## 1deuea2019001 - 1.5 percent in 2018. Nonetheless, unemployment hit a new record low, pushing wage growth up

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### Overview / Recent performance
- Real GDP growth: 2017: 2.2; 2018: 1.4.  
- Growth drivers in 2018: investment remained strong; net exports contributed negatively in 2018 as exports dropped sharply in Q3 and were only partially made up in Q4.  
- Current account surplus: 2017: 8.0 percent of GDP; 2018: 7.3 percent of GDP.  
- General government fiscal surplus: 2018: 1.7 percent of GDP (fifth consecutive year of surplus; largest in nearly 30 years).  
- Inflation: headline 2018: 1.9 percent; core inflation at the end of 2018: 1.6 percent.  
- Unemployment and wages: unemployment fell to a new record low in 2018, pushing wage growth above 3 percent in the second half of 2018.  
- Credit and lending: credit grew broadly in line with GDP in 2018; new lending to nonfinancial corporations increasingly directed to relatively riskier firms while lending standards were eased.  
- Real estate: prices of residential and commercial real estate continued to rise rapidly, especially in dynamic urban areas.  
- Financial sector profitability: under pressure from a “low-for-long” interest rate environment, compounded by high costs and slow progress with restructuring.

### Outlook and key risks
- Short-term staff baseline:
  - Gradual return of output to trend in the year following 2018, but subject to significant uncertainty due to export dependence and financial openness.  
  - Private consumption growth expected to recover, supported by strong labor market conditions and fiscal measures (e.g., income tax relief, family support).  
  - Exports volume (% change): 2017: 5.7; 2018: 2.3; projected 2019: 1.9; 2020: 3.6.  
  - Imports volume (% change): 2017: 6.0; 2018: 4.2; projected 2019: 3.7; 2020: 4.3.  
- Medium-term projections:
  - Growth projected to decelerate to 1.1 percent by 2024.  
  - Headline and core inflation should reach 2.2 percent by 2022.  
  - NIIP expected to exceed 80 percent of GDP in the medium term if CA surpluses continue.  
- Downside risk scenarios (tilted to the downside):
  - Significant rise in global protectionism; a more pronounced China slowdown; a no-deal Brexit—could hurt exports and FDI, disrupt supply chains, and weigh on domestic investment and productivity.  
  - Tighter global financial conditions: could trigger sharp corrections in stretched asset valuations and affect real estate and equity markets.  
  - Domestic risk: failure to revamp bank business models could lead to financial distress in major banks with external spillovers.  
- Upside risks: faster-than-anticipated wage growth, positive investment surprises, and a more expansionary fiscal policy.

### Labor market, wages, and distributional issues
- Unemployment rate (ILO): 2017: 3.8; 2018: 3.4; projections 2019: 3.2; 2020: 3.1.  
- Employment growth: 2017: 1.1; 2018: 0.5; projections 2019: 0.7; 2020: 0.4.  
- Wage dynamics: tight labor market and widespread reported labor shortages pushed wage growth above 3 percent in 2018H2; real wages grew faster than productivity, increasing the labor share.  
- Distributional outcome:
  - Household disposable income has declined relative to GDP by about 6.2 percentage points since 2005 (concentrated in the lower half of the income distribution).  
  - Private consumption share of GDP dropped from about 55 percent (1995–2005 average) to 51 percent at end-2017.  
  - Restoring household disposable income to its 2005 level (63 percent of GDP) through wage growth alone would require nominal wage growth to exceed annual nominal GDP growth by around 1.5 percentage points each year for over a decade.

### Fiscal and external sector details
- Fiscal balance (% of GDP): 2017: 1.0; 2018: 1.7; projections 2019: 1.0; 2020: 1.0.  
- Revenue (% of GDP): 2017: 45.0; 2018: 45.6; projections 2019: 45.6; 2020: 45.6.  
- Expenditure (% of GDP): 2017: 43.9; 2018: 43.9; projections 2019: 44.6; 2020: 44.6.  
- Public debt (% of GDP): 2017: 64.5; 2018: 60.9; projections 2019: 58.0; 2020: 55.0.  
- Trade and external flows:
  - Trade balance (% of GDP) 2017: 7.1; 2018: 6.0.  
  - Exports of goods (% of GDP) 2017: 38.3; 2018: 38.2.  
  - Imports of goods (% of GDP) 2017: 30.6; 2018: 31.6.  
- External debt (% of GDP): 2017: 145.0; 2018: 143.2.  
- Reserves minus gold (US$ billions): 2017: 59.4; 2018: 59.2.  
- Real effective exchange rate (2005=100): 2017: 93.8; 2018: 95.7.  
- Nominal effective rate (2005=100): 2017: 100.1; 2018: 102.5.

### External imbalances, REER assessment, and Box highlights
- Current account (CA) surplus:
  - Fell by 0.7 ppt of GDP in 2018 to 7.3 percent of GDP; cyclically-adjusted CA surplus remains 3.6–5.6 percentage points higher than value implied by fundamentals and desirable policies (staff CA norm: 2–4 percent of GDP for Germany).  
- REER assessment:
  - EBA REER Level model yields an undervaluation of 16 percent.  
  - Undervaluation implied by CA gap using standard trade elasticities: range of 12–27 percent.  
  - Staff overall assessment: 2018 REER undervalued in the range of 8-18 percent.  
  - Short-term movement: REER appreciated by 3.3 percent in 2018; depreciated by 1.3 percent through May 2019 relative to 2018 average.
- Box 2 — Potential US auto tariffs:
  - A 25 percent US tariff on autos and auto parts: estimated trade-channel impact on Germany of around 0.15 percent of GDP (GVC-aware).  
  - For Germany, half of the impact is direct lower car exports to the US; half is lower exports of intermediate goods used in car production in third countries.

### Financial sector, macrofinancial vulnerabilities, and housing
- Profitability: low profitability in both the bank and life insurance sectors; large banks underperform European peers due to high operating costs and legacy issues.  
- Credit dynamics:
  - Mortgage and NFC credit growth accelerated to a pace modestly faster than nominal GDP growth in 2018.  
  - Evidence that new credit to NFCs is increasingly channeled to relatively riskier firms; lending standards eased per Bank Lending Survey.  
- Real estate:
  - City-level house price overvaluation estimates (staff 2017):
    - Stuttgart and Dusseldorf: 10–15 percent.  
    - Hannover, Frankfurt and Hamburg: 25–30 percent.  
    - Munich: more than 40 percent.  
  - CRE prices have risen even faster than house prices; banks’ exposure to CRE has risen over the last three years.  
- Macroprudential policy:
  - Counter-cyclical capital buffer (CCyB) activation recommended and raised by 0.25 percent (Decision in May; effective Q3 2019; banks have 12 months from beginning Q3 2019 to meet new requirement).  
  - Urgent need to address data gaps; consider borrower-based measures (LTV cap, amortization requirements) and expand toolkit to include income-based instruments (cap on debt-to-income or debt-service-to-income) and CRE-specific measures.

### Banking and insurance supervisory recommendations
- Banking:
  - Press banking sector to accelerate restructuring plans to bolster profitability and reduce risks.  
  - Implement cost cuts (e.g., branch reductions, digitization); encourage fee-based income and consolidation among savings and cooperative banks.  
  - Full adoption of Basel III—especially output floor—expected to substantially increase minimum capital requirements.  
- Life insurance:
  - Reduce reliance on guaranteed-return products; diversify investment portfolios (e.g., infrastructure projects, foreign assets).  
  - Monitor solvency and pace of transitioning away from transitional measures under Solvency II.

### Policy recommendations: fiscal, structural, and distributional
- Fiscal stance and use of fiscal space:
  - Welcome moderate near-term fiscal expansion; staff recommends continued use of fiscal space to bolster potential growth and facilitate rebalancing while maintaining buffers for aging population and contingent liabilities.  
  - 2019 budget measures include family support and income tax relief worth 0.2 percent of GDP per year; moderate fiscal expansion ~⅔ percent of GDP.  
  - Staff projects structural surplus decrease from 1.2 percent of GDP in 2018 to about ½ percent of GDP in 2021–22.  
- Fiscal priorities:
  - Investments in infrastructure; tax measures to raise disposable income for low- and middle-income households; incentives to promote labor force participation by female and elderly workers; tax credit for further research and development.  
- Tax and redistribution:
  - Reduce high effective marginal tax rate for secondary earners (e.g., replace income splitting with tax allowance or credit) to promote female labor participation.  
  - Consider stronger increases in the minimum wage at the next revision in 2021.  
  - Consider reforming property and inheritance taxes to compensate revenue shortfalls and reduce excess saving and wealth concentration.  
- R&D and corporate taxation:
  - Government proposal: tax credit up to €500,000 per year provided for 25 percent of R&D costs up to €2 million starting in 2020; total envelope currently estimated at about €1¼ billion.  
  - Preserve competitive corporate tax system while maintaining leadership in anti-tax avoidance measures; support coordinated international minimum tax initiatives.  
- Structural reforms:
  - Speed up reforms to promote innovation, investment, and competition (including business services and regulated professions); upgrade digital infrastructure; implement National e-Government Strategy; improve access to venture capital; promote scale-up of venture capital funds.  
  - Increase childcare and after-school provision; rebuild planning capacity at local level; enhance coordination across government levels to implement large projects.

### Investment, productivity, and labor supply
- Business investment:
  - Real business investment around 12–13 percent of real GDP (mid/low relative to peers); nominal business investment declined ~4 percentage points of nominal GDP since early 1990s.  
  - Drivers of lower investment relative to peers: relatively low medium-term growth prospects and time-invariant country characteristics (fixed effects).  
- Digital and infrastructure:
  - Government committed to allocate up to €12 billion to build a nationwide fiber-optic network by 2025; auction proceeds of €6.5 billion added to Digital Infrastructure fund.  
  - Only 5 percent of SMEs use big-data analytics (EU average: 10 percent).  
- Labor supply:
  - Reported labor shortages amid a declining working-age population (15–64 years old).  
  - Old-age employment rate: 71 percent.  
  - New immigration law to attract skilled labor; further policies needed to prolong working lives and encourage participation.

### Public debt sustainability and stress tests
- Baseline debt dynamics:
  - Public debt falls rapidly and is expected to continue to decrease; public gross debt: 2017: 74.8; 2018: 64.5; 2019: 60.9; 2020: 58.0; 2021: 55.0; 2022: 52.4; 2023: 49.8; 2024: 47.2.  
  - Public gross financing needs: 2017: 16.0; 2018: 12.1; 2019: 10.7; 2020: 10.3; 2021: 7.5; 2022: 5.4; 2023: 5.0; 2024: 4.7.  
- Stress test outcomes:
  - Growth shock: debt peaks at 60.7 percent of GDP and gross financing needs peak at 9.2 percent of GDP; converge to 52.6 (debt) and 5.2 (GFN) percent of GDP by 2024.  
  - Contingent fiscal shock (cumulative 3 percent of GDP, about €100 billion over 2020–21): debt-to-GDP remains below 60 percent and continues to fall rapidly; gross financing needs remain below 10 percent.  
- Key baseline macro assumptions:
  - Real GDP growth: expected average 1.3 percent over next three years; potential level 1.1 percent per year in medium run.  
  - Inflation (GDP deflator): 2018: 1.9 percent; expected to reach 2.3 percent by 2024.  
  - Effective interest rate: 2018: 1.6 percent; expected to fall to 1.0 percent by 2024.

### Governance, AML/CFT, and anti-bribery
- AML/CFT:
  - BaFin strengthening AML/CFT supervision; appointed “Special Representatives” in major banks for audit and monitoring functions; preparing for FATF assessment in 2020.  
  - Transposing 5th EU Money Laundering Directive into national law.
- Anti-bribery enforcement:
  - Germany sanctioned 328 individuals and 18 companies in 67 foreign bribery cases since 1999 (OECD WGB recognition).  
  - Staff recommends stronger enforcement against legal persons, clearer guidance for self-reporting, conditional resolution, improved statistics, and a more comprehensive whistleblower protection framework.

