## _cr14216 ## Source details **Canonical URL:** [_cr14216](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14216.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14216.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14216.pdf.json) --- ### Energiewende — objectives, progress, and challenges - Objectives and targets - Full phase-out of nuclear power by 2022. - National targets for 2020: - Reducing carbon emissions by 40 percent relative to their 1990 level. - Reducing primary energy consumption by 20 percent relative to 2008. - Increasing the share of renewable energy (RE) in electricity consumption by 35 percent. - Equally ambitious targets set for 2050. - Progress and key metrics - In 2013, 24 percent of electricity came from renewable energy (RE). - Greenhouse emissions were lowered by 25 percent in 2012 relative to 1990 levels. - Primary energy consumption decreased by one percent (2012→2013) after adjustments. - RE surcharge increased from 1.1 cents/kWh in 2008 to 6.24 cents/kWh in 2014. - Main challenges and economic implications - Controlling costs: FITs (feed-in tariffs) funded by a surcharge have driven rapid RE growth and contributed to German electricity prices being among the highest in Europe. - Exemptions for energy-intensive internationally active firms transfer costs to households and SMEs. - Preserving conventional capacity: RE intermittency requires sizable conventional capacity; preferential grid access for RE has reduced conventional producers’ profitability. - CO2 emissions: despite RE expansion, CO2 emissions rose last year as conventional producers relied more on brown coal. - Distributional and competition concerns: subsidy exemptions raised concerns with the EU competition authority. - Grid, regional, and access concerns - Rapid RE capacity increase in the North has outpaced grid expansion; nuclear reductions in the South increase reliance on imports from the North. - Network expansion delayed partly due to public opposition, raising risk of transmission bottlenecks. - Southern industrial users may face difficulties accessing Northern RE while grid expansion lags. - Economic and sectoral consequences summarized - Renewable generation share: 24 percent of electricity production (2013). - RE surcharge: 6.24 cents/kWh in 2014. - Conventional producers’ profitability under pressure; increased reliance on brown coal contributed to a surge in CO2 emissions. - Exemptions shift costs to households and SMEs and raised EU competition concerns. - Grid expansion delays risk regional bottlenecks and constrained access for southern industrial users. ### Outlook and projections (growth, inflation, investment) - Baseline projections - Output expected to increase by 1.9 percent this year and 1.7 percent in the next. - Inflation expected to pick up to 1.4 percent in 2015. - Average German inflation to exceed that in the rest of the euro area throughout the projection horizon. - Investment expected to rebound, notably construction investment. - Private consumption supported by healthy labor market, high immigration, stronger wage growth, and healthy balance sheets. - Key risk factors to the baseline - Investment recovery sensitive to policy uncertainty; renewed policy uncertainty could weaken business investment. - External demand risk: exports-to-GDP ratio over 50 percent and value-added goods exports-to-GDP over 30 percent; model suggests each 1 percentage point temporary decline in domestic demand in Emerging Asia reduces German growth by about 0.1 percentage point. - Prolonged slower growth in euro area, advanced economies, or emerging markets could widen the output gap—automatic stabilizers should operate and proactive fiscal policies deployed if unemployment rises rapidly. - Geopolitical risk (Ukraine-Russia): heavy dependence on Russian oil and gas (40 percent of total consumption) makes Germany vulnerable to energy supply disruptions. ### Authorities’ measures, staff assessment, and policy guidance - New government measures - Increases in pension benefits and other spending priorities; new national minimum wage. - Coalition treaty envisages balanced federal budget in 2015 and no new general taxes. - Additional federal government spending: 0.2 percent of GDP per year (€23 billion over 2014–17) for infrastructure, education, childcare, and other priorities. - Pension package: 0.3 percent of GDP per year for higher benefits for mothers of children born before 1992 and more generous early retirement benefits. - New national minimum wage of €8.50 per hour starting in 2015 with exemptions and transitional arrangements. - Staff assessment and recommendations - Pension measures viewed as partial roll-back of previous reforms; higher benefits for mothers born before 1992 are costly and not targeted to lower-income pensioners. - Early retirement measures may reduce older workers’ labor force participation and worsen skills shortages. - Additional social spending risks higher social contribution rates, reduced benefits, or subsidies from general tax resources; periodic fiscal reviews recommended. - Minimum wage likely binding for about 10 percent of workers nationally and for 15–20 percent in some federal states; may exacerbate unemployment in some regions and among the low skilled. - Decisions on minimum wage adjustments should consider employment effects; staff concerned the envisaged commission may not represent the unemployed or sectors with low trade union representation. - Strengthening household surveys recommended to properly assess policy effects. ### Current account, investment, public investment case, and services reform - Current account (CA) and REER assessments - CA surplus: 7½ percent of GDP in 2013; cyclically adjusted surplus around 8¼ percent of GDP. - Model-based norm: 2½ percent of GDP for cyclically adjusted CA; staff assesses norm at 2¼–5¼ percent of GDP. - Cyclically adjusted CA is 3–6 percent of GDP stronger than implied by fundamentals and desirable policies. - REER assessment: model-based implausible 11 percent overvaluation in 2013; alternative metrics indicate REER undervaluation of 0 to 10 percent; staff assessment of REER undervaluation of 5–15 percent. - Outlook for the CA - CA surplus expected to decline gradually to some 5¾ percent of GDP in 2019. - About half of the gap (some ½–3½ percentage points of GDP) expected to persist in the medium term. - Public investment case and recommended program - Public investment is the second lowest in the OECD; net public investment negative since 2003. - Independent studies place transport investment needs at 0.2–0.4 percent of GDP per year. - Government envisaged boost: €5 billion over four years (~0.2 percent of 2013 GDP) — judged small relative to needs. - Germany has fiscal space to finance an increase in public investment of some 0.5 percent of GDP per year over four years. - With projected structural surpluses of 0.2–0.5 percent of GDP (general government) and 0.1 percent at federal level over 2015–18, the proposed additional investment could comply with fiscal rules. - Such an investment program estimated to yield a persistent increase in GDP of ¾ percent and temporarily reduce the CA surplus by 0.4 percentage points of GDP. - Regional spillovers: peak GDP effects in GIIPS and OEA countries of 0.3 and 0.4 percent respectively. - Services sector reforms - Targets: professional services (exclusive rights, compulsory chamber membership, pricing regulation), rail and postal services (reinforce regulator’s powers), retail sector (restrictions on large outlets and licensing). - Illustrative effects: reducing price mark-ups in nontradable private services by cumulative 2 percentage points over 4 years would raise average growth over four years by 0.1 percent and reduce the CA surplus by 0.2 percentage point of GDP. - Similar effects if nontradable-sector productivity rose by 0.1 percent per year. ### Energy uncertainty, investment needs, and illustrative macro effects - Investment needs and uncertainty - Investment needed to upgrade energy production, storage, and transmission infrastructure estimated at 1-1½ percent of GDP per year until 2020. - Uncertainty about energy costs and policy framework discouraging investment. - Slower transmission infrastructure expansion and project implementation noted. - Illustrative simulation of resolving uncertainty - Additional private investment of 0.5 percent of GDP over four years could: - raise GDP by 0.5 percentage point, - lower the current account balance by 0.3 percent of GDP, - yield positive regional spillovers. - Authorities’ energy policy stance - Cabinet-approved reform proposal would maintain targets, moderate growth in new RE generation capacity, and gradually transition to more market-oriented RE financial support mechanisms. - Revised European Commission state aid guidelines allow continued surcharge reductions for large energy users competing internationally at least until 2020. - Authorities acknowledge residual uncertainty about long-run exemption regime, conventional power producers’ profitability, and obstacles to grid expansion amid local opposition. ### Housing market, macroprudential readiness, and low interest rate implications - Housing market - Housing prices increased by 18 percent over the past five years (5 percent in 2013). - Bundesbank estimates apartments in selected large cities overvalued by up to 25 percent. - Main drivers: lack of attractive domestic alternatives, stronger immigration, foreign investor demand, lags in supply response. - Recommendation: ready macroprudential toolkit now; suggested instruments include loan-to-value and debt-service-to-income limits and stepped-up monitoring. - Low interest rates — household, banking, and insurance impacts - Households’ financial assets almost doubled since 1995; increasing share in age-related saving products, currency, and deposits earning low yields. - Banking sector: pressure on interest margins weakens profitability; weaker institutions more vulnerable; shifts to riskier portfolios should be monitored. - Life insurers: strong liquidity but long-term solvency risk due to high guaranteed rates and duration gap; policy options include amending rules on sharing valuation reserves with policyholders. - Insolvency of several mid-sized life insurers unlikely to be highly systemic but could have bank financing spillovers. ### Financial regulatory transitions, ECB Comprehensive Assessment, and resolution stance - Regulatory and supervisory transitions - EU-driven changes include capital, leverage, liquidity requirements, recovery and resolution, Single Supervisory Mechanism (SSM), and Single Resolution Mechanism. - Domestically systemic banks submitted first drafts of recovery plans; supervisors surveying bail-inable liabilities. - BaFin and the Bundesbank to be part of joint supervisory teams under ECB supervision. - ECB Comprehensive Assessment - 20 percent of banks included are German; about 1600 auditors reviewing portfolios representing over 50 percent of these banks’ risk-weighted assets. - Assessed banks and supervisors discussing capital plans; some large banks raising fresh equity. - Resolution and recapitalization views - Authorities intend to make bail-in tool immediately available when transposing BRRD. - Support for introducing leverage ratio as complement to risk-based capital ratios; reporting to precede binding measure in 2018. - Recapitalization support to viable banks only after burden-sharing with junior bondholders as required by EU state aid law. - ESM involvement conceived as a loan to a member state for recapitalization. ### Minimum wage — characteristics, staff concerns, and policy implications - Staff concerns - Minimum wage level of €8.50 per hour is high relative to current wages in parts of Germany; may lead to sizable unemployment concentrated in some regions and groups. - Socio-economic panel survey (2011): 4–6 million workers earn less than the proposed minimum wage; about 1.3 million qualify for social assistance (in-work benefits). - Minimum wage likely to be binding for about 20 percent of workers in some federal states; may have sizable adverse effects where unemployment is already high. - Without changes to in-work benefits, effects on real disposable income likely limited because some workers will lose employment and others will see in-work benefits decline. - Expert studies suggest modest effects on wage bill and aggregate demand; wages in export sector are well above proposed minimum, so external competitiveness unlikely to be affected. - Characteristics of low wage earners (Percent, 2011) - Region: West 15; East (including Berlin) 27. - Employment status: Full-time employees 10; Part-time employees 18; Marginally employed/mini jobs 54. - Gender: Male 12; Female 21. - Total employed 17. - Policy implications - Commission deciding future minimum wage levels should take employment effects into account and consider interests of those not well represented by employers’ and employees’ associations. - Exploration of alternative redistribution measures recommended. ### Risk Assessment Matrix — major risks, likelihood, impact, and responses - I. Weaker investment recovery: Relative likelihood M; Impact M; Policy response: allow automatic stabilizers, use proactive fiscal policies if labor market weakens. - II. Protracted slower growth globally: Relative likelihood H; Impact M. - III. Geopolitical tensions Russia-Ukraine: Relative likelihood M; Impact M; Policy response: accelerate energy strategy implementation if necessary. Exposure: gas 40 percent of total consumption. - IV. Global and regional financial instability: Relative likelihood H; Impact M; Policy response: increase capital buffers. - V. Medium-term distortions from low interest rates: Relative likelihood L; Impact M; Policy response: strengthen macroprudential framework and prudential supervision; require higher insurers’ reserves. ### Key macroeconomic indicators and medium-term projections (selected exact series) - Demographics and income - Total population (2013, million): 80.8 - GDP per capita (2013, USD): 44,999 - GDP growth (percentage change) — 2010 2011 2012 2013 2014 1/2015 1/: - GDP: 3.9 3.4 0.9 0.5 1.9 1.7 - Output gap (In percent of potential GDP) — 2010 2011 2012 2013 2014 1/2015 1/: - Output gap: -1.2 0.9 0.4 -0.6 -0.3 0.1 - Labor market (millions or percent) - Labor force: 41.7 42.2 42.4 42.7 43.0 43.3 - Employment: 38.7 39.7 40.1 40.5 40.7 40.9 - Unemployment: 2.9 2.5 2.3 2.3 2.3 2.4 - Unemployment rate (in percent): 7.1 6.0 5.5 5.3 5.3 5.4 - Prices and incomes (percentage change) - GDP deflator: 1.0 1.2 1.5 2.2 1.7 1.7 - Consumer price index (harmonized): 1.2 2.5 2.1 1.6 1.1 1.4 - External sector (selected) - Current account (in billions): 226.1 196.0 211.4 248.3 255.3 273.5 273.3 274.6 - Current account (in percent of GDP): 6.2 5.9 6.4 6.8 7.4 7.5 7.0 6.7 - General government operations (selected projections, percent of GDP) - Revenue (2011–2019): 44.3 44.8 44.7 44.4 44.2 44.1 44.1 44.0 44.0 - Expense (2011–2019): 45.2 44.9 44.6 44.3 44.0 43.8 43.7 43.6 43.6 - Net lending/borrowing (2011–2019): -0.8 0.1 0.2 0.2 0.2 0.4 0.4 0.5 0.5 - Public gross debt (Maastricht, 2011–2019): 80.0 81.0 78.4 75.1 71.8 68.8 65.8 62.9 60.1 - Medium-term projections (real sector and external balances, 2010–2019) - Real GDP: 3.9 3.4 0.9 0.5 1.9 1.7 1.5 1.4 1.4 1.3 - Consumer prices: 1.2 2.5 2.1 1.6 1.1 1.4 1.6 1.7 1.7 1.7 - Current account balance (percent of GDP): 6.4 6.8 7.4 7.5 7.0 6.7 6.4 6.0 5.9 5.7 ### Public Debt Sustainability Analysis — baseline, risks, and stress tests - Overall assessment - Public debt expected to remain sustainable reflecting ongoing primary surpluses and favorable interest rate-growth differential. - Baseline projections and outlook - Public debt-to-GDP ratio forecast to decline steadily to close to 60 percent in the medium term from current level of 78.4 percent. - Gross financing needs expected to reduce to about 13 percent of GDP in 2019. - Main risks - Negative growth shock is largest risk; contingent liabilities from bank recapitalization or winding-down institutions could increase debt trajectory by about 3 percent of GDP before declining. - Forecast accuracy and bias - Median forecast error for output (real GDP growth): 0.63 percent. - Median forecast error for inflation (GDP deflator): 0.14 percent. - Median forecast error for primary balance: 1.55 percent of GDP. - Stress-test design (selected shocks) - Growth shock: real output growth lower by one standard deviation over 2015-2016 (2.7 percentage points relative to baseline). - Primary balance shock: cumulative 1.6% deterioration in primary balance over 2015-2016. - Interest rate shock: 300 basis points increase in cost of debt. - Contingent fiscal shock: cumulative 3 percent of GDP (~€80 billion) additional support for financial sector over 2015-2016 (breakdown: €50 billion banking recapitalization, €20 billion half of capital shield guarantees, €10 billion worse performance of winding-down portfolios). - Selected DSA numeric projections (2012–2019 series where shown) - Nominal gross public debt: 70.7 81.0 78.4 75 72 69 66 63 60 - Public gross financing needs: 16.6 16.3 15.6 15.4 14.8 14.5 14.0 13.4 13.4 - Real GDP growth (in percent): 1.3 0.9 0.5 1.9 1.7 1.5 1.4 1.4 1.3 - Effective interest rate (in percent): 4.2 3.1 2.6 2.6 2.5 2.5 2.6 2.8 2.9 - Stress test outcomes - Under baseline and most single-shock scenarios, gross nominal public debt declines from 2014 through 2019. - Under Real GDP Growth Shock and Combined Macro-Fiscal Shock, gross nominal public debt initially increases before declining. - Public gross financing needs remain at or below 20 percent of GDP across scenarios. ### Executive Board assessment and policy recommendations (selected) - Directors commended authorities for prudence and European integration commitment. - Recommended priorities: - Strengthen domestic growth sources, promote private investment, and reduce current account surplus. - Use fiscal space to boost public investment in projects with true economic value while adhering to fiscal rules. - Increase competition in product markets and address energy sector challenges to encourage private investment. - Improve productivity and reduce barriers in services sector. - Implement the national minimum wage cautiously; explore well-targeted redistribution to raise labor market participation and minimize fiscal costs. - Encourage banks to build capital buffers ahead of the ECB Comprehensive Assessment. - Remain vigilant on housing market and insurance sector; enhance macroprudential toolkit. *Source: IMF staff report content provided in the supplied content unit.