## 1. The Effectiveness of OMTs

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### Impact of OMTs on financial stability and markets
- The ECB’s Outright Monetary Transactions (OMTs) framework "removed dangerous tail risks related to euro area breakup."
- Announcement effects:
  - reduced tail risks and improved the functioning of monetary policy.
  - led to declines in spreads on periphery government bonds from unsustainable levels, translating into lower private borrowing costs in those economies.
  - as perceptions of redenomination risk receded, capital flight from the periphery gradually reversed and Target 2 imbalances narrowed.
  - outside the euro area, funding costs of emerging European sovereigns declined to record low levels; safe haven flows to small advanced European countries (Switzerland, Denmark) subsided.
  - financial market volatility declined across large systemic economies.

### Recent market developments and limits to gains
- Global market turbulence tightened financial conditions in the euro area:
  - The prospect of scaled-back U.S. monetary support after the May 2013 FOMC meeting led to higher sovereign yields across the region, reversing some gains achieved in the periphery since the OMTs announcement.
  - Unlike earlier stress episodes, German yields also increased, limiting scope for periphery yields to decline without further compression in relative spreads.
  - Euro area money market rates increased, raising expectations of higher interbank funding costs and tighter monetary conditions.

### Growth, inflation, and social risks
- Growth and activity
  - GDP contracted by 0.3 percent in the first quarter of 2013, after declining by 0.6 percent in 2012.
  - Real activity remains below pre-crisis levels; recessionary forces persist in most periphery countries.
  - Lending rates to corporations vary widely among euro area members, especially for smaller enterprises.
- Inflation
  - Headline inflation was 1.6 percent in June 2013.
  - Core inflation moderated to about 1½ percent in the first quarter of 2013.
  - Market-based indicators for some large euro area countries have begun to drift downward.
- Labor market and social tensions
  - Euro area unemployment reached record highs (over 12 percent in May), with particularly acute youth unemployment.
  - Rising social stresses threaten political commitment to sustain national adjustment efforts.

### Indebtedness, deleveraging, and growth channels
- Channels by which high debt and simultaneous deleveraging weigh on growth:
  - Increased vulnerability to asset price shocks, financial volatility, and uncertainty.
  - Negative feedback loops between highly-indebted private sectors, a weak financial sector, and a stressed sovereign can constrain demand and credit conditions.
  - Uncertainty about private sector debt servicing ability can raise concerns about banks’ asset quality and impair financial intermediation.
- Historical and econometric insights
  - Historically, almost all of the run-up in household debt tends to be reversed in deleveraging episodes; in the euro area the reduction in debt-to-GDP ratios has "barely started" and the boom was more pronounced.
  - Past deleveraging was often facilitated by high inflation and growth and supported by expansionary fiscal policy—factors that will not contribute much in the euro area periphery.
  - Econometric analysis suggests when government, households, and firms are all highly indebted, the negative growth impact of debt is highest.
  - High corporate and household debt is associated with worse growth outcomes than public sector indebtedness.

### Macro risks and downside scenarios
- Near- and medium-term risks
  - Financial market stresses could quickly reignite because sovereign debt levels remain high and delivery on euro area policy commitments is incomplete (banking union, single rulebook, ESM direct recapitalization) or if fiscal adjustment and structural reforms are delayed.
  - In the medium-term, high risk of stagnation, especially in the periphery, from larger-than-envisaged deleveraging effects, entrenched fragmentation, and delayed structural reforms.
- Quantified downside outcome cited
  - In a stagnation scenario, euro area and global GDP levels might be about 4 percent and 1 percent below the baseline by 2018, respectively.

### Policy recommendations to support deleveraging and recovery
- Preserve and complete institutional and policy measures underpinning monetary union credibility:
  - Continue efforts to complete banking union components (Single Supervisory Mechanism, Single Resolution Mechanism, single rulebook) and finalize ESM direct recapitalization arrangements.
- Support private sector deleveraging and repair of bank balance sheets:
  - Make national insolvency regimes more effective (facilitate out-of-court settlements; reduce time for insolvency proceedings; provide greater flexibility for personal and corporate bankruptcy).
  - Encourage debt write-offs and policies that facilitate transfer of non-performing assets to new owners.
  - Foster a market for NPL-backed securities to help repair bank balance sheets.
- Monitor monetary transmission and fragmentation:
  - Address fragmentation that weakens monetary transmission and leads to wide dispersion in lending rates across member states, particularly for SMEs.
- Recognize policy constraints and need for sustained reform momentum:
  - Prioritize structural reforms that improve competitiveness and growth potential while mitigating social and political fallout from prolonged adjustment.

---

### Financial stress re-emerges and bank-sovereign links re-intensify

### Triggers and immediate risks (euro area policy commitments)
- Medium risk triggers:
  - Lack of agreement on a common backstop to bank resolution and/or deposit insurance.
  - ESM direct recapitalization is delayed.
  - Uneven transposition of the Fiscal Compact at the national level.
- High-impact consequences if triggered:
  - Undermine fragile market confidence.
  - Re-intensify adverse feedback loops between banks and sovereigns.
  - Threaten sovereign debt trajectories and growth and jobs prospects.
- Major recommended policy responses:
  - Complete banking union, in particular SRM and common safety nets, and allow direct recapitalization of banks by the ESM.
  - Make progress towards greater fiscal integration.

### Triggers and impact channels (national policy commitments)
- Medium risk triggers:
  - Social discontent with austerity increases, with political and economic fallout.
  - Implementation of fiscal adjustment falters and structural reforms stall (notably Greece, Italy, Spain).
- High-impact consequences:
  - Undermine market confidence, intensify cross-border contagion and bank deleveraging; drive sovereign and bank spreads back to very high levels.
- Policy recommendations:
  - Pace fiscal adjustment and make flexibility contingent on reforms.
  - Implement structural reforms to encourage job creation and raise competitiveness.
  - Strengthen implementation of the Macroeconomic Imbalance Procedure.

### Protracted period of slower European growth
- High likelihood drivers:
  - Negative impact of public and private deleveraging larger than expected.
  - Persistence of very weak investment and high unemployment further reduce potential growth.
- Policy recommendations:
  - Use monetary policy to tackle fragmentation and support demand.
  - Repair bank, corporate, and household balance sheets.
  - Implement structural policies to spur growth and advance rebalancing.

### External and global risks (summarized)
- Advanced economies bond market stress (Medium/Low): could undermine market confidence and increase spreads; recommendation to strengthen financial stability.
- Distortions from unconventional monetary policy in other advanced economies (High): mispricing and potential correction could increase volatility; recommendation to enhance monetary policy communication and strengthen financial stability.
- Oil price surge (Low): spike would damage economic activity.

---

### Reversing fragmentation — restoring banking sector health

### Key findings
- Restoring banking sector health is essential for recovery.
- Frail banks have relied on elevated lending rates to boost profitability and have been unable or unwilling to recognize and provision for higher losses, reinforcing fragmentation.
- Reversing dynamics requires recognizing losses, filling capital holes, closing or restructuring nonviable banks.

### Balance Sheet Assessment (BSA) and supervisory credibility
- A credible assessment of banks’ asset quality would help lower funding costs and address fragmentation.
- The forthcoming BSA of euro area banks, required ahead of the SSM start, to be followed by stress tests, provides such an opportunity.
- Key elements to ensure effectiveness:
  - (1) forward-looking framework incorporating risks to growth and clearly communicated in advance;
  - (2) harmonized methodologies and stringent standards for nonperforming loans, provisioning rules, and risk weights (as proposed by the EBA);
  - (3) full coverage of banks under direct SSM supervision.
- Independent third-party involvement, along with the ECB, the EBA and national authorities, is essential for credibility and transparency.

### Strategy for addressing capital shortfalls
- An agreed strategy on addressing capital shortfalls is critical to prevent pro-cyclical deleveraging.
- Where private funds are insufficient, the public sector would need to provide capital in countries with available fiscal space.
- If private capital and fiscal space are limited, clarity on a common backstop would be critical to avoid re-igniting bank-sovereign links.
- Competition and state-aid rules may need reassessment to ensure that conditions attached to public support do not lead to excessive deleveraging.

### The ESM and common backstops
- ESM can serve as an effective common backstop.
- Recent agreement covers conditions for access, timing, burden sharing, valuation, conditionality, and governance.
- Remaining issues:
  - Timing: final agreement on ESM direct recapitalization is uncertain and linked to BRRD and DSG Directive legislative processes.
  - Conditionality and burden sharing: state aid conditionality and bail-in rules raise issues for systemic institutions.
  - Size and access: limit for ESM resources available for direct recapitalization has been set at €60 billion (subject to review by the ESM Board); timely availability is critical for credibility.

### National legislative, judicial, and insolvency frameworks
- Improved national frameworks could support orderly deleveraging of the non-financial sector.
- Effective insolvency regimes would support bank balance sheet clean-up by accelerating workout of bad private sector debt.
- Out-of-court restructurings remain underutilized despite recent advances.

### Completing the banking union: SSM, SRM, and SRA
- Full banking union components required: SSM, SRM, common safety nets, and accompanying directives; delays or dilution risk destabilizing confidence.
- SSM operationalization steps include passing legislation through the European Parliament (expected in September), clarifying legal responsibilities, finalizing supervisory model, and ensuring national supervisors’ cooperation.
- SRM should be operational by the time SSM becomes effective; a centralized Single Resolution Authority (SRA) with access to a common fiscal backstop is advised to break bank-sovereign links.
- Bail-ins and depositor preference:
  - Council agreement confirms bail-ins as instrument for nonviable banks, specifying minimum "bail-in-able" instruments: 8 percent of total liabilities.
  - BRRD and new bail-in rules introduce tiered depositor preference; expected to come into force in 2018 but may be applied earlier case-by-case.

