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### Overview: Key messages and near-term outlook
- Despite headwinds, performance of the German economy was remarkable: strong employment creation and unemployment declined to post-reunification lows.
- Q4 2011 contraction was followed by a sharp rebound early in 2012, helping the euro area avoid a technical recession.
- Conditions supportive of a domestic demand-led recovery: healthy corporate and household balance sheets, higher wages, well anchored inflation expectations, and low borrowing costs.
- Growth poised to reach potential in the second half of 2012.
- Main near-term risk: an intensification of the euro area crisis spilling over through real and financial channels.
- Germany is one of the world’s most open large economies; medium-term policies must be viewed in a multilateral context.

### Recent economic developments and indicators
- Activity and labor market
  - Economic activity picked up in Q1 2012 due to rebound in external demand and strong consumption growth.
  - Output gap expected to close in 2012.
  - Unemployment at 5.3 percent (post-reunification low).
  - Since 2010, jobs with full social security benefits grew faster than atypical employment.
  - Nominal pay rates increased by about 2 percent in 2011; overall wage growth near 3 percent due to normalization of working hours and significant one-off payments.
- Fiscal outcomes and public debt
  - Overall deficit narrowed to 1 percent of GDP in 2011 (from 4.3 percent in 2010).
  - Structural balance improved by about 1¼ percent of GDP in 2011.
  - Public debt increased from 65 percent of GDP in 2007 to 81 percent in 2011 (including financial sector support operations).
- Financial markets and balance sheets
  - Persistent capital outflows reversed markedly; German banks withdrew from Europe’s cross-border interbank market and unwound positions in stressed economies.
  - Demand for safe assets pushed German government bond yields to record lows; ten-year government bond yield (period average): 2012: 1.9 (see selected statistics).
  - Bundesbank’s claims on the Eurosystem rose to €644 billion by April (approximately 24 percent of GDP).
  - Household leverage low relative to other euro area economies and has fallen recently.
  - Corporate profitability high and debt-to-income ratios lower than the euro area average.
  - Nationwide house prices rose moderately (1-4 percent in 2011), with localized stronger increases.

### Staff baseline outlook and risks
- Baseline projections
  - Activity expected to expand by 1 percent in 2012, and rise to 1.4 percent in 2013.
  - Net foreign demand expected to contribute significantly less to growth in 2012 and 2013 than in previous years.
  - Employment creation expected to fall to near zero over the medium term; unemployment decline expected to level off.
  - Economy projected to operate slightly above capacity in the medium term; headline inflation projected to settle slightly above 2 percent.
- Downside risks (mainly external)
  - Intensification of the euro area crisis could trigger higher funding costs for banks, trading losses, reduced private demand, weaker exports, and abrupt deleveraging with domestic lending cutbacks.
  - Broader risks: slowdown in global growth (notably U.S. and Asia) or a sharp rise in oil prices.
  - Medium-term risk: slowdown in potential growth if structural policies prove insufficient, with negative consequences for public debt.
  - Risk that accommodative monetary conditions lead to asset mispricing assessed as Low at the current juncture.

### Policy Theme #1 — Steering the recovery
- 2012 fiscal stance and consolidation
  - 2012 budget implies a modest fiscal withdrawal, less than half of that in 2011.
  - Staff estimates an improvement of about ½ ppt of GDP in the structural balance in 2012, with automatic stabilizers operating fully.
  - Germany on track for federal deficit not exceeding 0.35 percent of GDP from 2016 and balanced budgets for the Länder from 2020.
  - German structural fiscal deficit expected to fall below 0.5 percent of GDP already in 2013, likely aligning with the pan-European Fiscal Compact requirements.
- Credit conditions and banking vulnerabilities
  - Despite ample liquidity, credit growth remains moderate; bank balances with the Bundesbank are high and lending rates lower than elsewhere in Europe.
  - LTRO uptake by German banks in December and February was small.
  - Banking system vulnerabilities:
    - Some banks remain highly leveraged, dependent on wholesale funding, have low capital quality and profitability.
    - Some institutions significantly exposed to the euro area periphery.
    - Six larger banks called to strengthen capital after the EBA stress test; one bank is being wound down.
    - Progress on Basel III core capital, liquidity and leverage ratios is underway.

### SoFFin II and public financial support to banks
- SoFFin II details and outcomes
  - SoFFin II reintroduced on a preemptive basis with an overall amount of €480 billion available through end-2012.
  - Outstanding balances under SoFFin I continue to decline.
  - Capital support to banks reduced by about one third; few liquidity guarantees remain outstanding.
  - Portfolios of the two winding-up institutions remain high at just under 10 percent of GDP; further increase anticipated with transfer of a residual portfolio as part of Landesbank restructuring.
  - As of end-2011, operational losses of SoFFin I estimated at €22.1 billion, about half linked to restructuring of Greek sovereign bonds.
  - Preemptive reactivation of SoFFin II viewed as a welcome backstop; banks with capital shortfalls expected to comply with EBA requirements without resorting to SoFFin II.
  - Meeting Basel III requirements will create further pressure on banks to strengthen balance sheets.

### Institutional framework for macroprudential policy and FSC
- Proposed Financial Stability Commission (FSC)
  - Legislative initiative to establish FSC by early 2013 comprising BMF, Bundesbank, BaFin, and a non-voting representative from the Federal Agency for Financial Market Stabilization; chaired by BMF and drawing on Bundesbank analysis.
  - No menu of macroprudential instruments defined yet; measures under consideration include prescribing effective loan-to-value ratios for mortgages and adjusting capital buffers (countercyclical capital buffer, systemic risk buffer).
  - FSC’s independence from political influence should be ensured in line with ESRB recommendations.
  - Regional consistency and ESRB guidelines must guide deployment of macroprudential instruments.
  - Staff view: no need to tighten macroprudential policies at the current juncture; near-term priority is to support domestic demand rebound with natural relative price adjustment.

### Fiscal policy spillovers and contingency planning
- Fiscal room and spillovers
  - Available fiscal room in 2012 estimated at around ½ percent of GDP within constitutionally binding fiscal rule (unless escape clause invoked).
  - Fiscal spillovers from a two-year 1 percent of GDP fiscal stimulus in Germany to the rest of the euro area: maximum impact 0.2 percentage points if concentrated in public investment and accommodated by monetary policy.
  - Impact on German domestic GDP of a two-year 1 percent of GDP stimulus can range between 0.7 and 0.9 percent of GDP on average over two years if concentrated in public consumption and investment.
  - Impact on real GDP in Greece, Italy, Ireland, Portugal and Spain estimated not to exceed 0.15 percent.
  - Given limited fiscal room, Germany should not deviate from the 2012 budget under the baseline; automatic stabilizers should operate fully.
  - Available fiscal resources could facilitate reforms in the euro area periphery (increase EIB lending capacity, better-targeted EU structural funds).
- Contingency planning
  - More active fiscal policies appropriate only in event of renewed downturn; invoking escape clause could be appropriate depending on shock.
  - Develop contingency plan prioritizing revenue and expenditure measures with highest payoff that could be quickly implemented.
  - In negative shock, priority: measures that spur long-term potential growth (reduce labor and corporate income taxes, reorient social spending to education and childcare support).
  - Labor market support: expand short work scheme.

### Financial stability priorities and FSAP Update recommendations
- Key priorities
  - Step up momentum in Landesbanken reform; restructuring of a large Landesbank expected to be completed by mid-year.
  - Strengthen crisis management framework by establishing resolution plans.
  - Address fragmentation in deposit insurance regime.
- Status on recommendations and actions
  - Continue to improve stress testing; BaFin calls for corrective action when weaknesses are found.
  - Grant supervisors power to vet bank acquisitions of subsidiaries — legislative initiatives not expected in near term.
  - Define Bundesbank’s role as macroprudential supervisor and institute free exchange of information — legislative proposals for FSC expected by end year.
  - Continue to strengthen on-site supervision; progress made reducing securities market supervision over-dependence on external auditors.
  - Review reporting requirements — proposals being developed with implementation expected in 2013.
  - Institute harmonized and legally binding deposit guarantee of €100,000 backed by adequate prefunding — under consideration; no concrete action expected before European-level conclusion.
  - Ensure financial strength of new bank restructuring fund and clarify interaction with deposit guarantee and mutual protection schemes — contributions in 2011 at lower end of expectations and forecast to be less in current year.
  - Develop comprehensive strategy to improve banking efficiency and stability: reforms of Landesbanken business models proceeding gradually; no plans to loosen regional constraints or open public banks to private participation.

