## Investment in the Euro Area: Why has it been Weak?

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### Context: from crisis to recovery
- Real activity has expanded for four consecutive quarters.
- Revival in domestic demand partly from reduced fiscal drag, complemented by net exports.
- Financial market sentiment has improved: sovereign and corporate yields have fallen, sovereign spreads narrowed, corporate bond issuance and equity markets strengthened, and bank funding costs declined.
- Strong policy actions at national and area-wide levels have supported recovery (Comprehensive Assessment on track to be completed in October 2014; ECB assuming supervisory responsibilities in November 2014). Progress on banking union elements (Single Resolution Mechanism, Single Resolution Fund, BRRD, deposit insurance harmonization directive).
- Risks to integration: euro-skeptic election outcome may pose risks to the single market and test fiscal governance; potential reform fatigue as recovery and market rally progress.

### Findings on investment
- Investment has been hit hard since the crisis and remains below its pre-crisis level, particularly in stressed countries.
- Staff analysis:
  - Output changes explain broad investment trends, but a model controlling for output changes alone does not fully account for the decline in real non-residential private investment after the European sovereign debt crisis (except Spain).
  - Additional factors weighing on investment:
    - Elevated real cost of capital (in stressed economies currently higher than its historical average; for Germany it is lower).
    - Greater financial constraints (proxied by EC consumer and business survey), limiting investment particularly in stressed countries.
    - High corporate sector leverage.
    - Uncertainty, notably in Italy, Spain, and to a lesser extent Portugal and France.
- Quantitative illustration:
  - Investment in cumulative terms (since 2010Q2) has been below levels predicted by controlling only for output changes by about 3 to 6 percent of GDP.
  - Once real cost of capital, credit rationing, high corporate indebtedness, and uncertainty are controlled for, the “missing” investment declines to about ½ to 2 percent of GDP.
- Implication: output dynamics play a dominant role, but the real cost of capital, credit rationing, corporate indebtedness, and uncertainty are significant additional impediments.

### Outlook for investment, growth, inflation, and external balances
- Investment expected to pick up as the recovery strengthens and uncertainty declines.
- Conditions required for sustained recovery in investment:
  - Deal with corporate debt overhang (corporate debt-to-equity remains elevated in some stressed countries; deleveraging still at an early stage).
  - Address financial fragmentation and substantially lower borrowing costs, particularly for smaller firms.
- Growth projections:
  - "a little over 1 percent this year and 1½ percent next year."
  - Medium-run growth expected at 1½ percent.
  - Output gap not expected to close until 2019.
- Inflation projections:
  - Annual inflation forecast at 0.7 percent this year, before picking up to 1.2 percent in 2015.
  - Inflation expected to remain below the ECB’s primary price objective for a protracted period.
- External balances:
  - Current account surplus of about 2¼ percent of GDP is forecast to persist.

### Monetary policy options and recommended ECB actions
- Staff view: If inflation remains too low, the ECB should undertake a substantial balance sheet expansion, including through asset purchases.
- Sovereign bond purchases
  - Rationale: deepest potential market for asset purchases and likely the most effective channel to significantly expand the ECB’s balance sheet.
  - Expected effects:
    - Reduce government bond yields.
    - Induce higher equity and corporate bond values.
    - Raise demand and inflation expectations across the euro area.
    - Strengthen bank and corporate balance sheets, increasing banks’ capacity and willingness to lend.
  - Implementation note: Purchases could be made in proportion to the ECB capital key.
- Private asset purchases
  - Considerations: volume of eligible securities appears small; yields on covered bonds compressed; buying private assets would entail uneven help across the area.
  - Possible approach: allocate a portion of interventions to private markets; use a mix of purchases from highly rated private bond markets (including NFCs and securitized assets) to complement sovereign interventions.
- Large-scale, non-targeted LTRO
  - Design: long-term, fixed-rate operations could deliver a sizeable expansion of the ECB balance sheet and signal credibly accommodative policy.
  - Amplifier: impact stronger if SSM facilitates cross-border flow of liquidity.
- Recent ECB measures (as described by staff)
  - Reductions in policy interest rates:
    - 10 basis points reduction for each of the MRO and deposit rates (taking the deposit rate to negative territory).
    - 35 basis points reduction for the MLF.
  - Targeted longer-term refinancing operations:
    - TLTROs to support term funding and ensure credit provision.
  - Extension of fixed rate full allotment to strengthen forward guidance.
  - Suspension of sterilization of SMP holdings:
    - Frees up around €165 billion (current SMP holdings).
  - Extension of collateral eligibility to enhance access to liquidity for stressed banks.
  - Preparatory work to intensify outright purchases of ABS; effectiveness limited by small size of ABS market.

### Banking union, balance-sheet repair, and supervisory measures
- ECB Comprehensive Assessment and AQR
  - Status: well underway, results expected in October 2014.
  - Features: establishes consistent definitions of capital and NPLs; independent third-party involvement in valuing bank assets.
  - Staff views:
    - Capital hurdle rates: 8 percent Common Equity Tier 1 (CET1) ratio under the baseline and 5.5 percent under the stress scenario.
    - Treatment of sovereign risk might be perceived as too lenient by markets.
    - Recommend clear communications strategy and uniform independent third-party involvement across countries.
- Remediation timelines and recapitalization
  - Banks below AQR requirement: 6 months to fill the gap.
  - Banks below stress test requirement in adverse scenario: 9 months to fill the gap.
  - Banks must present a formal recapitalization strategy to supervisors within two weeks of results announcement.
  - Flexibility needed if capital needs are high and market conditions unfavorable.
  - Bail-ins: conversion of subordinated debt to capital must be applied before recourse to public support under EU state aid rules; staff urged consideration of financial stability concerns and possible invocation of systemic risk exception or proportionality principle.
- Common fiscal backstop and ESM direct recapitalization
  - Credibility enhanced by a common fiscal backstop to sever sovereign-bank links.
  - Direct recapitalization of banks from the ESM should be an option if private capital is insufficient.
  - Recent political progress toward operational ESM direct recap, but timetable uncertain and proposed access threshold is very high:
    - Direct recap must be preceded by bail-ins of at least 8 percent of eligible bank liabilities (in line with the BRRD).
    - The country’s fiscal position must rule out indirect recapitalization via the sovereign from the ESM.
- Progress toward banking union (three dimensions)
  - SSM: on-track to become fully operational in November 2014; expected to increase fungibility of liquidity and reduce fragmentation.
  - SRM/SRF: final agreement specifies faster mutualization; concerns remain about cumbersome decision-making, SRF transition period too long (8 years), and limited financial capacity.
  - Backstop: need for a common fiscal backstop deployable quickly in systemic crises.
- Macro-prudential authority and coordination
  - Authority shared between SSM and national competent authorities (NCAs).
  - ECB and national central banks via the Financial Stability Committee (FSC) to assess system-wide vulnerabilities; staff urged continued joint discussions with national authorities and the ESRB.
- Corporate debt overhang and insolvency reforms
  - Recommended measures:
    - Facilitate out-of-court settlements.
    - Reduce impediments to efficient debt restructuring.
    - Standardize debt restructuring contracts for SMEs.
    - Strengthen liquidation procedures to enable rapid exit of non-viable firms.
    - Introduce guidance on tax incentives and debt resolution procedures in line with international best practice.

### Fiscal stance, governance, and policy guidance
- Current stance: broadly neutral (area-wide) fiscal stance this year strikes a balance at the current juncture.
- Trade-offs:
  - Persistently high debt ratios cast a shadow over the medium term.
  - Large output gap argues for fiscal support.
- Policy guidance:
  - Fiscal response should remain flexible.
  - Large negative growth surprises should not trigger additional consolidation efforts.
  - If deflation risks materialize and monetary policy options are depleted, escape clauses in the fiscal framework may need to be used.
- Fiscal governance reforms: progress made but critical gaps remain.
  - Problems identified:
    - Increasing complexity of the system with possible inconsistencies and overlap between rules.
    - Structural budget balance undermined by large measurement errors, notably output gap estimates generally underestimated in real time, making the structural balance prone to significant downward revisions (on the order of 0.5 percent of potential GDP per year).
    - Potential disincentives to finance structural reforms with short-term budgetary costs and to fund public investment.
    - Enforcement mechanisms remain mild compared to federations.
  - Staff recommendations:
    - Examine complexity over the medium term and consider reducing the number of rules (e.g., consolidate preventive and corrective arms of the SGP and possibly focus on some measure of the structural balance as the single operational target).
    - Enhance credibility and compliance (e.g., introduce administrative sanctions, accelerate procedures in predefined cases, continue to strengthen national fiscal frameworks).

### Structural reforms, SME finance, and capital market development
- Role of structural reforms
  - Priorities: improve labor market functioning, increase competition in product and service sectors, implement the Services Directive, negotiate free trade agreements, and further integrate energy markets.
  - Energy strategy: increase interconnections of national networks to ensure security of gas and electricity supply.
- SME access to finance
  - SMEs account for around 80 percent of employment and 70 percent of value added in Italy, Spain, and Portugal.
  - Credit conditions: about a fifth of SMEs in Spain and Italy were credit rationed during the last 6 months (applications rejected or offers prohibitively expensive).
- Developing diversified funding markets and SME securitization (Box 3)
  - Benefits: reduce reliance on bank funding, rebalance financial structures, attract new investors, boost bank liquidity, free up regulatory capital, improve monetary policy transmission.
  - Challenges:
    - Unfavorable economic terms, lack of uniform reporting standards, cumbersome insolvency regimes.
    - Most recent transactions arranged for funding and do not offer regulatory capital relief; in 2013, more than half of issuances were “retained” well in excess of the 5 percent “skin in the game” CRD2 requirement.
    - European securitization market contracted by more than one-third since the start of the financial crisis to €1.4 trillion.
  - Policy recommendations:
    - Differentiate capital treatment between high- and low-quality SME-backed securities; reduce capital intensity for safer structures conditional on higher standards of disclosure and monitoring; harmonize reporting requirements.
    - Public sector to act as catalyst where markets are insufficiently developed; broaden area-wide and national initiatives (EC–EIB SME initiative, EIB-EIF securitization program).
    - Strengthen national insolvency frameworks, harmonize SME lending standards and credit registries, explore non-bank intermediated securitization and equity finance.
- Ongoing initiatives and prospects
  - Joint EC-EIB SME lending program operational by end-2014.
  - ECB and Bank of England published reviews in May 2014 of obstacles to securitization markets in the EU; EC issued a Commission Recommendation on a New Approach to Business Failure and Insolvency (2014/135/EU) in April 2014.