### Targeted monetary policies to reduce fragmentation (short run)
- Rationale: while balance sheet repair and banking union progress, ECB should prevent escalation of fragmentation.
- Recommended short-run ECB actions:
  - Provide additional term funding to avert contraction in credit and target measures to support SME financing.
  - Potential measures include a new LTRO of longer tenor (3-5 years) and review of collateral policies to lower haircuts on specific assets (e.g., additional credit claims linked to SME loans and asset backed securities).
  - Targeted LTROs (Funding for Lending–style) with low costs to incentivize participation.
  - Direct ECB purchases of private assets (securitized assets, corporate bonds, commercial paper, covered bonds) as a constrained option due to market size and regulatory hurdles.

---

### Monetary, fiscal, and structural policy options

### Monetary policy: further rate cuts and forward guidance
- Further policy rate cuts, including reducing deposit facility rates marginally below zero, would help support demand and bring inflation back in line with the primary objective.
- Negative deposit rates could:
  - help anchor expectations of a looser monetary stance;
  - act as strong forward guidance;
  - lower expectations of future increases in policy rates;
  - encourage banks with excess liquidity to reengage in the interbank market and extend credit.
- Potential unintended consequences:
  - Lower bank profitability may drive up interest rates on loans or fees for affected banks (likely to affect mostly core banks).
- Additional ECB actions if conditions worsen:
  - reducing interest rates into negative territory;
  - continuing full allotment MROs at fixed rates beyond mid-2014;
  - extending full allotment to additional LTROs;
  - intervening directly in short-term euro area money markets.

### Fragmentation and monetary transmission — findings and implications
- Key problems:
  - Term funding costs remain high for periphery banks, weighing on bond issuance.
  - Declining asset quality raises provisioning needs.
  - Cross-border banking flows remain low; weak banks are highly reliant on official liquidity.
  - Retail interest rates in stressed markets are significantly above those in the core, impeding credit flow and monetary transmission.
- Impaired channels:
  - Interest rate channel: declining interbank activity undermined transmission.
  - Bank lending channel: impaired by lack of term-funding and weak bank balance sheets.
  - Low demand for credit and higher nonperforming loans due to balance sheet adjustment.
- Distributional impact:
  - SMEs disproportionately affected; SMEs account for about 80 percent of employment and 70 percent of value added in Italy, Spain, and Portugal.
- Policy implications:
  - Clean up bank balance sheets and advance banking union to restore confidence and reduce fragmentation.
  - Interim measures to support credit supply, ensuring credit availability to viable SMEs.

### Fiscal policy: pacing adjustment to limit headwinds to growth
- Consolidation impact:
  - For the euro area as a whole, the negative growth impact of consolidation could reach as much as 1-1¼ percentage point this year.
- Policy challenge:
  - Avoid excessive damage to demand while placing debt levels on a sustainable downward path.
  - Define and assess adjustment in structural terms to prevent negative growth surprises from triggering additional consolidation.
  - Some EDP deadlines may be overly ambitious given weak growth; greater flexibility may be useful if fiscal space is used for ambitious structural reforms or bank recapitalization.
- Preconditions for paced adjustment:
  - Credible medium-term frameworks: well-defined, multi-year budgetary frameworks with fiscal measures identified in advance and realistic macro assumptions.
  - Implementation and enforcement: strengthen national legislation and independent fiscal agencies’ roles following the Fiscal Compact, Six Pack, and Two Pack.

### Structural policies: growth, jobs, and rebalancing
- Foster job creation:
  - Tackle labor market duality and promote bargaining arrangements conducive to sustainable wage developments and shock absorption.
  - Align severance costs for permanent contracts with EU norms; link employment protection more systematically to tenure.
  - Promote portability of pension and unemployment benefits; target incentives at female and older workers.
- Promote greater integration and competitiveness:
  - Targeted implementation of the Services Directive to reduce barriers in protected professions and foster cross-border provision of services.
  - Pursue new Free Trade Agreements to secure access to growing markets.
  - Allow wages to respond more flexibly, lower regulatory barriers to entry and exit, simplify tax systems, and tackle vested interests in product markets.
  - Example cited: electricity prices for industrial users in Italy are some 50 percent higher than the European average.
- Supporting credit provision and investment:
  - Proposed securitization schemes by the EC and the EIB: SME loans securitized using funds amounting to €10.4 billion, potentially leveraged up to 10 times depending on risk pooling.
  - To have meaningful initial impact, the scheme would need to be front-loaded, cover new and existing loans, and employ risk pooling.

---

### Agreement with authorities, Board and Directors’ assessments, and priorities

### Broad agreement and shared assessments
- Authorities and staff broadly agreed more credible progress needed on bank balance sheet repair and EMU architecture.
- Authorities concurred situation is substantially better than mid-2012 but restarting growth and reducing policy uncertainty remain challenges.
- Agreed priorities:
  - fuller banking union and greater fiscal integration to address underlying weaknesses and restore confidence.

### Bank asset quality, BSA, and stress tests
- BSA and stress tests critical for SSM credibility; quality and comprehensiveness should not be compromised.
- Importance of ESM backstop being in place ahead of BSA to motivate national authorities and address capital shortfalls where fiscal space is insufficient.
- Agreed pro-cyclical outcomes should be avoided by effective communication, third party expertise, and clear recapitalization/restructuring strategies.
- Loss recognition and resolution principles:
  - Losses should be fully recognized.
  - Failed banks closed and restructured.
  - Frail systemic banks may receive public support where private capital insufficient.
  - Common backstop (ESM) should be used where private capital and fiscal space are limited.

### Monetary policy options and unconventional measures
- Authorities acknowledged potential need for further monetary policy action, including negative deposit rates.
- Authorities cautioned such measures may be more muted than OMTs because fragmentation stems from capital market failures and higher macroeconomic risks.
- Staff recommendations:
  - Ensure term funding needs through an additional LTRO of sufficient tenor;
  - Accompany with lower collateral haircuts, particularly on SME loans;
  - Consider targeted LTRO linked to new SME lending or direct purchase of select private assets.

### Fiscal policy, governance, and structural reform priorities
- Authorities broadly acknowledged importance of setting EDP targets in structural terms and supported flexibility if fiscal space used for reforms or bank recapitalization.
- Pacing fiscal adjustment remains key; if downside risks materialize, pace should be slowed.
- Structural reform priorities include implementing the Services Directive, tackling labor market rigidities, improving judicial systems, and boosting SME lending.
- Staff appraisal policy priorities:
  - Repair banks’ balance sheets and facilitate resolution of private debt;
  - Make further progress on banking union;
  - Provide sufficient demand support;
  - Advance structural reforms.

---

### Key euro area indicators and projections (selected exact values)
- Real GDP: 2010 2.0; 2011 1.5; 2012 -0.6; 2013 -0.6; 2014 0.9; 2015 1.3
- Private consumption: 2010 1.0; 2011 0.2; 2012 -1.3; 2013 -0.8; 2014 0.4; 2015 0.9
- Gross fixed investment: 2010 -0.3; 2011 1.4; 2012 -4.3; 2013 -3.4; 2014 1.2; 2015 2.0
- Exports: 2010 11.2; 2011 6.3; 2012 2.7; 2013 1.5; 2014 3.7; 2015 3.9
- Unemployment rate: 2010 10.1; 2011 10.2; 2012 11.4; 2013 12.3; 2014 12.4; 2015 12.1
- Consumer prices: 2010 1.6; 2011 2.7; 2012 2.5; 2013 1.5; 2014 1.4; 2015 1.4
- General government balance (percent of GDP): 2010 -6.2; 2011 -4.2; 2012 -3.7; 2013 -3.1; 2014 -2.6; 2015 -2.1
- General government gross debt: 2010 85.7; 2011 88.0; 2012 92.8; 2013 95.9; 2014 96.5; 2015 95.8
- Current account balance: 2010 0.0; 2011 0.2; 2012 1.2; 2013 1.6; 2014 1.9; 2015 2.1
- EURIBOR 3-month offered rate: 2010 0.8; 2011 1.4; 2012 0.2; 2013 0.2
- 10-year government benchmark bond yield: 2010 3.8; 2011 4.3; 2012 2.3; 2013 2.7
- U.S. dollar per euro: 2010 1.33; 2011 1.39; 2012 1.30; 2013 1.30
- Real effective rate (2000=100): 2010 95.3; 2011 95.0; 2012 90.3; 2013 92.2

*Source: IMF staff report excerpts from _cr13231 (Euro area Article IV consultation materials).*

### 1. The Effectiveness of OMTs _______________________________________________________________________6

### 1. The Effectiveness of OMTs

### Impact of OMTs on financial stability and markets
- The ECB’s Outright Monetary Transactions (OMTs) framework "removed dangerous tail risks related to euro area breakup."
- The announcement of OMTs:
  - reduced tail risks and improved the functioning of monetary policy.
  - led to declines in spreads on periphery government bonds from unsustainable levels, translating into lower private borrowing costs in those economies.
  - as perceptions of redenomination risk receded, capital flight from the periphery gradually reversed and Target 2 imbalances narrowed.
  - outside the euro area, funding costs of emerging European sovereigns declined to record low levels; safe haven flows to small advanced European countries (Switzerland, Denmark) subsided.
  - financial market volatility declined across large systemic economies.

### Recent market developments and limits to gains
- Despite substantial stabilization over the prior year, recent global market turbulence tightened financial conditions in the euro area:
  - The prospect of scaled-back U.S. monetary support after the May 2013 Federal Open Market Committee meeting led to higher sovereign yields across the region, reversing some gains achieved in the periphery since the OMTs announcement.
  - Unlike earlier stress episodes, German yields also increased, limiting scope for periphery yields to decline without further compression in relative spreads.
  - Euro area money market rates increased, raising expectations of higher interbank funding costs and tighter monetary conditions.

### Growth, inflation, and social risks
- Growth and activity
  - GDP contracted by 0.3 percent in the first quarter of 2013, after declining by 0.6 percent in 2012.
  - Real activity in the euro area remains below pre-crisis levels; recessionary forces persist in most periphery countries.
  - Lending rates to corporations continue to vary widely among euro area members, especially for smaller enterprises.
- Inflation
  - Headline inflation was 1.6 percent in June 2013.
  - Core inflation moderated to about 1½ percent in the first quarter of 2013, reflecting increasing slack across the euro area.
  - Market-based indicators for some large euro area countries have begun to drift downward.
- Labor market and social tensions
  - Euro area unemployment reached record highs (over 12 percent in May), especially among the youth.
  - Rising social stresses threaten political commitment to sustain national adjustment efforts.

