## Executive Summary

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---

### Overview
- Europe’s economic recovery continues but is "falling well short of Europe’s full potential."
- High uncertainty—about persistent core inflation, the direction of economic policies, and geopolitical conflicts—is muting the rebound and weighing on the medium-term outlook.
- Structural headwinds: perennial productivity slowdown, potential effects of fragmentation, climate change, population aging, and other structural shifts.
- Constraints highlighted in accompanying analysis:
  - Advanced European economies: lack of market scale and access to capital and skilled labor limiting firms from operating at the global technology and innovation frontier.
  - CESEE countries: lagging structural reforms and low investment rates slowing convergence.

### Near-term economic performance and outlook
- Growth strengthened in the first half of 2024 to 1.7 percent.
- Projected growth:
  - 2024: advanced European economies = 1.0 percent; CESEE = 2.3 percent.
  - 2025: advanced European economies = 1.4 percent; CESEE = 3.1 percent.
- Disinflation and monetary/fiscal dynamics:
  - Gradually strengthening private domestic demand, further disinflation, and progressively easing financial conditions are expected to more than offset necessary fiscal consolidation.
  - Given high core inflation persistence, timing to reach inflation targets:
    - Advanced European economies: targets reached in 2025.
    - Most CESEE countries: targets reached in 2026.
- Household and firm behavior dampening recovery:
  - Private consumption moderate relative to household income growth; precautionary savings elevated and saving rates remain above pre-crisis levels.
  - Investment slow amid still tight financial conditions and declining real estate prices in some countries.
  - Service sector recovery robust; industrial production lags due to weak external demand (including from China).

### Risks
- Downside risks predominate:
  - Intensification of the war in Ukraine and escalation of armed conflicts in the Middle East raising commodity price volatility.
  - Rising economic policy uncertainty related to elections and policy directions on fiscal consolidation, EU-wide competitiveness reforms, climate goals, and trade policy.
  - Global financial market turbulence signaling concerns about US growth and global fragmentation.
- Financial sector vulnerabilities:
  - Exposures to commercial real estate could worsen in a downturn.
  - Nonbank financial intermediaries with high portfolio concentration, elevated leverage, and liquidity mismatches pose migration-of-risk concerns.

### Monetary policy recommendations
- Central banks have appropriately started to ease; guidance:
  - Advanced European economies: rate reductions should continue steadily; policy decisions can become more forecast-driven while responding flexibly to large data surprises or developments.
  - CESEE region: monetary policy should be more data-dependent and meeting-by-meeting; internalize asymmetric (high) costs of inflation overshooting and avoid premature or too rapid easing.
- Approach to end of easing cycle:
  - Given uncertainties around the level of neutral rates, central banks should approach the end of the easing cycle with care and be ready to adjust the terminal rate based on economic and inflation outcomes.

### Fiscal policy recommendations
- Fiscal policy must rebuild buffers and secure debt sustainability:
  - Public debt has risen substantially since 2020 as governments provided necessary policy support during crises.
  - With inflation closer to target and moderate growth, high debt would become a vulnerability if not addressed through medium-term adjustment efforts.
- Policy priorities:
  - Implement the new European fiscal governance framework as planned to reduce debt and strengthen sustainability.
  - Manage fiscal adjustment while addressing rising expenditure needs through spending prioritization and structural fiscal reforms.
  - In high-debt countries, fiscal adjustment should be front-loaded to demonstrate resolve, secure market confidence, and create room for future spending needs.

### Financial sector policy recommendations
- Supervisors should keep a watchful eye on downside risks despite banks’ substantial capital buffers.
- Suggested actions:
  - Rebuild macroprudential buffers to protect against potential downturns.
  - Prevent migration of risks to nonbank financial intermediaries, focusing on those with high portfolio concentration, elevated leverage, and liquidity mismatches.

### Structural policies and long-term growth
- To raise potential growth, Europe needs deeper integration:
  - A larger and more integrated single market—especially for goods, services, and capital—is needed to allow firms and entrepreneurs to innovate and raise growth sustainably.
  - A fully developed single market would facilitate structural reforms and raise investment incentives in converging countries, and help insulate businesses and labor markets from global fragmentation pressures.
- CESEE-specific priorities:
  - Upgrade infrastructure.
  - Enhance worker skills.
  - Improve institutions to resume income growth catch-up.

*International Monetary Fund, Regional Economic Outlook—Europe (Executive Summary).*

---

### Household Savings Rate

### Key indicators and recent dynamics
- Headline inflation: in about 60 percent of advanced European countries, headline inflation has declined to within 1 percentage point or less of central banks’ targets; in 22 percent of countries inflation has fallen below it.
- CESEE disinflation: in the CESEE region, only 33 percent of countries are within 1 percentage point of the target, whereas more than 40 percent of countries are still above it.
- Contribution to disinflation since peak in 2023: lower energy and food inflation account for about three-quarters of the euro area’s disinflation and about half in the CESEE region.
- Monetary transmission: in the euro area, about 80 to 90 percent of the transmission to growth occurred up to 2023:Q4/2024:Q1.
- Services inflation stickiness:
  - Services inflation in the euro area is still 2 percentage points above its 2015–19 average.
  - In CESEE countries, services inflation is 5 percentage points higher than the 2015–19 average.
- Wage dynamics:
  - Romania, Hungary, and Poland: wage growth has remained near or above double digits this year.
  - In advanced European economies, wages have grown less rapidly; real wages have only now recovered to pre-war levels in several countries.
- Household savings: normalization of household saving rates is slow; elevated savings rates expected to persist for precautionary reasons.

### Inflation persistence and composition
- Core inflation has slowed more gradually than headline inflation due to strong second-round effects from wage inflation in labor-intensive services sectors.
- In CESEE, the disinflation process is more drawn out because of more persistent wage and services inflation.
- Path to targets bumpy because of base effects and staggered reversal of support measures; expiring subsidies or tax relief can lift user prices and temporarily boost inflation.
- External shocks: attacks on Red Sea shipping lanes have increased shipping costs and created upward price pressures.

### Financial conditions and demand indicators
- Financial conditions indexes are liability-weighted; changes measured quarter-to-quarter (index above 0 = tighter than historical average).
- Global PMI for new export orders and manufacturing: 50+ indicates expansion (series shown Jan. 2018–Jan. 2024).
- Capacity utilization: deviation from long-term trend (long-term trend = average from 2000 to 2023).

### Outlook: A tepid recovery (baseline projections)
- 2024 growth projections:
  - Advanced European economies (AE excluding CESEE): 1.0 percent (2024).
  - CESEE: 2.3 percent (2024).
- 2025 growth projections:
  - Advanced European economies: 1.4 percent (2025).
  - CESEE: 3.1 percent (2025).
- Inflation returning to target:
  - Advanced European economies: inflation will return to target in 2025.
  - Most CESEE countries: inflation will return to target in 2026.
- Drivers and constraints:
  - Rising household purchasing power will only gradually feed into higher consumer spending because:
    - Labor markets will cool but remain sufficiently tight, especially in services, supporting robust wage growth.
    - Heightened uncertainty keeps saving rates elevated for precautionary reasons.
    - Slow decline of interest rates keeps investment in low-risk savings products attractive and disincentivizes debt-financed consumption.
    - Savings increasingly invested in less liquid financial assets, reducing immediate tapping for consumption.
  - Investment recovery dampened by slow easing of financial conditions, lingering uncertainty, and uncertainty about timing and strength of global manufacturing recovery, regional conflicts, and geoeconomic fragmentation.
  - Manufacturing-intensive advanced economies (for example, Germany) will see slower investment recoveries with spillovers to neighboring CESEE countries (for example, Czech Republic, Hungary, Poland, and Slovakia).
  - Some offset expected in 2025 from catch-up spending related to the Next Generation EU recovery plan supporting government infrastructure and climate investments.