### Unemployment, youth, and labor-market policies
- Unemployment legacy: average unemployment in the euro area: 12 percent; average youth unemployment across the region: 24 percent; youth unemployment in stressed economies at unprecedented highs (e.g., over 50 percent in Greece).
- Youth unemployment is especially cyclical; business cycle explains up to 70 percent of changes in youth unemployment rates in stressed countries.
- Quantitative effects (Box 4):
  - An additional percentage point of annual growth could lower the youth unemployment rate from 0.8 percentage points in Greece and Portugal to 1.9 percentage points per year in Spain.
  - A one percentage point increase in hiring costs raises youth unemployment rates by 0.2 to 1.2 percentage points.
  - A higher benefit replacement rate increases youth unemployment rates by up to 1.3 percentage points.
  - An increase of 1000 euros in ALMP spending per unemployed person can lower youth unemployment rates by up to 0.3 percentage points.
- Recommended measures:
  - Properly designed, cost-effective ALMPs (including work-related training).
  - Measures to lower hiring costs (reducing the tax wedge and better aligning minimum wages to average labor costs).
  - Country-specific comprehensive strategies combining growth-boosting and structural reforms.

### Risks and macro spillovers
- Overall risks tilted to the downside.
- Key risks:
  - Limited near-term policy space leaves recovery vulnerable to negative shocks that could push the economy into lower inflation or deflation.
  - Bond market stresses could re-emerge if AQR or stress tests uncover large capital shortfalls absent a common fiscal backstop.
  - External risks: slowdown in emerging market growth, escalation of geopolitical conflict, abrupt exit from unconventional U.S. monetary policies.
  - Medium-term high risk of stagnation from persistently depressed domestic demand due to deleveraging, insufficient policy action, and stalled structural reforms.
- Quantified spillovers:
  - Staff analysis suggests a 1 percentage point slowdown in the euro area could reduce growth in emerging European countries by an estimated ½-¾ percentage points.
- Risk Assessment Matrix highlights (likelihood / expected impact):
  - Protracted slower growth in advanced economies: High / High.
  - Reform fatigue at national and euro area levels: High / High.
  - Protracted slower growth in emerging economies (including China): Medium / High.
  - Surges in global financial market volatility: High / Medium.
  - Sharp increase in geopolitical tensions surrounding Russia/Ukraine: Medium / Significant disruptions in global financial, trade and commodity markets.
  - Sustained decline in commodity prices: Medium / High.

### Key macroeconomic indicators and near-term projections (selected exact figures)
- Real GDP (2011–2019): 1.6 -0.7 -0.4 1.1 1.5 1.7 1.6 1.6 1.6
- Gross fixed investment (2011–2019): 1.6 -4.0 -2.9 1.6 2.7 2.8 2.7 2.7 2.6
- Output gap (2011–2019): -0.8 -1.8 -2.8 -2.5 -2.0 -1.4 -1.0 -0.6 -0.3
- Unemployment rate (2011–2019): 10.1 11.3 12.0 11.7 11.4 10.8 10.3 9.8 9.4
- Consumer prices (2011–2019): 2.7 2.5 1.3 0.7 1.2 1.3 1.5 1.5 1.6
- General government gross debt (2011–2019): 88.2 92.9 95.2 95.9 94.9 93.2 91.2 89.0 86.3
- Current account balance (2011–2019): 0.1 1.3 2.2 2.3 2.5 2.5 2.4 2.4 2.4
- EURIBOR 3-month offered rate (latest monthly available for 2014): 1.4 0.2 0.3 0.3
- 10-year government benchmark bond yield (latest monthly available for 2014): 4.3 2.3 3.3 2.6
- U.S. dollar per euro (latest monthly available for 2014): 1.39 1.30 1.37 1.37
- Nominal effective rate (2000=100, latest monthly available for 2014): 104.2 99.8 108.5 108.6
- Real effective rate (2000=100, latest monthly available for 2014): 95.0 90.2 96.1 95.3

*Source: IMF staff report excerpts contained in content unit _cr14198.*

### 1. Investment in the Euro Area: Why has it been Weak? __________________________________________ 6

### 1. Investment in the Euro Area: Why has it been Weak?

### Context: from crisis to recovery
- Real activity has expanded for four consecutive quarters.
- An incipient revival in domestic demand, partly from reduced fiscal drag, is adding to impetus from net exports.
- Financial market sentiment has improved: sovereign and corporate yields have fallen, sovereign spreads narrowed, corporate bond issuance and equity markets strengthened, and bank funding costs declined.
- Strong policy actions at national and area-wide levels have supported recovery (Comprehensive Assessment of systemically important banks on track to be completed in October 2014; ECB assuming supervisory responsibilities in November 2014). Progress on banking union elements (Single Resolution Mechanism, Single Resolution Fund, BRRD, deposit insurance harmonization directive).
- Risks to integration: euro-skeptic election outcome may pose risks to the single market and test fiscal governance; potential reform fatigue as recovery and market rally progress.

### Key macroeconomic headwinds and indicators
- Real activity and investment: remain below pre-crisis levels; growth in 2014Q1 weaker than expected and uneven across countries.
- Financial fragmentation: private borrowing costs remain too high in stressed economies; flow of credit to private sector contracting faster in stressed economies; SMEs facing credit rationing; cross-border banking flows shrinking.
- Inflation: headline and underlying inflation fluctuating below 1 percent; ECB objective is close to (but below) 2 percent for headline inflation. Short- and medium-term inflation expectations drifting down despite long-term expectations anchored.
- Unemployment and debt:
  - Average unemployment in the euro area: 12 percent.
  - Average youth unemployment across the region: 24 percent.
  - Youth unemployment in stressed economies: unprecedented highs (e.g., over 50 percent in Greece).
- External position: for the euro area as a whole, broadly in line with medium-term fundamentals, but asymmetric adjustments persist (undervaluation in some creditor economies; overvaluation in most debtor economies). Current account surplus of the euro area as a whole has grown further, putting upward pressure on the euro.

### Findings on investment (Box 1)
- Investment has been hit hard since the crisis and remains below its pre-crisis level, particularly in stressed countries.
- Staff analysis: output changes explain broad investment trends, but a model controlling for output changes alone does not fully account for the decline in real non-residential private investment after the European sovereign debt crisis (except Spain).
- Additional factors that have weighed on investment:
  - Elevated real cost of capital (important in many cases; in stressed economies it is currently higher than its historical average, while for Germany it is lower).
  - Greater financial constraints (proxied by EC consumer and business survey), limiting investment particularly in stressed countries.
  - High corporate sector leverage.
  - Uncertainty, notably in Italy, Spain, and to a lesser extent Portugal and France.
- Quantitative illustration:
  - Investment in cumulative terms (since 2010Q2) has been below levels predicted by controlling only for output changes by about 3 to 6 percent of GDP.
  - Once real cost of capital, credit rationing, high corporate indebtedness, and uncertainty are controlled for, the “missing” investment declines to about ½ to 2 percent of GDP.
- Implication: output dynamics play a dominant role, but the real cost of capital, credit rationing, corporate indebtedness, and uncertainty are significant additional impediments.

### Outlook for investment
- Investment is expected to pick up as the recovery strengthens and uncertainty declines.
- A sustained recovery in investment will require:
  - Dealing with corporate debt overhang (corporate debt-to-equity remains elevated in some stressed countries; deleveraging still at an early stage).
  - Addressing financial fragmentation and substantially lower borrowing costs, particularly for smaller firms.

### Outlook: growth, inflation, and external balances
- Growth projections:
  - "a little over 1 percent this year and 1½ percent next year."
  - Medium-run growth expected at 1½ percent.
  - Output gap not expected to close until 2019.
- Inflation projections:
  - Annual inflation forecast at 0.7 percent this year, before picking up to 1.2 percent in 2015.
  - Inflation expected to remain below the ECB’s primary price objective for a protracted period.
- External balances:
  - Current account surplus of about 2¼ percent of GDP is forecast to persist.

### Risks
- Overall risks tilted to the downside:
  - Limited near-term policy space leaves the recovery vulnerable to negative shocks, which could push the economy into lower inflation or deflation.
  - Bond market stresses could re-emerge if AQR or stress tests uncover large capital shortfalls absent a common fiscal backstop.
  - External risks: slowdown in emerging market growth, escalation of geopolitical conflict, abrupt exit from unconventional U.S. monetary policies.
  - Medium-term high risk of stagnation from persistently depressed domestic demand due to deleveraging, insufficient policy action, and stalled structural reforms.
- Quantified spillovers:
  - Staff analysis suggests a 1 percentage point slowdown in the euro area could reduce growth in emerging European countries by an estimated ½-¾ percentage points.

### Policy agenda: strengthening the recovery
Three priority areas:
1. Support demand (to reduce spare capacity and combat low inflation/deflation risks).
2. Repair balance sheets and complete the banking union (to tackle fragmentation, revive credit supply, and ensure financial stability).
3. Advance structural reforms (to boost investment, employment, productivity, and foster rebalancing).