### Indebtedness, deleveraging, and growth channels
- High debt and simultaneous deleveraging of firms, households, banks, and the public sector can weigh on growth through multiple channels:
  - Increased vulnerability to asset price shocks, financial volatility, and uncertainty.
  - Negative feedback loops between highly-indebted private sectors, a weak financial sector, and a stressed sovereign can constrain demand and credit conditions.
  - Uncertainty about private sector debt servicing ability can raise concerns about banks’ asset quality and impair financial intermediation.
- Historical and econometric insights (Box 2)
  - Historically, almost all of the run-up in household debt tends to be reversed in deleveraging episodes; in the euro area the reduction in debt-to-GDP ratios has "barely started" and the boom was more pronounced.
  - Past deleveraging was often facilitated by high inflation and growth and supported by expansionary fiscal policy—factors that will not contribute much in the euro area periphery, implying a protracted adjustment relying on reductions in nominal debt.
  - Econometric analysis suggests that when government, households, and firms are all highly indebted, the negative growth impact of debt is highest.
  - High corporate and household debt is associated with worse growth outcomes than public sector indebtedness, implying particularly strong headwinds in periphery countries where all sectors are highly indebted.

### Macro risks and downside scenarios
- Near- and medium-term risks
  - Financial market stresses could quickly reignite because sovereign debt levels remain high and because delivery on policy commitments at the euro area level is incomplete (banking union, single rulebook, ESM direct recapitalization) or if fiscal adjustment and structural reforms at the national level are delayed.
  - In the medium-term, there is a high risk of stagnation, especially in the periphery, stemming from: larger-than-envisaged deleveraging effects, entrenched fragmentation, and delayed structural reforms.
- Quantified downside outcome cited
  - In a stagnation scenario, euro area and global GDP levels might be about 4 percent and 1 percent below the baseline by 2018, respectively.

### Policy recommendations and measures to support deleveraging and recovery
- Preserve and complete institutional and policy measures that underpin the credibility of the monetary union:
  - Continue efforts to complete banking union components (Single Supervisory Mechanism, Single Resolution Mechanism, single rulebook) and finalize ESM direct recapitalization arrangements.
- Support private sector deleveraging and repair of bank balance sheets through direct, decisive actions:
  - Make national insolvency regimes more effective (e.g., facilitate out-of-court settlements; reduce time for insolvency proceedings; provide greater flexibility for personal and corporate bankruptcy).
  - Encourage debt write-offs and policies that facilitate the transfer of non-performing assets to new owners.
  - Foster a market for NPL-backed securities to help repair bank balance sheets.
- Monitor monetary transmission and fragmentation:
  - Address fragmentation that weakens monetary transmission and leads to wide dispersion in lending rates across member states, particularly for SMEs.
- Recognize policy constraints and the need for sustained reform momentum:
  - Given limited near-term policy space for supportive fiscal or monetary measures in some countries, prioritize structural reforms that improve competitiveness and growth potential while mitigating social and political fallout from prolonged adjustment.

*Source: IMF — "1. The Effectiveness of OMTs" (extracted content).*

### 1. Financial stress re-emerges and bank-sovereign links re-intensify (triggered by stalled or incomplete delivery of

### 1. Financial stress re-emerges and bank-sovereign links re-intensify (triggered by stalled or incomplete delivery of euro area policy commitments)

### Triggers and immediate risks
- Medium risk triggers:
  - Lack of agreement on a common backstop to bank resolution and/or deposit insurance.
  - ESM direct recapitalization is delayed.
  - Uneven transposition of the Fiscal Compact at the national level.
- High-impact consequences if triggered:
  - Undermine fragile market confidence.
  - Re-intensify the adverse feedback loops between bank and sovereigns.
  - Threaten sovereign debt trajectories.
  - Undermine growth and jobs prospects.

### Major recommended policy responses (summary)
- Complete banking union, in particular single resolution mechanism and common safety nets (¶18-22) and allow direct recapitalization of banks by the ESM (¶16).
- Make progress towards greater fiscal integration (¶28).

---

### 2. Financial stress re-emerges and bank-sovereign links re-intensify (triggered by stalled or incomplete delivery of national policy commitments)

### Triggers and impact channels
- Medium risk triggers:
  - Social discontent with austerity increases, with political and economic fallout.
  - Implementation of fiscal adjustment falters (most euro area countries) and implementation of structural reforms stalls (Greece, Italy, Spain).
- High-impact consequences:
  - Undermine fragile market confidence.
  - Intensify cross-border financial contagion and bank deleveraging.
  - Drive sovereign and bank spreads back to very high levels.
  - Undermine growth prospects.

### Policy recommendations
- Pace fiscal adjustment and make flexibility contingent on reforms (¶27).
- Implement structural reforms to encourage job creation and raise competitiveness (¶29).
- Strengthen the implementation of the Macroeconomic Imbalance Procedure.

---

### 3. Protracted period of slower European growth

### Causes and high-impact risks
- High likelihood drivers:
  - Negative impact of public and private deleveraging larger than expected.
  - Persistence of very weak investment and high unemployment further reduce potential growth and make job skills obsolete.
- High-impact consequences:
  - Undermine fragile market confidence.
  - Emergence of unfavorable debt deflation dynamics, especially in the periphery.
  - Undermine growth prospects, including in the core, and further raise unemployment.

### Policy recommendations
- Use monetary policy to tackle fragmentation and support demand (¶23-25).
- Repair bank, corporate, and household balance sheets (¶13-17).
- Implement structural policies to spur growth (¶29) and advance rebalancing (¶32).

---

### 4–6. Additional external and global risks

### Advanced economies bond market stress (Medium/Low)
- Trigger: Lack of fiscal sustainability triggers a sharp rise in sovereign risk premium:
  - in Japan (Medium)
  - in the United States (Low)
- Medium-impact consequences:
  - Undermine fragile market confidence.
  - Intensify cross-border financial contagion and bank deleveraging.
  - Increases sovereign and bank spreads in the periphery.
- Recommendation: Strengthen financial stability (see above recommendations) to make the euro area more resilient to external shocks.

### Distortions from unconventional monetary policy in other advanced economies (High)
- Triggers and channels:
  - Mispricing of assets leads to a broad-based correction in valuation.
  - Market volatility and higher-than-expected increases in long-term rates as side effects from exit modalities.
- Medium-impact consequences:
  - Undermine fragile market confidence.
  - Increase sovereign and bank spreads, in particular in the periphery, only partially mitigated by exchange rate movements.
- Recommendations:
  - Enhance monetary policy communication, e.g., through forward guidance (¶25).
  - Strengthen financial stability (see above recommendations) to make the euro area more resilient to external shocks.

### Oil price surge (Low)
- Trigger: A spike in oil prices linked to geo-political events.
- Medium-impact consequence:
  - Damage economic activity further.

---

### A. Reversing fragmentation — restoring banking sector health

### Key findings
- Restoring banking sector health is essential for the recovery (¶13).
- Frail banks have relied on elevated lending rates to boost profitability and enhance capital buffers, and have been unable or unwilling to recognize and provision for higher losses, reinforcing fragmentation (¶13).
- Reversing dynamics requires recognizing losses, filling capital holes, closing or restructuring nonviable banks (¶13).

### Balance Sheet Assessment (BSA) and supervisory credibility (¶14)
- A credible assessment of banks’ asset quality would help lower funding costs and address fragmentation.
- The forthcoming Balance Sheet Assessment (BSA) of euro area banks, required ahead of the start of the Single Supervisory Mechanism (SSM), to be followed by stress tests, provides such an opportunity.
- Key elements to ensure effectiveness:
  - (1) a forward-looking framework that incorporates risks to growth and is clearly communicated well in advance of the exercise;
  - (2) harmonized methodologies and stringent standards for nonperforming loans, provisioning rules, and risk weights (as proposed by the EBA);
  - (3) full coverage of banks coming under direct supervision of the SSM.
- Independent third-party involvement (preferably from the private sector), along with the ECB, the EBA and national authorities, is essential for credibility and transparency.

### Strategy for addressing capital shortfalls (¶15)
- An agreed strategy on how to address capital shortfalls is critical to prevent pro-cyclical deleveraging.
- Without such a strategy, BSA and stress tests risk prompting banks to shed assets preemptively, reinforcing fragmentation.
- Where private funds are insufficient, the public sector would need to provide capital in countries with available fiscal space.
- If both private capital and fiscal space are limited, clarity on a common backstop would be critical to avoid re-igniting bank-sovereign links.
- Competition and state-aid rules may need reassessment to ensure that conditions attached to public support do not lead to excessive deleveraging.

---

### B. The ESM and common backstops (¶16)
- The ESM can serve as an effective common backstop.
- Recent agreement on main features of the ESM direct recapitalization framework covers conditions for access, time of entry, burden sharing, valuation, conditionality, and governance.
- Remaining issues:
  - Timing: final agreement on ESM direct recapitalization is still uncertain and linked to legislative processes of the BRRD and DSG Directive.
  - Conditionality and burden sharing: state aid conditionality is prerequisite and raises issues about the use of bail-ins under forthcoming EC rules; role of bail-ins clarified in BRRD but early activation raises concerns for large systemic institutions.
  - Size and access: limit for ESM resources available for direct recapitalization has been set at €60 billion (subject to review by the ESM Board). When needed, ESM direct recapitalization should be available on a timely basis so the ESM is seen as an effective and credible common backstop.

---

### C. National legislative, judicial, and insolvency frameworks (¶17)
- Improved national frameworks could support orderly deleveraging of the non-financial sector.
- Addressing high private sector debt can facilitate early rescue of viable firms and speedy exit of nonviable ones, enabling investment rebound and reallocation to productive sectors.
- Effective national insolvency regimes would support bank balance sheet clean-up by accelerating workout of bad private sector debt.
- Out-of-court restructurings remain underutilized despite recent advances.
- Stronger institutional infrastructure and supporting bank regulatory policies could incentivize debtors and creditors to engage in debt restructuring.