### Medium-term outlook and structural constraints
- Europe’s medium-term growth:
  - Compared to the prepandemic period 2000–19, Europe’s annual real GDP growth in the decade 2019–2029 is projected to be about 0.6 percentage points lower.
  - During 2019–24, the gap widened to 0.7 percentage points slower per year.
  - The forecast gap for the coming five years is 0.5 percentage points.
- Main headwinds:
  1. Slowing labor force growth from accelerating population aging (constraints especially in countries with a higher share of labor-intensive services, for example, Greece and Italy); steady outmigration from lower-income CESEE countries could aggravate skilled labor shortages.
  2. Low investment rate relative to capital stock:
     - In CESEE, the average capital stock remains at only about 30 percent of advanced economy levels.
     - Investment constrained by public infrastructure bottlenecks and energy price volatility concerns.
  3. Low productivity growth:
     - In advanced European economies, weak total factor productivity growth driven by small market size, less capital market funding, and an over-abundance of small and stagnating firms.
     - In CESEE, persistent low capital intensity of production and skill gaps further curtail productivity growth.
- Consequence: absent strong reform effort, Europe’s growth will remain below its full potential and convergence dynamics will be impaired.

### Risks to the outlook
- Downside risks:
  - Consumers may remain more cautious and retain more savings than anticipated.
  - Effects of past monetary policy tightening could be stronger than expected (for example, mortgage rate resets).
  - Demand could be suppressed by greater-than-expected core inflation persistence or renewed spikes in shipping costs or commodity prices due to escalation of regional conflicts, rising geopolitical tensions, or intensifying trade conflicts.
  - Financial amplification: financial institutions adjusting to rising risk premia, further declines in property prices, or crowded trades could amplify shocks.
- Upside risks:
  - Household spending and investment could pick up sooner or by a larger amount if uncertainty about economic policies and trade tensions wanes and consumer sentiment and financial conditions improve faster than anticipated.

*Source: Regional Economic Outlook—Europe, October 2024, International Monetary Fund*

---

### Real GDP in Europe

### Growth Outlook and beyond-the-baseline scenarios
- Europe’s 2019–29 growth path is projected to be 0.6% less growth per year for Europe, of which:
  - 0.7% for 2019–24
  - 0.5% for 2025–29
- Inflation risks:
  - Upside: more persistent services inflation and renewed spikes in commodity and global shipping costs could slow or reverse disinflation. Risks are elevated in countries with higher energy intensity and where wage growth is more persistent (mainly CESEE).
  - Downside: faster disinflation is possible if the recovery is weaker, trade tensions ease reducing supply constraints, and short-term inflation expectations continue to decline, allowing central banks to ease sooner.
- Structural downside risks:
  - Fragmentation and climate change could weaken potential growth, with heterogeneous country effects.
  - Geopolitical tensions and intensified protectionism could cause sharper trade and value-chain decoupling, leading to less efficient production and forgone gains from trade.
  - Skepticism about advancing the single market or pursuing climate goals could curtail private investment, notably in R&D and cleaner technologies.
  - Example: analysis of Europe’s electric vehicle sector dispute with China finds substantial efficiency losses despite potential location-specific gains (e.g., Hungary and Slovakia).

### Monetary policy guidance
- Current stance and outlook:
  - Monetary policy has appropriately started to ease, but current real rates in some countries remain above their neutral levels.
  - A still-restrictive stance is warranted given forecast of gradually receding inflationary pressure and in CESEE high inflation persistence.
- Policy calibration:
  - Where inflation is expected to be soon close to target, a smooth loosening path through 2025 that will lower real rates toward neutral levels can balance anchoring expectations and avoiding an inflation undershoot (example: euro area).
  - Countries where inflation is back to target and output gaps are negative (example: Sweden and Switzerland) have started easing earlier and should continue to balance inflation and output risks.
  - In countries where inflation is still further above target or approaching it slowly (examples: Hungary, Romania, Serbia, and Russia), limited scope exists for further rate reductions in 2024.
- Strategy recommendations:
  - Shift policy decisions toward being more inflation-forecast driven as inflation approaches targets and disinflation uncertainties recede.
  - Calibrate downward policy rate paths to allow flexibility—slower pace of cuts if upside inflation developments occur, and quicker cuts if growth and inflation slow materially.
  - In CESEE, adopt a data-dependent, meeting-by-meeting approach given higher inflation persistence and risks from strong wage growth (examples: Hungary, Poland, Romania, Serbia, and Russia).
  - In Türkiye, maintain a tight monetary policy stance to re-anchor inflation expectations.
- End of easing cycle:
  - Under the baseline, real interest rates in many countries should approach r* in 2025 or 2026, but estimates of the neutral rate are highly uncertain.
  - Central banks should be prepared to adjust terminal rates of the current easing cycle based on economic and inflation outcomes.

### Fiscal policy: sustainability, buffers, and prioritization
- Debt developments:
  - Public debt has risen substantially since 2020.
  - In advanced European economies, the debt-to-GDP ratio in 2023 reached 84 percent, about 5 percentage points of GDP higher than in 2019.
  - In CESEE countries, debt-to-GDP ratios increased by 7 percentage points, with the largest increases in medium-debt-level countries (examples: Slovakia and Poland).
  - Over the medium term, debt levels are expected to level off slowly, but the number of CESEE countries classified as high-debt is increasing.
- Fiscal pivot and cyclically adjusted balances:
  - Fiscal policy is projected to tighten in 2024.
  - In advanced economies, the cyclically adjusted primary balance (CAPB) is expected to improve by 0.8 percentage point in 2024, after a deterioration of 0.4 percentage point in 2023.
  - In CESEE, the CAPB is slightly deteriorating in 2024 before improving from 2025.
  - Romania’s deficit is projected to reach almost 8 percent of GDP in 2024 due to spending slippages despite solid GDP growth.
  - Under current fiscal plans, the deficit ratio in CESEE would remain above the debt-stabilizing level over the medium term.
- EU fiscal framework:
  - The EU’s new fiscal framework should be implemented as intended to provide a fiscal anchor, balancing debt reduction and investment needs.
  - With 17 of 27 member states currently exceeding the framework’s debt and deficit benchmarks, significant fiscal adjustments are likely required—especially in high-debt nations (examples: Italy, France, Spain, and Belgium).
  - Effective implementation depends on strong domestic medium-term budgetary frameworks and public financial management systems.
- Recommendations on consolidation and fiscal design:
  - Fiscal consolidation should be more front-loaded for EU countries with high debt and small output gaps to strengthen market confidence and reduce slippage risk.
  - For countries outside the EU (notably some Western Balkan states), near-term ambitious fiscal adjustment is recommended given weaker institutions and less-established fiscal track records.
  - Embed adjustment plans in medium-term fiscal frameworks with concrete objectives to strengthen credibility and minimize negative growth effects.
  - Fiscal paths should account for large and increasing spending pressures (health, pensions, defense, climate, and interest).
  - Near-term adjustment should prioritize low fiscal multiplier items (for example, removal of hiring subsidies and tax measures benefiting high-income households) to protect the recovery.
  - Over time, reforms should reallocate spending to current priorities, improve spending efficiency and targeting, broaden tax bases, close tax gaps, and improve revenue administration digitization.
  - Specific suggestion for CESEE outside the EU: create fiscal room through broadening tax bases and more balanced tax structures (examples: Albania, Bosnia and Herzegovina, Serbia, and Moldova).
- Long-term expenditure pressures:
  - By 2050, additional expenditures are estimated to constitute:
    - 5.7 percent of GDP in advanced European economies
    - 8.1 percent of GDP in CESEE
  - These long-term costs are additional and not explicitly accounted for in the EU-wide fiscal rule; countries should plan how to address them now or in the future.