Key rationale for further monetary easing
- Lowflation effects: very low inflation keeps real interest rates and real debt burdens elevated and hinders relative price and wage adjustments in debtor economies.
- Deflation risk from negative external shocks and/or further euro appreciation.
- Undershooting target could undermine central bank credibility and de-anchor expectations; even a small and temporary decline in inflation expectations could have sizeable output effects.
- Shrinking ECB balance sheet (LTRO repayments) makes it harder to communicate accommodative policy and puts upward pressure on the euro, pulling inflation down.

Recent ECB measures (described by staff)
- Reductions in policy interest rates:
  - 10 basis points reduction for each of the MRO and deposit rates (taking the deposit rate to negative territory).
  - 35 basis points reduction for the MLF.
- Targeted longer-term refinancing operations:
  - TLTROs to support term funding and ensure credit provision; substantial tenor and successive operations likely to attract a wide range of banks and help address fragmentation and low inflation.
  - Note: take-up of TLTROs depends on banks’ demand; ECB has only indirect control over balance sheet expansion via take-up.
- Extension of fixed rate full allotment to strengthen forward guidance and ensure liquidity availability.
- Suspension of sterilization of SMP holdings:
  - Frees up around €165 billion (current SMP holdings) to ease money market pressures.
- Extension of collateral eligibility to enhance access to liquidity for stressed banks.
- Preparatory work to intensify outright purchases of ABS:
  - Direct ABS purchases could circumvent the banking system, address fragmentation, and give ECB direct control over balance sheet expansion.
  - Effectiveness limited by the small size of the ABS market.

*Source: IMF staff report excerpt — "Investment in the Euro Area: Why has it been Weak?" (Box 1) from EURO AREA POLICIES IMF document.*

### 14. Also reassuring is that if inflation remains too low, the ECB has expressed willingness

### _cr14198 - 14. Also reassuring is that if inflation remains too low, the ECB has expressed willingness

### Monetary policy options and recommended ECB actions
- Staff view: If inflation remains too low, the ECB should undertake a substantial balance sheet expansion, including through asset purchases.
- Sovereign bond purchases
  - Rationale: The deepest potential market for asset purchases and likely the most effective channel to significantly expand the ECB’s balance sheet is the sovereign bond market.
  - Expected effects:
    - Reduce government bond yields.
    - Induce higher equity and corporate bond values.
    - Raise demand and inflation expectations across the euro area.
    - Work even in a bank-centric system by strengthening bank balance sheets (through higher asset prices) and corporate balance sheets (higher equity and bond values), thereby increasing banks’ capacity and willingness to lend.
  - Implementation note: Purchases could be made in proportion to the ECB capital key.
- Private asset purchases
  - Considerations:
    - Preferable on many counts, but the volume of eligible securities appears small and yields on assets like covered bonds have already compressed sharply.
    - Buying private assets would entail very uneven help across the area and favor banks that hold more marketable assets.
  - Possible approach: Allocate a portion of interventions to private markets; use a mix of purchases from highly rated private bond markets (including NFCs and securitized assets) to complement sovereign interventions and transmit lower interest rates through the credit channel.
- Large-scale, non-targeted LTRO
  - Design: Long-term, fixed-rate operations could deliver a sizeable expansion of the ECB balance sheet and send a credible accommodative signal.
  - Amplifier: Impact would be especially powerful if the establishment of the SSM facilitates cross-border flow of liquidity within and between banks.
- Expectations and exchange rate effects
  - Signaling the ECB’s commitment to its price stability objective via the above measures would have important expectation effects and may counter appreciation pressure on the euro, supporting higher inflation.

### Fiscal stance, flexibility, and governance
- Current stance: Broadly neutral (area-wide) fiscal stance this year strikes a balance at the current juncture.
- Trade-offs:
  - Persistently high debt ratios cast a shadow over the medium term and risks to fiscal forecasts remain significant.
  - Large output gap argues for fiscal support.
- Policy guidance:
  - Fiscal response should remain flexible.
  - Large negative growth surprises should not trigger additional consolidation efforts.
  - If deflation risks materialize and monetary policy options are depleted, escape clauses in the fiscal framework may need to be used.
- Fiscal governance reforms: Progress has been made but critical gaps remain.
  - Positive elements: Stronger economic underpinnings for rules; tighter link between fiscal targets and the debt objective; better enforcement; greater flexibility and specificity.
  - Problems identified:
    - Increasing complexity of the system with possible inconsistencies and overlap between rules.
    - Structural budget balance undermined by large measurement errors, notably output gap estimates generally underestimated in real time, making the structural balance prone to significant downward revisions (on the order of 0.5 percent of potential GDP per year).
    - Potential disincentives to finance structural reforms with short-term budgetary costs and to fund public investment.
    - Enforcement mechanisms remain mild compared to federations; EU governance structure can undermine strict implementation.
  - Staff recommendations:
    - Examine complexity over the medium term and consider reducing the number of rules (e.g., consolidate preventive and corrective arms of the SGP and possibly focus on some measure of the structural balance as the single operational target).
    - Enhance credibility and compliance (e.g., introduce administrative sanctions, accelerate procedures in predefined cases, continue to strengthen national fiscal frameworks).

### Mending balance sheets, banking union, and supervisory measures
- ECB Comprehensive Assessment and AQR
  - Status: Well underway, with results expected to be announced in October 2014.
  - Features: AQR establishes consistent definitions of capital and NPLs across jurisdictions and incorporates independent third-party involvement in valuing bank assets.
  - Staff views:
    - Capital hurdle rates set higher than Basel III regulatory minimum: an 8 percent Common Equity Tier 1 (CET1) ratio is required under the baseline and 5.5 percent under the stress scenario.
    - Treatment of sovereign risk might be perceived as too lenient by markets.
    - Recommend an effective and clear communications strategy for test results given national discretion over sovereign holdings, lack of an adverse scenario with a complete assessment of deflation risks, and heterogeneity in stress parameters.
    - Urged uniformity in the level of independent third-party involvement across countries.
- Remediation timelines and recapitalization
  - Banks below AQR requirement: 6 months to fill the gap.
  - Banks below stress test requirement in adverse scenario: 9 months to fill the gap.
  - Banks must present a formal recapitalization strategy to supervisors within two weeks of results announcement.
  - Staff supports ambitious timetable but notes flexibility is needed if capital needs are high and market conditions are unfavorable.
  - Bail-ins: Conversion of subordinated debt to capital must be applied before recourse to public support under EU state aid rules; staff urged careful consideration of financial stability concerns and possible invocation of systemic risk exception or proportionality principle if necessary.
- Common fiscal backstop and ESM direct recapitalization
  - Credibility of the exercise would be markedly enhanced by a common fiscal backstop to sever sovereign-bank links.
  - Direct recapitalization of banks from the ESM should be an option if private capital is insufficient.
  - Recent political progress toward operational ESM direct recap, but timetable uncertain and proposed access threshold is very high:
    - Direct recap must be preceded by bail-ins of at least 8 percent of eligible bank liabilities (in line with the BRRD).
    - The country’s fiscal position must rule out indirect recapitalization via the sovereign from the ESM.
- Progress toward banking union (three dimensions)
  - Single Supervisory Mechanism (SSM):
    - On-track to become fully operational in November 2014.
    - Expected to increase fungibility of liquidity within cross-border banking groups and reduce fragmentation.
    - Implementation risks to guard against, including home-host coordination and reciprocal macro-prudential policies for activities outside the euro area.
  - Single Resolution Mechanism and Fund (SRM/SRF):
    - Final agreement specifies a more streamlined decision-making process with faster mutualization compared to earlier plans.
    - Concerns: Decision-making procedure remains cumbersome, SRF transition period too long (8 years), and financial capacity limited given concentration and size of large financial institutions.
    - Possibility of a credit line with the ESM will help; making direct bank recapitalization via the ESM less stringent would mitigate concerns more directly.
  - Backstop:
    - Need for a common fiscal backstop deployable quickly in systemic crises.
    - Could reduce likelihood of use by supporting confidence; consider potential support for systemically relevant non-bank activities (insurance, central counterparties).
- Macro-prudential authority and coordination
  - Authority shared between SSM and national competent authorities (NCAs).
  - ECB and national central banks via the Financial Stability Committee (FSC) will assess system-wide vulnerabilities and scope for macro-prudential policies.
  - Staff urged continued joint discussions with national authorities and the European Systemic Risk Board (ESRB) on coordination, especially for EU banking activities outside the euro area and non-banking sectors.
  - Encourage effective cooperation with national authorities on anti-money laundering (AML) frameworks.
- Corporate debt overhang and insolvency reforms
  - Importance: Working out corporate debt overhang is key to repairing bank balance sheets and supporting investment.
  - Recommended measures:
    - Facilitate out-of-court settlements.
    - Reduce impediments to efficient debt restructuring (e.g., incentives for creditor coordination, schemes for priority financing for restructured entities).
    - Standardize debt restructuring contracts for SMEs.
    - Strengthen liquidation procedures to enable rapid exit of non-viable firms.
    - Introduce guidance on tax incentives and debt resolution procedures in line with international best practice.
  - Continued progress needed on harmonizing and strengthening national insolvency frameworks (terminology, definitions, processes).