---

### D. Completing the banking union (¶18–22)

### Role and components
- A fuller banking union would solidify efforts on bank balance sheets.
- All elements must be in place: the SSM, the SRM, common safety nets, and accompanying directives; further delays or dilution risk destabilizing confidence (¶18).

### Single Supervisory Mechanism (SSM) (¶19)
- An effective SSM is a precondition for systematic supervision and will help reverse fragmentation by restricting national ring-fencing.
- Remaining steps to make the SSM operational should be finalized without delay, including:
  - Passing the SSM legislation through the European Parliament (expected in September).
  - Clarifying outstanding legal uncertainties (e.g., respective responsibilities of the ECB and national authorities).
  - Finalizing a common supervisory model and detailed manual.
  - Ensuring full cooperation of national supervisors.
- Guaranteeing full sharing of supervisory information and building supervisory capacity at the ECB are critical for SSM credibility in the forthcoming balance sheet review.
- Early intervention powers are essential; the ECB should be able to bring any bank under direct supervision, take early intervention measures (e.g., capital conservation measures, replacement of management, sale of bank activities), and initiate resolution (¶19).

### Single Resolution Mechanism (SRM) and Single Resolution Authority (SRA) (¶20)
- Without a strong SRM complementing the SSM, banking union credibility is jeopardized.
- An SRM should become operational by the time the SSM becomes effective.
- Leaving resolution responsibilities at national level while supervision is centralized risks perpetuating bank-sovereign links and potential conflict among national authorities in cross-border resolution.
- An SRM based on a centralized resolution authority—Single Resolution Authority (SRA)—would allow swift decisions on burden sharing and ensure least-cost resolution.
- To break bank-sovereign links, the SRA would need access to an effective common fiscal backstop, ultimately backed by a combination of ex ante and ex post industry levies; a credit line by the ESM could be a bridge to that permanent solution.

### Bail-ins and depositor preference (¶21–22)
- Clear rules on bail-ins reduce uncertainty for private investors by spelling out the pecking order in bank intervention.
- Council agreement confirms role of bail-ins as instrument to ensure burden sharing for nonviable banks and specifies minimum amount of “bail-in-able” instruments: 8 percent of total liabilities.
- Bail-in provisions allow flexibility to account for specific threats to financial stability or institutional factors; minimizing such flexibility promotes a level-playing field across banks and countries.
- Enforcing depositor preference across EU member states and progress on the DSG Directive will play an important role.
  - BRRD and new bail-in rules introduce tiered depositor preference; IMF staff fully support these rules.
  - These rules are expected to come into force in 2018, but may be applied on a case-by-case basis before then.
  - Strong powers at the center (SRM) will help ensure bail-in rules are applied predictably and consistently across countries.

---

### E. Targeted monetary policies to reduce fragmentation in the shorter run (¶23 and subsequent)
### Rationale
- While cleaning up bank balance sheets and strengthening banking union proceed, the ECB should prevent escalation of fragmentation.
- BSA is not planned until early 2014, and benefits of a more complete banking union will take longer to accrue; risk of a vicious circle of recession, higher non-performing assets, further bank losses, and deeper fragmentation is present.

### Recommended short-run ECB actions
- Provide additional term funding to avert a more severe contraction in credit and target measures to support SME financing as a temporary bridge until banks can intermediate growth again.
  - These actions would require the ECB to take additional credit risks onto its balance sheet, which could be mitigated by offsetting measures or a potential backstop provided by the European Investment Bank (EIB).
- Providing term funding:
  - One option is for the ECB to provide term funding for weak but solvent banks to better match duration of assets.
  - A new LTRO of longer tenor (3-5 years) combined with a review of current collateral policies to lower haircuts on specific assets (e.g., additional credit claims linked to SME loans and asset backed securities) would achieve such a target; together these measures would be akin to credit easing.
- Targeted credit easing options:
  - i) Targeted LTROs, akin to the Funding for Lending Scheme implemented in the U.K., but with stronger incentives for banks to participate by keeping the cost of funding through the scheme low (costs close to ECB policy rates).
  - ii) Direct ECB purchases of private assets (bypassing the banking system while balance sheets are being repaired): private assets could include securitized assets (supporting SME financing), corporate bonds, commercial paper, and covered bonds. Impact constrained by small size of the securitized market and regulatory hurdles.

---

*Source: IMF staff chapter "1. Financial stress re-emerges and bank-sovereign links re-intensify (triggered by stalled or incomplete delivery of euro area policy commitments)"*

### 24. Further policy rate cuts, including negative deposit rates, would help support demand

### 24. Further policy rate cuts, including negative deposit rates, would help support demand

### Monetary policy: further rate cuts and forward guidance
- Further policy rate cuts, including reducing the interest rates on the deposit facilities (marginally) below zero, would help support demand and bring inflation back in line with the primary objective.
- The room for cuts remains limited, but negative deposit rates could:
  - help anchor expectations of a looser monetary stance;
  - act as a strong form of forward guidance;
  - lower expectations of future increases in policy rates;
  - encourage banks with excess liquidity to reengage in the interbank market and extend credit.
- Potential unintended consequences:
  - Lower bank profitability may drive up interest rates on loans or fees on certain banking services for affected banks.
  - These effects are likely to affect mostly core banks, which on average are stronger at this juncture.
- Additional ECB actions to consider if conditions worsen:
  - reducing interest rates into negative territory;
  - continuing full allotment MROs at fixed rates beyond mid-2014;
  - extending full allotment to additional LTROs;
  - intervening directly in short-term euro area money markets as a potentially powerful signal of intended policy stance.

### Fragmentation and monetary transmission (Box 3) — findings and implications
- Euro area financial markets remain fragmented despite ECB actions; sovereign and corporate risk has fallen after OMTs, but bank CDS spreads remain elevated.
- Key problems identified:
  - Term funding costs remain high for periphery banks, weighing on bond issuance.
  - Declining asset quality is raising provisioning needs.
  - Cross-border banking flows remain low; weak banks are highly reliant on official liquidity.
  - Retail interest rates in stressed markets are significantly above those in the core, impeding credit flow and monetary transmission.
- Channels impaired:
  - Interest rate channel: declining interbank activity has undermined transmission.
  - Bank lending channel: impaired by lack of term-funding for certain banks and weak bank balance sheets.
  - Low demand for credit and higher nonperforming loans due to corporate and household balance sheet adjustment.
- Distributional impact:
  - SMEs disproportionately affected: higher lending rates for small loans and high loan rejection rates compared to larger entities.
  - SMEs account for about 80 percent of employment and 70 percent of value added in Italy, Spain, and Portugal.
- Policy implications:
  - Clean up bank balance sheets and advance a banking union to restore confidence, weaken bank-sovereign loops, reduce fragmentation, and support credit and growth.
  - In the interim, measures to stem the decline in the real economy via support to credit supply are important.
  - Ensuring credit availability to viable SMEs is essential to support the recovery.

### Fiscal policy: pacing adjustment to limit headwinds to growth
- Consolidation impact:
  - For the euro area as a whole, the negative growth impact of consolidation could reach as much as 1-1¼ percentage point this year.
  - Adjustment remains highly pro-cyclical across the EMU: larger consolidations in the periphery and broadly neutral (or mildly expansionary) stances in Germany and Austria.
- Policy challenge:
  - Avoid excessive damage to demand while placing debt levels on a sustainable downward path.
  - Defining and assessing adjustment in structural terms is key to preventing negative growth surprises from triggering additional consolidation.
  - Given weak growth prospects, some EDP deadlines may be overly ambitious; greater flexibility may be useful if fiscal space is used for ambitious structural reforms or bank recapitalization.
  - The small projected loosening of the fiscal stance in Germany is considered appropriate.
  - If downside risks materialize, countries not under market pressure would benefit from a slower pace of fiscal adjustment.
- Preconditions for paced adjustment:
  - Credible medium-term frameworks:
    - Use well-defined, multi-year budgetary frameworks with fiscal measures identified in advance and realistic macroeconomic assumptions.
  - Implementation and enforcement:
    - Strengthen national legislation and independent fiscal agencies’ roles following the Fiscal Compact, Six Pack, and Two Pack.
    - Timely implementation, uniform ambition across national setups, and consistency between national and supranational objectives are important.
  - Complexity concerns:
    - The growing complexity and relatively weak central enforcement may cast doubt on efficiency and public acceptability; strengthening the role of the center and laying foundations for greater risk sharing could help prevent idiosyncratic shocks from becoming systemic.

### Structural policies: growth, jobs, and rebalancing
- A new growth agenda could catalyze area-wide and national efforts; firm commitments to attainable targets can lift confidence even if benefits take time to accrue.
- Fostering job creation:
  - Tackle labor market duality and promote bargaining arrangements conducive to sustainable wage developments and shock absorption by firms.
  - Align severance costs for permanent contracts with EU norms where significantly higher; link employment protection more systematically to tenure to avoid threshold effects in dual systems.
  - Promote portability of pension and unemployment benefits and bilateral national initiatives (e.g., job and language training) to support labor mobility.
  - Target incentives at female and older workers to raise labor force participation where low.
- Promoting greater integration:
  - Targeted implementation of the Services Directive to reduce barriers to entry in protected professions and foster cross-border provision of services.
  - Pursue new Free Trade Agreements to secure access to growing markets and improve services productivity through deeper integration.
- Boosting competitiveness:
  - Allow wages to respond more flexibly to collective agreements and adjust industry-level wage floors to foster internal devaluation.
  - Lower regulatory barriers to entry and exit, simplify tax systems, and tackle vested interests in product markets (transportation, energy, network industries).
  - Example: electricity prices for industrial users in Italy are some 50 percent higher than the European average.
- Supporting credit provision and investment:
  - Proposed securitization schemes by the EC and the EIB would provide credit support to SMEs:
    - SME loans would be securitized using funds from EU and EIB amounting to €10.4 billion.
    - These funds could be leveraged up to 10 times, depending on the degree of risk pooling among member countries.
  - To have meaningful initial impact, the scheme would need to be front-loaded, cover new and existing loans, and employ risk pooling.