### Financial sector risks and resilience
- Current conditions:
  - Risks to financial stability have improved, but credit and market risks remain elevated even under the baseline recovery.
  - Gradually easing financial conditions mean debt service costs remain elevated as existing debt is rolled over at higher rates.
  - Corporations with lower credit ratings and vulnerable households (particularly those with lower incomes or in regions predominantly using floating-rate mortgage lending) face elevated risks.
  - Downturns in property markets—especially commercial real estate—could reduce asset quality for some banks.
- Bank buffers and vulnerabilities:
  - Banks have ample capital buffers, bolstered by large profits in the past year; buffer growth has likely passed its peak.
  - Banks face exposures to private credit, real estate, and significant direct exposures to their home sovereigns’ debt—particularly in central and eastern Europe—which could become vulnerabilities if growth moderates, corporate defaults rise, and sovereign risk premia increase.
- Nonbank financial intermediaries (NBFIs):
  - NBFIs, predominantly investment funds, are highly interconnected and exposed to liquidity risk from potential investor redemptions, representing a potential source of contagion.
  - Common investment exposures, including commercial real estate, and reliance of banks on NBFIs for non-core funding amplify market stress risk.

*International Monetary Fund, Regional Economic Outlook — Europe, October 2024*

---

### Additional Spending Pressures: Advanced Economies

### Overview and measurement notes
- Annual spending pressures are reported as "beyond baseline." Baseline level: defense spending 2021–22, health and pensions 2023, and interest at constant interest rate. Climate transition is at 2011–20 levels. Weighted by GDP.
- CESEE excludes Belarus, Israel, Kosovo, Russia, Türkiye, and Ukraine.
- AE = advanced economies; CESEE = Central, Eastern, and Southeastern Europe.

### Key fiscal and climate spending findings
- Figures illustrate additional spending pressures (Percent of GDP) for AE excluding CESEE and CESEE (scale 0–9 percent; horizon label "2025").
- Climate-related metrics:
  - Annual spending pressures on climate transition shown in percentage points of GDP.
  - Carbon dioxide emissions per unit of GDP measured in kilograms per 1,000 euro.

### Financial sector and macroprudential policy recommendations
- Nonbank funding risks:
  - "roughly half of the repo funding to banks in the euro area" is short term (largely overnight) and backed by government bonds.
  - "Substantial interest-rate derivative exposures can also amplify adverse shocks through collateral and margin calls, triggering feedback loops which lead to market-wide stress (for example, UK pension funds in 2022)."
- Recommended policy actions:
  - Further develop nonbank-oriented macroprudential tools, such as restrictions on leverage and the ability of funds or regulators to suspend investor withdrawals.
  - Tackle data gaps and enhance data sharing among financial oversight agencies.
  - Incentivize risk management by NBFIs, set appropriate regulation, and intensify supervision.
  - Design a framework for central bank liquidity support subject to carefully laid guardrails (April 2023 Global Financial Stability Report Chapter 2).
- Bank-sector macroprudential guidance:
  - "Macroprudential policy can preempt potential pressures in the banking sector."
  - Implementing positive neutral countercyclical capital buffers is "not expected to restrict credit supply given bank profitability at the current juncture" and would help maintain lending if profits moderate and non-performing loans rise.
  - Supervisors should monitor banks’ substantial commercial real estate portfolios and, where appropriate, deploy sectoral systemic risk buffers or adjust risk weights while containing migration of risks to NBFIs.

### Structural policies and single market priorities
- Sources of Europe’s growth weakness: limited market size, capital market constraints, skilled labor shortages, and stalled structural reforms; segmented goods and services markets impede firm growth, R&D spending, and economies of scale.
- Evidence:
  - Following EU enlargement waves, regions in new member states saw on average GDP per capita rise by "more than 30 percent" relative to comparable non-accession regions and existing member states (post-accession decade).
  - New IMF analysis finds that in 2020 "trade costs within Europe were equivalent to a sizable ad-valorem tariff of 44 percent for the average manufacturing sector compared to 15 percent between US states, and as high as 110 percent in the case of services sectors."
  - "A particular problem is the substantial domestic barriers to entry in services in several countries."
- European-level reform priorities:
  - Level remaining barriers to a fully functioning single market for goods and services: open protected sectors (financial services, telecommunications, electricity); improve border infrastructure; harmonize rules for businesses operating in different jurisdictions (example: a common 28th corporate regime).
  - Advance capital markets and banking union: complete the European Single Access Point; review Solvency II to enhance long-term and equity financing from insurance companies; harmonize insolvency procedures; increase portability of pension products; streamline cross-border withholding tax procedures; foster supervisory convergence; centralize oversight of systemic financial market infrastructures. Implement Common Market Deposit Insurance reform proposed by the Commission in April 2023.
  - Realign EU fiscal capacity: "About 60 percent of the current EU budget goes to the Common Agricultural Policy and cohesion funds." The next EU budget should focus on connectivity infrastructure, climate adaptation, and R&D spending. An "EU Climate and Energy Security Facility" is proposed as a pooling/coordinating vehicle.
  - Improve use and implementation of Recovery and Resilience Facility funds: "only 40 percent of its resources deployed as of May 2024." Recommend improving absorptive capacity through better coordination across government levels, streamlining administrative processes, and enhancing implementation capacity at recipient countries.
- Domestic reform priorities:
  - Reduce market entry costs and administrative barriers to cross-border firm entry.
  - Address skill shortages through more fluid labor markets; protect workers while moving away from protecting specific jobs; provide adequate benefits, training, and job search support during unemployment spells (example: Denmark).
  - Make firm size–based tax and regulatory incentives temporary; accelerate governance reforms where institutions are weak; increase education spending to incentivize firm growth and attract private investment.
- Industrial policy guidance:
  - Targeted industrial policies can be appropriate for basic R&D, early-stage green technologies, supply-chain resilience, and strategic public goods (e.g., defense).
  - Such policies should be restricted to addressing market failures, be narrowly targeted, well-designed, time bound, and avoid negative cross-border spillovers; preserve level playing field in the single market and remain consistent with World Trade Organization rules.
- State aid risks:
  - "The EU should be particularly wary of national policies that could fray the single market."
  - Evidence shows subsidies by EU members can distort trade within the EU and that export effects "predominantly stems from exports to other EU countries." Calls for coordinated design of state aid at the EU level to avoid distorting the single market.