### Procedural and data recommendations
- Urgently address data gaps to enable fuller assessment of financial stability risks (regular collection of granular loan-level data).  
- Regularize the ad hoc bank survey on real estate lending and corporate credit underwriting standards.  
- Recommended next Article IV consultation on regular 12-month cycle.

*International Monetary Fund staff report for the 2019 Article IV Consultation (Germany).*

### 1.5 percent in 2018. Nonetheless, unemployment hit a new record low, pushing wage growth up

### 1deuea2019001 - 1.5 percent in 2018. Nonetheless, unemployment hit a new record low, pushing wage growth up

### Overview / Recent performance
- Real GDP growth: 2017: 2.2; 2018: 1.4.  
- Growth drivers in 2018: investment remained strong; net exports contributed negatively in 2018 as exports dropped sharply in Q3 and were only partially made up in Q4.  
- Current account surplus: 2017: 8.0 percent of GDP; 2018: 7.3 percent of GDP (decline reflecting a narrowing of the goods trade balance).  
- General government fiscal surplus: 2018: 1.7 percent of GDP (fifth consecutive year of surplus; largest in nearly 30 years).  
- Inflation: headline 2018: 1.9 percent; core inflation at the end of 2018: 1.6 percent (core hovering around 1½ percent).  
- Unemployment and wages: unemployment fell to a new record low in 2018, pushing wage growth above 3 percent in the second half of 2018.  
- Credit and lending: credit grew broadly in line with GDP in 2018; new lending to nonfinancial corporations increasingly directed to relatively riskier firms while lending standards were eased.  
- Real estate: prices of residential and commercial real estate continued to rise rapidly, especially in dynamic urban areas.  
- Financial sector profitability: under pressure from a “low-for-long” interest rate environment, compounded by high costs and slow progress with restructuring.

### Outlook and risks
- Short-term: staff assumes a gradual return of output to trend in the year following 2018, but outlook is subject to significant uncertainty due to Germany’s export dependence and financial openness.  
- External shocks that could hurt growth: rising global protectionism; a more pronounced China slowdown; a no-deal Brexit.  
- Financial conditions risk: tighter global financial conditions could trigger sharp corrections in stretched asset valuations.  
- Medium-term constraints: unfavorable demographics, low productivity growth, and the impending energy transition expected to weigh on growth.

### Labor market, wages, and distributional issues
- Unemployment rate (ILO): 2017: 3.8; 2018: 3.4; projections 2019: 3.2; 2020: 3.1.  
- Employment growth: 2017: 1.1; 2018: 0.5; projections 2019: 0.7; 2020: 0.4.  
- Wage dynamics: tight labor market and widespread reported labor shortages pushed wage growth above 3 percent in 2018H2; real wages grew faster than productivity, increasing the labor share.  
- Distributional outcome: benefits of strong performance not evenly shared; wage growth meager for much of past 20 years, with income growth concentrated at the top and stagnation for lower deciles—contributing to large external imbalances via depressed private consumption and high corporate savings concentrated among wealthier households.

### Financial sector and macrofinancial vulnerabilities
- Profitability: low profitability in both the bank and life insurance sectors noted by Directors.  
- Macrofinancial vulnerabilities: elevated; rapidly rising real estate prices in dynamic cities highlighted as a risk.  
- Policy tools: counter-cyclical capital buffer activated; Directors encourage expanding the macroprudential toolkit (including tools for commercial real estate) and urgently addressing data gaps to enable fuller assessment of financial stability risks.  
- Supervisory focus: monitor interest rate risk and accelerate bank restructuring to enhance resilience.

### Executive Board assessment and policy recommendations (key points)
- Commendation: Directors commended German authorities for skillful economic management, stronger fiscal position, and reduced unemployment to historically low levels.  
- Rebalancing and inclusiveness: Directors urged forceful policies to ensure benefits are broadly shared—recommend continued faster wage growth and boosting disposable income via tax and benefit system changes.  
- Fiscal policy stance: welcomed moderate fiscal expansion in the near term; most Directors encouraged continued use of fiscal space to bolster potential growth and facilitate rebalancing while maintaining buffers for aging population and contingent liabilities. Recommended fiscal priorities include:
  - investments in infrastructure;
  - tax measures to raise disposable income for low- and middle-income households;
  - incentives to promote labor force participation by female and elderly workers;
  - tax credit for further research and development.
- Structural reforms: speed up reforms to promote innovation, investment, and competition (including in business services and regulated professions); upgrade digital infrastructure; implement e-government strategy; improve access to venture capital.  
- Energy and climate policy: noted that Germany is on track to meet renewable energy target; Directors welcomed consideration of a carbon tax and carbon pricing as part of greenhouse gas emission strategy.  
- Financial-sector policy: press banking sector to accelerate restructuring plans; expand macroprudential toolkit; address data gaps; monitor interest rate risk.  
- Anti-corruption: welcomed voluntary participation in enhanced governance framework on supply and facilitation of corruption and strong anti-bribery enforcement actions.

### Key IMF staff summary (from "KEY ISSUES" and "Key Policy Recommendations")
- Central diagnosis: strong fundamentals (healthy public and private balance sheets, low unemployment) but external factors and structural challenges (export slowdown, low productivity growth, adverse demographics) weighing on growth.  
- Priority policy actions (bulleted):
  - Continue to use space within fiscal rules to bolster long-term growth and rebalance the economy (incentivize labor supply, provide more childcare, improve education and lifelong learning, R&D tax credits, high-speed digital networks, public infrastructure investment).  
  - Encourage strong wage growth, as warranted by the tight labor market, to realign competitiveness and support household purchasing power.  
  - Speed up structural reforms: cut administrative red tape (e-government), reduce policy uncertainty around the energy transition, support expansion of venture capital.  
  - Press banking sector to accelerate restructuring to bolster profitability and reduce risks.  
  - Expand macroprudential toolkit and urgently address data gaps to allow fuller assessment of financial stability risks.

*International Monetary Fund staff report for the 2019 Article IV Consultation (Germany).*

### 6.       In 2018, Germany recorded its largest fiscal surplus since reunification, marking the

### 6.       In 2018, Germany recorded its largest fiscal surplus since reunification, marking the

### Fiscal position and 2018 developments
- General government surplus rose to 1.7 percent of GDP in 2018, from 1 percent of GDP in 2017.
- Public investment increased by almost 8 percent in nominal terms, but only by 0.1 percentage point of GDP due to the low base.
- Fiscal stance (measured by the change in structural primary balance) was moderately contractionary in 2018, instead of expansionary as projected in the 2018 Article IV report.
- Public debt fell to 60.9 percent of GDP at end-2018.

### Large external imbalances: current account and NIIP
- Current account (CA) surplus:
  - Fell by 0.7 ppt of GDP in 2018 to 7.3 percent of GDP.
  - Gradual downward trend from a 2015 peak of 8.5 percent of GDP.
  - In cyclically-adjusted terms, the CA surplus remains 3.6–5.6 percentage points higher than the value implied by fundamentals and desirable policies (staff assesses the current account norm at 2–4 percent of GDP for Germany).
- Drivers:
  - Underlying decline in net exports was broad-based across destinations, more pronounced with respect to non-EU trading partners.
  - Import growth was robust on the back of higher investment.
  - Non-financial corporate (NFC) net lending came down substantially since its 2015 peak; government net lending increased.
- Net International Investment Position (NIIP) climbed to 60.6 percent of GDP at end-2018; the rise relative to 2015 is entirely explained by higher net portfolio investment.
- Real effective exchange rate (REER) assessment:
  - Remains 8–18 percent undervalued in 2018.
  - Appreciated by 2 percent in 2018 but depreciated by 1.3 percent in the months up to May 2019.

### Financial vulnerabilities and credit dynamics
- Credit growth:
  - Mortgage and NFC credit growth accelerated to a pace modestly faster than nominal GDP growth in 2018.
  - NFC leverage experienced a slight rise after many years of decline.
- Risk characteristics:
  - Evidence that new credit to NFCs is increasingly channeled to relatively riskier firms.
  - Lending standards have been eased, as suggested by the Bank Lending Survey.
- Low-for-long interest rate environment effects:
  - Yields on German government bonds have turned negative/scarcely positive across maturities and the yield curve has flattened.
  - Profitability pressures for banks and insurance companies expected to increase given high costs and slow restructuring.

### Near-term outlook and risks
- Staff baseline:
  - Weak external environment expected to weigh on exports, while domestic demand strengthens.
  - Private consumption growth expected to recover, supported by strong labor market conditions and fiscal measures (e.g., income tax relief, family support).
  - Private non-residential investment expected to expand but at a slower pace than last year.
  - Investment in construction (residential and commercial) expected to continue strong.
  - Output gap assessed as moderately positive in 2019, leading to modest upward pressure on core and headline inflation.
  - Wages expected to grow at a solid pace in the coming quarters.
  - Credit expected to continue to expand with low interest rates and ample liquidity.
- Medium-term projections:
  - Growth projected to decelerate to 1.1 percent by 2024 and the output gap projected to gradually close.
  - Headline and core inflation should reach 2.2 percent by 2022.
  - With continued CA surpluses, NIIP is expected to exceed 80 percent of GDP in the medium term.
- Risk scenarios (tilted to the downside):
  - Significant rise in global protectionism, more pronounced China slowdown, or a no-deal Brexit could hurt exports and FDI, disrupt supply chains, and weigh on domestic investment and productivity — particularly harmful to the auto industry.
  - Tighter global financial conditions and a return of sovereign debt concerns in the euro area may trigger sharp corrections across asset classes; German government bonds may benefit while real estate and equity markets would be adversely affected.
  - Domestic risks include failure to revamp bank business models, potentially leading to financial distress in major banks with external spillovers.
  - Upside risks: faster-than-anticipated wage growth, positive investment surprises, and a more expansionary fiscal policy.
  - Longer-term structural risks: failure to adapt to technological and digital changes (notably in the automotive sector), stalled structural reform agenda, unresolved bank legacy and profitability problems, and rising anti-euro/EU or anti-globalization sentiment.

### Authorities’ views
- Broad agreement with staff on the near-term macro outlook and risks.
- Authorities view the positive Q1 2019 growth surprise as temporary; manufacturing output stagnated in Q1.
- Authorities expect weakening foreign demand to continue; recent trade policy developments interpreted as signs of likely further escalation.
- Authorities’ recent growth estimates for 2019 are weaker than staff’s, implying a more pronounced slowdown.
- Acknowledge contribution of income dispersion to the large CA surplus and view recent wage growth pickup as welcome.
- Recent fiscal measures (social contribution and income tax relief, increased family benefits) expected to support lower incomes and household consumption.
- Authorities stress need to promote long-run growth potential via upgrading digital infrastructure and fostering innovation.

### Policy discussions — challenge and broad strategy
- Key challenge: raise long-term growth potential while rebalancing the economy amid demographic headwinds, low labor productivity growth, technological change, and the energy transition.
- Recommended multi-pronged policies:
  - Raise investment in human and physical capital.
  - Promote innovation and labor supply.
  - Advance structural reforms.
  - Continue strong wage growth to help rebalance and distribute benefits more evenly.
  - Reduce the tax burden on labor income, particularly in lower-middle income brackets, to reduce disincentives to labor supply and boost household purchasing power.