* ### 1. Energiewende _________________________________________________________________________________ 14 ### 1. Energiewende ### Objectives and targets - Full phase-out of nuclear power by 2022 (policy modified after the 2011 Fukushima disaster). - National targets for 2020 (going beyond EU requirements): - Reducing carbon emissions by 40 percent relative to their 1990 level. - Reducing primary energy consumption by 20 percent relative to 2008. - Increasing the share of renewable energy (RE) in electricity consumption by 35 percent. - Equally ambitious targets set for 2050. ### Progress and key metrics - In 2013, 24 percent of electricity came from renewable energy (RE), making it the second largest source of electricity after brown coal (lignite). - Greenhouse emissions were lowered by 25 percent in 2012 relative to 1990 levels. - Adjusted for inventory and temperature effects, primary energy consumption decreased by one percent compared to the previous year (2012→2013). - RE surcharge (used to fund feed-in tariffs) increased from 1.1 cents/kWh in 2008 to 6.24 cents/kWh in 2014. ### Main challenges and economic implications - Controlling costs: - Rapid RE growth has been mainly promoted through feed-in tariffs (FITs) guaranteeing sale prices (usually for 20 years). - FITs are funded by a surcharge passed onto consumers; the surcharge rose from 1.1 cents/kWh in 2008 to 6.24 cents/kWh in 2014, contributing to German electricity prices being among the highest in Europe. - Energy-intensive internationally active firms in certain sectors are eligible for surcharge reductions (exemptions); the cost of these exemptions is borne by other users (households and SMEs). - Preserving conventional capacity: - RE’s intermittency implies sizable conventional capacity must be preserved to complement it. - Preferential grid access for RE has reduced profitability of conventional producers, threatening preservation of needed capacity. - Reducing CO2 emissions: - Despite RE expansion, CO2 emissions rose last year as conventional producers increasingly relied on cheaper brown coal rather than nuclear power or natural gas. - Distributional and competition concerns: - Subsidy exemptions for large, energy-intensive firms have shifted burdens onto other users and raised concerns with the EU competition authority. ### Grid, regional, and access concerns - Facilitating grid expansion: - Rapid RE capacity increase in the North has outpaced grid expansion. - Planned reductions in nuclear capacity in the more industrial South heighten reliance on imports of RE generation from the North. - Network expansion has proceeded slowly in part because of public opposition to projects, raising concerns about potential transmission bottlenecks. - Regional industrial impacts: - Industrial users in the South may face difficulties accessing RE capacity located in the North while grid expansion lags. ### Economic and sectoral consequences summarized - Renewable generation share has surged to 24 percent of electricity production (2013). - Electricity prices have become among the highest in Europe due in part to the rising RE surcharge (6.24 cents/kWh in 2014). - Conventional electricity producers’ profitability is under pressure; increased reliance on brown coal has contributed to a surge in CO2 emissions. - Exemptions for energy-intensive firms shift costs to households and SMEs and have raised EU competition concerns. - Grid expansion delays risk regional bottlenecks and constrained access for southern industrial users. *Source: IMF staff report excerpt on "Energiewende" (provided content).* ### 8. A moderate pace of growth is expected to continue. Given favorable domestic financial ### 8. A moderate pace of growth is expected to continue. Given favorable domestic financial ### Outlook and projections - Output is expected to increase by 1.9 percent this year and 1.7 percent in the next, resulting in a slightly positive output gap. - Inflation is expected to pick up to 1.4 percent in 2015 after a subdued pace this year, as the commodity price downdraft fades and the output gap closes. - Throughout the projection horizon, the average rate of German inflation will exceed that in the rest of the euro area. - Investment is expected to rebound — particularly construction investment, buoyed by rising housing prices — contributing significantly to domestic demand. - Private consumption growth should continue to benefit from the healthy labor market, high immigration, stronger wage growth, and healthy balance sheets, though low interest rates may lead to stepped up saving for retirement. ### Key risk factors to the baseline - Investment recovery is a critical risk: investment is highly sensitive to policy uncertainty, notably over euro area–wide policies; indexes of policy uncertainty have declined noticeably in the last year, supporting a rebound in investment, but renewed policy uncertainty could weaken business investment and hurt growth. - External demand risk: Given exports-to-GDP ratio over 50 percent and value-added goods exports-to-GDP over 30 percent, Germany is highly susceptible to global recovery prospects. Model-based simulations suggest that each 1 percentage point temporary decline in domestic demand in Emerging Asia would drag down German growth by about 0.1 percentage point. - Prolonged slower growth in the euro area, other advanced economies, or emerging markets could widen the output gap; automatic stabilizers should be allowed to operate fully, and in case of significant slowdown and rapidly rising unemployment, proactive fiscal policies would be needed. - Geopolitical risk (Ukraine-Russia): escalation would hit Germany indirectly through disruptions to Central European supply chains and could trigger safe haven inflows; in a tail risk scenario with disruptions in energy supply, Germany would be strongly affected because of its heavy dependence on Russian oil and, especially, gas (40 percent of total consumption). ### Authorities’ views on outlook and risks - Authorities agreed with staff that the moderate expansion should continue and were more upbeat than staff about the strength of domestic demand, especially private investment in 2015. - Authorities expect wage growth to strengthen in 2014-15 and support consumption, and they forecast inflation reaching around 1.9 percent in 2016 due to a positive output gap and the introduction of the minimum wage. - Authorities saw risks as generally balanced: upside that expansion may be underestimated; downside that a worsening geopolitical situation in Ukraine is a serious tail risk; re-emergence of a euro area crisis seen as less likely in the current conjuncture; persistently low growth in advanced economies viewed as a medium-term risk. ### Policy discussions — overall guidance - Policies should focus on increasing growth in Germany in ways that also support the recovery in the euro area. - Higher public and private investment and services sector reform in Germany would raise medium-term output, help reduce the large and persistent current account surplus, and generate appreciable positive demand spillovers to the rest of the euro area. A. New government measures and assessment - New government package includes increases in pension benefits, other spending priorities, and a new national minimum wage. - Coalition treaty envisages a balanced federal budget in 2015 and no new general taxes; planned declines in social security contribution rates will be foregone and long-term care contribution rates will be raised slightly. - New federal government additional spending: 0.2 percent of GDP per year (€23 billion over 2014–17) for infrastructure, education, childcare, and other priorities; financed by eliminating federal government surpluses that would have been achieved without the new measures. - This additional spending will still leave the federal government with a margin of about 0.5 percent of GDP per year within the debt brake rule (which requires the federal structural deficit not to exceed 0.35 of GDP beginning in 2016), while the debt stock will remain on a declining path. - Package on pensions: 0.3 percent of GDP per year, including higher benefits for mothers of children born before 1992 and more generous early retirement benefits for workers with long contribution periods; financed by additional subsidies from the federal government and by foregoing the reduction in social security contributions. - New national minimum wage of €8.50 per hour to be