### Climate policy and global engagement
- Climate ambition and macro impacts:
  - "Europe has increased its climate mitigation ambitions and should continue progressing toward its climate objectives."
  - "Latest estimates of the macroeconomic impact of climate change are six times larger than previously documented (Bilal and Känzig 2024)."
- Policy prescriptions:
  - Uphold a strong commitment to carbon pricing.
  - Support development and adoption of early-stage clean technologies.
  - Provide clarity on decarbonization paths, including interim objectives and associated regulations, to strengthen firms’ incentives to invest and innovate.
  - Rely on pro-competition measures rather than protection that could be detrimental to growth and climate goals (example: protection of globally maturing technologies such as electric vehicles can be harmful).
- Multilateral engagement:
  - The EU should support reforms of the World Trade Organization to strengthen international collaboration and to settle trade disputes within a robust multilateral trade system.

*Sources: European Commission; European Investment Bank; Eurostat; IMF, World Economic Outlook database; and IMF staff estimates and projections. Regional Economic Outlook—Europe, INTERNATIONAL MONETARY FUND • October 2024.*

---

### Box 1. Europe’s Shift to Electrical Vehicles amid Intensifying Global Competition: Who Will Be Affected?

### Context and scope
- The EU’s climate goals include a steep transition toward the electrical vehicle (EV) sector.
- Currently, only 15 percent of total car sales in Europe are fully electric.
- The automotive sector accounts for a significant share of GDP in many economies: 4 to 5 percent in Czechia, Slovakia, Hungary, and Germany.
- The EV sector is increasingly dominated by Chinese producers, which have rapidly gained market share.

### Model scenarios and assumptions
- "EV-shock scenario": Chinese market share in Europe increases by 15 percentage points within five years.
- Comparative policy scenarios: trade restrictions in the form of 25- or 100-percentage-point additional tariffs on Chinese EV imports into Europe.
- FDI scenario: increased FDI inflows that result in a significant share of Chinese EVs being produced in Europe.

### Aggregate and country-level GDP impacts (five-year horizon)
- Aggregate Europe: small aggregate GDP impact but significant heterogeneity across countries.
- Large economies (Germany, France, Italy):
  - Cumulative output loss of about 0.15 percent of GDP after five years under the EV-shock scenario (no additional tariffs).
- Highly automotive-dependent smaller economies:
  - Czechia: cumulative output loss of 1.2 percent of GDP after five years under the EV-shock scenario; employment losses of up to 2½ percent of the total workforce in Czechia.
  - Hungary: cumulative output loss of 1.6 percent of GDP after five years under the EV-shock scenario.
- Countries without a large car manufacturing base:
  - Benefit from cheaper EVs under the EV-shock scenario.

### Effects of tariffs on outcomes
- Imposition of tariffs results in worse GDP outcomes for European economies with large car manufacturing sectors due to higher input costs.
- Combined region of Germany, France, and Italy — cumulative GDP loss over five years:
  - 0.15 percent under no additional tariffs (EV shock baseline),
  - 0.18 percent under 25-percent additional tariffs,
  - 0.46 percent under 100 percent additional tariffs.
- Higher tariffs also erase most of the gains for European economies that do not have significant car manufacturing bases.

### Role of foreign direct investment
- Increased FDI that leads to a significant share of Chinese EV production being located in Europe can help smaller economies.
- The FDI scenario undoes some of the economic losses from the baseline EV-shock scenario in the worst-affected EU economies proportionally.
- The distribution of gains depends on whether some individual economies are more successful in attracting Chinese FDI than others.

### Key takeaways
- A rapid 15 percentage-point increase in Chinese EV market share in Europe over five years would produce small aggregate GDP effects but large heterogeneous country impacts.
- Tariff-based protection worsens GDP outcomes for car-manufacturing countries and reduces net gains for non-manufacturing countries.
- Attracting Chinese FDI to produce EVs in Europe can mitigate losses for smaller, heavily exposed economies, with distributional outcomes depending on country-level success in attracting investment.

*The authors of this Box are Diego Cerdeiro, Anke Weber, and Jiaxiong Yao.*

---

### 7.5 percent by the end of the year.

### Fiscal Position (selected country/chapter data)
- Overall fiscal deficit is expected to expand in 2025 to 19.2 percent of GDP.
- Primary driver: defense spending remains high due to the longer war.
- Authorities’ planned measures to keep the deficit manageable:
  - Continued streamlining of nondefense expenditures.
  - New tax measures.
- Financing: The deficit will continue to be mostly financed by external sources.

### Balance of Payments (selected country/chapter data)
- Current account: expected to further deteriorate to $27.1 billion (14.3 percent of GDP).
  - Drivers: a worsening trade balance (recovering exports more than offset by sustained import demand for priority spending needs) and a persisting services balance deficit from migrant spending abroad.
- Gross reserves: projected to remain adequate at $44.8 billion (104.6 percent of Assessing Reserve Adequacy), supported by continued external financing.

### Outlook and Risks (selected country/chapter data)
- Risks to the outlook remain exceptionally high.
- Policy needs for 2025 amid a longer war:
  - Adapt fiscal and monetary policies to maintain macrofinancial stability.
  - Restore medium-term external viability and debt sustainability.
- Structural policy priorities:
  - Progress on structural reforms, particularly in governance and fiscal structural areas, will be critical.
  - Objectives tied to reforms: ensure robust growth prospects in line with the EU accession path, secure needed reconstruction investment, and enable the return of migrants.

### Key statistics (from the chapter)
- Overall fiscal deficit (2025 projection): 19.2 percent of GDP.
- Current account balance (2025 projection): $27.1 billion (14.3 percent of GDP).
- Gross reserves (projection): $44.8 billion (104.6 percent of Assessing Reserve Adequacy).

*International Monetary Fund, Regional Economic Outlook—Europe, October 2024.*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview
- Europe’s economic recovery continues but is "falling well short of Europe’s full potential."
- High uncertainty—about persistent core inflation, the direction of economic policies, and geopolitical conflicts—is muting the rebound and weighing on the medium-term outlook.
- Structural headwinds include a perennial productivity slowdown, potential effects of fragmentation, climate change, population aging, and other structural shifts.
- An in-depth analysis accompanying the report highlights constraints:
  - Advanced European economies: lack of market scale and access to capital and skilled labor limiting firms from operating at the global technology and innovation frontier.
  - CESEE countries: lagging structural reforms and low investment rates slowing convergence.