### Germany in an interconnected world and spillovers (Box 3 highlights)
- Trade and financial openness
  - Trade as a share of German GDP rose from 62 percent in 2000 to 94 percent by 2011.
  - Exposures to the Eurosystem (Target 2) about 24 percent of GDP as of end-April 2012.
  - Germany sensitive to macroeconomic and financial market developments abroad; business cycle dynamics driven largely by foreign shocks.
- Empirical spillover evidence
  - Financial shocks in the United States which increase its output gap by one percent estimated to raise the output gap in Germany by 0.52 percent.
  - Germany is an efficient transmitter of business cycle fluctuations to its regional supply chain but not a major originator of such shocks.
- Key external and financial exposure statistics
  - German banks’ foreign exposures about USD 2.8 trillion at end-Q4 2011.
  - These exposures represented ¼ of total assets of German monetary financial institutions and about 4½ times their total capital.
  - More than ¾ of total bank exposures concentrated in advanced economies, majority in Europe and the United States.
  - Total exposures to Greece, Ireland, and Portugal amounted to USD 139 billion — almost 10 percent of exposures to advanced Europe.
  - Current account surplus peaked at 7½ percent of GDP in 2007.
  - Net international investment position improved to a positive 35 percent of GDP at end-2011, from near-balance a decade earlier; about ½ of the net IIP reflected net claims on the Eurosystem.
- Staff views on external rebalancing
  - Staff estimates real effective exchange rate is undervalued by 0-10 percent.
  - Natural rebalancing expected to reduce current account balance to around 4 percent of GDP in the medium term.
  - Staff sees an additional reduction in the current account balance by 2 percent of GDP over and above natural rebalancing as appropriate.
  - Staff’s estimate of a 2 percent of GDP current account balance consistent with medium-term fundamentals (model in Ivanova (2012) IMF Working Paper No. 12/61).

### Structural and policy recommendations (staff views)
- Rebalancing and domestic demand
  - Allow pickup in wages and some asset prices as part of natural rebalancing to reduce high current account surplus.
  - Raising domestic demand will support exports from trading partners dependent on consumption and investment.
- Fiscal and European policy
  - Articulate a shared EU vision for post-crisis EMU architecture, including greater financial and fiscal integration.
  - Boost and better-target EU structural funds and increase lending capacity of the European Investment Bank to reinforce periphery reforms.
- Structural reforms to raise potential growth
  - Increase labor force participation (female, older workers), skilled migration, investment, and productivity growth, especially outside traditional strengths.
  - Tax reform priorities: reduce labor taxes at the participation margin; improve corporate tax regime; consider in-work or earned income tax credits; reform income splitting; reform local trade tax; introduce allowance for normal return on new equity.
  - Raise quality of human capital via education and training reform; raise services-sector productivity by promoting greater competition, including in regional network industries.
- Financial sector reforms
  - Broaden channels of financial intermediation (arms-length finance) to allocate resources to innovation and new growth engines; ensure regulation and supervision keep pace.
  - Address tax treatment ambiguities for venture capital and reexamine regulatory framework to encourage a larger investor base for risk capital.
  - Deploy intellectual property from universities and research institutions into industry more easily.
  - Explore out-of-court restructuring procedures to reduce stigma of business failure.
  - Reduce outstanding capital support to banks and balance sheets of winding-up institutions while minimizing state losses.

### Risk Assessment Matrix — top scenarios (selected)
- 1. Strong intensification of the euro area crisis — Likelihood: Medium; Impact: High. Channels: lower export demand, inward financial spillovers, deleveraging, uncertainty.
- 2. Slowdown of world growth — Likelihood: Medium; Impact: High. Channels: slowing demand from emerging Asia and the U.S., lower export demand.
- 3. Slowdown of potential growth — Likelihood: Medium; Impact: Medium. Channels: failure of strategies to counter demographic pressures and boost productivity.
- 4. Sharp increase in oil prices — Likelihood: Medium; Impact: Medium. Channels: higher energy prices depress demand and raise inflation.
- 5. Mispricing of assets — Likelihood: Low; Impact: Medium. Channels: loose liquidity leading to excessive asset price increases and costly corrections.
- 6. More acute deleveraging by the German banking system — Likelihood: Low; Impact: Low. Channels: higher write-downs, challenges meeting capital requirements, reduced domestic lending.

### Financial sector reforms, crisis-management and recommended actions
- Build momentum on FSAP Update recommendations while macro conditions favorable.
- Priority actions:
  - Reduce outstanding public capital support to some banks and balance sheets of winding-up institutions, minimizing state losses.
  - Advance comprehensive strategy to improve banking efficiency and stability.
  - Increase efforts to restructure Landesbanken and reform their business models.
  - Strengthen crisis management framework by establishing resolution plans and enhancing deposit insurance regime.

### Selected key statistics and medium-term projections (selected, preserved exactly)
- Total population (2011, million): 81.8
- GDP per capita (2011, USD): 44,556
- GDP (annual percentage change): 2008: 0.8; 2009: -5.1; 2010: 3.6; 2011: 3.1; 2012: 1.0; 2013: 1.4
- Output gap (In percent of potential GDP): 2008: 2.3; 2009: -3.7; 2010: -1.5; 2011: 0.2; 2012: 0.0; 2013: 0.1
- Unemployment rate (in percent) 4/: 2008: 7.6; 2009: 7.7; 2010: 7.1; 2011: 6.0; 2012: 5.3; 2013: 5.2
- Consumer price index (harmonized): 2008: 2.8; 2009: 0.2; 2010: 1.2; 2011: 2.5; 2012: 2.2; 2013: 2.0
- General government: overall balance (in percent of GDP): 2008: -0.1; 2009: -3.2; 2010: -4.3; 2011: -1.0; 2012: -0.7; 2013: -0.4
- General government debt (In percent of GDP): 2008: 66.9; 2009: 74.7; 2010: 83.5; 2011: 81.2; 2012: 82.2; 2013: 80.2
- Current account (in percent of GDP): 2008: 6.2; 2009: 5.9; 2010: 6.1; 2011: 5.7; 2012: 5.2; 2013: 4.6
- Medium-term projections (selected):
  - Real GDP: 2014–2017: 1.3 (each year)
  - Output gap (percent of potential GDP): 2014: 0.1; 2015: 0.2; 2016: 0.2; 2017: 0.3
  - Consumer prices: 2014: 2.1; 2015: 2.1; 2016: 2.1; 2017: 2.1
  - Current account balance (percent of GDP): 2014: 4.3; 2015: 4.2; 2016: 4.0; 2017: 3.9
  - General government overall balance (percent of GDP): 2014: -0.1; 2015: -0.1; 2016: 0.0; 2017: 0.0
  - Gross debt (percent of GDP): 2014: 78.1; 2015: 76.3; 2016: 74.6; 2017: 72.6
- Banking-sector indicators (selected):
  - Regulatory capital to risk-weighted assets (all banks, percent): 2007: 12.9; 2008: 13.6; 2009: 14.8; 2010: 16.1; 2011: 16.4
  - NPLs to gross loans (overall): 2.6; 2.9; 3.2 (with notes on methodological break)
  - Return on average assets (after-tax, overall): 2007: 0.2; 2008: -0.3; 2009: -0.1; 2010: 0.2; 2011: 0.2
  - Liquidity: liquid assets to total short-term liabilities (overall): 2007: 119.4; 2008: 120.3; 2009: 144.1; 2010: 137.0; 2011: 137.9

*Source: _cr12161 (Germany 2012 Article IV Report), INTERNATIONAL MONETARY FUND.*

### INTRODUCTION __________________________________________________________________________________  5

### INTRODUCTION

### Overview: Key Messages
- Despite considerable headwinds, the performance of the German economy has been remarkable: employment creation strong and unemployment declined to post-reunification lows.
- Contraction in activity in the last quarter of 2011 was followed by a sharp rebound early in 2012, helping the euro area avoid a technical recession.
- Conditions in Germany for a domestic demand-led recovery: healthy corporate and household balance sheets, higher wages, well anchored inflation expectations, and low borrowing costs.
- Growth is poised to reach potential in the second half of 2012.
- Main near-term risk: an intensification of the euro area crisis spilling over through real and financial channels.
- Over the medium term, raising potential growth and resilience must be viewed in a multilateral context because Germany is one of the world’s most open large economies.