introduced starting in 2015 with certain exemptions and transitional arrangements. A. Staff assessment and recommendations on new measures - Pension measures are a partial roll-back of previous reforms; higher pension benefits for mothers born before 1992 are particularly costly and do not specifically target lower-income pensioners. - Early retirement measures may reduce older workers’ labor market participation and add to skills shortages in some sectors. - As social security funds need to be financially balanced, additional spending could require an increase in already high social contribution rates, reduced benefits for other pensioners, or subsidies from general tax resources. - Given high uncertainty on take-up of new benefits, periodic reviews of fiscal costs and adverse impact on labor participation rates are highly recommended. - Minimum wage likely to be binding for some 10 percent of workers nationally, but for 15-20 percent of workers in some federal states mostly in the East; may exacerbate unemployment in some regions and among the low skilled. - Decisions on future minimum wage adjustments should take employment effects into account; the draft law envisages adjustments decided by a commission of employers’ organizations and trade unions with two non-voting academic advisors — staff expressed concern the commission may not sufficiently represent the unemployed or sectors with low trade union representation. - Household surveys might need to be strengthened to ensure policy effects can be properly assessed over time. B. Current account, investment, and regional spillovers - Current account (CA) surplus was 7½ percent of GDP in 2013, corresponding to an estimated cyclically adjusted surplus of around 8¼ percent of GDP. - A model-based analysis indicates a norm of 2½ percent of GDP for the cyclically adjusted CA balance; staff assesses the norm at 2¼–5¼ percent of GDP. - Thus, the cyclically adjusted CA is 3–6 percent of GDP stronger than that implied by fundamentals and desirable policies. - REER assessment: model-based estimates give an implausible 11 percent overvaluation in 2013; alternative metrics suggest a REER undervaluation of 0 to 10 percent; based on trade elasticity, CA gap implies misalignment of 9–18 percent; staff assessment of REER undervaluation of 5–15 percent. Outlook for the CA and role for German policy - In the baseline forecast, the CA surplus is expected to decline gradually to some 5¾ percent of GDP in 2019 reflecting gradual rebalancing of relative labor costs within the euro area, a recovery of investment in Germany, and a partial return of corporate savings to more normal levels. - About half of the gap (some ½–3½ percentage points of GDP) is expected to persist in the medium term. - Germany could play a stronger role to help regional rebalancing by durably increasing its output while generating positive outward demand spillovers and reducing the current account surplus. Public investment case and recommended program - Public investment in Germany is the second lowest in the OECD; net public investment has been negative since 2003. - Independent studies place transport investment needs at 0.2–0.4 percent of GDP per year. - Government envisaged boost: €5 billion over four years, or about 0.2 percent of 2013 GDP — considered small relative to estimated needs. - Germany has the fiscal space to finance an increase in public investment of some 0.5 percent of GDP per year over four years. - With projected structural surpluses of 0.2–0.5 percent of GDP at the general government level and of 0.1 percent at the federal government level over 2015–18, the proposed additional investment spending could be phased out to comply with the Medium-Term Objective of the Fiscal Compact (0.5 structural deficit for the general government) and the domestic debt brake rule (0.35 structural deficit for the federal government beginning in 2016). - Such an investment program would yield a persistent increase in GDP of ¾ percent and temporarily reduce the current account surplus by 0.4 percentage points of GDP. - Regional spillovers with accommodative monetary policy: peak GDP effects in GIIPS and OEA countries of 0.3 and 0.4 percent respectively, varying by trade linkages. - The increase in the debt-to-GDP ratio in Germany would be minimal given the growth offset. Implementation considerations - A 0.5 percent of GDP increase is large relative to current total public investment of 1.6 percent of GDP and would be challenging but feasible; many needs identified and much of the program would involve maintenance/refurbishing of existing infrastructure. - Involving the private sector through public-private partnerships may be appropriate; channeling resources to sub-national entities (municipalities) will need to be pursued. Services sector reforms to boost rebalancing - Further reducing barriers to competition in several services areas could increase productivity and reduce the current account surplus. - Targets include professional services (exclusive rights, compulsory chamber membership, regulation on prices and fees), rail transportation and postal services (reinforcing regulator’s powers to stop discrimination), and retail sector (restrictions on large outlets and professional body involvement in licensing). - Illustrative effects: reforms that reduce price mark-ups in nontradable private sector services by a cumulative 2 percentage points over 4 years would raise average growth over a four-year period by 0.1 percent, and reduce the current account surplus by 0.2 percentage point of GDP. - Similar results would follow if more competition boosted nontradable-sector productivity by 0.1 percent per year. *GERMANY — INTERNATIONAL MONETARY FUND.* ### 25. A reduction in uncertainty about energy costs would also stimulate private ### _cr14216 - 25. A reduction in uncertainty about energy costs would also stimulate private ### Energy uncertainty, investment needs, and macroeconomic effects - Surveys indicate that uncertainty about energy costs and the overall energy policy framework is discouraging investment. - Investment needed to upgrade the energy production, storage, and transmission infrastructure is estimated at 1-1½ percent of GDP per year until 2020. - Several factors have slowed the pace of transmission infrastructure expansion and the implementation of related projects. - An earlier resolution of uncertainty associated with energy policy could boost private sector investment within and outside the energy sector, thereby stimulating economic activity domestically and abroad. - Illustrative simulation: additional private investment of 0.5 percent of GDP over four years could - raise GDP by 0.5 percentage point, - lower the current account balance by 0.3 percent of GDP, - and yield positive regional spillovers. ### Authorities’ views on external rebalancing and valuation - Authorities acknowledged that the current account surplus was high but emphasized it did not reflect policy distortions and that rebalancing within the euro area was under way and expected to continue. - They welcomed indicating ranges rather than point estimates for gaps to signal uncertainty. - Authorities agreed that the REER was undervalued, but viewed the degree of misalignment as closer to the lower half of the range presented by staff. - They noted the cyclically adjusted current account may be biased upward because some of Germany’s trading partners may have suffered more permanent output losses than those built in staff’s analysis. ### Investment, fiscal constraints, and public-private partnerships - Authorities agreed that higher public and private investment would be welcome and lower the current account surplus. - They emphasized that any additional public investment should not lead to a higher public deficit, as buffers are needed to be preserved under the fiscal rule. - They pointed to public-private partnerships as possible avenues to boost infrastructure spending. ### Services sector reform stance - Authorities were open to further reforms in parts of the services sector but did not fully share staff’s diagnostic and emphasized progress already achieved. - Specific points: - No need for reform in postal services; no plans to sell government’s remaining participation in the historically dominant operator. - Long-distance bus transportation services had been liberalized last year. - Scope to strengthen the role of the federal regulator was acknowledged, but no new law was being prepared. - Constraints on large retail outlets were argued to reflect urban planning and environmental considerations. - Certain dimensions of regulation of professional services such as pricing could be revisited, preferably in a broader European context. - Authorities saw macroeconomic effects of further services-sector reforms, particularly on the current account, as likely smaller than staff suggested. ### Energy transition progress and residual uncertainties - Authorities noted progress: rising share of renewables in electricity consumption and lower carbon