### Near-term economic performance and outlook
- Growth strengthened in the first half of 2024 to 1.7 percent.
- Projected growth:
  - 2024: advanced European economies = 1.0 percent; CESEE = 2.3 percent.
  - 2025: advanced European economies = 1.4 percent; CESEE = 3.1 percent.
- Gradually strengthening private domestic demand, further disinflation, and progressively easing financial conditions are expected to more than offset necessary fiscal consolidation.
- Given high core inflation persistence, inflation targets timing:
  - Advanced European economies: targets reached in 2025.
  - Most CESEE countries: targets reached in 2026.
- Consumer and business behavior contributing to slow recovery:
  - Private consumption moderate relative to household income growth; precautionary savings elevated and saving rates remain above pre-crisis levels.
  - Investment slow to recover amid still tight financial conditions and declining real estate prices in some countries.
  - Service sector recovery robust; industrial production lags due to weak external demand (including from China).
- Long-term concerns:
  - Forecasters have grown more pessimistic about longer-term growth; uncertainty whether policies can reverse a decade-long productivity decline and narrow the "30-percent income per capita gap with the United States."
  - Productivity slump spans tech and non-tech sectors, driven by low business start-up rates and slow firm growth.

### Risks
- Downside risks predominate, including:
  - Intensification of the war in Ukraine and escalation of armed conflicts in the Middle East raising commodity price volatility.
  - Rising economic policy uncertainty related to elections and policy directions on fiscal consolidation, EU-wide competitiveness reforms, climate goals, and trade policy.
  - Global financial market turbulence signaling concerns about US growth and global fragmentation.
- Financial sector vulnerabilities include exposures to commercial real estate that could worsen in a downturn.
- Nonbank financial intermediaries with high portfolio concentration, elevated leverage, and liquidity mismatches pose migration-of-risk concerns.

### Monetary policy recommendations
- Central banks have appropriately started to ease; policy guidance:
  - Advanced European economies: rate reductions should continue steadily; policy decisions can become more forecast-driven while responding flexibly to large data surprises or developments.
  - CESEE region: monetary policy should be more data-dependent and meeting-by-meeting; internalize asymmetric (high) costs of inflation overshooting and avoid premature or too rapid easing.
- Given uncertainties around the level of neutral rates, central banks should approach the end of the easing cycle with care and be ready to adjust the terminal rate based on economic and inflation outcomes.

### Fiscal policy recommendations
- Fiscal policy must rebuild buffers and secure debt sustainability:
  - Public debt has risen substantially since 2020 as governments provided necessary policy support during crises.
  - With inflation closer to target and moderate growth, high debt would become a vulnerability if not addressed through medium-term adjustment efforts.
- A fiscal policy pivot is underway; priorities:
  - Implement the new European fiscal governance framework as planned to reduce debt and strengthen sustainability.
  - Manage fiscal adjustment while addressing rising expenditure needs through spending prioritization and structural fiscal reforms.
  - In high-debt countries, fiscal adjustment should be front-loaded to demonstrate resolve, secure market confidence, and create room for future spending needs.

### Financial sector policy recommendations
- Supervisors should keep a watchful eye on downside risks despite banks’ substantial capital buffers.
- Policy actions suggested:
  - Rebuild macroprudential buffers to protect against potential downturns.
  - Prevent migration of risks to nonbank financial intermediaries, focusing on those with high portfolio concentration, elevated leverage, and liquidity mismatches.

### Structural policies and long-term growth
- To raise potential growth, Europe needs a clear policy direction emphasizing deeper integration:
  - A larger and more integrated single market—especially for goods, services, and capital—is needed to allow firms and entrepreneurs to innovate and raise growth sustainably.
  - A fully developed single market would facilitate structural reforms and raise investment incentives in converging countries, and help insulate businesses and labor markets from global fragmentation pressures.
- CESEE-specific priorities:
  - Upgrade infrastructure.
  - Enhance worker skills.
  - Improve institutions to resume income growth catch-up.

*International Monetary Fund, Regional Economic Outlook—Europe (Executive Summary).*

### 1. Household Savings Rate

### 1. Household Savings Rate

### Key indicators and recent dynamics
- Headline inflation: in about 60 percent of advanced European countries, headline inflation has declined to within 1 percentage point or less of central banks’ targets; in 22 percent of countries inflation has fallen below it.
- CESEE disinflation: in the CESEE region, only 33 percent of countries are within 1 percentage point of the target, whereas more than 40 percent of countries are still above it.
- Contribution to disinflation since peak in 2023: lower energy and food inflation account for about three-quarters of the euro area’s disinflation and about half in the CESEE region.
- Monetary transmission: in the euro area, about 80 to 90 percent of the transmission to growth occurred up to 2023:Q4/2024:Q1.
- Services inflation stickiness:
  - Services inflation in the euro area is still 2 percentage points above its 2015–19 average.
  - In CESEE countries, services inflation is 5 percentage points higher than the 2015–19 average.
- Wage dynamics:
  - Romania, Hungary, and Poland: wage growth has remained near or above double digits this year.
  - In advanced European economies, wages have grown less rapidly; real wages have only now recovered to pre-war levels in several countries.
- Household savings: normalization of household saving rates is slow; elevated savings rates expected to persist for precautionary reasons.

### Inflation persistence and composition
- Core inflation has slowed more gradually than headline inflation due to strong second-round effects from wage inflation in labor-intensive services sectors.
- In CESEE, the disinflation process is more drawn out because of more persistent wage and services inflation.
- The path toward the inflation target has been bumpy across countries because of base effects and staggered reversal of support measures; expiring subsidies or tax relief measures can lift user prices and temporarily boost inflation.
- External shocks: attacks on Red Sea shipping lanes have increased shipping costs and created upward price pressures.

### Financial conditions and demand indicators
- Financial conditions indexes are aggregated using liability-weighted average; changes are measured as quarter-to-quarter changes (index above 0 = tighter than historical average).
- Global PMI for new export orders and manufacturing: 50+ indicates expansion (series shown Jan. 2018–Jan. 2024).
- Capacity utilization: deviation from long-term trend (long-term trend = average from 2000 to 2023); capacity utilization based on survey of manufacturing industry.

### Outlook: A tepid recovery (baseline projections)
- 2024 growth projections:
  - Advanced European economies (AE excluding CESEE): 1.0 percent (2024).
  - CESEE: 2.3 percent (2024).
- 2025 growth projections:
  - Advanced European economies: 1.4 percent (2025).
  - CESEE: 3.1 percent (2025).
- Inflation returning to target:
  - Advanced European economies: inflation will return to target in 2025.
  - Most CESEE countries: inflation will return to target in 2026.
- Drivers and constraints on recovery:
  - Gradually strengthening private domestic demand (supported by further disinflation and progressively easing financial conditions) more than offsets effects of necessary fiscal consolidation.
  - Rising household purchasing power will only gradually feed into higher consumer spending because:
    - Labor markets will cool but remain sufficiently tight, especially in services, supporting robust wage growth.
    - Heightened uncertainty keeps saving rates elevated for precautionary reasons.
    - Slow decline of interest rates keeps investment in low-risk savings products attractive and disincentivizes debt-financed consumption.
    - Savings increasingly invested in less liquid financial assets, reducing immediate tapping for consumption.
  - Investment recovery dampened by slow easing of financial conditions, lingering uncertainty, and uncertainty about timing and strength of global manufacturing recovery, regional conflicts, and geoeconomic fragmentation.
  - Manufacturing-intensive advanced economies (for example, Germany) will see slower investment recoveries with spillovers to neighboring CESEE countries (for example, Czech Republic, Hungary, Poland, and Slovakia).
  - Some offset expected in 2025 from catch-up spending related to the Next Generation EU recovery plan supporting government infrastructure and climate investments.