### A. Addressing external imbalances by restoring household purchasing power
- Role of NFC net lending and fiscal consolidation:
  - NFC net lending rose from -1.5 percent of GDP in 2001 to 3.8 percent in 2015, contributing the bulk of the surge in the CA surplus since 2000.
  - Increase in NFC net lending driven by rising gross saving (notably by family-owned firms), as firms reduced debt and increased holdings of cash and liquid assets.
  - Since 2008, surge in gross saving mostly reflected falling dividend payout ratios amid stable profitability.
  - After peaking in 2015, NFC net lending came down substantially due to lower profitability (in part from higher wage growth), higher dividend payout ratios, and modest pickup in investment.
  - Government net lending has also risen markedly due to fiscal consolidation.
- Household income and consumption:
  - Household disposable income has declined relative to GDP by about 6.2 percentage points since 2005 (concentrated in the lower half of the income distribution).
  - Private consumption as a share of GDP dropped from about 55 percent on average between 1995 to 2005, to 51 percent at the end of 2017.
  - Restoring household disposable income to its 2005 level (63 percent of GDP) through wage growth alone would require nominal wage growth to exceed annual nominal GDP growth by around 1.5 percentage points each year for over a decade.
- Inequality and savings:
  - Widening top income inequality may help explain high private savings and the rising CA surplus.
  - Home and equity ownership rates are the lowest in the euro area, particularly among middle- and lower-income households.
  - Large net wealth of German firms is highly concentrated at the top of the wealth distribution due to family-ownership and control of Mittelstand firms.
  - High corporate savings partly reflect savings of wealthy households accumulated within firms due to preferential tax treatment (mainly inheritance tax treatment of business wealth).
  - Staff analysis shows family-owned and -managed firms tend to save more than other firms and more than similar private firms in the euro area.
- Policy recommendations to boost disposable income and rebalance:
  - Encourage robust wage growth in public communications.
  - Consider stronger increases in the minimum wage at the next revision in 2021, given labor market tightness and the moderate level of the minimum wage.
  - Use tax policies to support purchasing power of middle- and lower-income earners.

### B. Fiscal policy to boost potential growth and support rebalancing
- 2019 fiscal stance:
  - Fiscal policy set to turn expansionary in 2019.
  - 2019 budget includes measures to increase family support and public investment, and income tax relief (higher basic tax allowance and correction of bracket creep) worth 0.2 percent of GDP per year.
  - Resulting in a moderate fiscal expansion of about ⅔ percent of GDP.
- Medium-term fiscal projections and space:
  - Staff projects structural surplus will decrease from 1.2 percent of GDP in 2018 to about ½ percent of GDP in 2021–22 based on the fiscal package agreed when the coalition government was formed.
  - Fiscal space in relation to the Stability and Growth Pact’s (SGP) medium-term objective (MTO) remains substantial (more than 1 percent of GDP over the medium term).
  - National rules (“debt brake”) set limits on structural net borrowing for central and state governments; budget surpluses have allowed central and many state governments to build up reserves.
  - Financing expenditures with reserves means national rules will not be binding for some time; the relevant constraint for now is the MTO.
  - Public debt ratio expected to cross the 60 percent of GDP benchmark this year and will continue to decline rapidly over the projection period.

*Source: IMF staff report (excerpt).*

### 22.      Germany’s fiscal space should be used to support potential growth and rebalancing.

### 22.      Germany’s fiscal space should be used to support potential growth and rebalancing.

### Fiscal policy stance and tax reform
- Using fiscal tools and resources to invest in physical and human capital, incentivize innovation, and bolster labor supply would help Germany confront long-term challenges and support external rebalancing by stimulating domestic demand in the short term.
- Scope to reform the tax system to make it more growth friendly:
  - Germany’s labor taxation (including the tax wedge) is high and a high marginal tax rate takes effect at relatively low wage levels.
  - Further tax relief for low-income households could boost disposable income and support domestic demand.
  - Reduce the high effective marginal tax rate for second earners (for example, replace the current income splitting system with a tax allowance or credit for couples) to promote full-time female labor force participation.
  - Further expanding provision of care for children under three years of age would help women work longer hours.
  - To compensate for revenue shortfalls, reforming property and inheritance taxes could be considered to reduce excess saving and wealth concentration.
- Authorities’ stance:
  - Authorities argued most of the space under fiscal rules would be used; in a severe downside scenario further fiscal stimulus would be considered.
  - The government highlighted fiscal priorities to boost productivity and growth potential through investment in infrastructure, education, and research.
  - Authorities noted additional fiscal space would be limited because their tax revenue projections are much lower than staff’s.
  - At present there are no plans to raise revenue by reforming property or inheritance taxes; work is underway on a revenue-neutral proposal to reform the immovable property tax regime by updating property valuations.

### R&D incentives and corporate taxation
- Incentivizing R&D would help long-term growth:
  - Government proposal: a tax credit up to €500,000 per year will be provided for 25 percent of R&D costs up to €2 million starting in 2020.
  - R&D expenditures are widely seen as a key driver of productivity growth; direct tax incentives targeting R&D inputs are more effective and efficient than “patent box” regimes.
  - A generous R&D tax credit would support innovation and generate positive growth spillovers.
  - Total envelope for the R&D tax incentive is currently estimated at about €1¼ billion and could be further expanded.
- International tax environment:
  - Germany should preserve a competitive corporate tax system while not engaging in damaging tax competition.
  - Germany has led in anti-tax avoidance measures; adjustments to provisions (notably regarding controlled foreign corporations) could be beneficial.
  - The Franco-German proposal of a minimum tax will benefit Germany; internationally coordinated solutions are powerful but their modalities and implementation issues need further development (some specific to Germany).
  - Authorities stressed commitment to collaborative solutions at G20, OECD and EU levels for the German-French minimum tax proposal and fair taxation of large digital companies.

### Public investment, local governments, and infrastructure gaps
- About two-thirds of public investment is executed by local governments.
- Historical pattern: local governments prioritized fiscal consolidation at the expense of public investment; more recently budget surpluses have alleviated constraints and public investment growth accelerated in 2018.
- Ongoing measures facilitating municipal investment execution include reform of federal fiscal relations, Municipal Investment Promotion Fund, Digital Infrastructure Fund, and technical support by Partnerschaft Deutschland.
- New obstacles: capacity constraints and price pressures in the construction industry.
- Recommendations:
  - Rebuild planning capacity at the local level.
  - Enhance coordination across government levels to ensure larger and longer-term projects are implemented.

### Role of fiscal policy in a downturn
- If downside risks materialize:
  - Allow automatic stabilizers to operate fully.
  - Fully use available fiscal space.
  - In a severe economic downturn, invoking the escape clause under both European and national fiscal rules could be appropriate to expand fiscal space and support a synchronized fiscal expansion.

### Boosting productivity and private investment
- Long-run productivity concerns:
  - Labor productivity growth has been declining over the last two decades; the decline is broad based, including manufacturing.
  - Within manufacturing, productivity growth has been relatively high in the automotive sector where robot density has intensified.
  - Productivity growth tends to be higher among large firms compared to small- and medium-sized firms.
- Supply-side constraints:
  - Reported labor shortages are widespread amid a declining working-age population (15–64 years old).
  - A new immigration law aims to attract skilled labor from outside the EU but more policy action is needed to prolong working lives and encourage labor force participation.
  - High capacity utilization rates and a decline in the stock of machinery and equipment (percent of GDP) indicate capital constraints.
  - Business investment in Germany is lower than in peers, possibly reflecting concerns about future growth, red tape, and lack of skilled workers.

### Digital infrastructure, e-Government, and energy transition
- Digital infrastructure and adoption:
  - Germany has made little progress in expanding high-speed fiber-optic internet coverage nationally, constraining productivity.
  - Only 5 percent of SMEs in Germany use big-data analytics, compared to 10 percent in the EU as a whole.
  - Government committed to allocating up to €12 billion to build a nationwide fiber-optic network by 2025.
  - Ongoing auctioning of 5G licenses (2 and 3.6 GHz) and expected allocation of the 88MHz spectrum in 2025 are expected to improve coverage.
  - Auction proceeds of €6.5 billion will be added to the Digital Infrastructure fund (created in 2018).
  - Government initiatives include SME consultancy for IT security, digital marketing, and digital processes; and creation of an Agency for Innovation in Cybersecurity (August 2018).
- e-Government:
  - Cumbersome procedures and high compliance costs hinder entrepreneurship.
  - Fully implement the National e-Government Strategy to provide public services at federal and local levels on one interface and reduce administrative burdens.
- Energy transition:
  - Uncertainty about the strategy for completing the energy transition is affecting business sentiment.
  - Under current policies, Germany is unlikely to meet its 2020 target on reducing greenhouse gas output.
  - A carbon tax could be part of a comprehensive strategy the government is preparing.
  - Germany is on track to reach its 2020 renewable energy target for electricity, but rising renewable shares without sufficient internal transmission capacity create network management challenges.
  - The Grid Expansion Acceleration Act (April 2019) simplifies procedures for grid expansion projects.
  - Government introduced competitive auctions for renewable energy to help stabilize costs.
  - The forthcoming National Energy and Climate Plan for 2021–30 will include concrete measures to attain the 2030 target on reducing greenhouse gas output; steps to phase out coal-fired power generation by 2038 are under preparation.

### Promoting innovation, competition, and labor supply
- Promote innovation and scale-up:
  - Venture capital investment has been rising, returning to pre-GFC level; investment in start-ups by non-VC companies and venture debt has risen.
  - Relatively small size of venture capital funds hinders capital-intensive scale-up stage.
  - Government should encourage scale-up of funds (e.g., promoting fund-of-funds to attract institutional investors) and encourage cross-border investment within the EU Capital Markets Union.
  - Introduction of generous incentives for R&D would help entrepreneurship and innovation.
- Increase competition in business services and regulated professions:
  - Liberalizing these sectors can reduce costs by lowering input prices from business services.
  - Government plans a 2019 review of regulations in professional services with the goal of reforming the Professional Law.
  - Other professions in need of reform include accountants, architects, and engineers.
  - Competition in freight and regional passenger rail is increasing; market share for new entrants in long-distance passenger services remains low due to high track-access charges; government plans to evaluate the Railway Regulation Act.
- Expand quality and quantity of labor supply:
  - Increase investment in education and life-long learning to equip workers for technological change and extend work lives.
  - Address teacher shortages in vocational education and training, and primary education as an urgent priority.
  - Germany’s old-age employment rate is 71 percent.
  - Pension reforms that explicitly link statutory retirement age with life expectancy can further increase old-age labor force participation by extending working years as life expectancy increases.
  - According to the EC, adjusting the pensionable age by two-thirds of the increase in life expectancy would maintain the current ratio of 1:2 regarding the average time spent in retirement versus time spent working, without reducing pension levels.
  - Refugee integration: employment rate of refugees from the top eight countries reached about 33 percent in November 2018, up by nearly 8 ppt from a year earlier.
  - Continue support for refugee integration: improve German language proficiency, gain experience in German labor market norms, and make selected qualifications transferrable.

*Source: IMF Staff Report excerpt — "Germany’s fiscal space should be used to support potential growth and rebalancing."*

### 33.      The authorities also highlighted ongoing efforts to support innovation and venture

### Shoring up Financial-Sector Profitability while Preventing Buildup of Financial Risks

### Innovation and venture capital
- Government initiatives guided by the “High-Tech Strategy 2025,” which lists six priority areas: digital economy, sustainable economy and energy, innovative work environment, healthy living, intelligent mobility, and civil security.
- Government drafting a bill on R&D tax credits to support innovation, especially of SMEs.
- Venture capital investment has been rising to pre-GFC levels with fund sizes growing, supported by government initiatives, inter alia jointly with the European Investment Fund and KfW Capital.
- Government plans to continue its co-investment strategy to crowd in private investment, especially by institutional investors.

### Banking and life-insurance profitability — findings
- The continued “low-for-long” environment is exacerbating profitability challenges for German banks and life insurance companies.
- Banking sector:
  - Low profitability erodes banks’ ability to generate capital organically and raises risk in the event of adverse earnings shocks.
  - Large German banks underperform European peers in market valuation due to high operating costs, outdated IT systems, provisions for compliance violations, and legacy costs from shipping exposures.
  - Leverage remains very high, particularly at the German global systemically important bank (G-SIB) and some Landesbanken.
  - Small and medium-sized banks lag peers in developing alternative income sources; low interest rates weigh on profitability.
  - Full adoption of Basel III—especially the introduction of an output floor for internal risk models—is expected to substantially increase German banks’ minimum capital requirement.
- Life insurers:
  - As of mid-2018, most German life insurers’ solvency ratios were well above the 100 percent threshold set by supervisors, although around two-thirds of them relied on transitional measures and the dispersion was large.
  - The prolonged low interest rate environment is forcing a shift away from guaranteed-return products, yet such products are expected to remain dominant in the next decade.
  - Diversification of insurers’ investment portfolios is proceeding only slowly.

