resolution schemes by the European Commission does not delay resolution decisions; legal timeframe is 24 hours and EU institutions have made arrangements to comply. - Authorities consider administrative liquidation tool for the SRB legally and operationally doubtful. - Authorities disagree with an FSSA recommendation for a financial stability exemption to depart from the 8% bail-in requirements for accessing the SRF and public funds; the SRF’s aim is not to replace bail-in but to ensure efficient application of resolution tools. - State aid and DIS - State aid control derives directly from EU Treaties and ensures a level playing field between banks in- and outside the Banking Union. - Deposit insurance scheme (DIS) interventions beyond reimbursing depositors may fall under State aid control; State aid rules require burden sharing and restructuring or market exit, protecting the DIS. - Brexit and financial stability - Potential financial stability risks from the withdrawal of the United Kingdom are being monitored, including via a joint technical group between the ECB and the Bank of England. - Firms should ensure continuation of services to clients; the financial services sector is accustomed to cross-border, multi-jurisdictional operations. - ECB supervision - Authorities welcome comprehensive assessment of ECB banking supervision methods and practices; staff recognize increased supervisory intensity and definition of clear methodologies and processes. - Authorities concur that supervisory powers for relevant cross-border investment firms carrying out bank-like activities need to be addressed. - On the EU prudential framework, authorities welcome recognition of progress while noting important areas remain to be harmonized. - Liquidity risk and supervisory practices - Authorities disagree with BCP24 assessment on Liquidity Risk, arguing it misrepresents intrusiveness, intensiveness, timeliness and efficiency of current supervisory practices and downplays the ECB’s capacity to act. - The ECB takes supervisory actions well ahead of actual liquidity constraints to ensure stakeholders are informed and decisions can be timely made. - Authorities generally agree with finding of an overall increase in banks’ resilience from solvency and liquidity analyses and liquidity stress-testing, while noting some scenario-specific shortfalls may stem from extreme or non-pragmatic assumptions. - Euro area banks have been consistently increasing liquidity buffers in response to regulatory changes, a main driver of ample system-wide liquidity. - Bank profitability and NPLs - Authorities broadly share staff’s assessment of structural drivers of bank profitability and that improving macro conditions alone is insufficient. - Banks have made progress in efficiency and tackling NPLs, but high NPL stocks continue to adversely affect performance. - Pace of NPL reduction is partly dependent on banks’ capital position and ability to raise capital; pace of NPL stock reduction has been accelerating since 2017. - Profitability levels of euro area banks have been recovering significantly in recent years. - Fragmented banking structures, cost inefficiency and little income diversification continue to drag on long-term profitability prospects. - Systemic liquidity management - Authorities take note of staff’s recommendation regarding ‘horizon scanning’ arrangements to better detect emerging liquidity strains. - These arrangements need careful consideration in light of existing arrangements to avoid overlaps in responsibilities. *Source: cr18223 - 6. The ECB continued working on several projects to enhance the availability and quality* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18223.pdf_