### Recent Economic Developments and Outlook
- Economic growth appears to have bottomed out; activity picked up in Q1 2012 due to a rebound in external demand and strong consumption growth.
- The output gap is expected to close in 2012.
- Labor market:
  - Unemployment at 5.3 percent, a post-reunification low.
  - Since 2010, creation of jobs with full social security benefits has grown faster than atypical employment.
  - Nominal pay rates increased by about 2 percent in 2011; overall wage growth pushed to near 3 percent due to normalization of working hours and significant one-off payments.
- Fiscal developments:
  - Overall deficit narrowed to 1 percent of GDP in 2011 (from 4.3 percent in 2010).
  - Structural balance improved by about 1¼ percent of GDP in 2011 due to withdrawal of stimulus and consolidation measures.
  - Public debt increased from 65 percent of GDP in 2007 to 81 percent in 2011, including financial sector support operations.
- Financial flows and markets:
  - Persistent capital outflows reversed markedly; German banks withdrew from Europe’s cross-border interbank market and unwound investment positions in economies under stress.
  - Demand for safe assets pushed German government bond yields to record lows.
  - Bundesbank’s claims on the Eurosystem rose to €644 billion by April (approximately 24 percent of GDP).
- Inflation:
  - Headline inflation fell to 2.2 percent in April 2012, reflecting moderation of fuel price increases.
  - Core inflation remained low at 1.4 percent (y/y, ex energy, food, alcohol, and tobacco).
  - Medium term price expectations remain well anchored below 2 percent as implied by break-even differentials on 5-year Bunds.
- Balance sheets and asset prices:
  - Household leverage is low relative to other euro area economies and has fallen recently.
  - Corporate profitability is high and debt-to-income ratios are lower than the euro area average.
  - Equity prices rebounded broadly; bank and public sector bond yields at record lows; corporate bond yields largely flat.
  - Nationwide house prices rose moderately (1-4 percent in 2011) with localized stronger increases, spurring construction activity.

### Staff Outlook and Risks
- Staff baseline:
  - Private sector-led rebound elements in place; consumption and investment (including residential) expected to gather pace.
  - Activity expected to expand by 1 percent in 2012, and rise to 1.4 percent in 2013.
  - Net foreign demand expected to contribute significantly less to growth in 2012 and 2013 compared to previous years.
  - Employment creation expected to fall to near zero over the medium term; unemployment decline expected to level off.
  - Economy projected to operate slightly above capacity in the medium term; headline inflation projected to settle slightly above 2 percent.
- Downside risks (mainly external):
  - Intensification of the euro area crisis could lead to a sharp downturn in Germany via higher funding costs for banks, trading losses, reduced private demand, deteriorating consumer and business confidence, weaker exports, and possible abrupt deleveraging with sharp domestic lending cutbacks.
  - Broader downside risks: slowdown in global growth (notably U.S. and Asia) or a sharp rise in oil prices due to geo-political factors.
  - Medium-term risk: slowdown in potential growth if structural policies prove insufficient, with negative consequences for public debt.
  - Risk that accommodative monetary conditions lead to asset mispricing is viewed as low at the current juncture.

### Authorities’ Assessment
- Authorities broadly agreed with staff’s baseline: conditions for rebalancing towards domestic demand are in place; strong labor market and sustained gains in real disposable income.
- Authorities expect the net contribution of foreign demand to growth could approach zero over the medium term.
- Authorities share view that anticipated wage and price increases are part of rebalancing and could help the euro area.
- Authorities’ view on risks:
  - Assessed downside risks as lower probability but noted interrelated risks could coincide.
  - Noted an additional medium-term risk from insufficiently ambitious policies in the euro area that could create contingent pressures on Germany’s public finances or delay financial sector restructuring.
  - Noted upside potential if uncertainty recedes quickly and factors such as higher migration raise growth potential.

### Policy Theme #1: Steering the Recovery in an Uncertain Environment
- 2012 fiscal stance and outlook:
  - 2012 budget implies a modest fiscal withdrawal, less than half of that last year.
  - Staff estimates an improvement of about ½ ppt of GDP in the structural balance, with automatic stabilizers operating fully.
  - Consolidation plans for 2013 and beyond have been scaled back given strong performance in 2011.
  - Germany on track to achieve national fiscal rule: federal deficit not exceeding 0.35 percent of GDP from 2016 and balanced budgets for the Länder from 2020.
  - German structural fiscal deficit expected to fall below 0.5 percent of GDP already in 2013, likely aligning with the pan-European Fiscal Compact requirements.
- Credit conditions and banking sector:
  - Despite ample liquidity, credit growth remains moderate; bank balances with the Bundesbank are high and lending rates lower than elsewhere in Europe.
  - LTRO uptake by German banks occurred in December and February but was rather small.
  - Rise in bank lending is moderate, reflecting still low demand from households and firms.
  - Banking system vulnerabilities:
    - German banks generally meet minimum regulatory capital and have ample liquidity, but some remain highly leveraged and dependent on wholesale funding, have low capital quality and profitability.
    - Some institutions are significantly exposed to the euro area periphery.
    - Six larger banks were called upon to strengthen capital after the EBA stress test and are well on their way to meet EBA requirements (one bank is in the process of being wound down).
    - Some large international financial institutions have substantial cross-border operations and significant counterparty risk exposures related to large derivative portfolios.
    - As banks seek to deleverage, they are reducing exposures outside core business lines and regions, generating outward spillovers.
    - German banks have made progress on raising core capital in line with Basel III, and in meeting the new liquidity and leverage ratios.

*Source: INTRODUCTION, GERMANY 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND*

### 17.      As a backstop, the financial stability support mechanism (SoFFin II) was

### 17.      As a backstop, the financial stability support mechanism (SoFFin II) was 

### SoFFin II and public financial support to banks
- SoFFin II was reintroduced on a preemptive basis with an overall amount of €480 billion available through end-2012.
- Outstanding balances of public financial support under the original Special Fund for Financial Market Stabilization (SoFFin I) continue to decline.
- Capital support to banks has been reduced by about one third, and few liquidity guarantees remain outstanding.
- The size of the portfolios of the two winding-up institutions remains high at just under 10 percent of GDP and a further increase is anticipated by mid-year with the transfer of a residual portfolio of non-core assets as part of the restructuring of a large Landesbank.
- As of end-2011, operational losses of SoFFin I are estimated at €22.1 billion, approximately half of it linked to the restructuring of Greek sovereign bonds.
- The pre-emptive reactivation of SoFFin II is viewed as a welcome backstop to limit the impact of deleveraging and ensure system stability if downside risks materialize.
- Banks identified as having a capital shortfall are expected to comply with EBA requirements without resorting to SoFFin II.
- Meeting Basel III requirements will create further pressure on banks to strengthen their balance sheets.

### Institutional framework for macroprudential policy
- Legislative initiative proposes a Financial Stability Commission (FSC) for crisis management coordination and to address financial stability risks, to be established by early 2013.
- The FSC will comprise the Federal Ministry of Finance (BMF), the Bundesbank, the financial supervisor (BaFin), and a non-voting representative from the Federal Agency for Financial Market Stabilization; it will be chaired by the BMF and draw on financial stability analysis prepared by the Bundesbank.
- No menu of instruments for macroprudential purposes has been defined yet; measures under consideration include prescribing effective loan-to-value ratios for mortgages and adjusting capital buffers (e.g., countercyclical capital buffer, systemic risk buffer).
- The FSC’s independence from political influence should be ensured in line with ESRB recommendations.
- The potential deployment of additional macro-prudential instruments will need to take into account ESRB guidelines and be regionally consistent.
- There is no need to tighten macroprudential policies at the current juncture; near-term priority is to support the rebound of domestic demand accompanied by a natural relative price adjustment.

### Staff’s views on fiscal policy and spillovers
- The available fiscal room in 2012 is estimated at around ½ percent of GDP within the constitutionally binding fiscal rule, unless the escape clause is invoked.
- Fiscal spillovers from Germany to the rest of the euro area would be small and concentrated in small and open neighboring countries (the Czech Republic, Austria, the Netherlands and Belgium).
- Simulations suggest the maximum impact of a two-year 1 percent of GDP fiscal stimulus in Germany on the rest of the euro area at 0.2 percentage points if all the stimulus is concentrated in public investment and accommodated by monetary policy.
- The impact on German domestic GDP of a two-year 1 percent of GDP stimulus can range between 0.7 and 0.9 percent of GDP on average over two years if stimulus is concentrated in public consumption and investment.
- The impact on real GDP in Greece, Italy, Ireland, Portugal and Spain is estimated not to exceed 0.15 percent, with a particularly small impact on Greece.
- Given limited fiscal room, Germany should not deviate from the 2012 budget under the baseline; automatic stabilizers should be allowed to operate fully.
- Any available fiscal resources could be used to facilitate reforms in the euro area periphery, including increasing the lending capacity of the European Investment Bank and enhanced, better-targeted EU structural funds.