### Supervisory and policy recommendations for banking and insurance
- Supervisors should continue monitoring interest rate risk and press for faster implementation of restructuring plans in both banking and insurance sectors.
- To boost profitability, more decisive cost cuts are necessary, for example by:
  - Reducing branches.
  - Promoting digitization.
- Specific actions:
  - Large banks: implement existing restructuring plans faster.
  - Savings and cooperative banks: develop fee-based income and pursue further consolidation.
  - Life insurers: reduce the share of guaranteed products and diversify investment (for example, in infrastructure projects or foreign assets).

### Real estate markets and credit — findings
- Residential real estate:
  - House prices in major cities have continued to rise rapidly, moving further into overvaluation territory.
  - Staff analysis (2017) suggests house prices were overvalued in Germany’s main cities:
    - Stuttgart and Dusseldorf: 10–15 percent.
    - Hannover, Frankfurt and Hamburg: 25–30 percent.
    - Munich: more than 40 percent.
  - Government measures to increase housing supply include allocating €2 billion to build 100,000 new social housing units during 2020–21, selling federally-owned properties to local authorities at reduced prices to build affordable housing, and providing a special depreciation allowance for new rental housing construction. The impact on house prices, however, is expected to be limited.
- Commercial real estate (CRE):
  - CRE prices have risen even faster than house prices with a moderate decline in the yield on CRE investment.
  - Price increases particularly large in the office sub-segment; banks’ exposure to the sector has risen over the last three years.
  - Bank lending to CRE-related activities appears relatively small compared to the EU average, but defaults on CRE tend to be higher than on residential real estate.
  - The European Systemic Risk Board’s report (November 2018) indicates German banks’ lending for real estate activities and construction is about 6 percent of GDP in Q4 2017, which is around half of the EU average.
- Aggregate credit:
  - Rapid price increases have not yet been accompanied by strong aggregate credit growth.
  - Credit growth accelerated to a pace slightly exceeding nominal GDP growth, but the credit-to-GDP ratio remains low from a historical perspective and compared with other advanced economies.

### Macro-financial vulnerabilities and provisioning
- Low default rates have led to a decline in banks’ loan loss provisioning.
- According to Bundesbank analysis, German banks’ average tier 1 capital ratio would be lower by around 2 percentage points if they used historical levels of risk provisioning.
- Banks that rely on internal models to calculate regulatory capital have reduced risk weights and there is evidence of “search for yield” behavior.
- These trends, alongside rising real estate prices and weak bank profitability, point to rising macro-financial vulnerabilities.

### Macroprudential policy actions and recommendations
- Activation of the counter-cyclical capital buffer (CCyB) is welcome:
  - In May, the Financial Stability Committee recommended raising the CCyB by 0.25 percent.
  - Banks have 12 months from the beginning of Q3 2019 to meet the new requirement.
  - The relatively small increase should have limited impact on credit supply.
- Additional macroprudential action needed to guard against real estate imbalances:
  - Urgently address data gaps: lack of granular loan information hinders assessment of financial stability risks in specific market segments.
  - Consider prompt activation of existing borrower-based measures: absent granular data and given prolonged house-price rises, consider implementing an LTV cap and amortization requirements on mortgages.
  - Expand the macroprudential toolkit:
    - Germany currently lacks income-based instruments for residential and CRE lending or other borrower-based instruments for CRE lending.
    - Authorities should consider introducing income-based instruments, such as a debt-to-income or debt-service-to-income cap.
    - Appropriate instruments for CRE should be considered, taking into account diverse financing structures.
  - The government is currently reviewing the effectiveness of existing instruments; this is an opportune time to consider expanding the toolkit.

### AML/CFT and supervisory enhancements
- Authorities are strengthening AML/CFT supervision, including for banks with cross-border operations:
  - BaFin has appointed “Special Representatives” to sit on-site in one of the major banks to carry out audit functions; the representative reports directly to BaFin and may be granted additional powers to take remedial actions within the bank.
  - Specialized units within BaFin focus on supervision of high-risks banks (major banks with cross-border operations) subject to continuous AML/CFT monitoring.
  - BaFin assesses, together with external auditors, implementation of group-wide policies by foreign branches and subsidiaries.
- Progress should continue, taking into account recently identified AML/CFT weaknesses across Europe, including by considering further integration of AML/CFT supervision at the European Union level.
- Authorities are transposing the 5th EU Money Laundering Directive into national law and preparing for the AML/CFT comprehensive assessment of Germany by FATF in 2020, which may entail additional revisions.

### Tackling the supply-side of corruption and enforcement findings
- Germany has taken strong anti-bribery enforcement actions:
  - The 2018 OECD WGB report recognized Germany as one of the highest enforcers of the OECD’s Anti-Bribery Convention: sanctioned 328 individuals and 18 companies in a total of 67 foreign bribery cases since 1999.
  - Detection sources include information provided by tax authorities; investigative authorities have used mutual legal assistance, coordinated investigations with tax authorities and joint investigative teams in multijurisdictional cases.
  - Creation of a Federal Debarment Register with mandatory debarment from public procurement was commended.
- OECD WGB recommendations and staff views:
  - Strengthen enforcement against legal persons involved in foreign bribery cases; concerns about insufficient and inconsistent enforcement actions against legal persons.
  - Encourage more effective, proportionate and dissuasive sanctions against legal persons, including tying punitive fines more closely to turnover as per the 2018 Coalition Agreement Commitment.
  - Review approach to holding companies liable, including prosecutorial discretion for legal persons, introduce clear guidance for self-reporting, and consider conditional resolution for legal persons.
  - Improve compilation of statistics at the Federal level or across regions to better monitor enforcement.
  - Clarify criteria for using non-trial resolution tools and, in line with data protection rules, make their main elements public.
  - Develop a more comprehensive framework for whistleblower protection.
  - Fund staff agrees with these recommendations and urges implementation.

### Authorities’ views summarized
- Authorities share view that risks to financial stability are building up but do not see acute systemic risks based on current indicators.
- Authorities supported activation of the CCyB from Q3 2019 but saw no substantial increase in risks from the flow of new housing loans requiring immediate sector-specific demand-side measures.
- Authorities will review their macroprudential toolkit and consider household income-based instruments; borrower-based instruments for CRE would need to reflect diverse CRE financing structures.
- Authorities agree on urgency of closing data gaps; an ongoing ad hoc survey on real estate lending and corporate credit underwriting standards is expected to provide further information.
- Authorities see the need for accelerated restructuring and consolidation in banks and life insurers, while noting the long transitional period through 2031 for full adoption of Solvency II.
- Authorities are preparing for FATF’s AML/CFT assessment in 2020 and welcome advancement of AML/CFT supervisory colleges at the EU level, while seeing challenges in a more centralized European AML/CFT supervisory framework.
- On anti-bribery, authorities will present a Phase 4 two-year written follow-up report at the WGB Plenary in June 2020 and will continue to strengthen enforcement actions in foreign bribery cases.

### Staff appraisal — key judgments and recommendations
- Germany’s economic performance has been strong over the last decade, but benefits have been unevenly shared; wage growth lagged and a rising share of national income took the form of savings inside the corporate sector.
- Recent developments show slow unwinding of large imbalances; faster wage growth is key to continue rebalancing and to help accelerate real exchange rate appreciation and external rebalancing.
- Short-term outlook: gradual return of growth to trend by end of 2019, but downside risks are significant (escalation of trade tensions, more pronounced China slowdown, disorderly Brexit, renewed euro-area stress).
- Long-term challenges: unfavorable demographics, weak productivity growth, and the energy transition will weigh on potential growth.
- Fiscal policy: remaining space under fiscal rules should be used from 2020 onwards to strengthen growth potential by promoting innovation, expanding labor supply to counter population aging, and continuing to fill infrastructure gaps.

*IMF staff report (section content).*

### 51.      There is scope to reform the tax system to make it more growth friendly and inclusive,

### 1deuea2019001 - 51.      There is scope to reform the tax system to make it more growth friendly and inclusive,

### Tax reform, inclusivity, and investment incentives
- Main findings and proposals:
  - Additional tax relief for low-income households would, alongside continued wage growth, boost their disposable income and consumption, supporting rebalancing.
  - Reducing the high effective marginal tax rate for secondary earners could help promote full-time female labor force participation.
  - Further expanding childcare and after-school programs would support higher female labor force participation.
  - The government’s new proposal of tax credits for R&D is welcome, but the total envelope could be usefully expanded.
  - In the face of changes in the global international tax environment, Germany should:
    - maintain its position of leadership in implementing anti-tax avoidance measures, and
    - preserve the competitive corporate tax system while not engaging in damaging tax competition.
  - Budgetary room for these plans, if needed, could be created by reforming property and inheritance taxes.

### Infrastructure gaps and local government capacity
- Assessment:
  - Continuing to address infrastructure gaps, particularly at the local government level, will require rebuilding planning capacity and better coordination across levels of government.
  - Historically, local governments (Länder and municipalities) prioritized fiscal consolidation at the expense of investment.
  - More recently, budget surpluses have alleviated financial constraints in most localities, but capacity constraints and price pressures in the construction industry have emerged as new obstacles.
- Recommendation:
  - Stronger coordination across various government levels to ensure larger and longer-term projects get under way.
  - Local governments should work to rebuild planning capacity.

### Medium-term challenges and growth potential
- Key areas for action:
  - Strengthen initiatives to upgrade the digital infrastructure and implement the “National E-Government Strategy” rapidly.
  - Scale up venture capital by attracting institutional investors and encouraging cross-border investment in the context of the EU-wide Capital Markets Union.
  - Develop a clearer strategy for curbing greenhouse gas emissions to reduce uncertainty about the energy transition; the introduction of a carbon tax could be part of the solution.

### Banking and life insurance sector restructuring
- Imperatives:
  - Banks and life insurance companies must accelerate restructuring to boost profitability and resilience.
  - Banking sector reforms: further consolidation, cost-cutting, and continued development of fee-based income.
  - Life insurance sector reforms: faster replacement of conventional guaranteed return products with other types of products given low interest rates.
  - Supervisory action: continue monitoring interest rate risk and progress in implementing restructuring plans in both banking and insurance sectors.

### Macro-financial vulnerabilities and recommended macroprudential actions
- Context:
  - Macro-financial vulnerabilities are building up; the recent activation of the counter-cyclical capital buffer is welcome and additional action should be considered.
- Recommended actions:
  - Urgently address data gaps to enable a fuller assessment of possible financial stability risks. The ongoing one-off bank survey on real estate lending and corporate credit underwriting standards is a step in the right direction, but regular collection of granular data is needed for effective macroprudential policy-making.
  - Early implementation of the existing borrower-based measures (cap on the loan-to-value ratio and amortization requirements) on residential mortgage lending to prevent the buildup of vulnerabilities in the residential real estate sector.
  - Expand the toolkit by introducing income-based instruments (e.g., cap on debt-service-to-income, cap on debt-to-income) for residential loans and appropriate borrower-based measures for CRE loans.

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

### Box 1 — Corporate saving, top income and wealth inequality, and external imbalances
- Empirical relationships and facts:
  - The correlation coefficient between the CA surplus and the share of national income accruing to the top 10 percent of the income distribution is 0.95 over 1992–2016.
  - As the CA increased by 9 percent of GDP, the top income share climbed by 6 percentage points, with the sharpest increase in both series occurring in the early-mid 2000s.
  - Since 2009, the top income share appears to have flattened, while corporate savings rose rapidly, further boosting the current account surplus. Retained earnings and other types of capital income are not properly captured as income of ultimate shareholders and thus are not reflected fully in the measured top income share since 2009.
  - If business ownership is highly concentrated at the top of the income distribution, appropriate attribution of corporate savings to their ultimate shareholders would lead to a continued rise in the top income share after 2009, which does not appear in the data.
  - The 10 percent wealthiest households own 60 percent of the aggregate net wealth in the economy – the highest level in the euro area, and most of the wealth at the top of the distribution is business wealth.
  - The rise in corporate saving, coupled with the high wealth inequality, can explain about half of the rise in top income inequality over the period 2000–2015 in Germany.
- Mechanisms highlighted:
  - Rising corporate profits— increasingly saved in firms owned by the wealthiest households— therefore supported the rise in top income inequality.
  - As wealthier households tend to have a higher propensity to save, widening income inequality boosted aggregate saving and depressed aggregate consumption, resulting in a rising current account surplus.
  - Survey data show that the lower/median income households in Germany tend to have a propensity to consume close to one.
  - Persistent, concentrated increases in private saving among top income households exacerbate wealth inequality over time; the interaction between wealth inequality and corporate saving is mutually reinforcing.