### Structural reforms and SME finance to boost growth and rebalance the euro area
- Role of structural reforms
  - Aim: Revive investment, employment, and productivity; resolve intra-euro area imbalances.
  - Priorities: Improve labor market functioning, increase competition in product and service sectors, implement the Services Directive, negotiate free trade agreements, and further integrate energy markets.
  - Energy strategy: Increase interconnections of national networks to ensure security of gas and electricity supply by pooling and allocating energy reserves across countries.
  - Some reforms (capital market development, youth unemployment, rebalancing) have both national and area-wide dimensions.
- SME access to finance
  - Importance: SMEs account for around 80 percent of employment and 70 percent of value added in Italy, Spain, and Portugal.
  - Credit conditions: SMEs applying for loans face difficulties, particularly in Spain and Italy where about a fifth of SMEs were credit rationed during the last 6 months (applications rejected or offers prohibitively expensive).
- Developing diversified funding markets and SME securitization (Box 3)
  - Benefits: Reduce reliance on bank-intermediated funding, rebalance financial structures toward longer maturities, attract new investors, boost bank liquidity, free up regulatory capital, improve monetary policy transmission, facilitate cross-border investment.
  - Challenges:
    - Unfavorable economic terms (high cost of issuance, lack of uniform reporting standards, cumbersome insolvency regimes).
    - Adverse cyclical factors (cheap alternative funding for banks, rising SME loan defaults).
    - Most recent transactions arranged for funding and do not offer regulatory capital relief; in 2013, more than half of issuances were “retained” well in excess of the 5 percent “skin in the game” CRD2 requirement, often used as collateral for short-term Eurosystem funding (“securitization to repo”).
    - Pending regulatory changes (Basel III, Solvency II) weakened institutional investor base by adversely affecting capital intensity and eligibility of securitization transactions.
    - The European securitization market contracted by more than one-third since the start of the financial crisis to €1.4 trillion (roughly a quarter of the size of the U.S. market).
  - Policy recommendations:
    - Regulatory frameworks: Differentiate capital treatment between high- and low-quality SME-backed securities; reduce capital intensity for safer structures conditional on higher standards of loan portfolio disclosure and performance monitoring; harmonize reporting requirements; consider SME loans as collateral in refinancing operations.
    - Public sector support: Official sector to act as catalyst and create institutional demand when markets are insufficiently developed; area-wide and national initiatives (EC–EIB SME initiative, EIB-EIF securitization program, plans by several national central banks to support bundling of SME-backed loans for ECB refinancing) should be broadened.
    - Structural improvements: Strengthen national insolvency frameworks, harmonize SME lending standards and credit registries, explore non-bank intermediated securitization (trade receivables) and equity finance where securitization impediments are high.
- Ongoing initiatives and prospects
  - Joint EC-EIB SME lending program operational by end-2014 to complement existing EIB/EIF schemes.
  - ECB and Bank of England published reviews in May 2014 of obstacles to securitization markets in the EU; EC issued a Commission Recommendation on a New Approach to Business Failure and Insolvency (2014/135/EU) in April 2014.

*Prepared from IMF staff text in content unit _cr14198 - 14. Also reassuring is that if inflation remains too low, the ECB has expressed willingness*

### 27. The crisis has left a legacy of unacceptably high unemployment, especially in stressed

### 27. The crisis has left a legacy of unacceptably high unemployment, especially in stressed

### Legacy and macroeconomic effects of high unemployment
- Youth unemployment increased to unprecedented levels in euro area countries hit hardest by the crisis, ranging from 25 percent in Ireland to over 40 percent in Spain on average during 2007–13.
- Large and persistent youth and adult unemployment rates lower potential output due to skill attrition and depreciated human capital.
- Youth unemployment consequences:
  - lower probability of future employment;
  - lower wages;
  - erosion of social cohesion and institutions.

### Determinants and policy levers to reduce unemployment
- Staff analysis: youth unemployment in the euro area has been especially sensitive to cyclical conditions.
- Structural factors associated with higher unemployment:
  - a larger tax wedge;
  - higher minimum wage (relative to median wage);
  - lower spending on active labor market policies (ALMPs), especially on training.
- Recommended comprehensive, country-specific strategy:
  - measures to boost growth;
  - remove country-specific structural impediments, including:
    - properly designed, cost-effective ALMPs (including work-related training);
    - measures to lower hiring costs (reducing the tax wedge and better aligning minimum wages to average labor costs).

### External rebalancing: risks, scenario gains, and policy actions
- Need for policy efforts in both creditor and debtor economies to prevent intra-euro area imbalances from re-emerging as the recovery takes hold.
- Policy mix: supportive macroeconomic policies plus product and labor market reforms to rebalance the euro area.
- Role of higher infrastructure investment in creditor countries:
  - could improve disposable incomes and lead to higher external demand;
  - would reduce excessive surpluses including vis-à-vis the rest of the world.
- Importance for stressed economies:
  - further improvements in competitiveness to lower costs, shift resources to tradable sectors, and reduce external debt.
- Scenario (staff analysis / EUROMOD simulations):
  - a “good” rebalancing scenario—with higher public investment in creditor countries and more structural reform progress across the euro area—would improve current account balances in debtor economies, while reducing the surpluses of creditor economies.
  - Growth dividends under this scenario: ranging from a ½ to ¾ percentage point rise in growth annually over a five year horizon.

### Box 4 — Youth Unemployment in the Euro Area: Okun’s Law and Beyond (key quantitative findings)
- The business cycle explains up to 70 percent of changes in the youth (age 15–24) unemployment rates in stressed euro area countries.
- Youth unemployment rates are more than twice as sensitive to the business cycle as adult (age 25-64) rates.
- Example effect of growth on youth unemployment:
  - an additional percentage point of annual growth could lower the unemployment rate from 0.8 percentage points in Greece and Portugal to 1.9 percentage points per year in Spain.
- Structural variable impacts (ranges reported):
  - A one percentage point increase in hiring costs (tax wedge, ratio of minimum to median wages) raises youth unemployment rates by 0.2 to 1.2 percentage points.
  - A higher benefit replacement rate increases youth unemployment rates by up to 1.3 percentage points.
  - An increase of 1000 euros in ALMP spending per unemployed person can lower youth unemployment rates by up to 0.3 percentage points.
- Additional notes:
  - Skill levels affect long-term unemployment.
  - Collective bargaining and labor market duality have mixed effects.
  - In stressed economies (e.g., Greece and Spain), a higher tax wedge makes unemployment rates more pro-cyclical.
  - Estimations assume structural factors have the same effect across countries; variables do not capture every labor market detail.

### Box 5 — External Rebalancing in the Euro Area: Developments and Policies (key findings)
- Post-crisis shift: the euro area has shifted into strong surplus, but with highly asymmetric country-level developments.
  - Debtor economies (Greece, Ireland, Portugal, Spain) saw large improvements in current accounts (sometimes into surplus).
  - Creditor economies (Germany, the Netherlands) have maintained surpluses.
- Sectoral driver: change in current accounts largely driven by falling private investment, mostly from the corporate sector.
- Statistical analysis:
  - external imbalances traceable to deviations in both saving and investment from model-based estimates;
  - creditor economies with large surpluses have seen persistent under-investment and over-saving relative to model predictions;
  - some debtor economies had persistent over-investment prior to the crisis (e.g., Spain), with magnitude falling since the crisis but with risk of reversal as output gaps close.
- Scenario analysis (EUROMOD general equilibrium model):
  - higher public investment in creditor economies and more structural reform progress across the euro area would:
    - improve current accounts in debtor economies;
    - reduce surpluses of creditor economies;
    - reduce excessively high net external liabilities in some debtor economies (such as Greece) and temper net external assets of some creditor economies (such as the Netherlands);
    - improve potential growth and productivity across the board, with growth dividends ranging from ½–¾ percentage points of real GDP over the medium term;
    - accelerate closing of output gaps and raise inflation (helping relative price adjustment).
- External Stability Report assessment (2013):
  - euro area as a whole: real exchange rate gap estimated between -5 and 0 percent;
  - current account gap estimated between -½ and 1 percent of GDP;
  - imbalances persist at member-economy level (e.g., Spain overvaluation, Germany undervaluation).
- Policy implication: continuing structural reforms in product and labor markets in both creditor and debtor economies; some creditor economies have scope to use fiscal space to boost public investment.

### The authorities’ views and policy responses
- General agreement with staff assessment of developments and downside risks to growth; recovery seen as too weak to significantly reduce high unemployment and debt.
- ECB:
  - recent package of policy measures aimed at raising inflation towards the price stability objective and countering financial fragmentation;
  - readiness to respond swiftly if inflation remains unacceptably subdued, including potentially asset purchases to expand the ECB’s balance sheet;
  - quantitative easing (QE) is an option—mainly through sovereign but also private asset purchases—particularly if external risks materialize and the inflation outlook worsens; QE has limitations but the expectations channel is expected to play a significant role.
- European Commission (EC):
  - broadly neutral fiscal stance at the euro area level is helping sustain the recovery but cautioned against policy complacency;
  - 2014 consolidation plans seen as based on more realistic macroeconomic assumptions and improved composition with less reliance on capital spending cuts;
  - warned that premature relaxation of SGP targets to tackle weak aggregate demand would undermine credibility; escape clauses could be activated if inflation remained subdued after monetary options exhausted.
- Fiscal governance:
  - authorities acknowledged need for some revisions but noted legal and political constraints to radical changes;
  - concern that modifying rules to accommodate structural reforms and higher public investment could create loopholes.
- Banking sector and banking union:
  - optimism about successful completion of AQR and stress tests to boost confidence and facilitate balance sheet repair;
  - since mid-2013 total capital has risen almost €90 billion, nearly 4 percent, since May 2013.
  - SSM preparations to assume supervisory responsibilities in November; SRM decision procedures improved; SRF mutualization front-loaded (40 percent mutualized by end of first year, 60 percent by end of second year);
  - BRRD passage establishes tiered depositor preferences and a bail-in tool; Directive on Deposit Guarantee Schemes harmonizes coverage and speed of payout.
  - progress enabling direct bank recapitalization from the ESM; threshold for direct recap viewed as very high but broadly appropriate.
- Rebalancing assessment:
  - ongoing rebalancing is incomplete; wages and current accounts improving in debtor countries but against still-large output gaps that could reverse improvements;
  - limited signs of symmetric adjustment in surplus countries; higher infrastructure investment in surplus countries recommended to reduce intra-euro area imbalances.
- Structural reforms and programmatic measures:
  - “Youth Guarantee Scheme” to provide EU structural funds to support country-specific programs, targeted at countries where youth unemployment exceeds 25 percent;
  - progress on single market for energy; challenges include inter-connecting electricity grids and harmonizing climate change measures to hit renewable targets by 2020;
  - ongoing free trade agreement negotiations with the US and other countries, subject to political uncertainty.
- Capital market development:
  - authorities welcomed emphasis on capital market development as integral to Single Market;
  - support for facilitating greater SME access to finance, widening EIB-EIF SME securitization program, exploring synergies with EC-EIB SME Initiative;
  - merit seen in proposals for differentiated capital intensity of high- and low-quality securitization transactions, equitable regulatory treatment of securitized and non-securitized SME loans, harmonization of loan reporting, credit scoring and registries, and non-bank intermediated structured finance (cash flow securitization).
- Risk assessment:
  - general agreement with staff’s risks: global financial market volatility from revised US UMP exit expectations, protracted EM slowdown, geopolitical escalation, internal risks from stagnation or de-anchoring of long-term inflation expectations.
  - authorities saw interconnectedness of risks and judged high impacts only if multiple risks materialize simultaneously; attached higher likelihood to reform fatigue, especially given a more euro-skeptic European Parliament.