### Contingency planning and policy response to renewed downturn
- Only in the event of a renewed downturn would more active fiscal policies be needed; invoking the escape clause could be appropriate depending on the size and nature of the shock.
- A contingency plan should be developed prioritizing revenue and expenditure measures with the highest payoff that could be quickly implemented.
- In a negative shock, priority should be given to measures that could spur long-term potential growth, including reduction in labor and corporate income taxes, and reorientation of social spending towards education and childcare support.
- The labor market could be supported through an expanded short work scheme.

### Financial stability priorities and FSAP Update recommendations
- Ensuring financial stability remains a key priority, including understanding and internalizing risks from the global activities of large German banks and strengthening cross-border supervision and cooperation.
- Some institutions, including the Landesbanken, remain vulnerable to increases in wholesale funding costs.
- Progress has been made on implementing 2011 FSAP Update recommendations, but much work remains; current favorable macroeconomic conditions provide an opportunity to accelerate reforms.
- Key FSAP priorities include:
  - Stepping up momentum in the reform of the Landesbanken; restructuring of a large Landesbank is expected to be completed by mid-year.
  - Strengthening the crisis management framework by establishing resolution plans.
  - Addressing challenges in the fragmented deposit insurance regime.
- Main outstanding FSAP Update recommendations and status highlights:
  - Continue to improve stress testing in the banking and insurance sectors — further stress testing improvements made; BaFin calls for corrective action when weaknesses are found.
  - Grant supervisors power to vet in advance bank acquisitions of subsidiaries — legislative initiatives on this matter are not expected in the near term.
  - Define the role of the Bundesbank as macroprudential supervisor and institute free exchange of information — legislative proposals for the FSC expected by end year, including clarification of roles and information sharing.
  - Continue to strengthen on-site supervision — important progress made reducing securities market supervision over-dependence on external auditors; banking supervisor does not anticipate changes in this area.
  - Review reporting requirements — proposals being developed with implementation expected in 2013.
  - Institute a harmonized and legally binding deposit guarantee of €100,000, backed by adequate prefunding — being considered for mutual protection schemes, but no concrete action expected before conclusion of European-level discussions; commercial banks’ private deposit protection scheme coverage remains high despite a reduction over time from currently 30 percent of a bank’s capital per depositor to 8.75 percent in 2025.
  - Ensure financial strength of the new bank restructuring fund and clarify its interaction with deposit guarantee and mutual protection schemes — contributions to the restructuring fund in 2011 were at the lower end of expectations and are forecast to be even less this year; contingency arrangements remain in place; interactions expected to be dealt with on a case-by-case basis.
  - Develop comprehensive strategy to improve efficiency and stability of the banking system, including reforms of the Landesbanken business models, loosening regional constraints, opening public banks to private participation, and strengthening governance — reform of the Landesbanken is proceeding gradually with no plans to loosen regional constraints or open public banks to private participation.

### Authorities’ views
- Authorities view continued fiscal consolidation in Germany as a key credibility anchor in Europe and see no need or space for fiscal relaxation given favorable macroeconomic developments, small potential spillovers to the southern euro area periphery, and constraints of the fiscal rule.
- Authorities note potentially negative implications in the periphery if the ECB tightened monetary policy in response to fiscal relaxation in Germany.
- Authorities do not see an immediate need for a contingency plan for fiscal stimulus and view past stimulus experience as a mixed success.
- Authorities broadly agree with staff on the financial system assessment, the importance of strengthening cross-border regulation and supervision, the merits of stress testing and forward-looking monitoring, and the need to strengthen reporting requirements.
- Authorities expect to move forward quickly with establishment of the FSC, well within the ESRB timetable for mid-2013, and envisage coordinating macro-prudential instruments consistent with EU initiatives.
- Authorities expressed reservations about vetting bank acquisitions of subsidiaries due to potential interference with bank business interests and noted further Landesbanken reforms are useful but challenging given sub-national consensus requirements.

### Germany in an interconnected world
- Trade as a share of German GDP rose from 62 percent in 2000 to 94 percent by 2011.
- Financial linkages are extensive; exposures to the Eurosystem (Target 2) were about 24 percent of GDP as of end-April 2012.
- The German economy is sensitive to macroeconomic and financial market developments abroad due to high and rising trade and financial openness; business cycle dynamics are driven in large part by foreign shocks.
- Trade linkages with the United States, United Kingdom and emerging Asia are particularly important for transmitting macroeconomic shocks; trade linkages within the euro area are significant but partly mitigated by monetary policy stabilization within the currency union.

*Source: IMF staff report excerpt (Germany 2012 Article IV Report).*

### Box 3. Spillovers Through Cyclical Fluctuations

### Box 3. Spillovers Through Cyclical Fluctuations

### Empirical findings on spillovers
- Empirical analysis that takes into account trade linkages as well as international money, bond and equity market linkages (Vitek 2012) suggests that the German economy is sensitive to macroeconomic and financial market developments in the rest of the world (inward spillovers).
- Example: financial shocks in the United States which increase its output gap by one percent are estimated to raise the output gap in Germany by 0.52 percent.
- Germany is an efficient transmitter of business cycle fluctuations to its regional supply chain, but has not been a major originator of such shocks (outward spillovers).
- Within the euro area, outward spillovers are mitigated by monetary policy responses, explaining the small effects on countries such as France and Spain.
- Note: the empirical analysis does not account for trend growth in demand, and hence does not capture potential benefits from a permanent increase in potential growth.

### Inward and outward spillover channels
- Inward spillovers:
  - Germany’s output gap responds to macroeconomic and financial shocks abroad (measured as percent increases in the output gap in Germany in response to a one percent increase in the source economy’s output gap).
- Outward spillovers:
  - Germany transmits real and financial shocks through regional supply chains to immediate European neighbors.
  - German banks’ overseas operations generate financial spillovers to economies in Europe and beyond.

### Key external position and financial exposure statistics
- German banks’ foreign exposures comprised about USD 2.8 trillion at the end of Q4 2011.
- These foreign exposures represented ¼ of total assets of German monetary financial institutions and about 4½ times their total capital.
- More than ¾ of total bank exposures are concentrated in advanced economies with the majority in Europe and the United States.
- Total exposures to Greece, Ireland, and Portugal amounted to USD 139 billion and comprise almost 10 percent of exposures to advanced Europe.
- Germany’s traditional current account surplus peaked at 7½ percent of GDP in 2007.
- Germany’s net international investment position (IIP) improved to a positive 35 percent of GDP at end-2011, from near-balance a decade earlier.
- About ½ of the net IIP position at end-2011 reflected net claims on the Eurosystem.

### Staff assessment of external rebalancing and projections
- Staff estimates suggest that Germany’s real effective exchange rate is undervalued by 0-10 percent.
- The natural rebalancing of domestic sources of growth is expected to reduce the current account balance to around 4 percent of GDP in the medium term.
- Staff sees an additional reduction in the current account balance by 2 percent of GDP over and above the natural rebalancing process as appropriate.
- Staff estimates of the current account balance of 2 percent of GDP consistent with medium-term fundamentals are based on a model described in Ivanova (2012) IMF Working Paper No. 12/61.

### Drivers of the external surplus and investment behavior
- The increase in the external surplus in the mid-2000s was largely driven by the corporate sector.
- Corporate savings increased significantly by the mid-2000s on the back of strong profits.
- Contributing factors to stronger corporate balance sheets included changes to the tax regime, changes to the close relationship between corporates and banks, regulatory changes (Basel II), and increased globalization of production requiring access to international bank financing.
- Investment was slow to respond; investment has been consistently below that predicted by traditional determinants beginning in the mid-80s.