emissions relative to 1990 levels; development of a renewable energy sector and job creation. - Recent reform proposal approved by the cabinet would: - maintain existing targets, - help contain costs for users by (i) moderating growth in new RE generation capacity to avoid over-subsidization, and (ii) gradually transitioning to more market-oriented RE financial support mechanisms. - Revised European Commission state aid guidelines would allow for continued surcharge reductions (exemptions) for large energy users competing internationally at least until 2020. - Authorities acknowledged residual uncertainty about the exemption regime in the long run, unclear resolution of lack of profitability of conventional power producers, and obstacles to expediting grid expansion amid strong local opposition. ### ECB policy and the low interest rate environment - Euro area inflation projected to remain persistently subdued; ECB expected to keep its main policy rate at or near zero for a long period of time. - ECB is putting in place further unconventional easing measures in the form of targeted long-term refinancing operations maturing in September 2018. - In the medium term, German inflation might rise above the ECB’s price stability objective as part of the needed rebalancing process within the euro area, though this is not envisaged under the baseline July 2014 World Economic Outlook (WEO) projections. ### Housing market and macroprudential readiness - Housing prices have increased by 18 percent over the past five years (5 percent in 2013), but remain below their mid-1990’s real-terms peak. - Relatively stronger price dynamics in some segments (i.e., apartments in selected large cities) are overvalued by up to 25 percent according to the Bundesbank. - Recent housing market strength appears to reflect lack of attractive alternative domestic investment options, stronger immigration flows, demand from foreign investors, and lags in the supply response. - Main transmission channel to the economy is through residential investment, which has been robust; effects on consumption likely close to nil or slightly negative given German housing finance features. - Recommendation: authorities should ready their macroprudential toolkit; stepped-up monitoring is appropriate now. - Suggested enhancements to the toolkit include adding at least loan-to-value and debt-service-to-income instruments. - Macroprudential framework improvements: clarifying the Financial Stability Committee’s scope of action and developing a comprehensive communication strategy. ### Low interest rates: household, banking, and insurance sector implications - Households’ financial assets almost doubled since 1995 with an increasing share concentrated in age-related saving products or held as currency and deposits, earning low yields in the current environment. - Households are not well positioned to gain from higher asset prices due to low share of equities, low home ownership rate, and low indebtedness. - Banking sector: pressure on interest margins exacerbates structurally weak profitability; Bundesbank survey suggests sector could withstand persistently low rates but weaker institutions become more vulnerable. - Banks’ responses (e.g., shifts to riskier portfolios, including cross-border) should be carefully monitored. - Life insurance sector: strong liquidity positions but exposed to long-term solvency risk owing to historically high guaranteed interest rates and a high duration gap between assets and liabilities. - Regulatory measures to force life insurers to build further reserves may prove insufficient; further policy action is being considered. - One policy avenue: amend a policy that compels insurers to share part of their valuation reserves with holders of matured or cancelled policies. - Insolvency of several mid-sized life insurers unlikely to be highly systemic but could have spillovers on banking sector financing given significant bank-insurance linkages. ### Authorities’ views on monetary policy and financial stability measures - Authorities saw limited case for further unconventional monetary policy measures in the euro area at the time of the mission. - They viewed very low inflation in the euro area periphery as a natural, temporary consequence of structural adjustment and saw limited effectiveness of additional monetary stimulus at that point. - Concern that European monetary union legal framework might not be consistent with certain asset purchase programs, given recent German Supreme Court ruling on the ECB’s Outright Monetary Transactions. - Authorities stepped up monitoring of the housing market and conducted a detailed survey of banks’ mortgage lending practices. - They viewed the FSB’s and staff’s recommendations on macroprudential framework as in line with their work program; the first Financial Stability Committee report to parliament would clarify its mode of operation. - On life insurance risks, authorities were confident planned government policy measures would improve insurers’ capital positions and remained wary of search-for-yield behaviors spreading to German financial institutions. ### Adapting to new financial regulatory and supervisory framework - Major transitions include EU-driven changes (capital, leverage, liquidity requirements, recovery and resolution—including a bail-in framework, structural measures, deposit insurance), euro area Single Supervisory Mechanism (SSM) and Single Resolution Mechanism, and national Act on Ring-fencing and on Recovery and Resolution Planning. - All domestically systemic banks submitted a first draft of their recovery plan as required by the Act and are fine-tuning with supervisors. - Authorities conducted a survey of 13 large banks to assess available bail-inable liabilities; creditor burden sharing is relevant to insurers since 30 percent of German insurers’ assets are banking sector liabilities (mostly vis-à-vis German banks). - Robust domestic supervision by BaFin and the Bundesbank remains a priority; they will be part of joint supervisory teams for banks under direct ECB supervision. - Staff recommendations echoed FSB peer review calls to enhance frameworks for prompt and comprehensive risk identification and timely intervention. ### ECB Comprehensive Assessment and capital efforts - The ECB’s Comprehensive Assessment is an important milestone; 20 percent of banks included are German. - About 1600 auditors are reviewing portfolios representing over 50 percent of these banks’ risk-weighted assets, including legacy exposures to foreign commercial real estate, the euro area periphery, shipping, and securitizations. - Assessed banks and supervisors are discussing capital plans; two of the largest privately owned banks have recently been or are in the process of raising fresh equity. ### Authorities’ views on resolution, leverage ratio, and recapitalization - When transposing the European directive on bank recovery and resolution, authorities intended to make the bail-in tool immediately available (i.e., not wait until January 1, 2016 as allowed under the directive). - They did not expect bail-in to be a source of contagion to the German insurance sector given diversified exposures and 70 percent collateralization. - Support for introducing the leverage ratio as a complement to risk-based capital ratios in line with international agreements; reporting obligations should allow calibration before migrating to a binding measure in 2018. - On potential capital shortfalls identified by the Comprehensive Assessment, authorities would support recapitalization only for banks with a viable business model and only after burden-sharing with junior bondholders as required by EU state aid law. - ESM involvement conceived as a loan to a member state for recapitalization purposes. - Authorities believed the banking union would eventually need a stronger legal footing, arguing current EU treaties did not provide sufficient legal basis for a genuine European supervisory or resolution authority and insufficient separation between monetary policy and banking supervision. ### Q&A highlights on staff analysis and public investment - Past staff analysis found higher German public consumption had limited spillovers to stressed euro area economies (effect <0.1 percent higher GDP in response to a 1 percent stimulus). - Current analysis finds higher public investment can generate sizeable growth spillovers because public capital increases productivity of private capital and induces higher private investment, amplified if monetary policy remains accommodative. - Example: a 4-year, ½ percent of GDP increase in German public investment yields a peak effect of higher GDP of 0.3 for the stressed economies. - Staff recommends higher public investment of ½ percent of GDP increase per year for 4 years—corresponding to over €50 billion in additional extra spending in addition to the €5 billion set aside for transportation infrastructure in the government’s economic program over 2014–17. - Emphasis that publicly financed projects must have true economic value and address identified bottlenecks and deficiencies; administrability, true economic needs, and compliance with fiscal rules constrain the feasible increase. *Source: IMF staff report content provided in the supplied content unit.