*Source: IMF staff report excerpt (EURO AREA POLICIES).*

### 42. The euro area’s economy has now expanded for four consecutive quarters, with

### 42. The euro area’s economy has now expanded for four consecutive quarters, with

### Recent developments and assessment
- The euro area’s economy has now expanded for four consecutive quarters, with varying strength across countries.
- Financial market sentiment is buoyant, sovereign spreads have narrowed to pre-crisis levels and bank funding costs have declined sharply.
- These improvements have been grounded in vigorous policy actions:
  - The ECB has provided demand support through conventional monetary policy—including the recent rate cut and negative deposit rates.
  - The fiscal drag in 2014 has diminished.
  - Rapid progress has been made with establishing a banking union, with the ECB ready to assume supervisory authority in November, soon after the results of the ongoing AQR are announced.

### Growth, credit, and labor market weaknesses
- The recovery is neither robust nor sufficiently strong:
  - Investment remains well below pre-crisis levels.
  - Bank credit continues to contract, constraining investment.
  - Credit conditions in periphery countries are particularly weak, with many SMEs being rationed.
  - Unemployment, especially youth unemployment, remains unacceptably high.
  - The private debt burden remains elevated in many countries.
- Greater growth momentum is required to substantially repair the damage from the crisis.

### Inflation dynamics and risks
- Inflation has been too low for too long:
  - Low inflation stifles demand by keeping real interest rates and real debt burdens too high.
  - Low inflation makes the unfinished task of rebalancing more difficult.
  - A protracted period of inflation below the central bank’s target could de-anchor expectations and undermine monetary policy credibility.
  - A negative external shock could tip the economy into deflation.

### Monetary policy stance and options
- The ECB’s recent policy package signals determination to address low, below-target inflation and fulfill its mandate.
- The measures should lead to a substantial expansion of liquidity.
- The provision of targeted term funding for banks should encourage credit to SMEs, especially in stressed economies.
- If low inflation and fragmentation are not reversed, a substantial expansion of the ECB’s balance sheet may be necessary to complement the recent package:
  - This could be achieved through a large program of asset purchases—primarily sovereign assets for reasons of market depth.
  - Or through a new non-targeted LTRO on a long-term, fixed-rate basis.
  - Both options involve balance sheet risk for the ECB, strengthen the pre-commitment to accommodative policy, and thereby influence inflation expectations.

### Fiscal stance
- The overall broadly neutral fiscal stance of the euro area in 2014 strikes an appropriate balance between demand support and debt sustainability considerations.
- Negative growth surprises should not trigger additional consolidation efforts.

### Banking union, AQR, and bank repair
- Successful completion of the AQR will facilitate bank balance sheet repair.
- The ambitious timetable for recapitalization of banks should be feasible given markedly improved market conditions, but some flexibility might be necessary if several banks need to raise capital at the same time.
- Creditor bail-ins for systemically important banks, if necessary, would need to be applied with due consideration given to financial stability concerns.
- Efforts are also needed to reduce the corporate debt overhang by strengthening national insolvency frameworks and facilitating debt restructurings.
- There has been rapid progress towards a more complete banking union:
  - The transition to a single supervisor—the SSM—should facilitate cross-border liquidity provision, thereby reducing fragmentation.
  - SRM decision-making procedures have been simplified, and the timetable for mutualization of the SRF has been shortened.
- Work needs to continue on establishing a common fiscal backstop to effectively sever sovereign-bank links.
  - While the proposal for ESM direct recap is a step in the right direction, as currently envisaged the thresholds for such support are too high.

### Capital markets and financial resilience
- Capital market development should be encouraged to provide an alternative to bank lending.
- Developing capital market financing alternatives, like greater securitization for corporate funding, would:
  - Help ensure lending to viable smaller firms.
  - Enhance the resilience of the financial system.
  - Improve monetary transmission.
- To bolster securitization markets, regulatory risk weights for high quality (simple and transparent) liquid asset-backed securities should be reduced to free up capital for further lending.

### Structural reforms and rebalancing
- More structural reforms are necessary to tackle high unemployment, burnish competitiveness, and facilitate rebalancing.
- A comprehensive strategy to tackle youth unemployment would involve both measures to boost growth and remove country-specific structural impediments, which could include:
  - Cost-effective ALMPs.
  - Measures to lower the opportunity cost of employment.
  - Better-targeted training programs.
- Higher infrastructure investment in the creditor countries would help reduce excessive surpluses.
- Competitiveness-enhancing reforms to product and labor markets in debtor countries would aid further rebalancing by boosting export growth as the recovery takes hold and import compression unwinds.
- Efforts should continue to implement the Services Directive, make progress with free trade agreements, and more closely integrate energy platforms and policies.

### Fiscal governance over the medium term
- Over the medium term, ideas to simplify and strengthen the fiscal governance framework should be explored:
  - Consideration should be given to a more parsimonious framework with a single objective and an economically sound operational lever.
  - The credibility of the rules would be enhanced by much stronger enforcement mechanisms.
  - Boosting the ability of the center to fund public infrastructure projects—such as cross-border investments in transportation, communications and energy networks—would help lay the foundations for sustained growth, while keeping countries within the bounds of the fiscal framework.

*International Monetary Fund*

### 55. Staff proposes that the next Article VI consultations on euro area policies follow the

### Staff proposes that the next Article VI consultations on euro area policies follow the standard 12-month cycle.

### Main economic indicators and near-term projections (Table 1)
- Real GDP (2011–2019): 1.6 -0.7 -0.4 1.1 1.5 1.7 1.6 1.6 1.6
- Private consumption (2011–2019): 0.3 -1.3 -0.7 0.6 1.1 1.3 1.4 1.4 1.4
- Public consumption (2011–2019): -0.1 -0.6 0.1 0.3 0.3 0.4 0.5 0.6 0.7
- Gross fixed investment (2011–2019): 1.6 -4.0 -2.9 1.6 2.7 2.8 2.7 2.7 2.6
- Final domestic demand (2011–2019): 0.5 -1.7 -0.9 0.7 1.2 1.4 1.5 1.5 1.5
- Stockbuilding contribution (2011–2019): 0.3 -0.5 0.0 0.1 0.0 0.0 0.0 0.0 0.0
- Domestic demand (2011–2019): 0.7 -2.2 -1.0 0.8 1.2 1.4 1.4 1.5 1.5
- Foreign balance contribution (2011–2019): 0.9 1.5 0.5 0.3 0.3 0.2 0.2 0.2 0.2
- Exports (2011–2019): 6.5 2.5 1.4 3.9 4.5 4.9 4.9 4.9 4.8
- Imports (2011–2019): 4.5 -0.9 0.4 3.4 4.1 4.7 4.9 4.9 4.9
- Potential GDP (2011–2019): 0.6 0.4 0.6 0.8 1.0 1.1 1.2 1.2 1.3
- Output gap (2011–2019): -0.8 -1.8 -2.8 -2.5 -2.0 -1.4 -1.0 -0.6 -0.3
- Employment (2011–2019): 0.3 -0.6 -0.8 0.3 0.7 0.9 0.8 0.8 0.8
- Unemployment rate (2011–2019): 10.1 11.3 12.0 11.7 11.4 10.8 10.3 9.8 9.4
- GDP deflator (2011–2019): 1.2 1.3 1.5 1.1 1.4 1.4 1.5 1.5 1.6
- Consumer prices (2011–2019): 2.7 2.5 1.3 0.7 1.2 1.3 1.5 1.5 1.6
- General government balance (% of GDP, 2011–2019): -4.1 -3.7 -3.0 -2.7 -2.1 -1.5 -1.1 -0.7 -0.4
- General government structural balance (2011–2019): -3.7 -2.3 -1.3 -1.2 -0.9 -0.6 -0.5 -0.3 -0.1
- General government gross debt (2011–2019): 88.2 92.9 95.2 95.9 94.9 93.2 91.2 89.0 86.3
- Current account balance (2011–2019): 0.1 1.3 2.2 2.3 2.5 2.5 2.4 2.4 2.4
- EURIBOR 3-month offered rate (latest monthly available for 2014): 1.4 0.2 0.3 0.3
- 10-year government benchmark bond yield (latest monthly available for 2014): 4.3 2.3 3.3 2.6
- U.S. dollar per euro (latest monthly available for 2014): 1.39 1.30 1.37 1.37
- Nominal effective rate (2000=100, latest monthly available for 2014): 104.2 99.8 108.5 108.6
- Real effective rate (2000=100, latest monthly available for 2014): 95.0 90.2 96.1 95.3

Notes:
- Projections are based on aggregation of WEO projections submitted by IMF country teams.
- Contributions to growth, intra-euro area trade, and other metadata are presented as in the source.