### Structural and policy recommendations (staff views)
- Rebalancing and domestic demand:
  - Raising domestic demand will support exports from Germany’s trading partners that depend on domestic consumption and investment rather than regional manufacturing supply chains.
  - Allowing a pickup in wages and some asset prices as part of the natural rebalancing process will help reduce Germany’s high current account surplus.
- Fiscal and European policy:
  - Germany can support euro area adjustment and market confidence by articulating a shared EU vision for post-crisis Economic and Monetary Union (EMU) architecture, including greater financial and fiscal integration.
  - Pan-European actions that could reinforce periphery reforms include boosting and better targeting EU structural funds and increasing the lending capacity of the European Investment Bank.
- Structural reforms to raise potential growth:
  - Increase labor force participation, investment, and productivity growth, especially outside Germany’s traditional strengths.
  - Tax reform priorities include reduction of labor taxes at the participation margin, improvements in the corporate tax regime, possible introduction of in-work and earned income tax credit programs, reform of the regime of income splitting, reforms of the local level trade tax, and the introduction of an allowance for the normal return on new equity.
- Financial sector reforms:
  - Broaden channels of financial intermediation to facilitate allocation of resources towards innovation and new engines of growth by developing intermediation outside traditional banking (so-called arms-length finance).
  - Ensure regulation and supervision keep pace with development of a more arms-length system to maintain financial stability.
  - Address ambiguities in the tax treatment of venture capital firms and consider reducing differences in tax treatment of venture capital firms with other European countries.
  - Reexamine the regulatory framework to encourage a larger investor base for risk capital.
  - Deploy intellectual property held by universities and research institutions into industry more easily.
  - Recent corporate and personal insolvency reforms are welcome; explore feasibility of out-of-court restructuring procedures to reduce stigma associated with business failure.
  - Strengthen resilience of the financial system by reducing outstanding capital support to banks and the sizeable balance sheets of the two winding-up institutions while minimizing potential losses to the state.
- Macroprudential and bank support measures:
  - Pre-emptive reactivation of the backstop facility for financial institutions (SoFFin II) is welcome.
  - Banks are expected to meet EBA capital requirements without the use of public support under the baseline.
  - Establish a framework for implementing macroprudential policies following European Union initiatives; no need to tighten macroprudential policies at this juncture.

### Risks and near-term policy priorities (staff appraisal)
- Main downside risks:
  - Intensification of the euro area crisis, which would spill over into Germany directly through real and financial channels and indirectly through dampened business and consumer sentiment.
  - Lower global growth prospects more broadly.
  - An abrupt rise in oil prices due to geo-political shocks.
- Near-term policy priority:
  - Manage the transition to domestic demand-led growth and guard against downside risks.
  - Maintain a modest structural fiscal consolidation and allow full operation of automatic stabilizers given Germany’s advanced cyclical position and status as an EFSF/ESM guarantor.
  - Secure financial stability given high leverage ratios, low quality of bank capital, significant cross-border exposures, and large reliance on wholesale funding; ensure risks from global activities of large banks are fully understood and internalized.

### Structural context and potential growth
- Germany’s potential growth is around 1¼ percent and has been highly dependent on external sources of demand.
- Aging population and labor force shrinkage pose long-term adverse effects on potential growth.
- Productivity growth in the services sector (about 60 percent of private employment and about 70 percent of value added) was about a quarter of that in goods production during 2000-07.
- Investment has lagged and contributed to external imbalances despite healthy corporate balance sheet positions.

*Source: _cr12161 - Box 3. Spillovers Through Cyclical Fluctuations (Germany 2012 Article IV Report), INTERNATIONAL MONETARY FUND.*

### 44.      The current environment provides a window of opportunity to build

### _cr12161 - 44.      The current environment provides a window of opportunity to build

### Financial sector reforms and crisis-management
- Build momentum in financial sector reforms in line with the 2011 Financial Sector Assessment Program (FSAP) Update recommendations.
- Priority actions:
  - Reduce outstanding public capital support to some banks and the sizable balance sheets of the two winding-up institutions, while minimizing potential losses to the state.
  - Advance a comprehensive strategy to improve the efficiency and stability of the banking system.
  - Increase efforts to restructure the Landesbanken and reform their business models.
  - Strengthen the crisis management framework by establishing resolution plans and enhancing the deposit insurance regime.

### Germany’s role in addressing the euro-area crisis
- As the euro area’s largest economy, Germany can play a pivotal role in addressing the crisis.
- Policy and coordination recommendations:
  - Articulate more clearly the Economic and Monetary Union’s shared vision of an appropriate post-crisis architecture to help restore market confidence.
  - Complement national structural reform agendas with pan-European measures, potentially including using EU structural funds and increasing the lending capacity of the European Investment Bank.
  - Recognize that natural rebalancing of Germany’s economy would help reduce euro-area imbalances.
  - Note on inflation dynamics: consistent with the mandate of the European Central Bank, disinflationary pressures incipient in the periphery economies (essential for their relative price realignment) could imply inflation in Germany that is somewhat higher than the euro area average for some time.

### Domestic structural reforms to raise potential growth
- Germany should pursue structural reforms to raise potential growth and diversify growth sources, reinforcing euro-area reform momentum.
- Recommended measures:
  - Increase labor force participation through higher participation of female and older workers and migration of skilled workers (ongoing efforts are welcome).
  - Raise the quality of human capital via reforms to the system of education and training.
  - Raise productivity in the services sector by promoting greater competition, including at the regional level in network industries such as transportation and energy.

### Financial deepening and broadening access to risk capital
- Broaden access to risk capital through structural financial reforms.
- Specific actions urged:
  - Develop more arms-length financial intermediation as a complement to the relationship-based system.
  - Continue recent reform initiatives in corporate and personal insolvency.
  - Reexamine the policy framework to encourage a larger investor base for risk capital.
- Expected outcome: Broadening channels of financial intermediation would facilitate allocation of resources towards innovation and new engines of growth.

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

### Selected key statistics and projections (as presented)
- Total population (2011, million): 81.8
- GDP per capita (2011, USD): 44,556

- GDP (annual percentage change):
  - 2008: 0.8
  - 2009: -5.1
  - 2010: 3.6
  - 2011: 3.1
  - 2012: 1.0
  - 2013: 1.4

- Output gap (In percent of potential GDP):
  - 2008: 2.3
  - 2009: -3.7
  - 2010: -1.5
  - 2011: 0.2
  - 2012: 0.0
  - 2013: 0.1

- Unemployment rate (in percent) 4/:
  - 2008: 7.6
  - 2009: 7.7
  - 2010: 7.1
  - 2011: 6.0
  - 2012: 5.3
  - 2013: 5.2

- Consumer price index (harmonized):
  - 2008: 2.8
  - 2009: 0.2
  - 2010: 1.2
  - 2011: 2.5
  - 2012: 2.2
  - 2013: 2.0

- General government: overall balance (in percent of GDP):
  - 2008: -0.1
  - 2009: -3.2
  - 2010: -4.3
  - 2011: -1.0
  - 2012: -0.7
  - 2013: -0.4

- General government debt (In percent of GDP):
  - 2008: 66.9
  - 2009: 74.7
  - 2010: 83.5
  - 2011: 81.2
  - 2012: 82.2
  - 2013: 80.2

- Current account (in percent of GDP):
  - 2008: 6.2
  - 2009: 5.9
  - 2010: 6.1
  - 2011: 5.7
  - 2012: 5.2
  - 2013: 4.6

- Medium-term projections (selected, percent change or percent of GDP):
  - Real GDP: 2010: 3.6; 2011: 3.1; 2012: 1.0; 2013: 1.4; 2014–2017: 1.3 (each year)
  - Output gap (percent of potential GDP): 2010: -1.5; 2011: 0.2; 2012: 0.0; 2013: 0.1; 2014: 0.1; 2015: 0.2; 2016: 0.2; 2017: 0.3
  - Consumer prices: 2010: 1.2; 2011: 2.5; 2012: 2.2; 2013: 2.0; 2014: 2.1; 2015: 2.1; 2016: 2.1; 2017: 2.1
  - Current account balance (percent of GDP): 2010: 6.1; 2011: 5.7; 2012: 5.2; 2013: 4.6; 2014: 4.3; 2015: 4.2; 2016: 4.0; 2017: 3.9
  - General government overall balance (percent of GDP): 2010: -4.3; 2011: -1.0; 2012: -0.7; 2013: -0.4; 2014: -0.1; 2015: -0.1; 2016: 0.0; 2017: 0.0
  - Gross debt (percent of GDP): 2010: 83.5; 2011: 81.2; 2012: 82.2; 2013: 80.2; 2014: 78.1; 2015: 76.3; 2016: 74.6; 2017: 72.6