*Source: IMF staff summary of content unit 1deuea2019001.*

### Box 2. The Impact of Potential US Auto Tariffs on Germany

### Box 2. The Impact of Potential US Auto Tariffs on Germany

### Overview and Context
- Germany was one of the major car and car parts exporters to the United States in 2017, along with Canada, Mexico, and Japan. Five European countries, including Germany, the UK, Italy, Sweden, and the Slovak Republic, were among the top 10 exporters, which together accounted for 99 percent of the car exports to the US.
- Export values embodied value-added created not only by the exporting countries but also by other countries in their supply chains: About ⅔ of the value of German car exports is domestically generated while ⅓ of the value can be attributable to other countries in its supply chain.

### Estimated Trade-Channel Impact (GVC-aware)
- A 25 percent US tariff on autos and auto parts has an estimated trade-channel impact on Germany of around 0.15 percent of GDP when global value chains (GVCs) are fully considered.
- The impact estimate excludes confidence effects, retaliation, or trade diversion.
- GVC data used: Eora global supply chain database.

### Network Analysis Findings
- Network analysis that traces trade-channel impacts through GVC linkages suggests the imposition of US tariffs on autos and auto parts would affect a broader group of countries than gross export data indicates.
- Within Europe, Germany, Sweden, and Slovakia would be most adversely affected by the US tariff shock.
- For Germany:
  - Half of the impact is due to the direct effect of lower car exports to the US.
  - Half of the impact is due to lower exports of intermediate goods used in car production in third countries — reflecting Germany’s strong GVC linkages.

### Wider Macroeconomic Considerations
- Output losses can be significantly larger for all countries once confidence effects and financial channels are taken into account (see October 2018 WEO).
- Sources cited in the analysis include the EORA database, UNComtrade, and IMF staff calculations.

*Source: IMF staff calculations using the Eora global supply chain database and UNComtrade as presented in Box 2.*

### 3.3 percent in 2018, respectively, reflecting the nominal appreciation of the euro against the currencies of key

### Germany — External Sector Assessment and Annexes

### Real Effective Exchange Rate (REER) and Valuation
- REER appreciation: "3.3 percent in 2018, respectively, reflecting the nominal appreciation of the euro against the currencies of key trading partners – most notably the US Dollar, the Yen and the Swiss Franc – and the relative pick-up in labor costs."
- Short-term movement: "Estimates through May 2019 show that the REER has depreciated by 1.3 percent relative to the 2018 average."
- Model and assessment results:
  - "The EBA REER Level model yields an undervaluation of 16 percent."
  - "The undervaluation implied by the assessed CA gap using standard trade elasticities is in the range of 12–27 percent."
  - Staff overall assessment: "Taking these estimates into consideration and the 2018 real appreciation, staff assesses the 2018 REER to have been undervalued in the range of 8-18 percent."
- Model caveats:
  - "For Germany, the bulk of the EBA-estimated gap for 2018 reflects the regression’s residual rather than gaps in the policies variables included in the EBA model."
  - "The EBA REER Index model implies that the REER is close to equilibrium. However, the EBA REER Index model has an unusually poor fit for Germany."

### Capital and Financial Accounts: Flows and Composition
- 2018 composition and direction:
  - "In 2018, net portfolio outflows constituted over ¾ of the capital and financial accounts balance, with direct investment being the second largest item (1/5 of total)."
  - Destination of outflows: "80 percent of the outflows went to European countries, with about 6 percent going to the Americas (mostly the US)."
  - Source of gross inflows: "only 14 percent of inflows originating from the EU, due to falling investment by non-euro EU countries (UK, Denmark), while investment by emerging markets (especially Turkey) and North America picked up considerably."
  - FDI: "Foreign direct investment inflows and outflows continued to recover, after a drop in 2016, coming/going mostly from/to euro area countries."
- Assessment: "Safe-haven status and the strength of Germany’s current external position limit risks."

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

### Technical Background Notes (selected)
- Note 1: "For Germany, the bulk of the EBA-estimated gap for 2018 reflects the regression’s residual rather than gaps in the policies variables included in the EBA model."
- Note 2: "The estimated norm reflects changes in the credit gap estimates to better reflect the German financial cycle. Staff assesses the credit-to-GDP to be currently lower than its long-term equilibrium, and that gradually closing of such gap will help support investment over the medium term."
- Note 3: "The EBA REER Index model implies that the REER is close to equilibrium. However, the EBA REER Index model has an unusually poor fit for Germany."

### Risk Assessment Matrix — Key Risks, Likelihood, Impact, and Policy Responses
- I. Rising protectionism and retreat from multilateralism
  - Relative Likelihood: H
  - Impact: H
  - Key vulnerability/impact: "With its high degree of trade openness, Germany is especially susceptible to fluctuations in global demand; fiscal buffers are comfortable."
  - Policy responses:
    - "Continue support for the multilateral rules-based trading system, trade liberalization, and free trade agreements."
    - "Let automatic stabilizers fully operate."
    - "Consider a discretionary fiscal expansion. If the output gap widens significantly, depending on the size and nature of the shock to the economy, invoke the escape clause under the national debt brake rule could be appropriate to support the German economy."
- II. A disorderly Brexit
  - Relative Likelihood: H
  - Impact: H
  - Key vulnerability/impact: "Significant disruptions, including border delays and a sudden increase in tariff and non-tariff costs, and long-term efficiency losses from a disorderly Brexit."
  - Policy responses:
    - "Contingency planning and collaboration between U.K. and EU authorities to reduce cliff-edge effects and disruptions."
    - "Let automatic stabilizers fully operate. If the output gap widens significantly, invoke the escape clause under the national debt brake rule could be appropriate to support the German economy."
- III. A shift in market sentiment against some high-debt euro area countries
  - Relative Likelihood: H
  - Impact: M
  - Key vulnerability/impact: "Rise in sovereign yields may have knock-on effects on the broader financial sector and affect German banks. Germany is also especially susceptible to fluctuations in global demand;"
  - Policy responses:
    - "The authorities should ensure that banks liquidity and capital buffers are adequate, engage in contingency planning, and put in place coordination mechanisms among the relevant authorities involved."
    - "To the extent that financial stress translates in lower foreign demand, let automatic stabilizers work. If the output gap widens significantly, invoke the escape clause under the national debt brake rule could be appropriate to support the German economy."
- IV. Weaker than expected global growth
  - Relative Likelihood: M
  - Impact: H
  - Key vulnerability/impact: "With its high degree of trade openness, Germany is especially susceptible to fluctuations in global demand; fiscal buffers are comfortable"
  - Policy responses:
    - "The authorities should ensure that structural reforms aimed at increasing potential growth are conducted in a timely manner in Germany, helping to reorient growth drivers toward domestic sources."
    - "They should also let automatic stabilizer work to offset the slowdown in foreign demand."
- V. Further pressure on traditional bank business models
  - Relative Likelihood: M
  - Impact: H
  - Key vulnerability/impact: "Legacy problems, structurally high cost of bank operations, and high competition curtail banks’ profitability, which could lead to financial distress in one or more major banks."
  - Policy responses:
    - "Improve profitability through completion of restructuring plans, consolidation, and cost-cutting is essential."
    - "The authorities should ensure that liquidity buffers are adequate, engage in contingency planning, and put in place coordination mechanisms among the relevant authorities involved."

### Public Debt Sustainability Analysis — Baseline and Risks
- Overall trajectory and headline outcomes:
  - "Public debt falls rapidly and is expected to continue to decrease in the medium term due to projected high primary surpluses and a favorable interest rate-growth differential."
  - "Under the current macroeconomic outlook, the public debt-to-GDP ratio is expected to fall below the 60 percent mark this year, from 60.9 percent in end 2018."
  - "A negative growth shock represents the largest risk to the debt outlook."
  - "The realization of contingent liabilities related to financial sector support would push debt up by about 3 percent of GDP."
  - "In both cases, gross financing needs would remain below 10 percent of GDP, and debt would swiftly return to a firm downward path after the shock."
- A. Baseline Scenario — Macroeconomic assumptions and fiscal context
  - Macroeconomic assumptions:
    - "Real GDP growth is expected at an average of 1.3 percent over the next three years, supported by continued strong labor market conditions and fiscal measures."
    - "In the medium run, growth should converge to its potential level, estimated at 1.1 percent per year."
    - "Inflation—measured by the GDP deflator—should be 1.9 percent in 2018, and steadily rise thereafter, reaching 2.3 percent by 2024."
    - "Sovereign interest rates remain low and are currently negative up to a 10-year maturity. Thus, average interest rates are expected to continue falling, from 1.5 percent in 2018 to 1.0 percent in 2024."
    - Footnote on interest rate: "The interest rate on new borrowing is derived from forecasts of the real interest rate and inflation, and it does not necessarily match market-based interest rate forecasts. Using market-based forecasts would make little difference to the debt sustainability analysis."
  - Fiscal context and scrutiny:
    - "Public gross debt is still above the indicative DSA threshold for high scrutiny of 60 percent of GDP."
    - Historical peak: "Debt increased significantly over 2009–10, reaching a peak of 82.5 percent of GDP, reflecting sizable fiscal stimulus, large financial sector support and euro zone crisis-related lending."
    - Recent evolution: "Since the peak, it has declined gradually on the back of fiscal consolidation and a favorable interest rate-growth differential."
    - Financing needs: "Estimated gross financing needs are however already below 11 percent of GDP and should continue to fall through the forecast horizon."
  - Realism of baseline assumptions:
    - "The forecasts of macro-fiscal variables affecting debt dynamics have been on the conservative side."
    - Forecast errors and biases:
      - "The median forecast error for real GDP growth during 2009–17 is 0.13 percent, suggesting that there is slight downward bias in the staff projections, but the forecast bias is in line with other surveillance countries."
      - "The median forecast error for inflation (GDP deflator) is 0.54 percent, suggesting that the staff underestimated inflation in the past (particularly post-2009)."
      - "The median forecast bias for the primary balance is 0.53 percent of GDP, relatively conservative for surveillance countries."
  - Feasibility of projected fiscal adjustment:
    - "Both the maximum 3-year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection period (0.5 percent of GDP) and 3-year average cyclically adjusted primary balance (1.5 percent of GDP) are not ambitious in cross-country comparison."
    - "Germany was able to deliver larger fiscal consolidations in the past, notably in 2011 and 2012."

- B. Shocks and Stress Tests through the Medium Term
  - "A negative growth shock represents the largest risk to the debt outlook."
  - "The realization of contingent liabilities related to financial sector support would push debt up by about 3 percent of GDP."
  - "In both cases, gross financing needs would remain below 10 percent of GDP, and debt would swiftly return to a firm downward path after the shock."

*International Monetary Fund — Germany Annexes (selected content from provided source)*

### 5.      Germany’s government debt should remain below 61 percent of GDP under plausible

### 5.      Germany’s government debt should remain below 61 percent of GDP under plausible macro-fiscal shocks, while gross financing needs would remain below 10 percent of GDP

### Summary findings
- Under all considered macro-fiscal stress tests, both the debt-to-GDP ratio and gross financing needs either continue to fall or swiftly return to a downward path after the shock.
- Temporary shocks to real GDP growth, a combined macro-fiscal shock, or a contingent fiscal shock would drive a temporary increase in debt and/or gross financing needs.
- Given the historical variability of growth, debt dynamics in Germany is most sensitive to growth shocks.
- Under the growth shock scenario, debt would peak at 60.7 percent of GDP and gross financing needs would peak at 9.2 percent of GDP, then converge to 52.6 percent (debt) and 5.2 percent (gross financing needs) of GDP by 2024.
- Under the contingent fiscal shock (cumulative 3 percent of GDP, about 100 billion euros over 2020–21), the debt-to-GDP ratio remains below 60 percent and continues to fall rapidly; gross financing needs would remain comfortably below 10 percent.