* ### 46. Question: Given increases in wage and income inequality in Germany, why is staff not ### Question: Given increases in wage and income inequality in Germany, why is staff not more supportive of the new national minimum wage? Won’t it also help rebalancing? ### Staff concerns about the new minimum wage - The minimum wage’s level is high relatively to current wages in parts of Germany and for some groups, suggesting it may lead to a sizable increase in unemployment concentrated in those regions and groups. - According to statistics from the socio-economic panel survey as of 2011, low wage earners are disproportionately concentrated in the East, among part-time workers, mini-job holders, and women. - Many recipients of the minimum wage are not necessarily the working poor: - An estimated 4-6 million workers earn less than the proposed minimum wage. - Only some 1.3 million workers qualify for social assistance in the form of in-work benefits. - Without a change in the existing in-work benefits system, the effects of the minimum wage on real disposable income are likely to be limited because: - Some workers will lose employment. - Others will see their in-work benefits decline as their wages rise. - Expert studies suggest modest effects on the wage bill and aggregate demand, implying small external spillovers (see Chapter I, Selected Issues). - Wages in the export sector are well above the proposed minimum, so the new law is not expected to affect external competitiveness. ### Characteristics of low wage earners (Percent, 2011) - Share in respective group earning hourly wage lower than 8.5 euros - Region - West 15 - East (including Berlin) 27 - Employment status - Full-time employees 10 - Part-time employees 18 - Marginally employed/mini jobs 54 - Gender - Male 12 - Female 21 - Total employed 17 - Source: DIW Berlin. ### Related staff assessment and policy implications - Expert estimates suggest the proposed minimum wage will be binding for about 20 percent of workers in some federal states where unemployment is already relatively high; sizable adverse effects in these areas could materialize. - Decisions by the to-be-created commission on the future level of the minimum wage should: - Take employment effects into account. - Give adequate consideration to the interests of those not well represented by employers’ and employees’ associations. - Alternative ways to achieve income redistribution could usefully be explored. *Source: IMF staff Q&A and staff appraisal (excerpts).* ### 58. It is recommended that the next Article IV consultation take place on the regular 12-month ### _cr14216 - 58. It is recommended that the next Article IV consultation take place on the regular 12-month ### Recommendation - It is recommended that the next Article IV consultation take place on the regular 12-month cycle. ### Risk Assessment Matrix — Major Risks, Likelihood, Impact, and Policy Responses - I. Weaker investment recovery. - Description: German investment growth has been shown to be sensitive to policy uncertainty. A resurgence of policy uncertainty could weaken business investment and adversely affect growth. - Relative likelihood: M - Impact: M - Policy response: If the output gap widens, automatic stabilizers should as usual be allowed to operate freely. However, if prospects sour markedly and the labor market is expected to weaken significantly, then proactive fiscal policies would be needed. - II. Protracted period of slower growth in advanced and emerging economies. - Description: Includes lower-than-anticipated growth and persistently low inflation in advanced economies, the maturing of the cycle in emerging markets, and/or a growth slowdown in China. Given its high degree of trade openness, Germany is highly susceptible to fluctuations in global demand. - Relative likelihood: H - Impact: M - III. Geopolitical tensions surrounding Russia-Ukraine. - Description: Could lead to disruptions in global financial, trade, and commodity markets. Germany is exposed to an escalation of trade sanctions with Russia given its heavy dependence on Russian gas (40 percent of total consumption). - Relative likelihood: M - Impact: M - Policy response: Accelerating the implementation of Germany’s energy strategy may become necessary. - IV. Global and regional financial instability. - Description: Surges in global financial market volatility triggered by geopolitical tensions or revised expectations on UMP exit/emerging market fundamentals; re-emergence of sovereign stress in the euro area due to incomplete reforms or unanticipated stress test outcomes without a fiscal backstop. - Relative likelihood: H - Impact: M - Policy response: Keep reducing vulnerabilities in the financial sector by increasing capital buffers. - V. Medium-term risk — Distortions from a protracted period of low interest rates. - Description: Strength in pockets of the German housing market could spread nationwide, real estate assets could become overvalued and associated with excess leverage; banks’ net interest margin could shrink further leading to risky search-for-yield strategies; some life insurers may become distressed. - Relative likelihood: L - Impact: M - Policy response: Take precautionary measures now by strengthening the macroprudential framework and prudential supervision, as well as requiring higher reserves in life insurers. ### Key Macroeconomic Indicators (selected, exact values as presented) - Demographics and income: - Total population (2013, million): 80.8 - GDP per capita (2013, USD): 44,999 - GDP growth (percentage change) — 2010 2011 2012 2013 2014 1/2015 1/: - GDP: 3.9 3.4 0.9 0.5 1.9 1.7 - Output gap (In percent of potential GDP) — 2010 2011 2012 2013 2014 1/2015 1/: - Output gap: -1.2 0.9 0.4 -0.6 -0.3 0.1 - Labor market (millions or percent) — Labor force / Employment / Unemployment / Unemployment rate (in percent) 4/: - Labor force: 41.7 42.2 42.4 42.7 43.0 43.3 - Employment: 38.7 39.7 40.1 40.5 40.7 40.9 - Unemployment 3/: 2.9 2.5 2.3 2.3 2.3 2.4 - Unemployment rate (in percent) 4/: 7.1 6.0 5.5 5.3 5.3 5.4 - Prices and incomes (percentage change) — GDP deflator / Consumer price index (harmonized): - GDP deflator: 1.0 1.2 1.5 2.2 1.7 1.7 - Consumer price index (harmonized): 1.2 2.5 2.1 1.6 1.1 1.4 - Public finances (selected, in percent of GDP where indicated) - General government expenditure (In percent of GDP): 44.1 48.3 47.9 45.2 44.7 44.5 44.3 44.0 (levels shown for years 2008–2013 in euros also provided in table) - General government revenue (In percent of GDP): 44.0 45.2 43.7 44.3 44.8 44.7 44.4 44.2 - Overall balance (In percent of GDP): -0.1 -3.1 -4.2 -0.8 0.1 0.2 0.2 0.2 - Structural balance (In percent of GDP): -1.0 -1.2 -2.6 -1.2 -0.1 0.6 0.4 0.2 - Federal government overall balance (In percent of GDP): -0.7 -1.6 -3.3 -1.0 -0.5 -0.1 0.0 0.1 - General government debt (In percent of GDP): 66.8 74.6 82.5 80.0 81.0 78.4 75.1 71.8 - External sector (in billions and percent of GDP) - Current account (in billions): 226.1 196.0 211.4 248.3 255.3 273.5 273.3 274.6 - Current account (in percent of GDP): 6.2 5.9 6.4 6.8 7.4 7.5 7.0 6.7 - Trade balance (in billions): 164.7 121.8 142.5 138.4 156.7 168.7 156.4 152.7 - Interest and exchange rates (period averages where noted) - Three-month interbank rate: 4.6 1.2 0.8 1.4 0.6 0.2 - Yield on ten-year government bonds: 2.9 2.8 2.8 2.7 1.6 1.6 - Euro per US$: 0.73 0.68 0.76 0.76 0.76 0.73 - Monetary aggregates and credit (percentage change) - Money and quasi-money (M3): 9/ 10/9.6 -0.3 -0.3 5.8 6.9 2.7 - Credit to private sector: 9/ 2.6 -1.6 -0.3 1.2 1.3 0.8 ### General Government Operations (selected ratios, percent of GDP) - Revenue (2011–2019 projections, percent of GDP): 44.3 44.8 44.7 44.4 44.2 44.1 44.1 44.0 44.0 - Taxes (2011–2019 projections, percent of GDP): 22.9 23.2 23.2 23.3 23.4 23.4 23.4 23.4 23.4 - Social contributions (2011–2019 projections, percent of GDP): 16.7 16.8 16.8 16.7 16.7 16.7 16.8 16.8 16.8 - Expense (2011–2019 projections, percent of GDP): 45.2 44.9 44.6 44.3 44.0 43.8 43.7 43.6 43.6 - Net lending/borrowing (2011–2019 projections, percent of GDP): -0.8 0.1 0.2 0.2 0.2 0.4 0.4 0.5 0.5 - Primary balance (2011–2019 projections, percent of GDP): 1.7 2.5 2.3 2.1 1.9 2.1 2.2 2.3 2.3 - Memorandum: Structural balance (2011–2019 projections, percent of GDP): -1.2 -0.1 0.6 0.4 0.2 0.3 0.4 0.5 0.5 - Public gross debt (Maastricht definition, percent of GDP): 80.0 81.0 78.4 75.1 71.8 68.8 65.8 62.9 60.1 ### Medium-Term Projections (real sector and external balances, percent or percent of GDP) - Real GDP (2010–2019): 3.9 3.4 0.9 0.5 1.9 1.7 1.5 1.4 1.4 1.3 - Total domestic demand (2010–2019): 2.3 2.8 -0.2 0.8 1.8 1.7 1.4 1.4 1.3 1.3 - Foreign balance (contribution to growth) (2010–2019): 1.7 0.7 1.1 -0.2 0.2 0.1 0.2 0.2 0.2 0.2 - Output gap (percent of potential