- Banking-sector indicators (selected):
  - Regulatory capital to risk-weighted assets (all banks, percent):
    - 2007: 12.9
    - 2008: 13.6
    - 2009: 14.8
    - 2010: 16.1
    - 2011: 16.4
  - NPLs to gross loans (overall): 2.6; 2.9; 3.2 (with notes on methodological break)
  - Return on average assets (after-tax, overall):
    - 2007: 0.2
    - 2008: -0.3
    - 2009: -0.1
    - 2010: 0.2
    - 2011: 0.2
  - Liquidity: liquid assets to total short-term liabilities (overall):
    - 2007: 119.4
    - 2008: 120.3
    - 2009: 144.1
    - 2010: 137.0
    - 2011: 137.9

*Source: GERMANY 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND.*

### 1. Strong intensification of

### Strong intensification of the euro area crisis

### Risk Assessment Matrix (RAM) — events that could materially alter the baseline
- 1. Strong intensification of the euro area crisis
  - Likelihood: Medium
  - Impact: High
  - Channels: Heightened financial stress could adversely alter the outlook for the euro area. Direct effects through lower export demand and inward financial spillovers, indirect effects through deleveraging and uncertainty.
- 2. Slowdown of world growth
  - Likelihood: Medium
  - Impact: High
  - Channels: Slowing demand from emerging Asia and the U.S. Lower export demand could hurt Germany’s export performance.
- 3. Slowdown of potential growth
  - Likelihood: Medium
  - Impact: Medium
  - Channels: Strategies to counteract demographic pressures and increase productivity may fail to deliver results. Potential growth would decline in the medium term.
- 4. Sharp increase in oil prices
  - Likelihood: Medium
  - Impact: Medium
  - Channels: Geo-political risks could lead to a sharp increase in oil prices. Higher energy prices could depress demand and raise inflation.
- 5. Mispricing of assets
  - Likelihood: Low
  - Impact: Medium
  - Channels: Loose liquidity conditions in the banking sector may lead to excessive asset price increases. Subsequent price corrections could be costly.
- 6. More acute deleveraging by the German banking system
  - Likelihood: Low
  - Impact: Low
  - Channels: Write-downs could be higher than expected, and meeting capital requirements could be challenging. Deleveraging could force banks to reduce domestic lending, with negative effects on activity.

### Authorities’ response to past IMF policy recommendations (IMF 2011 Article IV)
- Fiscal policy
  - Recommendation: The fiscal consolidation path is appropriate.
  - Authorities’ response: Fully consistent
  - Note: The 2011 outturn was better than projected due to favorable macro developments; no new consolidation measures were taken.
- Financial sector policy I
  - Recommendation: Address the legacy of the financial crisis by stepping up the resolution of the winding-up institutions and reduce vulnerabilities.
  - Authorities’ response: Broadly consistent
  - Note: Banks are strengthening their capital buffers, but progress in the winding-up institutions is slow.
- Financial sector policy II
  - Recommendation: Consolidate Landesbanken and revisit their business model, clarify the regulatory and supervisory regime, and gradually shift the ownership the Sparkassen away from the public sector, while carving out their public functions.
  - Authorities’ response: Marginally consistent
  - Note: Consolidation efforts in the Landesbanken sector are slow. The proposed Financial Stability Committee will help clarifying the regulatory and supervisory roles for macroprudential oversight.
- Structural reforms
  - Recommendation: To raise potential growth, increase labor force participation, including through tax policy measures, facilitate conditions for investment, including through tax reform and reform the education system. Enhance the provision of risk capital and provide for a more efficient insolvency process.
  - Authorities’ response: Broadly consistent
  - Note: Measures to increase the labor force have been taken, and reforms of the education system are underway in the Länder; there are reform initiatives for the insolvency process.

### Real sector and inflation
- GDP: Deceleration in activity is broad based; domestic sources of demand are expected to lead the recovery. GDP will return to potential as cyclical effects fade.
- World trade: The external environment has deteriorated as world trade growth has slowed.
- Inflation:
  - Inflation has picked up due to higher energy prices, but core inflation remains well contained.
  - Inflation expectations are well anchored below the ECB’s target rate of 2 percent.

### Labor market developments
- Labor force and employment
  - The labor force is growing and the share of atypical employment is falling.
  - Annual change in employment and unemployment shown in millions of people (figure series).
- Matching and exit rates
  - The matching efficiency of the labor market has improved.
  - The average monthly exit rate from unemployment series indicates a shift to a new level.
- Wages and pay
  - Wages have edged up, but so has inflation.
  - Agreed pay increases are moderate, but one offs are growing large.

### Credit, interest rates, and lending standards
- Credit trends
  - Domestic credit is on an upward trend.
  - The pickup in housing loans is associated with low interest rates.
  - Interest rates on corporate loans are also low.
  - Overall liquidity conditions are loose.
- Housing loan specifics
  - Housing loans with maturity over 5 years represent 95 percent of all housing loans and about 40 percent of total lending by Monetary Financial Institutions to Domestic Enterprises and Households.
- Lending standards
  - Credit standards for enterprise loans changed little since the second half of 2011, as did credit standards for mortgages.

### Balance sheets and asset prices
- Households and firms
  - Households’ indebtedness is low.
  - Firms are profitable; business profit share of non-financial corporations increased.
- Asset prices
  - Equity prices have recovered while bond yields remain depressed.
  - Residential property prices have increased in 2011.
- Home equity and leverage
  - Households are not highly leveraged (home equity and gross debt-to-income series presented).

### Vulnerabilities of large banks
- Structural characteristics and risks
  - Large German banks continue to rely on wholesale funding and exhibit low profitability.
  - They have relatively low capital quality and generate substantial income abroad.
- Sample note: Simple averages are based on a sample of 83 large global financial institutions, incorporated in 21 countries, representing almost 75 percent of global banking system assets. Germany is represented by seven institutions.

### External position
- Current account
  - The German current account surplus increased substantially in mid-2000.
  - The German corporate sector played a major role in raising the current account surplus during this period.
- Real exchange rate and trade composition
  - While the real exchange rate depreciated vis-à-vis trading partners in the euro area since the introduction of the euro, it returned to the levels of the early 2000s vis-à-vis non-euro area trading partners after appreciating until 2009.
  - Exports have grown largely on the back of demand from outside the euro area; German imports are also sourced more from outside.
- Net foreign asset position
  - The net foreign asset position of the private sector strengthened substantially since the early 2000s.

### Corporate sector developments
- Profits and savings
  - Corporate profits rose substantially by mid-2000s, driving an increase in gross savings.
- Investment
  - Corporate investment declined in the early 2000s and remains low in international comparison.
  - The return to capital and slow investment response in mid-2000s can explain the behavior of investment.
- Structural factors
  - Slow response likely reflects a decade of disappointingly low growth, unfavorable demographic developments dampening growth expectations, and the loss of interest rate advantage vis-à-vis other European countries.

### Policy recommendations and institutional developments
- Macroprudential framework and Financial Stability Committee (FSC)
  - A legislative initiative proposes a Financial Stability Committee (FSC) to be established by early 2013 comprising the Ministry of Finance (in a central role), the Bundesbank, and BaFin, for crisis management coordination and to address financial stability risks.
  - Authorities need to remain vigilant to ensure the FSC’s operational independence from the political process as recommended by the European Systemic Risk Board (ESRB).
  - No menu of instruments for macroprudential purposes has been defined yet. Potential measures include prescribing effective loan-to-value ratios for mortgages and adjusting capital buffers (e.g., counter-cyclical capital buffer, systemic risk buffer); such measures should be coordinated regionally where needed for consistency and to avoid regulatory arbitrage, as underscored by the ESRB.
- Near-term monetary/liquidity stance
  - Authorities should resist pressure to respond to concerns about excess liquidity in the banking system and record low interest rates at the current juncture; the near-term priority is to not choke off the rebound of domestic demand.

*Source: GERMANY 2012 ARTICLE IV REPORT — Informational Annex (June 14, 2012).*

### ANNEX I: FUND RELATIONS

### ANNEX I: FUND RELATIONS

### Mission and Staff
- Mission: April 24 to May 8, 2012 in Frankfurt, Bonn, Munich and Berlin. The concluding statement of the mission is available at http://www.imf.org/external/np/ms/2012/050812.htm
- Staff team: Messrs. Valdes (Reviewer), Lall (Head), Ms. Ivanova, and Mr. Bornhorst, (all EUR), Mr. Kiff (MCM), Mr. Vitek (SPR), and Ms. Luedersen (LEG).
- Country interlocutors: the Bundesbank President Weidmann, the Minister of Finance Schäuble, senior representatives at the Chancellery, several ministries, the Bundesbank, and BaFin and members of the German Council of Economic Experts. Mr. Temmeyer, Executive Director, also participated. Additional meetings with research institutes, law firms, and financial market participants.