### Rebalancing the euro area (Box 4) — findings and policy implications
- Background and recent history:
  - Pre-crisis: large net foreign liabilities in the periphery (Greece, Ireland, Portugal, Spain) from deteriorating competitiveness and domestic demand booms; export-oriented economies (Germany, Netherlands) ran rising external surpluses.
  - Since the crisis: current account deficits in periphery narrowed, but adjustments may reflect depressed demand or structural changes.
- Main findings:
  - Substantial REER adjustments in deficit economies largely driven by declining unit labor costs via wage adjustments and labor shedding.
  - CPI deflators have been sticky; GDP deflators have declined in the periphery relative to trading partners.
  - Limited evidence of resource reallocation across sectors; some current account improvement is cyclical (especially Greece).
  - Export performance improvements depend heavily on external demand and initial trade specialization.
  - Further relative price adjustment of about 5-15 percent in deficit economies would be needed to restore competitiveness (based on current account or REER targets).
  - Beyond price adjustments, resources need reallocation to more productive sectors and movement up the value chain; labor and product market flexibility is required.
  - Convergence to net foreign asset positions considered safe elsewhere will be challenging for some countries; others may continue accumulating large foreign surpluses.
- Policy implications:
  - Deficit economies: lower costs and shift resources to tradable sectors; continue labor and product market reforms; ease credit constraints affecting SMEs to support entry and investment in tradable sectors.
  - Surplus economies: product market reforms to ease entry in non-tradable sectors and boost domestic demand to support rebalancing.
  - Reducing euro area uncertainty would support a pick-up in investment and domestic demand (notably in Germany), contributing to sustained reduction in current account surpluses over the medium term.

*Source: _cr13231 - 24. Further policy rate cuts, including negative deposit rates, would help support demand*

### 33. There was broad agreement between staff and authorities that more credible progress

### There was broad agreement between staff and authorities that more credible progress

### Banks, balance sheet repair, and EMU architecture
- Broad agreement that more credible progress is needed on bank balance sheet repair and EMU architecture.
- Authorities (the ECB and the European Commission (EC)) stressed the importance of decisive policy actions to boost confidence in the euro banking system and the long-term viability of the monetary union.
- Authorities concurred that while the situation is substantially better than in mid-2012, the challenge to restart growth and reduce policy uncertainty remains.
- Agreed that more progress was needed to complete the EMU architecture, including:
  - providing a fuller banking union; and
  - achieving greater fiscal integration,
  to address underlying weaknesses, fully restore confidence, and lay the foundations for higher durable growth.

### Assessment of economic developments and downside risks
- Authorities broadly agreed with the assessment of economic developments in the euro area and the downside risks to growth.
- Noted strong headwinds to growth from ongoing fragmentation, private sector deleveraging, and still-weak confidence.
- While significant progress in deleveraging had been achieved in some countries, overall balance sheet weakness is restraining growth.
- Risks emphasized:
  - renewed financial market stress from policy complacency and rising sovereign debt ratios;
  - potential for stress-triggered additional fiscal consolidation;
  - medium-term drag from private and public sector deleveraging could be higher than expected;
  - external risks from a larger-than-expected slowdown in demand from emerging economies coupled with a fall in commodity prices;
  - a rise in long term interest rates in excess of what may be warranted by world or U.S. growth could have a very detrimental impact on sovereign financing costs;
  - concern that protracted low inflation could unanchor inflation expectations.

### Bank asset quality, BSA, and stress tests
- A credible assessment of bank asset quality is essential to restore confidence in the euro area banking system.
- The BSA and following stress tests are seen as critical elements to establish the credibility of the SSM.
- Quality and comprehensiveness of the exercise should not be compromised, though this will be challenging.
- Importance of having the ESM backstop in place ahead of the BSA to motivate national authorities and address capital shortfalls where fiscal space is insufficient.
- Full approval of the BRRD and the DGS directive is a pre-requisite for finalizing the ESM direct recapitalization framework; this could take some time.
- Agreed that pro-cyclical outcomes should be avoided by:
  - effectively communicating the exercise;
  - involving third party expertise; and
  - having in place clear strategies for recapitalization and restructuring.
- Loss recognition and resolution principles highlighted:
  - Losses should be fully recognized;
  - Failed banks should be closed and restructured;
  - Frail systemic banks should receive public support where private capital is insufficient;
  - A credible national fiscal backstop needs to be available ahead of time;
  - Where private capital and fiscal space are limited, a common backstop such as the ESM should be used.

### Banking union, resolution, and single rule book
- ECB and EC strongly prefer a centralized resolution mechanism to make a banking union work.
- A single resolution authority with strong powers was deemed essential for the credibility and effectiveness of the SSM.
  - EC noted such an authority could be established within current EU Treaties if decision-making power is given to the EC; some member states hold the view that a treaty change is necessary, which could significantly delay establishment.
  - Concern that a weaker proposal based on a network of national resolution authorities could prevail, limiting the SRM’s ability to act efficiently.
  - Authorities supported introduction of bail-ins as best practice resolution tools, but only when a bank is deemed nonviable and not as a recapitalization tool.
- Authorities welcomed finalization of the CRR/CRDIV and Council agreement on the BRRD.
- Other elements of the single rule book (e.g., the DGS Directive) should be agreed upon and transposed in national legislations as soon as possible.
- European Council goal: reaching agreement on adopting the BRRD and DGS directives by end-2013 for transposition into national law by end-2014.
- Authorities supported depositor preference with:
  - full protection of insured depositors; and
  - a clear pecking order ranking uninsured depositors as the last to suffer losses among uninsured unsecured claimants.
- Favored minimizing flexibility left to national authorities in application of resolution tools.
- Staff appraisal view:
  - A strong SRM, based on a centralized authority with independent power to trigger resolution and make decisions on burden sharing, is critical.
  - SRM should become operational at around the time when the SSM becomes effective in 2014.
  - The ESM can initially provide a fiscal backstop; access to its funds for direct recapitalization should not be unduly restrictive.
  - Ultimately the SRM should be backed by ex ante and ex post levies on industry resources.
  - Swift adoption of the BRRD and the DGS Directive—including clarification on bail-ins, depositor preference, and deposit limits—is essential.

### Monetary policy options and unconventional measures
- There was broad agreement on the potential need for further monetary policy action, particularly if conditions worsen substantially.
- ECB actions and considerations:
  - Introduced explicit forward guidance for interest rates in early July.
  - Would consider further standard and non-standard measures (including negative deposit rates) if domestic and external conditions worsen.
- Authorities cautioned that impacts of such measures are likely more muted compared with the OMTs because fragmentation stems from capital market failures and higher macroeconomic risks.
- Authorities noted monetary policy plays a role in demand management, but structural policies are more important in managing overall macroeconomic risks.
- Concern that further monetary policy to relieve demand pressures could blunt incentives for difficult national-level measures.
- On direct asset purchases, authorities emphasized limited market size of securitized assets and regulatory hurdles could limit effectiveness.
- Staff recommendations for additional unconventional support:
  - Ensure term funding needs for weak but solvent banks through an additional LTRO of sufficient tenor;
  - Accompany with lower collateral haircuts, particularly on SME loans;
  - Consider targeted LTRO linked to new SME lending or direct purchase of select private assets.
- Additional monetary easing likely necessary given a very benign inflation outlook:
  - Further policy rate cuts, including negative deposit rates, would support demand and address deflationary pressures.
  - ECB’s forward guidance will help anchor interest rate expectations amid uncertainty about exit from unconventional U.S. policies.

### Fiscal policy, EDP targets, and governance
- Authorities broadly acknowledged importance of setting EDP targets in structural terms:
  - While targets are set in nominal terms, structural adjustment is critical for assessments.
  - European Commission noted readiness to extend deadlines if outlook worsens.
  - Authorities cautioned linking EDP extensions to structural reforms should not be seen as a tradeoff; extensions are justified on economic grounds.
  - Structural reforms are being pushed through the European Semester where extensions have been granted.
- Pacing fiscal adjustment remains key:
  - Extension of EDP deadlines is welcome, but current targets could still prove too ambitious.
  - Additional flexibility may need to be given to countries, especially if fiscal space is used for ambitious structural reforms (including to entitlement and taxes) or to recapitalize viable banks.
  - If downside risks materialize, the pace of fiscal adjustment should be slowed further.
- Recent reforms have strengthened fiscal governance, but outstanding issues remain:
  - Super-imposition of different layers of rules has increased complexity.
  - Concerns about implementation, enforcement, and transparency of various rules, including at the national level.
  - Proving by practice the capability of the framework to deliver credible medium-term fiscal anchors is critical to allow sufficient short-term flexibility.
  - In the longer run, fiscal governance will need to evolve to strengthen the role of the center and lay the foundation for greater fiscal risk sharing.
- To strengthen credibility of fiscal frameworks in the medium term:
  - Implementation of country specific recommendations and evenhandedness in applying the frameworks are of particular importance.
  - Need to address country specific issues and changing economic circumstances within the current legal setup.
  - Agreement that greater fiscal integration combined with stronger governance frameworks, including a stronger role for the center, could provide the basis for more risk sharing.
- Targeted contractual arrangements:
  - Authorities argued for targeted and limited contractual arrangements such as the proposed Convergence and Competitiveness Instrument (CCI) to incentivize reforms.
  - CCIs could be linked to the European Semester and the Macroeconomic Imbalances Procedure (MIP).
  - Financial support would have to rely on existing budgets and moral hazard would have to be addressed.
  - Authorities called for strong implementation and follow-up on MIP recommendations, particularly for countries where imbalances were deemed excessive (Spain and Slovenia).