### List of shocks and stress tests (definitions and key quantified assumptions)
- Growth shock:
  - Real output growth rates are lower than in the baseline by one standard deviation over 2020–21, i.e. 2.7 percentage points.
  - Assumed decline in growth leads to lower inflation (0.25 percentage points per 1 percentage point decrease in GDP growth).
  - Interest rate assumed to increase 25 basis points for every 1 percent of GDP worsening of primary balance.
  - Outcome: Debt (gross financing needs) peak at 60.7 (9.2) percent of GDP; converge to 52.6 (5.2) percent of GDP by 2024.
- Primary balance shock:
  - Dual shock of lower revenues and rise in interest rate, leading to a cumulative 1.4 percent deterioration in the primary balance over 2020–21 (one standard deviation shock to the primary balance).
  - Outcome: modest deterioration of debt dynamics.
- Interest rate shock:
  - Assumes an increase of 365 basis points in debt servicing costs throughout the forecast horizon, mimicking the historical maximum interest rate experienced since 2009.
  - Outcome: relatively modest effect on public debt and gross financing needs.
- Combined macro-fiscal shock:
  - Combines shocks to growth, the interest rate, and the primary balance while avoiding double-counting individual shock effects.
  - Outcome: impact on debt dynamics is slightly worse than that of a growth shock.
- Contingent fiscal shock (additional stress test):
  - Assumes a cumulative 3 percent of GDP (about 100 billion euros) additional support to the financial sector over 2020–21, similar to fiscal support during the global financial crisis.
  - Outcome: sizable but limited impact on debt ratio; debt-to-GDP remains below 60 percent and continues to fall rapidly; gross financing needs remain below 10 percent.

### Baseline projections and key indicators (selected figures as presented)
- Nominal gross public debt: 74.8 (2017), 64.5 (2018), 60.9 (2019), 58.0 (2020), 55.0 (2021), 52.4 (2022), 49.8 (2023), 47.2 (2024), 44.7 (projection end).
- Public gross financing needs: 16.0 (2017), 12.1 (2018), 10.7 (2019), 10.3 (2020), 7.5 (2021), 5.4 (2022), 5.0 (2023), 4.7 (2024), 4.5 (projection end).
- Real GDP growth (in percent): 1.1 (2017), 2.2 (2018), 1.4 (2019), 0.7 (2020), 1.7 (2021), 1.5 (2022), 1.4 (2023), 1.3 (2024), 1.1 (projection end).
- Inflation (GDP deflator, in percent): 1.4 (2017), 1.5 (2018), 1.9 (2019), 2.0 (2020), 1.9 (2021), 2.0 (2022), 2.2 (2023), 2.2 (2024), 2.3 (projection end).
- Effective interest rate (in percent): 2.9 (2017), 1.6 (2018), 1.5 (2019), 1.5 (2020), 1.4 (2021), 1.2 (2022), 1.2 (2023), 1.1 (2024), 1.0 (projection end).
- Change in gross public sector debt (cumulative 2017–2024): -16.2 (sum).
- Identified debt-creating flows (cumulative 2017–2024): -14.7.
- Primary (noninterest) revenue and grants (sum): 271.4 (cumulative).
- Primary (noninterest) expenditure (sum): 263.5 (cumulative).
- Automatic debt dynamics (cumulative 2017–2024): -6.7.
- Real interest rate contribution (cumulative): -2.7.
- Real GDP growth contribution (cumulative): -4.0.
- Residual, including asset changes (cumulative 2017–2024): -1.5.

### Stress test results and scenario comparisons (selected dynamics)
- Under the Real GDP Growth Shock:
  - Real GDP growth path example: 0.7 (2019), -1.0 (2020), -1.2 (2021), 1.4 (2022), 1.3 (2023), 1.1 (2024).
  - Inflation path example: 2.0 (2019), 1.2 (2020), 1.3 (2021), 2.2 (2022), 2.2 (2023), 2.3 (2024).
  - Primary balance path example: 1.7 (2019), 0.1 (2020), -1.8 (2021), 1.1 (2022), 1.2 (2023), 1.2 (2024).
  - Effective interest rate example: 1.5 (2019), 1.4 (2020), 1.3 (2021), 1.2 (2022), 1.1 (2023), 1.1 (2024).
- Under the Primary Balance Shock:
  - Primary balance path example: 1.7 (2019), 0.8 (2020), 0.5 (2021), 1.1 (2022), 1.2 (2023), 1.2 (2024).
  - Debt and gross financing needs paths show modest deterioration relative to baseline but do not breach the indicated thresholds.
- Under the Real Interest Rate Shock:
  - Effective interest rate path example: 1.5 (2019), 1.4 (2020), 1.7 (2021), 2.0 (2022), 2.1 (2023), 2.3 (2024).
  - Effects on public debt and gross financing needs are relatively modest.
- Combined macro-fiscal shock and contingent liability shock plots indicate that gross nominal public debt and gross financing needs rise temporarily but remain below critical benchmarks in the scenarios displayed.

### Risk assessment highlights
- Heat map and risk indicators show low vulnerability on key metrics:
  - Gross financing needs in 2018: 12 (percent of GDP).
  - Public debt held by non-residents in 2018: 48 (percent of total).
  - Bond spread and external financing requirement indicators do not indicate breach of upper early-warning benchmarks in the presented tables.
- Evolution of predictive densities of gross nominal public debt shows downward medians and percentile bands across 2017–2024 under baseline and restricted distributions.

### Authorities’ response to past IMF policy recommendations (selected policy follow-up and actions)
- Fiscal policy:
  - The 2019 budget includes measures to boost public investment and provide income tax relief.
  - Municipal Investment Promotion Fund (MIPF): Almost 94 percent of the first tranche (€3.5 billion) was earmarked as of June 2018; 12 percent of the second tranche (€3.5 billion) was earmarked as of March 2018.
  - Partnerschaft Deutschland (PD) is providing advisory services to municipalities on planning and procurement.
  - Amendment to the Basic Law on public finances for educational infrastructure, social housing, and public rail transport entered into force on 4 April 2019.
  - Childcare program (2017–2020) with a financial volume of €1.126 billion is ongoing.
- Financial sector policy:
  - No new macroprudential regulation since the 2018 Article IV, but authorities are reviewing macroprudential policy instruments.
  - Authorities conducting a bank survey on real estate lending and corporate credit underwriting standards; results scheduled for publication in September 2019 and intended to be regularized.
  - On May 27, 2019, the Financial Stability Committee decided to raise the counter-cyclical capital buffers by 0.25 percent; banks must meet new required capital by end-June 2020.
  - Authorities did not activate sector-specific macroprudential instruments (e.g., LTV caps, amortization requirements).
- Structural reforms:
  - Pension and labor market: No new action taken; prior Act (2017) has led to a rise in old-age labor force participation; government plans to review the law in 2022.
  - Digitalization: Government plans to allocate up to EUR 12 billion to support a nationwide fiber-based gigabit network; investment-friendly regulation per the European Electronic Communications Code to be implemented by end-2020; master plan for mobile coverage and 5G deployment is being prepared.
  - Entrepreneurship and e-government: Draft bill on R&D tax credit; continuation of co-investment strategy to crowd in private investment, especially by institutional investors; progress on National e-Government Strategy.
  - Competition: No action yet, but 2019 plans include a review of regulations in professional services and evaluation of the Railway Regulation Act.

*Source: IMF staff.*

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

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

### Financial stability policy framework
- Recommendation: Establish a core set of readily-available, consistent data for banks and non-banks to strengthen financial stability and macroprudential policy analysis.
  - Time Frame: Short term
  - Status: Bundesbank is integrating selected granular supervisory and statistical data of banks, insurance companies, and investment funds to build a “house of microdata (HoM),” which will be used for financial stability and macroprudential policy analysis along with other information sources. Currently the HoM contains 8 datasets with 130 million timeseries data, including those for MFIs. Bundesbank is in the process of integrating bank supervisory microdata according to the common reporting framework (COREP), Germany security holding statistics, centralized securities database, and German transactions of TARGET2.
- Recommendation: Develop the legal basis for real estate-related macroprudential tools.
  - Time Frame: Short term
  - Status: On March 30, 2017, the Bundestag passed legislation that implements part of the FSC’s recommendation of June 2015 and entered into force on June 10, 2017. The law introduced new instruments for residential real estate loans (does not cover non-residential CRE loans), allowing for capping LTV ratios and setting amortization requirements for financial stability purposes. The requirements are meant to apply to all financial institutions if activated. The law omits complementary DTI and DSTI ratio instruments, which had also been recommended by the FSC in 2015, and does not address important data requirements for the effective operation of the real estate-related macroprudential instruments. The ongoing one-off bank survey on real estate lending and corporate credit underwriting standards is expected to provide valuable information on possible financial risks in specific segments of real estate markets.

### Banking oversight
- Recommendation: Implement measures to strengthen the oversight role of the banks’ supervisory board.
  - Time Frame: Short term
  - Status: Within the German two-tier system, the supervisory board’s role is passive and restricted to a pure control function. The authorities consider the current system compliant with the requirements of Basel Core Principle 14, thus do not plan to amend the legal framework.
- Recommendation: Provide guidance on risk management and other supervisory requirements, e.g. regarding loan portfolio management, concentration and related party risk, and operational risk.
  - Time Frame: Short term
  - Status: Bundesbank and BaFin are currently following-up on the 2016 FSAP recommendations when reviewing relevant provisions in MaRisk. The authorities consider that concentration risk is sufficiently covered by MaRisk, and further guidance has not been issued.
- Recommendation: Increase granularity and coverage of bank supervisory data.
  - Time Frame: Short term
  - Status: Since June 2017, all LSIs have to report using FINREP templates, increasing the granularity and comprehensiveness of the information available to supervisors. The new reporting standard will also allow to access data at a consolidated level (e.g., NPLs). The requirements have been set on a harmonised basis throughout the SSM-covered countries. However, national regulatory reporting will remain in place as a necessary complement from a German banking supervisory perspective.
- Recommendation: Increase the effectiveness of the AML/CFT supervisory framework over cross-border banks.
  - Time Frame: Short term
  - Status: Since the 2016 FSAP, BaFin’s AML Department has hired 32 new staff for the two new divisions established for AML/CFT banking supervision, which focus on banks with higher risk and need for intense supervision (i.e., major banks with cross-border operations). The additional staff conducts AML/CFT audits (rather than external auditors). BaFin has also set up in one case an inhouse “special representative” in a major bank to conduct audit functions and ongoing AML/CFT monitoring of this bank. The AML/CFT legal framework was revised in June 2017, in line with the 4th EU Money Laundering Directive, with efforts underway to transpose the 5th EU Money Laundering Directive.