### Risks and policy recommendations (Risk Assessment Matrix, Table 2)
- Protracted period of slower growth in advanced economies
  - Likelihood: High
  - Expected impact: High
  - Risks: Lower-than-anticipated potential growth; persistently low inflation; deanchoring of inflation expectations; debt-deflation dynamics; low investment; high unemployment; larger output gaps; lower growth potential
  - Policy recommendations:
    - Use monetary policy and ECB balance sheet expansion to support demand
    - Repair bank, corporate, and household balance sheets to improve credit and support domestic demand
    - Implement structural policies to spur investment, productivity, competitiveness, and advance rebalancing
- Reform fatigue at national and euro area levels
  - Likelihood: High
  - Expected impact: High
  - Risks: Stalled/incomplete delivery of bank reforms and policy commitments; unanticipated outcomes from asset quality review and stress tests; absence of common fiscal backstop; financial stress; reintensified bank-sovereign-real economy links; procyclical fiscal policies; negative shocks to growth
  - Policy recommendations:
    - Undertake sound implementation of asset quality review and stress tests with clear plan for recapitalization
    - Proper communication about process and results
    - Complete banking union, in particular single resolution mechanism and a common safety net and fiscal backstop
    - Maintain appropriate pace of fiscal consolidation and debt reduction
- Protracted period of slower growth in emerging economies (including growth slowdown in China)
  - Likelihood: Medium (Growth slowdown in China: Medium)
  - Expected impact: High for general protracted slowdown; Medium for China-specific buildup/unwinding risk
  - Risks: Slower export-led growth; higher output gaps; lower growth potential; undermined market confidence; increase in sovereign spreads; buildup and unwinding of financial excess capacity
- Surges in global financial market volatility
  - Likelihood: High
  - Expected impact: Medium
  - Risks: Tightening of financial conditions; uncertainty hampering growth
  - Policy recommendations:
    - Ease monetary policy to support demand
    - Keep national and euro area-wide reforms on track to preserve market confidence
    - Establish sufficient common backstops to help bank reform, break sovereign-bank links
    - Consider revisiting euro area’s energy strategy if necessary
- A sharp increase in geopolitical tensions surrounding Russia/Ukraine
  - Likelihood: Medium
  - Expected impact: Significant disruptions in global financial, trade and commodity markets
- Sustained decline in commodity prices
  - Likelihood: Medium
  - Expected impact: High (further decline in inflation due to lower inflation expectations)
  - Policy recommendation: Tackle further declines in persistently low inflation as above

Note:
- The Risk Assessment Matrix entries reflect staff subjective likelihood assessments: "low" ≈ probability below 10 percent, "medium" ≈ 10–30 percent, "high" ≈ 30 percent or more.

### Near-term fiscal stance (Table 3 — scorecard approach)
- The scorecard aggregates cyclical conditions, monetary policy space, and sustainability conditions to inform fiscal stance decisions; it produces country-level signals (examples shown):
  - Germany (2014 metrics): Space/gap -0.1; Change in CAPB (WEO/staff/report): 0.2/1.7/1.4/2.8; Monetary policy? N; Overall GG debt and other indicators shown; Staff advice: consider an additional deficit of -0.5 percent of GDP, with spending tilted toward public investment (note in table)
  - France (2014 metrics): Space/gap -2.4; Change in CAPB 1.1/0.1/1.0/1.0/2.0; Monetary policy? N; other indicators listed
  - Italy, Spain, Netherlands, Euro area and memo entries for UK and US are presented with comparable multi-indicator signals
- Thresholds and color-coding rules are used to translate indicators into recommended fiscal stances (strong tighten, modest tighten, neutral, modest stimulus, strong stimulus) based on specific numeric cutoffs for variables such as debt, output gap, unemployment, growth, inflation, primary gap, and CDS spreads
- Notes clarify technical definitions (e.g., primary gap, weighted averages, and adjustments for monetary policy space) and data sources (e.g., staff-estimated structural adjustments)

### Structural reform plans and progress (Table 4 — selected countries)
- Germany
  - Reform priorities: Increase labor force participation; facilitate immigration of qualified workers; increase productivity and competition, especially in services; clarify future energy policy
  - Recent progress: Extended child care provision; reduced contribution rate for statutory pension insurance; increased personal basic tax-free allowance and mini-job threshold in 2013; law to facilitate recognition of foreign qualifications (2012); EU blue card supports skilled immigration; additional R&D allocations in 2012–2014 budgets; framework to encourage larger investor base
  - Staff recommendations: Lower tax wedge for low-skilled and women; further facilitate immigration for medium-skilled workers; review family policy for efficiency; tie minimum wage adjustments to independent expert council recommendations; accelerate integration of pan-European transport and energy networks; increase competition in network industries and services
- France
  - Priorities: Improve labor market functioning (focus on youth unemployment); increase competition in service sectors; pursue business-friendly environment; increase labor mobility
  - Recent progress: Pension reforms initiated 2011 and additional reforms in 2013; €4,000 subsidy for permanent hiring of young workers; EUR 30 billion labor tax cuts committed over 2013–16; training reform (Dec. 2013); unemployment insurance reform (March 2014) leaves benefit structure unchanged; Services Directive implementation strengthened competition
  - Staff recommendations: Make unemployment benefits more degressive and strengthen activation; open up distribution, some transport, and professional services; strengthen competition authority; regulatory simplification; simplify employment protection and reduce judicial uncertainty; remove obstacles to labor mobility
- Italy
  - Priorities: Improve civil justice efficiency; reduce costs in regulated network sectors; improve competition in product markets and services; address very high unemployment and ineffective active labor market policies
  - Recent progress: New mandatory mediation; measures to reduce case backlog (2013); wage bargaining decentralization and labor contract packages (2011) with stalled implementation; youth employment measures (July 2013); Fornero labor market reform (April 2012); gas sector liberalization; transport authority established
  - Staff recommendations: Promote out-of-court mediation; review court fees; strengthen court organization; remove structural bottlenecks raising production costs; enhance competition in electricity supply and distribution; improve coordination and efficiency of ALMPs; shift to flexible single contracts that increase protection with seniority; decentralize wage setting; redesign unemployment support conditional on job search/training; speed up opening of professional services and privatization of local services
- Spain
  - Priorities: Improve labor market functioning; reduce youth and unskilled unemployment; address low revenue collection (esp. indirect taxes); raise TFP; improve competitiveness by reducing regulatory burden and rents in protected professions
  - Recent progress: Labor reform (Feb 2012) reduced severance and eased fair dismissals; replacement rate reduction and hiring subsidy reforms (July 2012); youth employment strategy (Feb 2013); Market Unity law approved (2013)
  - Staff recommendations: Build on 2012 labor reform to reduce duality and ensure wage flexibility; strengthen ALMPs and training; reduce labor cost for unskilled employment; adopt comprehensive tax reform to boost jobs and revenue; fully implement Market Unity and liberalize professional services
- Greece
  - Priorities: Improve labor market flexibility; foster competition in services and product markets; improve business environment
  - Recent progress: Major labor market reforms since 2010 (reduced severance, firm-level bargaining, 5 percentage-point tax wedge reduction); liberalization of restricted professions, transport services, energy; regulatory reform in 4 key sectors with OECD assistance
  - Staff recommendations: Align collective dismissals and industrial action rules with EU best practice; continue opening regulated professions; reduce regulatory barriers in 4 additional sectors; lower administrative burden; overhaul licensing while reducing short-term costs to start businesses; simplify customs and finalize electronic trade declaration system by 2014
- Ireland
  - Priorities: Address high long-term unemployment; increase efficiency and competitiveness
  - Recent progress: Increased staffing for employment services (2013); tendered for private provision; priorities for further education and training identified; completed sale of Bord Gais Energy for €1.125 billion
  - Staff recommendations: Improve engagement with long-term unemployed; implement further education and training reforms; introduce charging for water usage; finalize legal services reform; implement further state asset disposals in an orderly process
- Portugal
  - Priorities: Improve labor market functioning; enhance competition and tackle rents in product markets
  - Recent progress: Implemented "organized decentralization" on collective agreements; introduced representation threshold for sectoral agreement extension; severance payment reduced; New Labor Code effective August 1, 2012 aligning severance accumulation rates
  - Staff recommendations (excerpt): Authorities investigating options to reduce upward pressures on electricity prices, including addressing rents

*Source: EURO AREA POLICIES, INTERNATIONAL MONETARY FUND (content unit: _cr14198 - 55).*

### introduction of an energy levy to claw

### introduction of an energy levy to claw

### Key policy recommendations and measures
- Introduction of an energy levy to claw back part of the rents.
- Maintain energy levy and apply proceeds toward reducing upward pressures on electricity prices.
- Implement measures to reduce electricity system costs.
- Need to follow up on plans to further ease EPL, foster more effective wage bargaining (including by encouraging firm-level agreements and reducing survival periods), and strengthen activation policies.
- Complete ongoing negotiations with port concessionaires with a view to passing on labor cost reductions generated by the new Ports Work Law to end-users.

### Labor market and employment findings
- Unemployment rate (percent) and Employment (right scale, thousands) tracked from May-08 to May-14 show persistently high unemployment continues to present a significant challange.
- Activity has been gradually picking up with net exports remaining the most important driver of growth.
- Business confidence has improved, but firms are still cautious about their investment plans, and households are cautious about their consumption expenditures.

### External sector, trade, and confidence indicators
- Exports and Imports series (May-08 to May-14) with CA balance (12-month rolling sum; right scale) indicate net exports as a major growth driver.
- Business confidence (ESI, long-term average=100) and Household confidence (balance of opinions, right scale) tracked May-08 to May-14 show improvement but lingering caution.