### Structural reforms and rebalancing
- Ongoing rebalancing is incomplete:
  - Wages are adjusting and exports are improving in the periphery, but limited signs of symmetric adjustment in surplus countries.
  - Higher total factor productivity is essential to boost competitiveness.
  - Implementation of the Services Directives would generate higher productivity and stronger demand in surplus countries, and facilitate provision of credit to SMEs.
- Key priority areas for structural reform:
  - Pan-European training initiatives to signal solidarity and enhance firms’ incentive to hire young workers.
  - Implementing the Services Directive.
  - Reforming the energy sector.
  - Improving lending to SMEs.
  - Fostering cross-border labor mobility.
- Additional structural reform actions recommended:
  - Targeted implementation of the Services Directive to remove barriers to protected professions, raise productivity, and promote cross-border provision of services and competition.
  - A new round of free trade agreements could push improvements in services productivity.
  - Tackle labor market rigidities to raise participation, address labor market duality, and promote more flexible bargaining arrangements.

### Staff appraisal: collective actions, remaining challenges, and priorities
- Collective actions have reinforced the commitment to the monetary union:
  - ECB introduced the OMTs framework to address severe distortions in sovereign bond markets.
  - Completion of the ESM firewall, extension of official loan maturities to program countries, improvement in policy coordination framework, and agreements on Greece and Cyprus were important steps.
  - National governments continue progress in restoring public finances and advancing structural reforms.
- Remaining macroeconomic environment concerns:
  - Demand is weak and unemployment is increasing.
  - Financial market fragmentation persists, hampering monetary transmission and credit flow.
  - Consumers and businesses restrained by large debt overhang and ongoing balance sheet repair; fiscal policies are pro-cyclical.
  - Structural weaknesses in labor and product markets hinder competitiveness restoration.
  - Risks of stagnation and long-term damage to potential growth are increasing, with negative spillovers to other EU and southeastern European countries.
- Policy priorities outlined:
  - Repair banks’ balance sheets and facilitate resolution of private debt;
  - Make further progress on banking union;
  - Provide sufficient demand support;
  - Advance structural reforms.
- Political economy:
  - Undisputed resolve and steadfast support for deeper integration are hard to achieve but will help restore confidence.
  - Swift progress on remaining elements of the banking union and advancing toward greater fiscal integration would send a strong positive signal and underpin confidence.
- Interim policy measures:
  - Use flexibility in the recently agreed framework to prevent negative sovereign-bank loops during the BSA and stress test exercises.
  - At the national level, ensure efficient insolvency regimes and strong institutions to facilitate workout of excessive private debt.

*Source: _cr13231 - 33.*

### 54. While  the  euro  is  assessed  to  be  broadly  in  line  with  fundamentals,  there  are  still

### _cr13231 - 54. While  the  euro  is  assessed  to  be  broadly  in  line  with  fundamentals,  there  are  still

### Competitiveness, productivity, and rebalancing
- While the euro is assessed to be broadly in line with fundamentals, there are still substantial competitiveness gaps between countries.
- Further productivity gains in the tradable sector and adjustment in relative prices should help rebalancing in the periphery.
- Increasing productivity in non-tradable sectors would improve disposable incomes in surplus economies, which could support the rebalancing efforts of the deficit countries.

### Policy process recommendation
- The staff proposes that the next consultation on euro area policies in the context of the Article IV obligations of member countries follow the standard 12-month cycle.

### Structural reform plans and progress (selected countries)
- Germany
  - Reform priorities: Increase labor force participation and facilitate immigration of qualified workers; Increase productivity, in particular in the services sector
  - Recent progress: Progress in extending the provision of child care; Corporate tax reform of 2008 improved Germany's tax competitiveness; A law to facilitate recognition of qualifications obtained abroad came to force. The EU blue card facilitates immigration of skilled workers; Additional allocation to research and development in the 2012/13 budget
  - Staff recommendations: Lower the tax wedge, in particular for the low skilled; Improve quality and availability of early childhood education; Remove disincentives to invest in higher risk, higher growth sectors. Promote widespread use of ICT; Review the family policy to improve its efficiency; Accelerate the integration of pan-European transportation and energy networks and increase competition in network industries
- France
  - Reform priorities: Improve the functioning of labor markets to re-absorb the unemployed, with a focus on youth unemployment; Increase competition in service sectors; Undertake a tax reform
  - Recent progress: In 2011, approval of measures to accelerate pension reform implementation. Partial roll-back of the reform in mid-2012; The G-20 commitment (Cannes) for further liberalization of some services has not been implemented; In 2012, Parliament approved a reduction in the labor tax wedge
  - Staff recommendations: Achieve minimum wage moderation; reduce inactivity traps for young and low-skilled workers; support the unemployed in their job search; Empower an independent advocate of reform, for instance the competition authority with accrued powers to review practices and regulations; Undertake a growth friendly tax reform to support the consolidation
- Italy
  - Reform priorities: Improve the functioning of the labor market; Boost product market competition
  - Recent progress: In 2011, packages on wage bargaining decentralization and labor contracts; In April 2012, introduced Fornero labor market reform to encourage open-ended and apprenticeship contracts and to reduce cost of individual dismissal; Introduced reforms on product market liberalization and administrative simplification
  - Staff recommendations: Clarify conditions for reinstatement via the judicial process; Introduce flexible open-ended contract; promote firm-level contracts; Consider regional differentiation in public sector wages, and support private wage flexibility; Need further steps on privatization, especially on local public services
- Spain
  - Reform priorities: Improve the functioning of the labor market; Further reform in the service and product markets
  - Recent progress: The labor reform reduced severance payments and eased the use of fair dismissals, and facilitated firm-level agreements (February 2012); Reduction of the replacement rate for unemployment insurance and hiring subsidies In July 2012; In February 2013, the government announced a strategy for youth employment and entrepreneurship
  - Staff recommendations: Commission and publish an independent evaluation of the reform; Reduce further severance payments, legislate against wage indexation, and simplify opt-outs from collective bargaining; Reduce labor cost on the low skilled and the young, strengthen active labor market policies; Implement decisively the reforms in the NRP; set an independent “growth commission” to help define priorities and identify key measures
- Greece
  - Reform priorities: Improve labor market flexibility; Foster competition in service and product markets; Improve the business environment
  - Recent progress: Major labor market reforms were undertaken, including reduction of the severance pay; promotion of firm-level bargaining; lowering tax wedge, etc.; Legislation was adopted liberalizing restricted professions, transportation services and energy; Legislation to improve the business environment
  - Staff recommendations: Reduction in the labor tax wedge in a budget-neutral way and take additional measures to lower unit labor costs; Define an action plan to tackle remaining rigidities in product market and facilitate investments; Simplify export legislation and finalize implementation of new licensing laws during 2013
- Ireland
  - Reform priorities: Labor market reform; Increase efficiency and competitiveness of the overall economy
  - Recent progress: Introduced law reforming sectoral wage-setting agreements; Expanded number of activation and training places; strengthened the activation and training policies; Improved the enforcement powers of the Competition Authority through a new Competition Act in 2012
  - Staff recommendations: Further improve engagement with the long-term unemployed; finalize the reform of further education and training; Finalize the reform of the legal services to better align the costs; Implement an ambitious program of state assets disposals, including associated regulatory reforms especially in the gas and electricity sectors
- Portugal
  - Reform priorities: Improve the functioning of the labor market; Improve competition framework; Reduce costs in regulated network sectors; Further improve the business environment
  - Recent progress: Implemented "organized decentralization" on collective agreements and introduced representation threshold for extension of sectoral agreements; Severance payment has been reduced; Labor Code revisions to make working time arrangements more flexible; A new Competition Law was approved by Parliament; a framework law for regulators was recently submitted to Parliament; Privatization program on track
  - Staff recommendations: Promote firm-level wage bargaining; relax working time regulations; Streamline licensing processes for businesses and reduce rent; Reform the judicial system to improve efficiency and promote better out-of-court dispute resolution; Reform corporate insolvency regime

### Main economic indicators (Euro Area, 2010-2015) — Table 3 highlights (Projections 1/)
- Demand and Supply
  - Real GDP                         2.01.5-0.6-0.60.91.3
  - Private consumption                  1.00.2-1.3-0.80.40.9
  - Public consumption                  0.8-0.1-0.4-0.2-0.1-0.1
  - Gross fixed investment      -0.31.4-4.3-3.41.22.0
  - Final domestic demand        0.70.3-1.7-1.20.50.9
  - Stockbuilding 2/                0.60.2-0.5-0.10.00.0
  - Domestic Demand1.30.5-2.2-1.30.50.9
  - Foreign balance 2/0.70.91.60.70.40.4
  - Exports 3/                  11.26.32.71.53.73.9
  - Imports 3/               9.74.2-0.8-0.13.03.4
- Resource Utilization
  - Potential GDP                 0.70.60.40.50.70.8
  - Output gap-1.6-0.8-1.8-2.8-2.5-2.1
  - Employment                          -0.50.3-0.6-0.90.00.4
  - Unemployment rate 4/              10.110.211.412.312.412.1
- Prices
  - GDP deflator                       0.81.21.31.21.31.3
  - Consumer prices1.62.72.51.51.41.4
- Public Finance 5/
  - General government balance-6.2-4.2-3.7-3.1-2.6-2.1
  - General government structural balance      -4.6-3.7-2.3-1.4-1.1-0.8
  - General government gross debt85.788.092.895.996.595.8
- External Sector 5/, 7/
  - Current account balance             0.00.21.21.61.92.1
- Interest Rates 4/, 6/
  - EURIBOR 3-month offered rate0.81.40.20.2......
  - 10-year government benchmark bond yield3.84.32.32.7......
- Exchange Rates 6/
  - U.S. dollar per euro1.331.391.301.30......
  - Nominal effective rate (2000=100)103.2104.299.7103.1......
  - Real effective rate (2000=100) 6/95.395.090.392.2......
- Notes (from table)
  - 1/  Projections are based on aggregation of WEO projections submitted by IMF country teams.
  - 2/  Contribution to growth.
  - 3/  Includes intra-euro area trade.
  - 4/  In percent.
  - 5/  In percent of GDP.
  - 6/  Latest monthly available data for 2013.
  - 7/  Projections are based on member countries' current account aggregations excluding intra-euro flows and corrected for aggregation discrepancy over the projection period.