### Insurance oversight
- Recommendation: Prepare a communication strategy ahead of the publication of Solvency II indicators.
  - Time Frame: Short term
  - Status: BaFin conducted bilateral discussions with life insurance (LI) companies ahead of the publication date of May 21, 2017, but no common communication strategy was decided.
- Recommendation: Extend the application of G-SII toolkit on a risk-based basis to other large groups, including recovery and resolution planning, enhanced supervision and regular stress tests.
  - Time Frame: Medium term
  - Status:
    - BaFin has extended the requirement for recovery plans to two other groups headquartered in Germany, beyond the country’s single G-SII. The supervisory teams responsible for the respective groups are in the process of defining the elements of the plans and will review them once they are finalized. BaFin does currently not intend to further extend this requirement to other groups.
    - Germany also participates in the EIOPA stress testing exercises. In 2016, 20 life insurers covering three quarters of the market participated. The fourth EU-wide stress test exercise in 2018 included 5 large German insurance groups. Furthermore, insurers are required to perform additional stress tests on their own as part of their risk and solvency analysis (according to the Insurance Supervision Act, section 27). Those results are also part of the narrative reporting to BaFin.
- Recommendation: Communicate supervisory expectations based on the ORSA (Own Risk Solvency Assessment) review more systematically; use Solvency II framework to impose capital add-ons.
  - Time Frame: Medium term
  - Status:
    - BaFin gives feedback to insurance firms based on the ORSA review, especially when those do not seem to hold sufficient own funds over and above the SCR to comply with capital requirements on a continuous basis. BaFin has also been encouraging insurers to improve the quality of ORSA reports, especially in the areas where BaFin identifies as weak in the 2017 assessment (e.g., depth of information; assessment of overall solvency needs, continuous compliance with the regulatory capital requirements and technical provisions, and risk profile’s deviation from the SCR assumptions; quality of stress tests).
    - At the IAIS level, discussions are ongoing as to the future framework for addressing systemic risk in the insurance sector, which would have to be taken into account.
    - Capital add-ons are not a first resort measure, but the supervisor is ready to set capital add-ons on a case by case basis when pre-conditions are found to be in place under Solvency II.
- Recommendation: Require action plans for companies facing difficulties in meeting Solvency II requirements, including stress testing to ensure that they would be met even after a plausible shock.
  - Time Frame: Medium term
  - Status: BaFin monitors companies’ progress towards compliance with solvency capital requirements without Solvency II transition measures, and assesses the plausibility and appropriateness of the companies’ plans on a yearly basis. BaFin is also thoroughly reviewing internal models, including by developing a new stochastic approach (BSM—Branchensimulationsmodell) that better accounts for embedded options and guarantees of typical LI products.

### Asset management oversight
- Recommendation: Intensify frequency of on-site inspections and enhance risk classification methodology.
  - Time Frame: Short term
  - Status: BaFin revised the risk classification methodology for supervised asset managers, and, since 2018, uses improved impact criteria. BaFin also substantially increased the frequency of on-site inspections.
- Recommendation: Introduce stronger rules on reporting of pricing errors and investor compensation rules.
  - Time Frame: Short term
  - Status: BaFin published the “Mindestanforderungen an das Risikomanagement von Kapitalverwaltungsgesellschaften” (KAMaRisk) in January 2017, which is a circular on, inter alia, the minimum requirements for the risk-management of investment managers. According to chapter 6, no. 3 v) and w) of the KAMaRisk, asset management companies are required to have policies in place (1) to inform depositaries of material pricing errors and (2) to compensate investors in the event of material pricing errors.

---

### Time frame definitions
- Short term is one year.
- Medium term is 2-3 years.

*Annex V. Authorities’ Response to FSAP 2016 Recommendations — provided content.*

### Annex VI. Regional Fiscal Differences and Implications for Public Investment

### Context and headline
- Public investment in Germany has remained around 2–2½ percent of GDP, comparatively low among advanced economies.
- Two-thirds of public investment is executed by local governments (Länder and municipalities).

### Key findings on public investment and capital stock
- Public investment has hovered around 2-2½ percent of GDP.
- Municipal government share of total public investment: fell from 40 percent in 2005 to 33 percent in 2017, and slightly increased to 35 percent in 2018.
- KFW (2018) estimates a public investment backlog at close to €159 billion (about 5 percent of GDP), with shortfalls of:
  - Educational facilities: €48 billion
  - Transport infrastructure: €39 billion
- Average capital stock per capita, at replacement cost, in 2015:
  - Bavaria, Baden-Württemberg, and Hamburg: about €145,000
  - This is about €40,000 higher than that in the East Länder and Berlin.
  - This is about €45,000 higher than that in North Rhine-Westphalia.

### Drivers and regional dynamics
- Investment needs: deterioration of infrastructure, decline in modernization in East Länder, West Länder capital stock with lower degree of modernization.
- Local governments prioritized fiscal consolidation and debt reduction to meet the national fiscal rule (“Debt Brake”), resulting in reduced public investment until very recently.
- National fiscal rule: introduced in 2009; generally prohibits structural borrowing by any Länder starting in 2020. Länder with higher deficits/debt in 2011 implemented larger fiscal consolidations.
- By 2018, all Länder registered budget surpluses; surpluses were used to build up reserves and off-budget entities (special funds) that can supplement future budgetary resources without new borrowing (Bundesbank 2018).

### Regional specifics
- West Länder and city states:
  - Fiscal consolidation largely achieved through improved revenue, but capital expenditure cuts also contributed.
  - Capital expenditure cuts were particularly pronounced in Länder with larger consolidation needs (i.e., higher fiscal deficits in 2011).
- East Länder:
  - Expected phasing out of federal grants under the Solidarity Pact II prompted cautious expenditure management, including cuts to capital expenditures.
  - Solidarity Pact II provided €156 million support to the East Länder for rebuilding their infrastructure between 2005 and 2019.
- Municipal level:
  - Länder redistribute revenue to municipalities via (i) a fixed percentage of state tax revenue and (ii) additional general and special purpose funds based on need.
  - Strong tax revenue led to higher municipal revenue overall via the first channel. However, larger consolidation needs in some West Länder and lower Federal grants to the East Länder reduced capital transfers to municipalities, contributing to municipal capital expenditure cuts.
  - In the East Länder, municipal capital revenue and expenditure declined by 0.5 percent and 0.3 percent of Länder GDP, respectively, since 2011.

### Summary of implications
- Local governments prioritized fiscal consolidation at the expense of public investment at both Länder and municipal levels.
- In the West Länder, capital expenditures were cut despite higher revenue to facilitate consolidation.
- In the East Länder, the loss of grants prompted cautious expenditure planning and capital expenditure cuts.
- Länder-level consolidation led to municipal capital expenditure cuts via lower discretionary capital transfers.

*Annex VI. Regional Fiscal Differences and Implications for Public Investment — provided content.*

### Annex VII. Business Investment in Germany

### Objective
- Study dynamics of aggregate private nonresidential investment (“business investment”) in Germany.

### Main conclusion
- Recent level of business investment in Germany is broadly in line with past developments in aggregate demand and income, nonfinancial corporations’ profits, funding cost, financial conditions, and Tobin’s Q.
- Business investment in Germany is lower than in its European peers due mainly to its relatively low growth prospects.

### Key findings and quantitative points
- Since the early 1990s, Germany’s nominal business investment declined by around 4 percentage points of nominal GDP, contributing to the improvement in the external balance.
- Decline breakdown:
  - Nominal investment in machinery and equipment declined by 3¼ percentage points of nominal GDP.
  - Decline driven by a substantial decline in the relative price of machinery and equipment (prices of machinery and equipment relative to consumption prices).
  - Decline in the relative price of “other” investment (e.g., intellectual property products, cultivated biological resources) was less significant.
  - Nonresidential construction relative price returned to the level in the early 1990s after a moderate decline through the mid-2000s.
- Real business investment:
  - Returned to the level seen in the early 1990s.
  - Following a decline to around 11 percent of GDP in the mid-1990s, Germany’s real business investment has been moving around 12–13 percent of real GDP since then.
  - This level is at the bottom quartile of the European country peers.
  - Real business investment in relation to real capital stock is also relatively low.
  - Compositionally, decline in real investment in non-residential structure following reunification was offset by a rise in “other” investment and a small increase in investment in machinery and equipment.
- Broader context:
  - The large decline in the relative price of machinery and equipment has been observed across advanced, emerging markets, and developing economies over the past three decades (IMF, 2019).
  - Literature attributes decline in relative price of investment goods to faster productivity growth in capital goods production and deepening trade integration.

*Annex VII. Business Investment in Germany — provided content.*

### 3. To explain the dynamics of business investment, we estimate an “accelerator” model

### 3. To explain the dynamics of business investment, we estimate an “accelerator” model

### Model specification and estimation
- Basic framework: An accelerator model where business investment increases when aggregate demand or income increases; past demand or income growth signals future demand or income.
- Augmenting variables: nonfinancial corporations’ financing cost (real interest rate), financial conditions (leverage ratio), profits, Tobin’s Q (constructed as the ratio of nonfinancial corporations’ equity liabilities to their total financial assets), and the relative price of business investment.
- Normalization and lags:
  - Equation normalized by lagged capital stock, Kt–1, to address non-stationarity.
  - Includes 12 lags of the changes in output (N = 12).
- Estimation details:
  - Quarterly data for 1992 Q1-2017 Q4 (or the longest available timeseries).
  - Standard errors computed with the Newey-West procedure.
  - Dependent variable: Real Private Nonresidential Investment in % of Real Net Capital Stock.

### Germany: single-country regression results (Table A1 and Figure A2)
- Key qualitative findings:
  - Positive past real output growth tends to be associated with higher real business investment.
  - Higher real interest rates and higher corporate leverage are associated with lower business investment.
  - Higher profits and Tobin’s Q are associated with higher business investment.
  - The relative price of business investment has a negative coefficient (a decline in the relative price of business investment increases real business investment) but its inclusion does not much improve model fit.
  - Recent levels of real business investment do not significantly deviate from model projections (Figure A2).
- Selected estimated coefficients and statistics (from Table A1):
  - Reverse of capital stock (t-1):
    - Specification (1): -19.995 **
    - Specification (2): -19.771 ***
    - Specification (3): -51.977 ***
    - Specification (4): -57.515 ***
    - Specification (5): -61.321 ***
    - Specification (6): 23.386
  - Real interest on corporate bonds (t-1) in specification (2): -0.0002 ***
  - NFC leverage ratio (t-1) in specification (3): -0.00001 ***
  - NFC Tobin's Q (t-1) in specification (4): 0.00002 *
  - NFC Profit (t-1) in specification (5): 0.00000
  - Relative price of business investment (t-1) in specification (6): -0.00687 *
  - Constant (all specs): coefficients reported as 0.011 ***, 0.012 ***, 0.016 ***, 0.015 ***, 0.016 ***, 0.013 ***
  - Model fit and diagnostics:
    - R-squared: 0.505, 0.704, 0.828, 0.803, 0.786, 0.550 (for specifications 1–6 respectively)
    - Adjusted R-squared: 0.433, 0.657, 0.788, 0.757, 0.736, 0.478
    - S.E. of regression: 0.000 (reported for all specs)
    - F-statistic: 7.056, 14.927, 20.612, 17.499, 15.715, 7.678
    - Prob(Wald F-statistic): 0.000 for all specs
    - Observations: 104, 103, 75, 75, 75, 103
  - Accelerator lag coefficients (selected):
    - Accelerator (t-3): 0.166 ***, 0.140 ***, 0.123 ***, 0.131 **, 0.179 ***, 0.209 ***
    - Accelerator (t-6): 0.238 ***, 0.216 **, 0.162 ***, 0.177 ***, 0.219 ***, 0.231 ***
    - Accelerator (t-12): 0.196 **, 0.125 **, 0.100 *, 0.117 **, 0.135 ***, 0.215 ***
  - Significance notation: "*", "**" and "***" denote significance at 10, 5, and 1 percent levels, respectively.
  - Estimation note: Estimated with the Newey-West robust standard error approach (consistent with heteroskedasticity and autocorrelation of unknown form).