GDP) (2010–2019): -1.2 0.9 0.4 -0.6 -0.3 0.1 0.1 0.0 0.0 0.0 - Consumer prices (2010–2019): 1.2 2.5 2.1 1.6 1.1 1.4 1.6 1.7 1.7 1.7 - Current account balance (percent of GDP) (2010–2019): 6.4 6.8 7.4 7.5 7.0 6.7 6.4 6.0 5.9 5.7 - Goods and services balance (percent of GDP) (2010–2019): 5.7 5.4 6.0 6.2 5.6 5.3 5.0 4.7 4.5 4.3 - General government overall balance (percent of GDP) (2010–2019): -0.8 0.1 0.2 0.2 0.2 0.4 0.4 0.5 0.5 - Gross debt (percent of GDP) (2010–2019): 82.5 80.0 81.0 78.4 75.1 71.8 68.8 65.8 62.9 60.1 ### Financial Sector Soundness — Key Indicators (selected exact series) - Capital adequacy — Regulatory capital to risk-weighted assets (2008–2013): 13.6 14.8 16.1 16.4 17.9 19.2 - NPLs to gross loans (selected values): 2.9 3.3 3.2 3.0 2.9 - Return on average assets (after-tax) (2008–2013): -0.3 -0.1 0.2 0.3 0.2 - Liquid assets to total short-term liabilities (2008–2013): 120.3 144.1 137.0 137.9 144.2 140.5 - Deposit-taking institutions — Capital to assets (2008–2013): 4.5 4.8 4.3 4.4 4.7 5.5 - Household debt to GDP (selected): 62.0 64.6 62.0 59.8 - Real estate prices indices (yearly average, 2010 = 100): - Real estate prices, new dwellings: 94.8 96.5 100.0 106.3 111.6 - Real estate prices, resale: 98.0 97.9 100.0 105.0 111.0 - Real estate prices, new and resale: 96.9 97.4 100.0 105.4 111.2 - Real estate prices, commercial property: 95.4 97.1 100.0 104.8 109.9 - Residential real estate loans to total loans (selected): 15.7 16.9 16.8 16.7 17.1 18.3 *Source: IMF staff report material as presented in the content unit.* ### Annex I. Germany: Authorities’ Response to Past IMF Policy ### Annex I. Germany: Authorities’ Response to Past IMF Policy Recommendations ### Fiscal Policy - IMF 2013 Article IV recommendation: If fiscal overperformance appears definitive, planned expenditures should be accelerated, especially in areas that enhance growth potential (e.g., public investment). - Authorities' response and developments: - After an overperformance of 1.1 percent of GDP in 2012, the general government registered a zero balance in 2013, 0.5 percent of GDP stronger than planned. - In 2013, it was decided to increase federal spending (including on infrastructure) by €23 billion over 2014-2017 financed by eliminating the small fiscal surplus that would have been achieved without these measures. - IMF 2013 Article IV recommendation: Reform the tax and social security system to further increase labor force participation of the low-skilled and secondary earners. - Authorities' response: - The contribution rate for statutory pension insurance was reduced (reflecting the adjustment rules of the pension insurance scheme). - The personal basic tax-free allowance for income tax and the monthly pay threshold for mini-jobs were increased in 2013. ### Financial Sector Policy - IMF 2013 Article IV recommendations: - At the domestic level, consolidate financial strength by pushing banks to further augment capital buffers, improve profitability and efficiency, and adjust business models. - Firmly anchor the surveillance of large cross-border banks by strong domestic supervision and close coordination with key financial centers' supervisory authorities. - Keep developing a clear, harmonized, and coherent roadmap towards achieving domestic and European initiatives, including steps towards reversing the fragmentation of banking systems across Europe and creating an integrated pan-European banking system. - Authorities' response and developments: - Further progress on the implementation of FSAP recommendations has been made, but more progress is needed in some areas. - Banks’ capital ratios keep improving, and some large banks have raised fresh equity. Profitability is under pressure from the low interest environment. - Progress has been made on the restructuring of large banks but further efforts are needed. - Joint supervisory teams with the ECB are being established for large cross-border banks ahead of the transition to the SSM. Supervision at the European level is expected to help strengthen the supervision of cross-border activities. - Two key pillars of the European Banking Union (SSM, SRM) legislation have been put in place. - Progress on establishing recovery and resolution plans has been made but there is little momentum in reforming the fragmented deposit insurance regime. - German initiatives on bank structures will have to be meshed with European proposals. Further advances on solving the too-big-to-fail problem will take place at the same pace as regional and global initiatives. ### Structural Reforms - IMF 2013 Article IV recommendation: Continue to take measures to raise potential growth and diversify its sources, in particular, by addressing the decline in working-age population and by raising productivity outside of the manufacturing sector. - Authorities' response and developments: - To increase female labor force participation new spending has been allocated to all-day schools and childcare. - A pension reform to facilitate early retirement for workers with long contributions period will likely reduce participation by older workers. - Steps to strengthen competition in network industries, financing research and development and providing risk capital were taken, but further efforts are needed. --- ### Annex II. Main Outstanding 2011 FSAP Update Recommendations and Status ### Strengthen stress testing and supervisory action - Recommendation: Continue to improve stress testing in the banking and insurance sectors. Rigorously ensure that any institution that displays weaknesses on a forward looking basis strengthens its balance sheet and takes managerial action. - Status: - Stress tests (including thorough asset quality reviews) for the large SSM banks (24 institutions) are part of the Comprehensive Assessment carried out by the ECB (in close cooperation with the national competent authorities and the EBA). In this exercise all relevant risk factors of the large German banks are stressed. - For the smaller banks the Bundesbank has developed a macroeconomic stress test which covers both expected losses in the credit portfolio and losses resulting from declining profits in an adverse macroeconomic scenario. ### Supervisory powers over bank acquisitions - Recommendation: Grant supervisors power to vet in advance bank acquisitions of subsidiaries. - Status: - Legislative initiatives on this matter are not expected in the near term. - German authorities believe they would overstep their role as supervisors if they formally vet and give prior approval for major acquisitions proposed by banks; therefore, no changes to the German Banking Act have been made. - In light of CRD IV, the authorities expect to continue to review compliance with legal thresholds for qualifying holdings and acquisitions made by banks. ### Macroprudential governance and information sharing - Recommendation: Define the role of the Bundesbank as macroprudential supervisor, and institute free exchange of information between macro and microprudential supervisors. - Status: - Since 2013, very significant progress has been made in developing and implementing the macroprudential framework. - The Financial Stability Committee (FSC) held regular quarterly meetings and discussed all relevant threats to financial stability and European developments (e.g., ESRB). - The FSC will file an annual report to the German Parliament beginning in mid-2014. ### On-site supervision - Recommendation: Continue to strengthen on-site supervision. - Status: - BaFin and the Bundesbank have continued to expand their staff capacity and improve expertise among staff. - The intensity of on-site supervisions of banks has been enhanced by increasing the number of inspections, including more inspections of non-capital related areas (remuneration, liquidity risk management, assessment of complex products, commodities business, IT risks), particularly of larger banks. - Special inspections focused on credit risk models and credit risk management have been conducted. - The scope of audits has been broadened by preparing inspections in the area of compliance. - Assessing asset quality and credit provisioning processes will play a more important role with the introduction of the SSM, especially during the ECB asset quality review. - Amendments of the Minimum Requirements for Risk Management (MaRisk) will be prepared during 2014 to specify supervisory expectations and introduce tougher supervisory requirements, subject to future on-site inspections. - New reporting requirements on internal capital adequacy shall provide information to strengthen the supervision of Pillar II requirements and deliver new starting points for intense on-site inspections. ### Reporting requirements - Recommendation: Review reporting requirements to ensure timely and systemic information is available on emerging risk factors. - Status: - Implementation of the EBA guidelines on the "Implementing Technical Standards” is to take place in 2014 with a first reference date for COREP reporting as of end of March and for FINREP as of end