### High-frequency indicators and sectoral dynamics (figures summary)
- Labor market and activity
  - Unemployment rate reached a record high; employment and unemployment shown in high-frequency series (May-07 to May-13).
  - Activity remains depressed with net exports as the only driver of growth; firms are wary to invest and households to consume.
- Debt overhang and balance-sheet stress
  - Public and private sector debt increased rapidly in the last decade; external indebtedness also increased.
  - Household deleveraging has begun but has some way to go; corporate leverage remains high with pro-cyclical financing conditions.
  - Private sector balance sheet stress is weighing on output as all sectors deleverage simultaneously.
- Inflation developments
  - Annual headline inflation has fallen to below 2 percent since the beginning of the year and stands at 1.4 percent as of May, with wide variation across Europe, including Greece in negative territory.
  - Decline mainly driven by declining energy prices and moderation in non-energy components; headline and core inflation converging with core fluctuating around 1-1½ percent.
- External sector developments
  - Net exports have been the most important source for growth recently and explained most of the current account improvement across countries.
  - Substantial REER adjustments were driven by unit labor costs; mixed results of wage adjustments and labor shedding across countries.
  - Limited evidence of reallocating resources from non-tradable to tradable sectors; net foreign asset liabilities will remain very high in the periphery going forward.
- Fiscal developments
  - Fiscal consolidation will continue in 2013 before easing in the medium term, with sizeable adjustment envisaged in the periphery.
  - Fiscal policies remain largely pro-cyclical with widening output gaps; public debt is expected to peak in 2014 before declining gradually while remaining elevated in many countries.

### Appendix: Statistical issues and institutional cooperation
- Statistical data for the euro area are produced by Eurostat and the ECB in collaboration with national statistical institutes (NSIs), and the national central banks (NCBs) of countries participating in the Economic and Monetary Union.
- The statistics are of sufficient quality, scope, and timeliness to allow for effective macroeconomic surveillance.
- 1. Strengthened cooperation on European statistics:
  - The European Statistical System (ESS) and the European System of Central Banks (ESCB) cooperate under separate legal frameworks reflecting their governance structures.
  - A Memorandum of Understanding (MoU) has recently been established between the ESS and the ESCB creating a new body—the European Statistical Forum, which includes the heads of the NSIs and the statistics departments of the NCBs—to further strengthen cooperation.
  - The Forum will also ensure consistency of the statistical work programs of the ESS and of the ESCB.
  - The MoU preserves the role of the Committee on Monetary, Financial and Balance of Payments Statistics (CMFB) to implement cooperation on transversal or cross-cutting issues between the two statistical systems.

*INTERNATIONAL MONETARY FUND*

### 2. Developments  in  statistics to  enhance  fiscal  and  economic  governance. The Enhanced

### 2. Developments  in  statistics to  enhance  fiscal  and  economic  governance. The Enhanced Economic Governance Package (so called “Six Pack”)

### Enhanced Economic Governance Package and fiscal data reporting
- Legal requirements under the Enhanced Economic Governance Package ("Six Pack") have implications for the collection and dissemination of fiscal data and statistics.
- Eurostat established a Task Force on the implications of the Directive under the “Six Pack” to provide timely, regular and publicly accessible monthly and quarterly fiscal data based on public accounts for all sub-sectors of general government, data on contingent liabilities, and other indicators with potential impact on the general government deficit and/or debt.
- Conceptual frameworks adopted to:
  - publish monthly and quarterly fiscal data; and
  - publish annual data on government contingent liabilities.
- A detailed reconciliation table describing the link between nationally based fiscal data and the ESA95 based data will be published.
- Eurostat intends to collect and publish selected indicators (contingent liabilities, non-performing loans).
- The publication of data will start in 2014.

### Macroeconomic Imbalances Procedure (MIP) statistics proposal
- The Commission submitted a draft proposal for a regulation on the provision and quality of statistics for the MIP to the Council and the European Parliament.
- The draft regulation introduces new tasks for the Commission (Eurostat) including:
  - assessing and validating relevant data against various quality criteria;
  - analyzing member states’ inventories of the sources and methods used to compile the MIP data; and
  - developing and implementing an improvement action plan.

### Improved compilation and reporting of national accounts (ESA 2010)
- The revised European System of Accounts (ESA 2010) is to be implemented by member states by September 2014.
- Main methodological changes and challenges:
  - Recognition of the investment nature of expenditure on research and development: research and development expenditure is to be recorded as gross fixed capital formation and no longer as current expenditure.
  - More detailed analysis and presentation of pension schemes: a compulsory supplementary table on pension entitlements will be required to show the liabilities of all pension schemes, including those of government, whether unfunded or funded. These implicit government liabilities will not be reported in the core financial accounts and will not impact the Maastricht debt.
  - Challenges include improvements in timeliness for main national accounts aggregates (from t+70 to t+60 days) and quarterly sector accounts (from t+90 to t+85 days), and the backward calculation of time series.

### Developments in statistics to support monetary policy
- Financial sector surveillance:
  - Since 2013, individual balance sheet information on some 246 large euro area banks is transmitted on a monthly basis to the ECB. This supports analysis of deposit and lending decisions of the non-financial private sector and provides insights into sources of bank funding.
  - Quarterly data on activities of non-bank financial institutions (including investment funds other than money market funds, hedge funds, financial vehicles engaged in securitization, insurance companies and pension funds) are now collected by the ECB, complementing existing data on money market funds. These data facilitate the study of the shadow banking system.
- Data reporting improvements:
  - The ECB and the IMF Statistics Department are finalizing the migration of the balance sheet data for depository corporations to the IMF’s Standardized Report Forms (SRFs) for monetary statistics. Work continues on mapping data for Other Financial Corporations.
- Household Finance and Consumption Survey (HFCS):
  - The ECB published first results of the HFCS in April 2013, providing detailed household-level data on household balance sheets and related economic and demographic variables, including income, voluntary pensions, employment and measures of consumption.
  - Subsequent data collection should aim to increase coverage to all euro area countries and comparability of cross-country data.
- Sector accounts:
  - Euro area quarterly institutional sector accounts have improved, showing euro area non-financial assets by institutional sector and total euro area economy data on produced non-financial assets by main asset type, household housing wealth, and from-whom-to-whom data for loans and deposits.
  - At the country level, gaps remain regarding the non-financial assets position of sectors.
  - The ECB is part of a research project led by the IMF Statistics Department on global flow of funds and balance sheet approach matrices; matrices for the euro area and for the 17 countries of the euro area have been agreed. These provide metadata on data availability of international investment position data broken down geographically.

### European statistics supporting financial stability
- Risk dashboard for the European Systemic Risk Board (ESRB):
  - The ECB developed a risk dashboard released in September 2012. The initial set of 45 indicators will be regularly updated and revised.
- ESCB Register of Financial Institutions and Affiliates (RIAD):
  - RIAD has been upgraded to include information on banking groups and conglomerates to support financial stability analysis and the management of collateral in market operations.

### Prospects for banking supervision and new reporting
- A new European Parliament and Council Regulation is expected to confer to the ECB the sole responsibility for prudential supervision of all banks located in the euro area and in those EU member states that voluntarily adhere to the Single Supervisory Mechanism (SSM).
- New statistical reporting will be required to enable the ECB to perform its expected duties within the SSM.
- The ECB will collect supervisory data for banking groups under ECB’s direct supervision based on the harmonized Implementing Technical Standards (ITS) of the EBA, which has six parts:
  - financial reporting;
  - consolidated reporting;
  - asset encumbrance;
  - large exposures;
  - liquidity ratios; and
  - leverage ratios.
- Additional ad hoc datasets, including but not limited to those required for stress-testing purposes, may also be requested.

### Steps to improve Balance of Payments statistics
- Transition to BPM6:
  - Eurostat and the ECB are engaged with member states to implement the new methodology.
  - The new ECB data requirements related to the BPM6 implementation are due by mid-2014.
  - It is envisaged that members will gradually move their national compilation systems to the new methodology between 2013 and mid-2014.
- Aggregation of EU/EA current account and adjustment of intra-EU/EA trade:
  - Asymmetries in intra-EU/EA exports and imports persist but are relatively stable over time.
  - Methodological differences arise mainly from partner country allocation and the treatment of goods in transit.
  - Eurostat and the ECB engage with countries in regular “reconciliation rounds” to facilitate exchange of bilateral data.

### Data Gaps Initiative (DGI)
- The ESS and the ESCB are working to implement amended legal acts on European statistics aligned to ESA 2010 and BPM6.
- The new European statistics also support the SDDS Plus and G-20 DGI Recommendations.
- Going forward, European economic and financial statistics will be fit to support the G-20 Mutual Assessment Process and similar global surveillance exercises.

### IMF Executive Board Article IV consultation summary (Press Release No. 13/275)
- Press Release No. 13/275 FOR IMMEDIATE RELEASE July 25, 2013.
- On July 23, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Euro Area.
- Background findings and outlook:
  - Substantial collective actions have addressed important tail risks, and extreme market stresses have subsided.
  - The ECB’s Outright Monetary Transactions (OMTs) framework has helped address severe market distortions and improved effectiveness of monetary policy.
  - Initial progress on banking union (SSM agreement), the European Stability Mechanism (ESM) framework for direct bank recapitalization, and the Bank Recovery and Resolution directive (BRRD) has demonstrated commitment to improving EMU architecture.
  - Euro area GDP is expected to contract by 0.6 percent for a second consecutive year in 2013, before expanding modestly by 0.9 percent in 2014.
  - Headline inflation is expected to remain subdued, highlighting risks of underlying deflationary pressures.
  - Unemployment, especially among the youth—at record levels—poses a risk of long-term damage to potential growth and to political support for reforms.
- Risks to growth:
  - Risks remain tilted to the downside.
  - With limited policy space, very high (and still rising) public debt ratios, and substantial economic slack, further negative shocks could severely impact growth.
  - Recent turbulence in global markets has tightened financial conditions in the euro area.