### Inflation and price developments
- Inflation has been declining since 2013, driven partly by energy prices and appreciation of the euro.
- Underlying inflation—excluding commodity, administered prices, and VAT effects—is trending down and fluctuates at or below 1 percent.
- Negative inflation is not broad-based across product groups, but low inflation is.
- Labor costs have moderated gradually in 2013.
- Country Reforms Estimated price impact (selected examples):
  - Belgium: Gas and electricity reforms estimated impact about 0.6 pps and telecommunications about 0.1 pps in 2013.
  - France: Telecommunications estimated annual impact about 0.3 pps in 2013.
  - Italy: Gas price declined by 4.2 percent in 2013.
  - Greece: Minimum wage cut lowered by 22 percent (by 32 percent for youth); estimated impact on restaurant and canteens prices about 1/4 pps.

### Debt overhang, balance sheets, and leverage
- Indebtedness in the Euro Area (percent of GDP) displayed for Government, Non-financial corporates, Households across 2003, 2008, 2013.
- Public and private sector debt increased rapidly in the last decade in the stressed countries and the external position worsened.
- Household deleveraging has begun but has some way to go.
- Corporate leverage is high in countries where financing conditions are procyclical.
- Private sector balance sheet stress is weighing on output as all sectors de-lever simultaneously.
- Corporate Leverage in the Euro Area (NFC debt/equity ratio, percent) shows elevated levels in several countries.

### Financial market and banking sector developments
- Capital ratios have been rising and loan-to-deposit ratios falling across the euro area, but differences remain between the core and stressed economies.
- Credit supply is still contracting, and corporates have yet to begin deleveraging.
- Bank profitability has shown wide variability, improving in some core economies and Ireland and Spain, while deteriorating elsewhere.
- Loan loss provisioning rates have picked up across the euro area recently, with stressed economies like Italy and Spain showing a marked rise.
- Non-performing loans have also risen across the euro area, but more in stressed economies, acting as a drag on profitability.
- NPLs, profitability, and counterparty risk concerns may be contributing to falling interbank lending, which is seen across the euro area.
- Change in Return on Bank Assets (June 2012 to June 2013, annual percentage points) varies across countries.
- Loan Loss Provisioning (LLP) (Percent of pre-provisioning income, weighted by assets) and Non-Performing Loans (2008=100) series indicate deterioration in stressed economies.

### Comparisons with Japan and policy space
- In the euro area, policy rates were cut swiftly, but conventional space is now exhausted.
- In Japan, the BOJ started a substantial balance sheet expansion once expectations de-anchored; the ECB’s balance sheet has been shrinking.
- In Japan, investment recovered only after balance sheets were repaired; in the euro area, corporate leverage is lower, but incomplete and ongoing.
- Initial fiscal stimulus was stronger in the euro area, but there is less room going forward compared with Japan.
- In Japan, long-term inflation expectations declined only gradually; in the euro area, they have remained anchored so far.
- Banking reforms in Japan started late; credit picked up a few years later. In the euro area, banking sector reforms started earlier, but NPLs remain high.

### Fiscal developments and outlook
- Fiscal consolidation will slow down in 2014 with moderated adjustment envisaged in both core and periphery.
- The pro-cyclicality of fiscal policies has largely diminished and fiscal drag on growth is waning, while remaining elevated in many countries.
- Public debt is still expected to peak in 2014 before declining slowly.
- Euro area: Pace of fiscal consolidation, 2012-18 (% change in GG structural balance, percent of potential GDP) indicators show changes from Oct. 2013 WEO and Aprlil 2014 WEO.

### Statistical issues and methodological changes
- Significant progress has been made in implementation of the new international statistical standards: shifts to ESA 2010 and BPM6 are well on track.
- According to the current schedule:
  - The new set of national accounts under ESA 2010 will be compiled and disseminated from September 2014.
  - The new euro area BOP statistics in line with the BPM6 will be published from Q4 2014.
  - Monetary and financial statistics adaptations (e.g., interest rate, investment funds, financial vehicle corporations, securities issues) will become available in 2015.
- Expected benefits and changes:
  - Broadened data coverage and shorter transmission periods: national account aggregates transmission at t+60 days (rather than t+70 days); quarterly non-financial accounts by sector at t+85 days (instead of t+90 days).
  - Flash quarterly GDP estimates at T+30 days: Task Force started June 2013, intends to finalize by end of 2015; provided feasibility, a first T+30 flash estimate for Q1 2016 could be published.
  - More detailed analysis and presentation of pension schemes: compulsory supplementary table on pension entitlements required from 2017 to show liabilities of all pension schemes; under ESA 2010 unfunded pension obligations of general government will not be reported in the core financial accounts and will not impact the Maastricht debt.
  - Improved statistics and coverage of BOP data under BPM6, more detailed instrument detail and a comprehensive back-data release; quarterly geographical breakdown of the euro area international investment position will be available.
- Revisions to economic statistics:
  - Revisions of historical GDP components are expected to raise GDP estimates for most EU members, partially due to the capitalization of research and development (R&D) expenditure and military weapons.
  - The average impact of methodological changes (leaving aside statistical changes) on nominal EU GDP is expected to be an increase of 2.4 percent.
  - Inclusion of part of illegal activities is likely to raise GDP estimates for some countries.
  - Most methodological revisions are expected to affect GDP levels backwards with a limited impact on growth profile.

*Source: IMF country teams; figures and text extracted from EURO AREA POLICIES (INTERNATIONAL MONETARY FUND) content provided.*

### 4.      There are remarkable improvements in government finance statistics to enhance

### 4.      There are remarkable improvements in government finance statistics to enhance

### Enhanced fiscal data reporting
- The Enhanced Economic Governance Package (so called “Six Pack”) adopted in 2011 required adoption of measures for the collection and dissemination of monthly and quarterly fiscal data based on public accounts, and data on contingent liabilities for all general government subsectors.
- Eurostat established a Task Force on the implications of the Directive under the “Six Pack” on the collection and dissemination of fiscal data.
- By the end of 2013, countries brought into force the provisions necessary to comply with these requirements.
- Since February 2014, monthly fiscal data for central and state government and social security funds are publicly accessible for almost all countries on their national websites.
- A complete set of the general government accounts (including also local government) is available on a quarterly basis since end June 2014.
- Note on accounting basis: The monthly fiscal data are cash based in the majority of countries, but the link with the accrual ESA 95 accounts is explained in the explanatory notes and a reconciliation table.

### Planned publication of general government contingent liabilities
- National publication of annual data on contingent liabilities and other indicators with potential impact on fiscal deficit and/or debt will start from October 2014.
- Eurostat will collect and disseminate new comparable sets of data regarding contingent liabilities and potential obligations of general government, such as:
  - the amounts of guarantees,
  - the debt of public corporations,
  - nonperforming loans,
  - potential obligations under Public Private Partnerships.

### ECB’s role as single supervisor and expanded data collection
- In October 2013 a new EU regulation conferred to the ECB the sole responsibility for supervision of large banks in the euro area and in those EU member states that voluntarily adhere to the Single Supervisory Mechanism (SSM). (See EU regulation No. 1024/2013.)
- The ECB will collect supervisory data for the banking groups based on the harmonized Implementing Technical Standards (ITS) of the European Banking Authority, 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.
- Data is also to be transmitted directly from national supervisory authorities when the national central bank is not the supervisory authority.
- Since 2013 balance sheets of 246 monetary financial institutions (MFIs) are transmitted to the ECB on a monthly basis to support analysis of deposit and lending decisions and to provide insights into the sources of bank funding.
- Quarterly data on the activities of non-bank financial institutions are now collected by the ECB, including:
  - investment funds other than money market funds (including hedge funds),
  - financial vehicles engaged in securitization,
  - insurance companies and pension funds.
- A new dataset on securities holdings statistics is being collected by the ECB since end 2013 on the basis of the ECB Regulation concerning statistics on holdings of securities:
  - The new data contains security-by-security information on holdings of individual securities by institutional sectors.
  - A second module comprises security-by-security information on the holdings by each of the largest euro area banking groups (including securities held by their subsidiaries and branches, both inside and outside the euro area) identified as important for the stability and functioning of the financial system in the euro area and in each euro area country.
- 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.

### Survey on access to finance of SMEs in the euro area (SAFE)
- The ECB conducted the tenth semiannual survey on SME financing conditions, which provides evidence mainly on changes in the financial situation, financing needs, and access to financing from October 2013 to March 2014.
- The survey results suggest that financing conditions for SMEs continue to differ significantly across euro area countries and are in general more difficult than those of larger companies.
- Increasing quantitative coverage are to be expected in future surveys on firm characteristics including investment, export intensity, employees, and lending conditions such as interest rates, payment delays, and sources of financing.
- From 2014, a larger version of the survey which is conducted every second year together with the Commission will become annual.
- Sample size detail: The total euro area sample size was 7,520 firms, of which 6,969 (93 percent) had fewer than 250 employees.

### Improvements in statistics for the Macroeconomic Imbalances Procedure (MIP)
- The ESS and the ESCB cooperate closely to assure the quality of MIP relevant statistics.
- In July 2013 the Commission submitted a draft proposal for a regulation on the provision and quality of statistics for the MIP to the European Parliament.
- The aim of this proposal is to develop a robust quality monitoring procedure in order to ensure the highest quality of the MIP relevant data.
- The proposal is currently under discussion at working party meetings of the Council.