### Medium-term outlook and structural constraints
- Europe’s medium-term growth:
  - Compared to the prepandemic period 2000–19, Europe’s annual real GDP growth in the decade 2019–2029 is projected to be about 0.6 percentage points lower.
  - During 2019–24, the gap widened to 0.7 percentage points slower per year.
  - The forecast gap for the coming five years is 0.5 percentage points.
- Main headwinds to reaching full potential:
  1. Slowing labor force growth from accelerating population aging (constraints especially in countries with a higher share of labor-intensive services, for example, Greece and Italy); steady outmigration from lower-income CESEE countries could aggravate skilled labor shortages.
  2. Low investment rate relative to capital stock:
     - In CESEE, the average capital stock remains at only about 30 percent of advanced economy levels.
     - Investment constrained by bottlenecks in public infrastructure (including utilities and road transportation) and concerns about energy price volatility given higher energy intensity.
     - Among non-EU members, weak governance and inefficient public institutions are additional brakes on inward investments.
  3. Low productivity growth:
     - In advanced European economies, weak total factor productivity growth driven by small market size, less capital market funding, and an over-abundance of small and stagnating firms.
     - In CESEE, persistent low capital intensity of production and skill gaps further curtail productivity growth.
- Consequence: absent strong reform effort, Europe’s growth will remain below its full potential and convergence dynamics will be impaired.

### Risks to the outlook
- Downside risks (biased downward):
  - Consumers may remain more cautious and retain more savings than anticipated.
  - Effects of past monetary policy tightening could be stronger than expected (for example, mortgage rate resets adding pressure to household budgets).
  - Demand could be suppressed by greater-than-expected core inflation persistence or renewed spikes in shipping costs or commodity prices due to escalation of regional conflicts, rising geopolitical tensions, or intensifying trade conflicts.
  - Financial amplification: financial institutions (banks and nonbanks) adjusting to rising risk premia, further declines in property prices, or crowded trades could amplify shocks.
- Upside risks:
  - Household spending and investment could pick up sooner or by a larger amount if uncertainty about economic policies and trade tensions wanes and consumer sentiment and financial conditions improve faster than anticipated.

*Source: Regional Economic Outlook—Europe, October 2024, International Monetary Fund*

### 1. Real GDP in Europe

### 1. Real GDP in Europe

### Growth Outlook and Beyond-the-Baseline Scenarios
- Europe’s 2019–29 growth path is projected to be 0.6% less growth per year for Europe, of which:
  - 0.7% for 2019–24
  - 0.5% for 2025–29
- Inflation risks:
  - Upside: more persistent services inflation and renewed spikes in commodity and global shipping costs could slow or reverse disinflation. Risks are elevated in countries with higher energy intensity and where wage growth is more persistent (mainly CESEE).
  - Downside: faster disinflation is possible if the recovery is weaker, trade tensions ease reducing supply constraints, and short-term inflation expectations continue to decline, allowing central banks to ease sooner.
- Structural downside risks to potential growth:
  - Fragmentation and climate change could weaken potential growth, with heterogeneous country effects.
  - Geopolitical tensions and intensified protectionism could cause sharper trade and value-chain decoupling, leading to less efficient production and forgone gains from trade.
  - Skepticism about advancing the single market or pursuing climate goals could curtail private investment, notably in R&D and cleaner technologies.
  - Example finding: analysis of Europe’s electric vehicle sector dispute with China finds substantial efficiency losses despite potential location-specific gains (e.g., Hungary and Slovakia).

### Monetary Policy Guidance
- Current stance and outlook:
  - Monetary policy has appropriately started to ease, but current real rates in some countries remain above their neutral levels.
  - A still-restrictive stance is warranted given forecast of gradually receding inflationary pressure and in CESEE high inflation persistence.
- Policy calibration:
  - Where inflation is expected to be soon close to target, a smooth loosening path through 2025 that will lower real rates toward neutral levels can balance anchoring expectations and avoiding an inflation undershoot (example: euro area).
  - Countries where inflation is back to target and output gaps are negative (example: Sweden and Switzerland) have started easing earlier and should continue to balance inflation and output risks.
  - In countries where inflation is still further above target or approaching it slowly (examples: Hungary, Romania, Serbia, and Russia), limited scope exists for further rate reductions in 2024.
- Strategy recommendations:
  - Shift policy decisions toward being more inflation-forecast driven as inflation approaches targets and disinflation uncertainties recede.
  - Calibrate downward policy rate paths to allow flexibility—slower pace of cuts if upside inflation developments occur, and quicker cuts if growth and inflation slow materially.
  - In CESEE, adopt a data-dependent, meeting-by-meeting approach given higher inflation persistence and risks from strong wage growth (examples: Hungary, Poland, Romania, Serbia, and Russia).
  - In Türkiye, maintain a tight monetary policy stance to re-anchor inflation expectations.
- End of easing cycle:
  - Under the baseline, real interest rates in many countries should approach r* in 2025 or 2026, but estimates of the neutral rate are highly uncertain.
  - Central banks should be prepared to adjust terminal rates of the current easing cycle based on economic and inflation outcomes.

### Fiscal Policy: Sustainability, Buffers, and Prioritization
- Debt developments:
  - Public debt has risen substantially since 2020.
  - In advanced European economies, the debt-to-GDP ratio in 2023 reached 84 percent, about 5 percentage points of GDP higher than in 2019.
  - In CESEE countries, debt-to-GDP ratios increased by 7 percentage points, with the largest increases in medium-debt-level countries (examples: Slovakia and Poland).
  - Over the medium term, debt levels are expected to level off slowly, but the number of CESEE countries classified as high-debt is increasing.
- Fiscal pivot and cyclically adjusted balances:
  - Fiscal policy is projected to tighten in 2024.
  - In advanced economies, the cyclically adjusted primary balance (CAPB) is expected to improve by 0.8 percentage point in 2024, after a deterioration of 0.4 percentage point in 2023.
  - In CESEE, the CAPB is slightly deteriorating in 2024 before improving from 2025.
  - Romania’s deficit is projected to reach almost 8 percent of GDP in 2024 due to spending slippages despite solid GDP growth.
  - Under current fiscal plans, the deficit ratio in CESEE would remain above the debt-stabilizing level over the medium term.
- EU fiscal framework:
  - The EU’s new fiscal framework should be implemented as intended to provide a fiscal anchor, balancing debt reduction and investment needs.
  - With 17 of 27 member states currently exceeding the framework’s debt and deficit benchmarks, significant fiscal adjustments are likely required—especially in high-debt nations (examples: Italy, France, Spain, and Belgium).
  - Effective implementation depends on strong domestic medium-term budgetary frameworks and public financial management systems.
- Recommendations on consolidation and fiscal design:
  - Fiscal consolidation should be more front-loaded for EU countries with high debt and small output gaps to strengthen market confidence and reduce slippage risk.
  - For countries outside the EU (notably some Western Balkan states), near-term ambitious fiscal adjustment is recommended given weaker institutions and less-established fiscal track records.
  - Embedding adjustment plans in medium-term fiscal frameworks with concrete objectives will strengthen credibility and minimize negative growth effects.
  - Fiscal paths should account for large and increasing spending pressures (health, pensions, defense, climate, and interest).
  - Near-term adjustment should prioritize low fiscal multiplier items (for example, removal of hiring subsidies and tax measures benefiting high-income households) to protect the recovery.
  - Over time, reforms should reallocate spending to current priorities, improve spending efficiency and targeting, broaden tax bases, close tax gaps, and improve revenue administration digitization.
  - Specific suggestion for CESEE outside the EU: create fiscal room through broadening tax bases and more balanced tax structures (examples: Albania, Bosnia and Herzegovina, Serbia, and Moldova).