### Cross-country panel analysis and drivers of Germany’s investment relative to peers (panel regressions, Table A2 and Figure A3–A4)
- Panel setup:
  - Fixed-effect estimation on an annual unbalanced panel dataset for 1995-2017 for 27 European countries (list provided in the source).
  - Augmented accelerator includes projected medium-term growth rates vis-à-vis the rest of the world and output per worker vis-à-vis the average of Germany, Japan, and the U.S. (to account for catch-up needs).
- Key panel regression findings (Table A2, selected coefficients and diagnostics):
  - Reverse of capital stock (t-1): -38.90 ***, -41.79 **, -43.10 *, -42.87 (specifications 1–4)
  - Accelerator (t-1): 0.12 ***, 0.12 ***, 0.11 ***, 0.11 ***
  - Profit (t-1): 0.19 ***, 0.20 ***, 0.26 **, 0.26 **
  - Real interest rate (t): -0.06 ***, -0.07 ***, -0.06 ***, -0.06 **
  - MT growth differential (vis-à-vis ROW) (t-1): 10.76 ***, 9.83 ***, 14.66 *, 14.71 **
  - Productivity differential (vis-à-vis DEU, JPN, USA) (t-1): -2.76 ***, -2.68 ***, -3.49 ***, -3.50 ***
  - Relative price of business investment: reported as "..." in some specs and 0.44 / -0.06 in others (table shows partial reporting)
  - Constant: -0.13, -0.53, -0.19, -0.12
  - Goodness of fit:
    - R-squared: 0.9098, 0.9099, 0.8938, 0.8938
    - Adjusted R-squared: 0.9042, 0.9041, 0.8820, 0.8818
    - S.E. of regression: 0.6861, 0.6873, 0.6882, 0.6889
    - F-statistic: 160.4812, 155.5296, 75.8972, 74.3650
    - Prob(F-statistic): 0.0000 for all specs
    - Country fixed effects: y for all specifications
    - Time fixed effects: n, n, y, y (specs 1–4 respectively)
    - Observations: 542 (all specs)
  - Robustness and covariance estimation:
    - Table A2 results based on robust covariances estimated with the White diagonal method.
    - Results remain generally unchanged when the White cross-section (period clustered) or White-period (cross section clustered) methods are used.
    - Specifications without time fixed effects are adjusted for cross-sectional heteroskedasticity.
- Interpretation of panel results:
  - Higher medium-term growth prospects vis-à-vis the rest of the world are associated with higher real business investment.
  - Negative coefficient on output per worker implies countries with relatively low labor productivity have higher real business investment (catch-up need or lower labor cost).
  - Model predicts Germany’s business investment is slightly below what is predicted by the model and slightly below the sample median, though above France, Italy, and the UK.
- Factors behind Germany’s relatively low business investment compared with high-investment advanced European peers (Austria, Belgium, Switzerland, Sweden):
  - Less favorable medium-term growth prospects for Germany are a key downward factor.
  - Country fixed effects (time-invariant characteristics possibly linked to investment environment) also push down Germany’s business investment relative to peers.
  - Offsetting factors: Germany’s relatively high profits and low real interest rates support business investment compared to peers.
  - Fixed effects interpretation caveat: fixed effects capture time-invariant characteristics and involve significant uncertainties; possible links include ease of starting a business, product market regulations, digital infrastructure, availability of skilled labor.

### Key takeaways and policy implications
- Key takeaways (verbatim from source):
  - Recent levels of Germany’s real business investment do not seem to be low from a historical perspective, given the demand and nonfinancial corporations’ profits and financial conditions.
  - However, from a cross-country perspective, Germany’s real business investment is relatively low due mainly to its relatively low future growth prospects.
  - To lift real business investment, Germany should boost growth prospects, for example by investing more in human capital and increasing labor supply, expanding digital infrastructure, and reducing uncertainties about energy transition. The low-interest rate environment would support business investment.

*Source: IMF staff report informational annex — Germany, June 20, 2019 (Chapter: “To explain the dynamics of business investment, we estimate an ‘accelerator’ model”), prepared by European Department.*

### 8.10 of the Sustainable Development Goals (SDGs).

### 1deuea2019001 - 8.10 of the Sustainable Development Goals (SDGs).

### Financial sector surveillance
- Germany participates in the IMF’s Coordinated Direct Investment Survey (CDIS), Coordinated Portfolio Investment Survey (CPIS) and financial soundness indicators (FSIs) databases.
- Of the 40 FSIs, Germany reports all except net foreign exchange exposure to equity (I31).
- Germany reports all of the 12 core FSIs; however six FSIs are reported on an annual basis only:
  - NPL Net of Provisions to Capital
  - NPL to Total Gross Loans
  - Return on Assets
  - Return on Equity
  - Interest Margin to Gross Income
  - Non-Interest Expense to Gross Income
- Plans are underway to change the legal basis for the periodicity of deposit taking institutions’ reporting requirements.
- The quality of data on bank exposures submitted to the BIS needs improvement, including provision of data on ultimate risk basis for advanced countries.

### External sector statistics
- The Bundesbank compiles the balance of payments in close cooperation with the Federal Statistical Office.
- Balance of payments, International Investment Position statistics, and related cross-border statistics are compiled according to the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6), and the legal requirements of the ECB and Eurostat.

### Data standards and quality
- Adherent to the Special Data Dissemination Standards Plus (SDDS Plus) since February 2015.
- Implementing G-20 DGI recommendations: currently disseminates a residential property price index and a commercial property price index.
- Data ROSC from 2006 is available.

### Table of Common Indicators Required for Surveillance (As of June 4, 2019) — selected entries
- Exchange Rates: Date of latest observation June 4, 2019; Date received June 4, 2019; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation April 19; Date received May 19; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Date of latest observation April 19; Date received May 19; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Broad Money: Date of latest observation April 19; Date received May 19; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Central Bank Balance Sheet: April 19; May 19; M; M; M.
- Consolidated Balance Sheet of the Banking System: April 19; May 19; M; M; M.
- Interest Rates: May 19; May 19; M; M; M.
- Consumer Price Index: May 19; May 19; M; M; M.
- Revenue, Expenditure, Balance and Composition of Financing — General Government: Q1:19; May 19; Q; Q; Q.
- Stocks of General Government and Government-Guaranteed Debt: December 18; April 19; A; A; A.
- External Current Account Balance: March 19; May 19; M; M; M.
- Exports and Imports of Goods and Services: March 19; May 19; M; M; M.
- GDP/GNP: Q1:19; May 19; Q; Q; Q.
- Gross External Debt: Q4:18; March 19; Q; Q; Q.
- International Investment Position: Q4:18; March 19; Q; Q; Q.

### Statement by Mr. Meyer, Executive Director for Germany (July 8, 2019) — macroeconomic outlook and policy priorities
- Economic performance and labor market:
  - The German economy continues to grow, making this year the tenth successive year of expansion.
  - The unemployment rate is expected to drop to historically low levels in 2019, whilst employment rises further.
  - The German Federal Government expects that net wages and salaries of employees will grow by 5.1 percent in 2019.
  - Net wages and salaries per employee are expected to grow by 3.8 percent in 2019.
  - Personal incomes will again see a substantial increase due to rising wages, employment and corporate investment; domestic economy will remain the driver of growth.
- Risks and external environment:
  - Outlook subject to significant uncertainty due to unresolved trade tensions and risks surrounding the Brexit process.
  - Heightened geopolitical risks weigh on investor sentiment.
  - Germany firmly supports an open, fair, and rules-based multilateral trading system.
- Structural challenges and opportunities:
  - Challenges: demographic change, digitization, and the energy transition (phasing-out of nuclear power and coal).
  - These challenges create opportunities to enhance domestic sources of growth and well-being.

### Fiscal policy
- Public debt is projected to decline below the debt ceiling of 60 percent of GDP this year.
- Fiscal policy is projected to be expansionary.
- Automatic stabilizers will be able to operate freely in case of slower growth; sound fiscal position allows decisive counter-cyclical action in a severe downturn.
- General government investment reached a multi-year high of €79.3 billion in 2018 and is projected to rise further in 2019 and coming years.
- Investment priorities: infrastructure, education, universities, research, and digital technology.
- Federal government sponsors increased investment through initiatives and fiscal support for other government levels.
- Germany committed to promoting international corporate tax reform, including support for establishment of a minimum taxation framework; joint declaration with France on taxation of digital companies and minimum taxation in December 2018.
- Income tax measures in the current legislative period will boost disposable incomes of households by around €25 billion per year.
- Phasing out of the solidarity surcharge for low- and middle-income earners will raise disposable incomes by around €11 billion annually.

### External sector and corporate savings
- Authorities view the current account surplus as mainly the result of private sector decisions in international trade and investment, not domestic policy choices.
- Authorities expect the current account surplus will continue to decline as more people retire and real wages continue to rise.
- Given model and estimation uncertainties in the IMF model, authorities suggest classifying Germany’s competitiveness position as overall neutral (contrary to staff’s assessment).
- Corporate profits and gross savings have contributed to rising wealth inequalit y and corporate savings have been a big driver of Germany’s current account surplus.
- Foreign direct investment of German companies, statistically reported as corporate savings, is particularly relevant.
- Authorities call for more granular analysis to identify potential policy distortions that incentivize retaining earnings rather than disbursing them.
- The fall in the labor share has been reversed largely due to higher wage agreements.
- Family-owned firms, to which a large part of corporate savings accrue, are an integral part of the German economy.

### Structural reforms
- Planned introduction of R&D tax credits:
  - Tax credits are capped at a base of €2 million per firm and will primarily benefit small and medium sized enterprises.
  - They are intended to complement direct funding for R&D.
- Authorities emphasize ensuring favorable conditions for expanding labor supply and skill enhancement:
  - Promote higher labor force participation of women and the elderly.
  - Better training and integration of refugees into the labor market.
  - Modernizing immigration laws.
- Educational outcomes strengthened through increased supply of all-day childcare and all-day schools.
- Digital infrastructure:
  - Strategy and substantial funding to support a nationwide fiber-based gigabit network.
- Energy transition:
  - In April 2019 the Federal Government set up a “Climate Cabinet” to coordinate policies and establish a legal framework to reach climate goals for 2030 and discuss transition to climate-neutrality by 2050.
  - Germany is a net exporter of electricity for the foreseeable future.
  - Costs of producing energy from renewables projected to decline further and below that of fossil fuels; trend supported by increasing CO2 prices.
  - No concrete decisions yet on higher taxes on fossil fuels; carbon pricing and an aviation tax are being discussed.

### Financial sector and housing market
- Authorities share staff’s view that macro-financial vulnerabilities are on the rise after long growth and low interest rates; cyclical systemic risks have built up.
- Vulnerabilities include potential underestimation of credit risk and potential overvaluation of assets when real estate is used as collateral; these could be amplified by interest rate risk build-up.
- German banks have significantly topped up capital since the global financial crisis and capital buffers are generally deemed comfortable.
- Financial Stability Committee recommended activation of the countercyclical capital buffer (CCyB) in May.
- BaFin issued a general decree on June 28th,2019 to set the CCyB at 0.25 percent effective July 1st,2019, with banks having 12 months to meet the new requirement.
- Authorities agree bank profitability is relatively low but consider it primarily the task of individual banks to achieve viable profitability; low profitability may reflect prudent risk-taking.
- German banking sector is well-capitalized and resilient; restructuring and consolidation are ongoing.
- Housing prices have continued to rise, especially in large cities; authorities are monitoring developments closely.
- Authorities do not see a substantial increase in risks to financial stability from the flow of new housing loans based on available indicators:
  - Growth rate of housing loans to private households does not appear exceptionally high.
  - No indication of substantial easing of credit standards.
  - Aggregate indebtedness of private households is fairly low by historical and international standards.
- Authorities are contemplating measures to expand housing supply and prevent excessive rental price hikes to address affordability.
- Authorities concur with staff that addressing gaps in data regarding real estate lending would allow a more complete picture of potential emerging financial stability risks:
  - Ongoing ad hoc survey on real estate lending and corporate credit underwriting standards expected to provide valuable information.

### Supply-side of corruption and AML/CFT
- Germany welcomes participation in the IMF’s voluntary assessment under the Enhanced Engagement on Governance Framework on the supply-side of corruption.
- Authorities are strongly committed to fighting corruption; OECD Working Group on Bribery acknowledged Germany as one of the “highest enforcers” of the OECD’s Anti Bribery Convention.
- Germany is working to further improve the effectiveness of the AML/CFT supervisory framework, including higher staffing at BaFin.
- An in-depth assessment will be provided in conjunction with the FATF 4th Round of Mutual Evaluations, projected to be discussed in June 2021.

*Source: 1deuea2019001 - 8.10 of the Sustainable Development Goals (SDGs).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1deuea2019001.pdf_