*IMF — Press Release No. 14/341, July 14, 2014 (excerpt).*

### 1.5 percent in 2015. Headline inflation is expected to remain below the ECB’s primary price

### _cr14198 - 1.5 percent in 2015. Headline inflation is expected to remain below the ECB’s primary price

### Summary assessment and risks
- Headline inflation is expected to remain below the ECB’s primary price objective for a protracted period, underscoring the risks from low inflation.
- Remaining structural gaps exist in capital, labor, and product markets, presenting hurdles to financing investment, intra-euro area rebalancing, and raising productivity.
- Risks to growth are tilted to the downside; further negative shocks—either domestic or external—could undermine financial market sentiment, halt the recovery, and push the economy into lower inflation and even deflation.
- External risks include a slowdown in emerging market growth, escalation of geopolitical conflict, and an abrupt exit from unconventional monetary policies in the United States.
- Over the medium term, there is a risk of stagnation from persistently depressed domestic demand due to deleveraging, insufficient policy action, and stalled structural reforms; improved confidence could raise growth above forecast levels.

### Executive Board assessment and collective priorities
- Directors welcomed strong policy actions at euro area and national levels that have propped up demand, eased financial conditions, and improved market sentiment and recovery prospects.
- Sustained, higher growth is needed to reduce unemployment and debt burdens in the euro area and to generate positive spillovers globally.
- Concerted efforts should focus on:
  - additional demand support;
  - completion of bank balance sheet repair and of a banking union;
  - further advancement of structural reforms.
- Directors underscored the importance of continued collective commitment to completing the architecture of the Economic and Monetary Union.
- Directors welcomed ECB exceptional measures to address low inflation and its willingness to use further unconventional instruments; agreed that if inflation remains too low, consideration could be given to a large-scale asset purchase program, primarily of sovereign assets.
- Directors considered the neutral area-wide fiscal stance broadly appropriate, while urging national fiscal policies to support growth where space permits and to adhere to medium-term objectives of reducing public debt-to-GDP ratios.
- Recommendation to use escape clauses in the fiscal framework if deflation risks materialize and monetary policy options are depleted.
- Directors underlined urgency of repairing bank balance sheets and reducing financial fragmentation; saw merit in maintaining some flexibility on recapitalization timetable to account for market conditions and stability concerns.
- A common fiscal backstop would decisively sever bank-sovereign links and enhance the credibility of the ECB’s Comprehensive Assessment (AQR) and stress tests.
- Priority structural reform areas identified by Directors:
  - diversifying funding markets through securitization, especially to credit-constrained smaller firms;
  - removing country-specific structural impediments to tackle high youth unemployment;
  - higher public investment in creditor countries and competitiveness-enhancing reforms in debtor countries;
  - improving labor market functioning and increasing competition in product and services sectors to support implementation of the Services Directive, free trade agreements, and energy market integration.

### Monetary policy and price stability outlook (authorities’ view)
- Current inflation: 0.5% in May 2014 and 0.5% in June 2014 (flash estimate).
- Inflation expected to remain at low levels over the coming months, increasing only gradually during 2015 and 2016.
- Inflation expectations over the medium to long term are firmly anchored in line with the ECB’s aim to maintain inflation rates at levels below, but close to, 2% over the medium term.
- ECB measures taken:
  - Cut in key ECB interest rates in November; comprehensive monetary policy package in early June.
  - Introduction of a negative rate on the deposit facility now standing at -0.10%.
  - Longer-term refinancing operations targeted to support bank lending to the non-financial private sector.
  - Preparatory work related to outright purchases in the ABS market.
  - All refinancing operations to be conducted as fixed rate tender procedures with full allotment at least until end 2016.
  - Weekly operations sterilising the liquidity injected under the SMP have been suspended.
- ECB stance: maintain high degree of monetary accommodation and keep key ECB interest rates at present levels for an extended period; stands ready to use further unconventional instruments within its mandate if necessary.
- Expected effect: measures should contribute to a return of inflation to levels closer to 2% and provide impetus to an expansion of loans to the real economy.

### Fiscal policy guidance (authorities’ view)
- Authorities agree current fiscal stance for the euro area is appropriate; possibilities offered by the EU's existing fiscal framework should be used to balance fiscal discipline with the need to support growth.
- Given persistently high debt and unemployment, low nominal GDP growth, ageing society challenges, and need to support job creation (particularly for the young), fiscal consolidation must continue in a growth-friendly and differentiated manner.
- Structural reforms that enhance growth and improve fiscal sustainability should be prioritized alongside appropriate assessment of fiscal measures and structural reforms, making best use of the flexibility built into the Stability and Growth Pact (SGP).
- Authorities stress the Fund should take legal Treaty requirements into account when assessing governance changes; substantial progress achieved in improving the SGP and methodology to interpret fiscal effort and structural indicators.
- Composition of fiscal consolidation is important to ensure growth-friendly adjustment; credible implementation and enforcement in Member States is essential.

### Financial markets, fragmentation, and banking union
- Financial crisis led to unwarranted fragmentation of financial markets and revealed overreliance on bank lending.
- Progress toward banking union expected to reduce fragmentation, overcome home bias among banks, diversify risk, and rekindle cross-border lending.
- Debt overhang in the private sector constrains growth; authorities welcome recommendations to improve national insolvency regimes.
- Authorities support development of capital markets options for corporate financing, particularly for SMEs, and welcome EIB/EIF support and initiatives (e.g., European Commission-EIB SME Initiative).
- Proposals to explore include:
  - creation of a European High Quality Securitisation market;
  - enhancing data transparency for SMEs to facilitate capital markets access;
  - enhancing market for corporate private placements on a European scale;
  - widening existing EIB-EIF program for SME securitisation.
- ECB Comprehensive Assessment (AQR) and subsequent EBA stress test are on track and should reinforce banking system soundness.
- ESM instruments, including a new direct recapitalisation instrument, will be available when needed for eligible Member States.
- Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM) will further reduce fragmentation and enhance resilience.
- SRM arrangements:
  - SRM Regulation introduces centralised decision making and establishes the Single Resolution Fund (SRF).
  - Transition period for bridge financing: 1 January 2016 to 31 December 2023; bridge financing available from national sources backed by bank levies or from the ESM in line with agreed procedures.
  - A common backstop will be developed during the transition period.
  - Resolution funds can be used only after a minimum bail-in of no less than 8% of total liabilities, including own funds, of the institution under resolution; resolution funds are not meant to be a financing mechanism for bank capital.

### Advancing structural reforms and labor markets
- Structural reforms needed to address weak medium-term prospects, foster job creation (particularly youth unemployment), and boost potential growth.
- As financing conditions improve, structural drivers become more important in the medium term.
- Sustained efforts required to implement structural reform measures in labor and product markets to strengthen potential growth and ensure continued external rebalancing.
- Debtor countries need to further improve or sustain current account balances to reduce external sustainability risks; creditor countries with large surpluses need policies to increase demand and potential growth, particularly to support investment.
- Authorities’ initiatives to tackle youth unemployment include reformed vocational education training, revised apprenticeship frameworks, targeted hiring incentives, reformed public employment services, and reformed EPL systems; financing provided through EU structural funds (the "Youth Guarantee Scheme"), subject to European Commission assessment.
- Completion of the Single Market remains central; full implementation of the Services Directive could lead to an additional economic gain of about 2.6% EU GDP in the long term (European Commission estimate).
- Further integration of energy markets is important; improving interconnection of national gas networks and electricity grids both highlighted as crucial.
- Policy advice under the European Semester emphasizes:
  - liberalising the services sector;
  - reducing the tax wedge on labour;
  - improving framework conditions for growth and jobs (including ICT industries and competition framework);
  - improving quality of research and innovation systems and prioritising R&D efforts;
  - investing more in R&D, innovation, education, skills, active labour market policies, energy, transport, and the digital economy.
- Authorities committed to respect country-specific policy recommendations endorsed in June under the European Semester.

### Key economic indicators (selected figures preserved exactly as presented)
- Real GDP: 1.6 (2011), -0.7 (2012), -0.4 (2013), 1.1 (2014), 1.5 (2015), 1.7 (2016)
- Private consumption: 0.3, -1.3, -0.7, 0.6, 1.1, 1.3
- Public consumption: -0.1, -0.6, 0.1, 0.3, 0.3, 0.4
- Gross fixed investment: 1.6, -4.0, -2.9, 1.6, 2.7, 2.8
- Final domestic demand: 0.5, -1.7, -0.9, 0.7, 1.2, 1.4
- Exports: 6.5, 2.5, 1.4, 3.9, 4.5, 4.9
- Imports: 4.5, -0.9, 0.4, 3.4, 4.1, 4.7
- Potential GDP: 0.6, 0.4, 0.6, 0.8, 1.0, 1.1
- Output gap: -0.8, -1.8, -2.8, -2.5, -2.0, -1.4
- Employment: 0.3, -0.6, -0.8, 0.3, 0.7, 0.9
- Unemployment rate: 10.1, 11.3, 12.0, 11.7, 11.4, 10.8
- GDP deflator: 1.2, 1.3, 1.5, 1.1, 1.4, 1.4
- Consumer prices: 2.7, 2.5, 1.3, 0.7, 1.2, 1.3
- General government balance: -4.1, -3.7, -3.0, -2.7, -2.1, -1.5
- General government structural balance: -3.7, -2.3, -1.3, -1.2, -0.9, -0.6
- General government gross debt: 88.2, 92.9, 95.2, 95.9, 94.9, 93.2
- Current account balance: 0.1, 1.3, 2.2, 2.3, 2.5, 2.5
- EURIBOR 3-month offered rate: 1.4, 0.2, 0.3, 0.3
- 10-year government benchmark bond yield: 4.3, 2.3, 3.3, 2.6
- U.S. dollar per euro: 1.39, 1.30, 1.37, 1.37
- Nominal effective rate (2000=100): 104.2, 99.8, 108.5, 108.6
- Real effective rate (2000=100): 95.0, 90.2, 96.1, 95.3

*Prepared from the IMF staff report and the authorities' statement contained in the source content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14198.pdf_