- Long-term expenditure pressures:
  - By 2050, additional expenditures are estimated to constitute:
    - 5.7 percent of GDP in advanced European economies
    - 8.1 percent of GDP in CESEE
  - These long-term costs are additional and not explicitly accounted for in the EU-wide fiscal rule; countries should plan how to address them now or in the future.

### Financial Sector Risks and Resilience
- Current conditions:
  - Risks to financial stability have improved, but credit and market risks remain elevated even under the baseline recovery.
  - Gradually easing financial conditions mean debt service costs remain elevated as existing debt is rolled over at higher rates.
  - Corporations with lower credit ratings and vulnerable households (particularly those with lower incomes or in regions predominantly using floating-rate mortgage lending) face elevated risks.
  - Downturns in property markets—especially commercial real estate—could reduce asset quality for some banks.
- Bank buffers and vulnerabilities:
  - Banks have ample capital buffers, bolstered by large profits in the past year; buffer growth has likely passed its peak.
  - Banks face exposures to private credit, real estate, and significant direct exposures to their home sovereigns’ debt—particularly in central and eastern Europe—which could become vulnerabilities if growth moderates, corporate defaults rise, and sovereign risk premia increase.
- Nonbank financial intermediaries (NBFIs):
  - NBFIs, predominantly investment funds, are highly interconnected and exposed to liquidity risk from potential investor redemptions, representing a potential source of contagion.
  - Common investment exposures, including commercial real estate, and reliance of banks on NBFIs for non-core funding amplify market stress risk.

*International Monetary Fund, Regional Economic Outlook — Europe, October 2024*

### 1. Additional Spending Pressures: Advanced Economies

### 1. Additional Spending Pressures: Advanced Economies

### Overview and measurement notes
- Annual spending pressures are reported as "beyond baseline." Baseline level: defense spending 2021–22, health and pensions 2023, and interest at constant interest rate. Climate transition is at 2011–20 levels. Weighted by GDP.
- CESEE excludes Belarus, Israel, Kosovo, Russia, Türkiye, and Ukraine.
- Data labels in the figure use International Organization for Standardization (ISO) country codes.
- AE = advanced economies; CESEE = Central, Eastern, and Southeastern Europe.

### Key fiscal and climate spending findings
- Figures illustrate additional spending pressures (Percent of GDP) for:
  - Advanced Economies excluding CESEE (scale 0–9 percent; horizon label "2025").
  - CESEE (scale 0–9 percent; horizon label "2025").
- Climate-related metrics:
  - Annual spending pressures on climate transition are shown in percentage points of GDP.
  - Carbon dioxide emissions per unit of GDP are measured in kilograms per 1,000 euro.
- Climate Spending Pressures by 2050 are displayed (Percent of GDP) distinguishing AE excluding CESEE and CESEE.

### Financial sector and macroprudential policy recommendations
- Nonbank funding risks:
  - "roughly half of the repo funding to banks in the euro area" is short term (largely overnight) and backed by government bonds.
  - "Substantial interest-rate derivative exposures can also amplify adverse shocks through collateral and margin calls, triggering feedback loops which lead to market-wide stress (for example, UK pension funds in 2022)."
- Recommended policy actions:
  - Further develop nonbank-oriented macroprudential tools, such as restrictions on leverage and the ability of funds or regulators to suspend investor withdrawals.
  - Tackle data gaps and enhance data sharing among financial oversight agencies to strengthen monitoring and risk assessment capacity across the financial sector.
  - Incentivize risk management by NBFIs, set appropriate regulation, and intensify supervision.
  - Design a framework for central bank liquidity support subject to carefully laid guardrails (April 2023 Global Financial Stability Report Chapter 2).
- Bank-sector macroprudential guidance:
  - "Macroprudential policy can preempt potential pressures in the banking sector."
  - Although overall capital requirements are adequate under the baseline outlook, "continued tight macroprudential policy can strengthen the capacity of the banking sector to deal with rising credit defaults or a repricing of assets."
  - Implementing positive neutral countercyclical capital buffers is "not expected to restrict credit supply given bank profitability at the current juncture" and would help maintain lending if profits moderate and non-performing loans rise.
  - A tightening of macroprudential policy could lower downside risks to growth as financial conditions loosen.
  - Supervisors should monitor banks’ substantial commercial real estate portfolios and, where appropriate, deploy sectoral systemic risk buffers or adjust risk weights while containing migration of risks to NBFIs.

### Structural policies and single market priorities
- Sources of Europe’s growth weakness: limited market size, capital market constraints, skilled labor shortages, and stalled structural reforms; segmented goods and services markets impede firm growth, R&D spending, and economies of scale.
- Evidence and quantifications:
  - Following EU enlargement waves, regions in new member states saw on average GDP per capita rise by "more than 30 percent" relative to comparable non-accession regions and existing member states (post-accession decade).
  - New IMF analysis finds that in 2020 "trade costs within Europe were equivalent to a sizable ad-valorem tariff of 44 percent for the average manufacturing sector compared to 15 percent between US states, and as high as 110 percent in the case of services sectors."
  - "A particular problem is the substantial domestic barriers to entry in services in several countries."
- European-level reform priorities (summary of recommended measures):
  - Level all remaining barriers to a fully functioning single market for goods and services: open protected sectors (financial services, telecommunications, electricity) to more foreign competitors; improve border infrastructure; harmonize rules for businesses operating in different jurisdictions (example: a common 28th corporate regime).
  - Advance capital markets and banking union: complete the European Single Access Point; review Solvency II to enhance long-term and equity financing from insurance companies; harmonize insolvency procedures; increase portability of pension products; streamline cross-border withholding tax procedures; foster supervisory convergence; centralize oversight of systemic financial market infrastructures. Implement Common Market Deposit Insurance reform proposed by the Commission in April 2023.
  - EU Funds and fiscal capacity: realign EU fiscal capacity to support common public goods. "About 60 percent of the current EU budget goes to the Common Agricultural Policy and cohesion funds." The next EU budget should focus on shared challenges such as connectivity infrastructure (transportation, energy, digital), climate adaptation, and R&D spending. An "EU Climate and Energy Security Facility" is proposed as a pooling/coordinating vehicle.
  - Improve use and implementation of Recovery and Resilience Facility funds: "only 40 percent of its resources deployed as of May 2024." Recommend improving absorptive capacity through better coordination across government levels, streamlining administrative processes, and enhancing implementation capacity at recipient countries.
- Domestic reform priorities:
  - Reduce market entry costs and administrative barriers to cross-border firm entry.
  - Address skill shortages through more fluid labor markets; protect workers while moving away from protecting specific jobs; provide adequate benefits, training, and job search support during unemployment spells (example: Denmark).
  - Make firm size–based tax and regulatory incentives temporary; accelerate governance reforms where institutions are weak; increase education spending to incentivize firm growth and attract private investment.
- Industrial policy guidance:
  - Targeted industrial policies can be appropriate for basic R&D, early-stage green technologies, supply-chain resilience, and strategic public goods (e.g., defense).
  - Such policies should be restricted to addressing market failures, be narrowly targeted, well-designed, time bound, and avoid negative cross-border spillovers; preserve level playing field in the single market and remain consistent with World Trade Organization rules.
- State aid risks:
  - "The EU should be particularly wary of national policies that could fray the single market."
  - Evidence shows subsidies by EU members can distort trade within the EU and that export effects "predominantly stems from exports to other EU countries." Calls for coordinated design of state aid at the EU level to avoid distorting the single market.