*Source: IMF staff report text as provided in the content unit.*

### introduction of forward guidance by the ECB has had a mitigating effect. Continued

### Introduction of forward guidance by the ECB has had a mitigating effect. Continued

### Executive Board assessment and macroeconomic risks
- Directors commended actions at regional and national levels for stabilizing financial markets and reducing tail risks related to a euro break up.
- Directors noted persistent weaknesses:
  - Growth remains elusive and high unemployment persists, especially among the youth.
  - Household and corporate indebtedness remains elevated in a number of countries, holding back domestic demand.
  - Narrowing policy space and fragile, fragmented banking sectors increase risks of stagnation, social and political tensions, and spillovers to the global economy.
- Directors judged it imperative to revive growth and create jobs via a comprehensive strategy:
  - Repair bank balance sheets.
  - Make further progress on banking union.
  - Support demand while advancing structural reforms.
  - Unwavering political backing for institutional reforms is critical.

### Banking-sector repair, banking union, and market confidence
- Priority actions to restore sound bank balance sheets:
  - Full recognition of losses.
  - Recapitalization of weak but viable banks.
  - Closure or restructuring of non-viable banks.
- Directors supported plans for:
  - A comprehensive balance sheet assessment followed by stress tests to assess potential capital needs.
  - Involvement of an independent third party to ensure transparency and credibility.
  - A credible backstop, including direct recapitalization by the European Stability Mechanism (ESM); Directors looked forward to early agreement.
- Progress toward fuller banking union urged:
  - Adopt enabling legislation for the Single Supervisory Mechanism (SSM).
  - Agree on the Bank Recovery and Resolution Directive (BRRD).
  - Make progress on the Deposit Guarantee Scheme Directive.
  - Establish a strong, centralized Single Resolution Mechanism (SRM) with independent power to trigger resolution and decide burden sharing.
- Directors saw benefits from:
  - An asset quality review (AQR) before SSM operationalization to reassure investors.
  - EU-level agreement on the operational framework for ESM direct bank recapitalisation and clarity on bail-in rules in line with BRRD.

### Monetary policy, forward guidance, and non-standard measures
- Given weak growth and subdued inflation, Directors generally considered that further monetary support would likely be necessary, including:
  - Policy rate cuts by the ECB, especially if conditions worsen substantially.
  - An explicit role for forward guidance to anchor expectations.
  - Additional unconventional support from the ECB, including targeting lending to small- and medium-size enterprises to help repair monetary transmission.
- ECB policy actions noted:
  - Early May decisions lowered two key interest rates: main policy rate (MRO rate) now stands at 0.50 percent; marginal lending facility rate stands at 1.00 percent; deposit rate remains unchanged at 0.0 percent.
  - ECB announced in July that it expects key ECB interest rates to remain at present or lower levels for an extended period.
  - All ECB refinancing operations to be conducted as fixed-rate tender procedures with full allotment, at least until mid-July 2014.
  - The OMT-announcement has proven to be an efficient backstop against unfounded fears of a euro break-up.
- Inflation and price stability outlook:
  - Euro area annual inflation was 1.6 percent in June 2013 (Eurostat flash estimate), up from 1.4 percent in May.
  - Underlying price pressures expected to remain subdued over the medium term.
  - Medium-term inflation expectations remain firmly anchored in line with price stability.
  - Risks to inflation are broadly balanced: downside from weaker growth; upside from increases in administrative prices, indirect taxes, and higher commodity prices.

### Fiscal policy stance and governance
- Directors agreed on the need for a flexible, differentiated pace of fiscal adjustment within a credible medium-term framework.
- Recent extension for some countries to meet fiscal deficit targets was welcomed; additional flexibility may still be needed if fiscal space is used for deeper structural reforms or bank recapitalization.
- Authorities stressed:
  - Adhering to sound medium-term deficit reduction plans is key to preserve fiscal credibility and low interest rates.
  - The EU framework (including the "Six Pack" and "Two Pack") provides surveillance, medium-term budgetary frameworks (MTBFs), and tools for assessment and flexibility (including deadline extensions under the Stability and Growth Pact).
  - The growth impact of consolidation presented by staff of more than 1 percentage point in the aggregate euro area seems high from the authorities' view.

### Structural reforms and external rebalancing
- Directors urged further structural reforms at all levels to enhance growth potential and rebalance demand within the euro area:
  - Targeted implementation of the Services Directive to remove barriers to protected professions, promote cross-border competition, and raise productivity.
  - Labor market reforms to remove rigidities, raise participation, and where necessary promote more flexible bargaining arrangements.
  - Improve functioning of judicial systems and strengthen independent sectoral regulators.
- External sector and current account dynamics:
  - After a roughly balanced current account since euro launch, the euro area shifted into a mild surplus of around 1.2 percent of GDP in 2012.
  - Commission Spring Forecast suggests the surplus may increase by around 0.8 percent of GDP over 2012-14.
  - Adjustment concentrated in deficit countries; vulnerable countries expected to reach a collective surplus of around 0.5 percent in 2013.
  - Authorities argue much of adjustment in vulnerable countries is non-cyclical, supported by strong export performance and permanent contractions in domestic demand.
  - Surplus countries can contribute by increasing domestic demand, addressing market failures, pursuing structural reforms, and wages growing in line with productivity.

### Financial fragmentation and credit conditions
- Continued fragmentation remains in some segments of euro area financial markets; funding costs differ by bank location and size.
- Deleveraging by banks magnifies lending challenges, producing heterogeneity in lending across the euro area.
- Cost of borrowing for NFCs in Germany and France remains significantly lower than in Greece, Italy, Portugal, or Spain.
- Weak credit growth results from both demand-side (low investment appetite, high leverage) and supply-side (need to repair bank balance sheets and monetary transmission) constraints.
- Authorities highlight:
  - High bank lending rates in some Member States may partly reflect banks' efforts to boost margins and offset high provisions.
  - Other factors: high cost of private (unsecured) funding and the need to change bank funding structure away from short-term funding of long positions.

### Key euro area economic indicators (2010–2015 projections and recent values)
- Real GDP: 2010 2.0; 2011 1.5; 2012 -0.6; 2013 -0.6; 2014 0.9; 2015 1.3
- Private consumption: 2010 1.0; 2011 0.2; 2012 -1.3; 2013 -0.8; 2014 0.4; 2015 0.9
- Public consumption: 2010 0.8; 2011 -0.1; 2012 -0.4; 2013 -0.2; 2014 -0.1; 2015 -0.1
- Gross fixed investment: 2010 -0.3; 2011 1.4; 2012 -4.3; 2013 -3.4; 2014 1.2; 2015 2.0
- Final domestic demand: 2010 0.7; 2011 0.3; 2012 -1.7; 2013 -1.2; 2014 0.5; 2015 0.9
- Domestic Demand: 2010 1.3; 2011 0.5; 2012 -2.2; 2013 -1.3; 2014 0.5; 2015 0.9
- Exports: 2010 11.2; 2011 6.3; 2012 2.7; 2013 1.5; 2014 3.7; 2015 3.9
- Imports: 2010 9.7; 2011 4.2; 2012 -0.8; 2013 -0.1; 2014 3.0; 2015 3.4
- Potential GDP: 2010 0.7; 2011 0.6; 2012 0.4; 2013 0.5; 2014 0.7; 2015 0.8
- Output gap: 2010 -1.6; 2011 -0.8; 2012 -1.8; 2013 -2.8; 2014 -2.5; 2015 -2.1
- Employment: 2010 -0.5; 2011 0.3; 2012 -0.6; 2013 -0.9; 2014 0.0; 2015 0.4
- Unemployment rate: 2010 10.1; 2011 10.2; 2012 11.4; 2013 12.3; 2014 12.4; 2015 12.1
- GDP deflator: 2010 0.8; 2011 1.2; 2012 1.3; 2013 1.2; 2014 1.3; 2015 1.3
- Consumer prices: 2010 1.6; 2011 2.7; 2012 2.5; 2013 1.5; 2014 1.4; 2015 1.4
- General government balance (percent of GDP): 2010 -6.2; 2011 -4.2; 2012 -3.7; 2013 -3.1; 2014 -2.6; 2015 -2.1
- General government structural balance (percent of GDP): 2010 -4.6; 2011 -3.7; 2012 -2.3; 2013 -1.4; 2014 -1.1; 2015 -0.8
- General government gross debt: 2010 85.7; 2011 88.0; 2012 92.8; 2013 95.9; 2014 96.5; 2015 95.8
- Current account balance: 2010 0.0; 2011 0.2; 2012 1.2; 2013 1.6; 2014 1.9; 2015 2.1
- EURIBOR 3-month offered rate: 2010 0.8; 2011 1.4; 2012 0.2; 2013 0.2
- 10-year government benchmark bond yield: 2010 3.8; 2011 4.3; 2012 2.3; 2013 2.7
- U.S. dollar per euro: 2010 1.33; 2011 1.39; 2012 1.30; 2013 1.30
- Nominal effective rate (2000=100): 2010 103.2; 2011 104.2; 2012 99.7; 2013 103.1
- Real effective rate (2000=100): 2010 95.3; 2011 95.0; 2012 90.3; 2013 92.2

### Policy recommendations and priorities
- Restore bank balance-sheet health through:
  - Full loss recognition, recapitalization of viable banks, and closure/restructuring of non-viable banks.
  - Comprehensive balance sheet assessment and stress tests with independent oversight.
  - A credible backstop, including ESM direct recapitalization.
- Complete the Banking Union by:
  - Finalizing SSM, BRRD, Deposit Guarantee Scheme Directive, and establishing a strong SRM.
- Monetary policy support:
  - Use policy rate cuts, explicit forward guidance, and targeted unconventional measures (e.g., lending to SMEs) if conditions warrant.
- Fiscal policy:
  - Maintain a flexible, differentiated pace of adjustment within credible medium-term frameworks.
  - Use available fiscal space to support structural reforms and viable bank recapitalization where needed.
  - Strengthen fiscal risk sharing over the longer run.
- Structural reforms:
  - Implement Services Directive, product- and labor-market reforms, improve judicial systems and regulatory frameworks to reallocate resources to tradable sectors and raise productivity.

*Source: Statement and staff report excerpts from the Euro area Article IV consultation materials provided in the source content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13231.pdf_