### Membership and General Resources Account
- I. Membership Status: Joined August 14, 1952; Article VIII.
- II. General Resources Account (SDR Million; Percent of Quota):
  - Quota: 14,565.50 — 100.00
  - Fund holdings of currency: 10,131.67 — 69.56
  - Reserve position in Fund: 4433.94 — 30.44
  - Lending to the Fund: 2853.54

### SDR Department
- III. SDR Department (SDR Million; Percent of Allocation):
  - Net cumulative allocation: 12,059.17 — 100.00
  - Holdings: 11,819.17 — 97.86

### Outstanding Purchases and Loans
- IV. Outstanding Purchases and Loans: None

### Financial Arrangements
- V. Financial Arrangements: None

### Projected Payments to Fund
- VI. Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs, as of May 5, 2012):
  - Charges/Interest:
    - 2012: 0.43
    - 2013: 0.52
    - 2014: 0.52
    - 2015: 0.52
    - 2016: 0.52
  - Total:
    - 2012: 0.43
    - 2013: 0.52
    - 2014: 0.52
    - 2015: 0.52
    - 2016: 0.52
- Note: 1/ When a member has overdue financial obligations outstanding for more than three months, the amount of such arrears will be shown in this section.

### Exchange Rate Arrangement
- Germany’s currency is the euro, which floats freely and independently against other currencies.
- Germany is an Article VIII member and maintains an exchange system free of restrictions on payments and transfers for current international transactions.
- It maintains measures adopted for security reasons, which have been notified to the Fund for approval in accordance with the procedures of Decision 144 and does so solely for the preservation of national or international security.

### Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT)
- An assessment under the international standard for AML/CFT was conducted by the Fund's Legal Department in May 2009. The detailed assessment report was adopted by the joint MENAFATF-FATF Plenary Meeting held in Abu Dhabi from February 17-19, 2010.
- The report concluded that, despite Germany introducing a number of measures in recent years to strengthen its AML/CFT regime, the AML/CFT framework is not fully in line with the standard.
- Identified weaknesses and areas requiring action:
  - amending the Criminal Code to criminalize TF in a way fully consistent with international standards;
  - ensuring that entities report transactions when an institution suspects or has reasonable ground to suspect that a transaction involves the proceeds of crime;
  - ensuring that the FIU carries out more robust analysis of Suspicious Transaction Reports (STRs);
  - fully and effectively implementing the UN Security Council Resolutions (UNSCRs) on TF;
  - applying sanctioning powers more effectively for breaches of AML/CFT obligations;
  - strengthening the effective implementation of AML/CFT obligations imposed on designated non-financial businesses and professions (DNFBPs);
  - improving the collection of statistics and the provision of guidance and feedback to FIs.
- Germany has demonstrated a commitment to strengthen the national system for the prevention, detection and suppression of money laundering and terrorist financing.

### Staff Analytical Work on Germany, 2003–12
- Growth, Current Account and Competitiveness:
  - Growth Linkages within Europe, IMF Country Report No. 08/81.
  - Economic Impact of Shortages of Skilled Labor in Germany, IMF Country Report No. 08/81.
  - What explains Germany’s Rebounding Export Market Share? CESifo Working Paper No. 1957.
  - Long-run Growth in Germany. IMF Country Report No. 06/17.
  - Does Excessive Regulation Impede Growth in Germany? IMF Country Report No. 06/17.
  - The Performance of Germany’s Non-Financial Corporate Sector – An International Perspective. IMF Country Report No. 06/17.
  - Investment Trends in OECD Countries: Long-Term Developments and Future Prospects. IMF Country Report No. 04/340.
  - Does PPP hold in the Long Run? Germany and Switzerland. IMF Country Report No. 04/340.
  - Business Investment in the Current Cycle. IMF Country Report No. 03/342.
  - After the Crisis: Lower Consumption Growth but Narrower Global Imbalances? IMF Working Paper No. 10/11.
  - The Crisis Impact on Potential Growth in Germany: The Nature of the Shock Matters, forthcoming.
  - German Productivity Growth: an Industry Perspective, forthcoming.
  - International and European Growth Spillovers: the Role of Germany, IMF working paper No. 11/218.
  - Current Account Imbalances: Can structural policies make a difference, IMF working paper No. 12/61.
- Inflation:
  - Inflation Smoothing and the Modest Effect of VAT in Germany, IMF Working Paper No. 08/175.
  - Simulating Inflation Forecasting in Real-Time: How Useful Is a Simple Phillips Curve in Germany, the UK, and the US? IMF Working Paper No. 10/52.
- Fiscal Policy and Entitlement Programs:
  - Tax Reform and Debt Sustainability in Germany: An Assessment Using the Global Fiscal Model. IMF Country Report No. 06/436.
  - Business Tax Reform. IMF Country Report No. 06/436.
  - Why is Germany’s Deficit so Large? IMF Country Report No. 06/17.
  - A Preliminary Public Sector Balance Sheet for Germany, IMF Country Report No. 06/17.
  - Germany: A Long-Run Fiscal Scenario Based on Current Policies, IMF Country Report No. 06/17.
  - Pensions and Growth. IMF Country Report No. 04/340.
  - Federalism and the Political Economy of Adjustment. IMF Country Report No. 04/340.
  - Fiscal Policy in the Euro Area: Does Germany Play a Leadership Role? IMF Working Paper, forthcoming.
  - Do Fiscal Spillovers Matter? IMF Working Paper, No. 11/211.
- Labor Markets:
  - The Employment Effects of Labor and Product Markets Deregulation and their Implications for Structural Reform. CESifo Working Paper No 1709, May 2006.
  - Employment, Unemployment, and Labor Supply in Germany. IMF Country Report No. 04/340.
  - The Unbearable Stability of the German Wage Structure: Evidence and Interpretation. IMF Staff Papers, August 2004.
  - What Does The Crisis Tell Us About The German Labor Market? forthcoming.
- The Financial System:
  - Landesbanken: A Measure of the Costs for Taxpayers. IMF Country Report No. 06/436.
  - The German Banking Sector: Credit Decline, Soundness and Efficiency. IMF Country Report No. 06/17.
  - Germany’s Three-Pillar Banking System. IMF Occasional Paper 233 (2004).
  - Germany’s Financial System: International Linkages and the Transmission of Financial Shocks. IMF Country Report No. 03/342.
  - Credit Conditions in Germany Following the Global Sub-Prime Crises, IMF Working Paper, forthcoming.
- Corporate Governance:
  - Germany’s Corporate Governance Reforms: Has the System Become Flexible Enough?, IMF Working Paper No. 08/179.

*Source: ANNEX I: FUND RELATIONS (As of May 5, 2012).*

### 4.3 percent in 2010), reflecting in part the phasing out of one-off financial sector support

### _cr12161 - 4.3 percent in 2010), reflecting in part the phasing out of one-off financial sector support

### Fiscal developments and public debt
- Structural balance improved by about 1¼ percent of GDP in 2011, reflecting the withdrawal of stimulus and consolidation measures, including unwinding of temporary tax and labor market measures, the removal of some exemptions, and reductions in social spending and administrative costs.
- Overall public debt increased from 65 percent of GDP in 2007 to 81 percent in 2011, including due to financial sector support operations.
- Executive Directors: most viewed the current fiscal stance as appropriate while allowing automatic stabilizers to operate fully; in the event of a serious economic downturn, more active fiscal policies within available fiscal space and consistent with the EU fiscal framework would be needed.
- A few Directors considered fiscal stimulus warranted to aid the regional and global economic recovery.
- Directors encouraged growth-oriented revenue and expenditure reforms, including measures to enhance tax and expenditure efficiency.
- My authorities: no need for a fiscal stimulus at the current stage of the business cycle; skeptical about a debt-financed stimulus.

### Macroeconomic outlook and growth rebalancing
- Executive Directors commended Germany’s strong macroeconomic management and favorable economic performance amid external uncertainty; near-term outlook clouded by downside risks, including intensification of the euro-area crisis and lower global growth prospects.
- Directors called on the authorities to work with European partners to outline concrete further efforts to enhance the broader European response to the ongoing crisis.
- Directors urged policies to spur domestic demand growth to generate beneficial spillovers in the euro area and globally.
- Directors: natural rebalancing likely due to tight labor market conditions, ample liquidity and low interest rates, and disinflationary pressures in euro-area periphery countries; structural reforms needed to encourage higher investment, remove labor market bottlenecks, and increase economic efficiency and productivity.
- My authorities emphasized Germany’s commitment to strengthening domestic sources of growth, noting favorable conditions: increasing household incomes and employment, strong balance sheets of households and the corporate sector, and a supportive financing environment.
- My authorities: Germany is among the world’s most open large economies; external demand will continue to play an important role.