### Climate policy and global engagement
- Climate ambition and macro impacts:
  - "Europe has increased its climate mitigation ambitions and should continue progressing toward its climate objectives."
  - "Latest estimates of the macroeconomic impact of climate change are six times larger than previously documented (Bilal and Känzig 2024)."
- Policy prescriptions to reconcile growth and climate objectives:
  - Uphold a strong commitment to carbon pricing.
  - Support development and adoption of early-stage clean technologies.
  - Provide clarity on decarbonization paths, including interim objectives and associated regulations, to strengthen firms’ incentives to invest and innovate.
  - Rely on pro-competition measures rather than protection that could be detrimental to growth and climate goals (example cited: protection of globally maturing technologies such as electric vehicles can be harmful).
- Multilateral engagement:
  - The EU should support reforms of the World Trade Organization to strengthen international collaboration and to settle trade disputes within a robust multilateral trade system.

*Sources: European Commission; European Investment Bank; Eurostat; IMF, World Economic Outlook database; and IMF staff estimates and projections. Regional Economic Outlook—Europe, INTERNATIONAL MONETARY FUND • October 2024.*

### Box 1. Europe’s Shift to Electrical Vehicles amid Intensifying Global Competition:

### Box 1. Europe’s Shift to Electrical Vehicles amid Intensifying Global Competition: Who Will Be Affected?

### Context and scope
- The EU’s climate goals include a steep transition toward the electrical vehicle (EV) sector.
- Currently, only 15 percent of total car sales in Europe are fully electric.
- The automotive sector accounts for a significant share of GDP in many economies: 4 to 5 percent in Czechia, Slovakia, Hungary, and Germany.
- The EV sector is increasingly dominated by Chinese producers, which have rapidly gained market share.

### Model scenarios and assumptions
- Forthcoming analysis (Wingender and others 2024) assumes the Chinese market share in Europe increases by 15 percentage points within five years; this scenario is labeled the “EV-shock scenario.”
- Comparative policy scenarios include trade restrictions in the form of 25- or 100-percentage-point additional tariffs on Chinese EV imports into Europe.
- A foreign direct investment (FDI) scenario considers increased FDI inflows that result in a significant share of Chinese EVs being produced in Europe.

### Aggregate and country-level GDP impacts (five-year horizon)
- Aggregate Europe: The impact of the “EV shock” on GDP for Europe is small in the aggregate but significantly heterogeneous across countries.
- Large economies (Germany, France, Italy):
  - Cumulative output loss of about 0.15 percent of GDP after five years under the EV-shock scenario (no additional tariffs).
- Highly automotive-dependent smaller economies:
  - Czechia: cumulative output loss of 1.2 percent of GDP after five years under the EV-shock scenario; employment losses of up to 2½ percent of the total workforce in Czechia.
  - Hungary: cumulative output loss of 1.6 percent of GDP after five years under the EV-shock scenario.
- Countries without a large car manufacturing base:
  - Benefit from cheaper EVs under the EV-shock scenario.

### Effects of tariffs on outcomes
- Imposition of tariffs results in worse GDP outcomes for European economies with large car manufacturing sectors due to higher input costs.
- Combined region of Germany, France, and Italy — cumulative GDP loss over five years:
  - 0.15 percent under no additional tariffs (EV shock baseline),
  - 0.18 percent under 25-percent additional tariffs,
  - 0.46 percent under 100 percent additional tariffs.
- Higher tariffs also erase most of the gains for European economies that do not have significant car manufacturing bases.

### Role of foreign direct investment
- Increased FDI that leads to a significant share of Chinese EV production being located in Europe can help smaller economies.
- The FDI scenario undoes some of the economic losses from the baseline EV-shock scenario in the worst-affected EU economies proportionally.
- The distribution of gains (averted losses) depends on whether some individual economies are more successful in attracting Chinese FDI than others.

### Key takeaways
- A rapid 15 percentage-point increase in Chinese EV market share in Europe over five years would produce small aggregate GDP effects but large heterogeneous country impacts.
- Tariff-based protection worsens GDP outcomes for car-manufacturing countries and reduces net gains for non-manufacturing countries.
- Attracting Chinese FDI to produce EVs in Europe can mitigate losses for smaller, heavily exposed economies, with distributional outcomes depending on country-level success in attracting investment.

*The authors of this Box are Diego Cerdeiro, Anke Weber, and Jiaxiong Yao.*

### 7.5 percent by the end of the year.

### 7.5 percent by the end of the year.

### Fiscal Position
- The overall fiscal deficit is expected to expand in 2025 to 19.2 percent of GDP.
- Primary driver: defense spending remains high due to the longer war.
- Authorities’ planned measures to keep the deficit manageable:
  - Continued streamlining of nondefense expenditures.
  - New tax measures.
- Financing: The deficit will continue to be mostly financed by external sources.

### Balance of Payments
- Current account: expected to further deteriorate to $27.1 billion (14.3 percent of GDP).
  - Drivers: a worsening trade balance (recovering exports more than offset by sustained import demand for priority spending needs) and a persisting services balance deficit from migrant spending abroad.
- Gross reserves: projected to remain adequate at $44.8 billion (104.6 percent of Assessing Reserve Adequacy), supported by continued external financing.

### Outlook and Risks
- Risks to the outlook remain exceptionally high.
- Policy needs for 2025 amid a longer war:
  - Adapt fiscal and monetary policies to maintain macrofinancial stability.
  - Restore medium-term external viability and debt sustainability.
- Structural policy priorities:
  - Progress on structural reforms, particularly in governance and fiscal structural areas, will be critical.
  - Objectives tied to reforms: ensure robust growth prospects in line with the EU accession path, secure needed reconstruction investment, and enable the return of migrants.

### Key statistics (from the chapter)
- Overall fiscal deficit (2025 projection): 19.2 percent of GDP.
- Current account balance (2025 projection): $27.1 billion (14.3 percent of GDP).
- Gross reserves (projection): $44.8 billion (104.6 percent of Assessing Reserve Adequacy).

*International Monetary Fund, Regional Economic Outlook—Europe, October 2024.*

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_Source: https://www.imf.org/-/media/files/publications/reo/eur/2024/october/english/text.pdf_