### Financial sector stability and reform
- Directors: despite progress, the banking sector remains vulnerable to external shocks because of high leverage, dependence on wholesale finance, and low capital quality and profitability; urged faster implementation of the 2011 Financial Sector Assessment Program Update recommendations.
- Directors called for greater efforts to restructure Landesbanken and strengthen the crisis management framework.
- Directors welcomed pre-emptive reactivation of the backstop facility for financial institutions and steps to establish a macroprudential policy framework following EU initiatives.
- My authorities: bank profitability has been improving; savings and cooperative banks remained profitable during the crisis.
- Wholesale funding has decreased substantially; share of deposits relative to total liabilities has been rising for several years.
- Adjustment in the Landesbanken sector is ongoing, including reducing risk weighted assets, focusing on core business (lending to domestic SMEs and municipalities), downsizing, and restructuring a major Landesbank.
- Raising capital as required by Basel III is well on track; early compliance with EBA capital requirements has helped resilience.
- My authorities reactivated the Special Financial Market Stabilization Fund (SoFFin) in March 2012 for precautionary purposes with currently no foreseeable cases of utilization.
- Institutional changes: plan to establish an operationally independent Financial Stability Commission by January 2013, with a central role for the Bundesbank and enhanced information-sharing with BaFin; progress on recovery and resolution planning following the bank restructuring law (December 2010).

### Labor market and structural policies
- Directors commended exceptional labor market performance from past reforms; welcomed efforts to increase labor force participation of female and older workers and migration of skilled workers; urged further enhancements to education and training.
- My authorities: employment rate of women and men aged 20-64 is approaching authorities’ target of 77 percent; EU employment rate target of 75 percent has already been surpassed.
- “Skilled Labor Strategy” (established in 2011) includes measures to:
  - improve availability of childcare facilities;
  - promote more family-friendly working hours in cooperation with business associations;
  - reduce, by 2015, the share of persons aged 20-29 that lack vocational training from 17 percent to 8.5 percent;
  - increase the number of academics and the share of women with a degree in natural sciences;
  - reintegrate older unemployed into labor markets;
  - increase effectiveness of existing labor market instruments.
- Regarding growth-oriented tax policy: introduction of an allowance for the normal return on new equity is not under consideration due to significant revenue losses observed elsewhere.

### Key statistics (selected, exactly as reported)
- Real GDP (change in percent): 2007 3.4; 2008 0.8; 2009 -5.1; 2010 3.6; 2011 3.1; 2012 1.0; 2013 1.4.
- Net exports (contribution to GDP growth): 2007 1.5; 2008 -0.1; 2009 -2.8; 2010 1.4; 2011 0.7; 2012 0.5; 2013 0.2.
- Total domestic demand (change in percent): 2007 1.9; 2008 1.3; 2009 -2.6; 2010 2.4; 2011 2.5; 2012 0.4; 2013 1.3.
- Private consumption (change in percent): 2007 -0.2; 2008 0.6; 2009 -0.1; 2010 0.6; 2011 1.4; 2012 0.9; 2013 1.3.
- Gross fixed investment (change in percent): 2007 4.7; 2008 1.7; 2009 -11.4; 2010 5.5; 2011 6.4; 2012 0.6; 2013 2.3.
- Gross national saving (percent of GDP): 2007 25.9; 2008 24.8; 2009 23.2; 2010 23.6; 2011 23.9; 2012 23.2; 2013 22.6.
- Gross domestic investment (percent of GDP): 2007 18.4; 2008 18.6; 2009 17.2; 2010 17.5; 2011 18.2; 2012 17.9; 2013 18.0.
- Labor force (percent of population, national accounts definition): 2007 43.4; 2008 43.4; 2009 43.5; 2010 43.6; 2011 43.7; 2012 43.7; 2013 43.8.
- Employment (percent of population): 2007 39.8; 2008 40.3; 2009 40.3; 2010 40.5; 2011 41.0; 2012 41.4; 2013 41.5.
- Standardized unemployment rate (in percent): 2007 8.8; 2008 7.6; 2009 7.7; 2010 7.1; 2011 6.0; 2012 5.3; 2013 5.2.
- Unit labor costs (industry, change in percent): 2007 -2.8; 2008 6.8; 2009 21.6; 2010 -8.6; 2011 -2.2; 2012 2.3; 2013 1.5.
- GDP deflator (change in percent): 2007 1.5; 2008 1.0; 2009 1.1; 2010 0.7; 2011 0.7; 2012 2.0; 2013 1.7.
- Harmonized CPI index (change in percent): 2007 2.3; 2008 2.8; 2009 0.2; 2010 1.2; 2011 2.5; 2012 2.2; 2013 2.0.
- General government balance (percent of GDP, net lending/borrowing): 2007 0.2; 2008 -0.1; 2009 -3.2; 2010 -4.3; 2011 -1.0; 2012 -0.7; 2013 -0.4.
- Structural government balance (percent of GDP): 2007 -1.1; 2008 -0.8; 2009 -1.2; 2010 -2.3; 2011 -1.0; 2012 -0.7; 2013 -0.4.
- General government gross debt (percent of GDP): 2007 65.4; 2008 66.9; 2009 74.7; 2010 83.5; 2011 81.2; 2012 82.2; 2013 80.2.
- Private sector credit (change in percent over 12 months): 2007 3.3; 2008 6.6; 2009 -0.6; 2010 -1.9; 2011 1.0; 2012 0.9.
- M3 (change in percent over 12 months): 2007 10.8; 2008 9.8; 2009 -1.6; 2010 4.4; 2011 5.9; 2012 6.3.
- Three month interbank rate (period average in percent): 2007 4.3; 2008 4.6; 2009 1.2; 2010 0.8; 2011 1.3; 2012 0.9.
- Ten-year government bond yield (period average in percent): 2007 4.3; 2008 4.1; 2009 3.3; 2010 2.8; 2011 2.7; 2012 1.9.
- Exports (billions of USD, goods and services): 2007 1,579; 2008 1,760; 2009 1,400; 2010 1,552; 2011 1,807; 2012 1,784; 2013 1,845.
- Imports (billions of USD, goods and services): 2007 1,345; 2008 1,534; 2009 1,234; 2010 1,367; 2011 1,624; 2012 1,604; 2013 1,663.
- Trade balance (percent of GDP, trade in goods including supplementary trade items): 2007 7.6; 2008 6.6; 2009 5.4; 2010 5.8; 2011 5.4; 2012 5.5; 2013 5.4.
- Current account balance (billions of USD): 2007 248.0; 2008 226.1; 2009 195.8; 2010 199.9; 2011 205.4; 2012 181.7; 2013 165.8.
- Current account (percent of GDP): 2007 7.4; 2008 6.2; 2009 5.9; 2010 6.1; 2011 5.7; 2012 5.2; 2013 4.6.
- Euro per US dollar (period average): 2007 0.73; 2008 0.73; 2009 0.68; 2010 0.76; 2011 0.76; 2012 0.76.
- Nominal effective rate (1990=100): 2007 103.8; 2008 104.1; 2009 106.1; 2010 100.1; 2011 100.1; 2012 99.2.
- Real effective rate (1990=100, based on relative normalized unit labor cost in manufacturing): 2007 99.9; 2008 99.1; 2009 104.6; 2010 98.0; 2011 96.5; 2012 96.2.

### Policy recommendations and actions
- Continue to work with European partners to define concrete further efforts to enhance the broader European response to the crisis.
- Implement policies to spur domestic demand growth to generate positive euro-area and global spillovers.
- Pursue structural reforms to encourage higher investment, remove labor market bottlenecks, and increase economic efficiency and productivity.
- Step up implementation of Financial Sector Assessment Program Update recommendations; accelerate Landesbanken restructuring and strengthen crisis management framework.
- Broaden channels of financial intermediation to facilitate allocation of resources toward innovation and new engines of growth.
- Strengthen system of education and training and continue policies to raise labor force participation (female and older workers) and attract skilled migration.
- Enhance tax and expenditure efficiency and pursue growth-oriented revenue and expenditure reforms consistent with fiscal sustainability and EU fiscal rules.

*Sources: Deutsche Bundesbank; IMF, International Financial Statistics; IMF, World Economic Outlook; and staff projections.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12161.pdf_