September accordingly. - National requirements implemented in 2014 with a new "Financial Information Regulation (FinaV)" providing risk based information on financial measures with the first reference date as of end March 2014 at solo level and of end September 2014 at consolidated level. - From 2015 on, additional reporting requirements will provide supervisors with more regular, more structured and more detailed information on the internal capital adequacy of banks. - The new reporting requirements have already been implemented into the German Banking Act. ### Deposit guarantee harmonization - Recommendation: Institute a harmonized and legally binding deposit guarantee of €100,000, backed by adequate prefunding. - Status: - The approval of the amended EU Directive on Deposit Guarantee Schemes is expected for mid-2014. National implementation has to be finalized one year after approval. - In Germany, the Deposit Insurance and Investor Compensation Act (EAEG) will have to be amended accordingly by mid 2015. - The harmonized and legally binding deposit guarantee of €100,000 is unchanged by the Directive. - Terms of prefunding are part of the harmonization efforts and will have to be implemented accordingly at national level. The Directive asks for prefunding and defines a concrete "target level" up to the conditions specified in the Directive. ### Bank restructuring fund and resolution framework - Recommendation: Ensure the financial strength of the new bank restructuring fund, and clarify the interaction between the restructuring fund and the various deposit guarantee and mutual protection schemes. - Status: - The Restructuring Fund is fully operational and enjoys access to contingency funding from the federal government. - In the context of the European banking union, the role of national restructuring funds in relation to the Single Bank Resolution Fund at European level will have to be re-assessed, possibly ending in the merger of the German fund into the European fund over a transitional period. - The BRRD provides that resolution funds may only be used if no other private sector measures, including measures by institutional protection schemes (if institutional protection arrangements are concerned), would prevent the failure of the institution. ### Exiting government support to banks - Recommendation: Finalize specific strategies for exiting from the government support to banks, and require the affected banks to formulate strategic plans. - Status: - There are no SoFFin guarantees outstanding and capital injections have been reduced further between 31.12.2012 (€18.8 billion) and 31.12.2013 (€17.1 billion). - The two winding up institutions are gradually deleveraging. - The failure to privatize DEPFA bank in May 2014 will result in the transfer of its remaining assets (€49bn at end-2013) to one of the bad banks (FMS-WM). ### Banking system structure and Landesbanken - Recommendation: Develop comprehensive strategy aimed at improving the efficiency and stability of the banking system: - (a) Establish viable business models for the Landesbanken; - (b) Loosen the regional constraints under which local banks operate; - (c) Open up the public banks to private participation; and - (d) Strengthen these banks' governance to reduce noncommercial influences. - Status: - The reform of the Landesbanken is still under way, with headcount, aggregate balance sheets and RWAs still adapting to challenging circumstances. - Overall, for the Landesbanken sector, capital has improved, and business models are being reviewed and streamlined to adapt to the new operating and regulatory environments. Sustaining restructuring efforts is key to ensuring the viability of business models. - There are no plans to loosen regional constraints on local banks, open up the public banks to private participation, and reduce non-commercial influences. --- ### Annex III. Germany — Public Debt Sustainability Analysis (DSA) — Key Findings and Risks - Overall assessment: - Public debt is expected to remain sustainable reflecting ongoing primary surpluses and favorable interest rate-growth differential. - Baseline projections: - Under the baseline, the public debt-to-GDP ratio is forecast to decline steadily to close to 60 percent in the medium term from the current level of 78.4 percent. - Gross financing needs are expected to reduce gradually to about 13 percent of GDP in 2019. - Main risks to the debt outlook: - A negative growth shock represents the largest risk to the debt outlook. - Realization of contingent liabilities coming from future bank recapitalization needs or worse than expected performance of winding-up institutions may push the debt trajectory up by about 3 percent of GDP before the debt-to-GDP declines gradually in the medium-term. - Interest rate risk is important but remains limited, reflecting the safe haven status of Germany and moderate financing needs. - Background on methodology: - The new debt sustainability analysis (DSA) framework for market access countries is used, employing a risk-based approach and expanding the basic DSA to include: - (i) an assessment of the realism of baseline assumptions and the projected fiscal adjustment; - (ii) an analysis of risks associated with the debt profile; - (iii) macro-fiscal risks; - (iv) a stochastic debt projection taking into account past macro-fiscal volatility; and - (v) a standardized summary of risks in a heat map. - Macroeconomic assumptions cited: - Growth is projected to reach 1.9 percent in 2014 on the back of a rebound in domestic and foreign demand. - Inflation is expected to stay well below 2 percent over the forecast horizon, reflecting the drop in global energy prices while core inflation remains robust around 1.2 percent on the back of robust wage growth. - Growth will average 1.3 percent in the medium term, close to potential. - The output gap is closed over 2017-2019. - Rationale for higher scrutiny: - Germany’s high level of government debt calls for using the higher scrutiny framework. - Government’s gross debt increased significantly over 2009-2010, peaking at 82.5 percent of GDP in 2010 from 65.2 percent in 2007. - Since the peak, debt has declined gradually on the back of fiscal consolidation and favorable interest rate-growth differential. - Gross financing needs are estimated at 16 percent of GDP in 2014 and are expected to remain around 13-16 percent in the medium term. - Realism of baseline assumptions: - The forecasts of variables affecting debt reduction have been on the conservative side. - The median forecast error for real GDP growth during 2005−2013 is *Annex I. Germany: Authorities’ Response to Past IMF Policy Recommendations — IMF staff compilation* ### 0.63 percent, suggesting that there is slight downward bias in the staff projections, but the forecast ### _cr14216 - 0.63 percent, suggesting that there is slight downward bias in the staff projections, but the forecast ### Forecast accuracy and bias - Median forecast error for output (real GDP growth): 0.63 percent, suggesting a slight downward bias in the staff projections, but the forecast bias is in line with other surveillance countries. - Median forecast error for inflation (GDP deflator): 0.14 percent, suggesting that the staff underestimated inflation, but to a lesser degree in recent years. - Median forecast error for primary balance: forecast bias of 1.55 percent of GDP, suggesting staff projections have been conservative. ### Fiscal adjustment feasibility and DSA baseline - Cross-country experience: the maximum 3 year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection period is 2 percent of GDP and is not ambitious in cross-country comparison; Germany delivered larger fiscal consolidation in the past. - DSA baseline projection: debt-to-GDP ratio is projected to decrease to close to 60 percent by 2019. - Under most macro-fiscal stress tests, the debt-to-GDP ratio continues to decline; exception: - One standard deviation shock to real GDP growth: debt-to-GDP ratio initially increases to 78 percent in 2016 and declines thereafter. - Gross financing needs under all scenarios remain at or below 20 percent of GDP and decline by a few percentage points by the end of the projection horizon. ### List of shocks and design of stress tests - Growth shock: - Real output growth rates are lower by one standard deviation over 2015-2016, i.e. 2.7 percentage points relative to the baseline. - Assumed decline in growth leads to lower inflation (0.25 percentage points per 1 percentage point decrease in GDP growth). - Interest rate assumed to increase 25 basis points for every 1 percent of GDP worsening of primary balance. - Primary balance shock: - Dual shock of lower revenues and rise in interest rate, leading to a cumulative 1.6% deterioration in primary balance over 2015-2016 (one standard deviation shock to primary balance). - Interest rate shock: - Assumes an increase of 300 basis points increase in cost of debt throughout the forecast horizon, mimicking the historical maximum cost of debt experienced. - Real exchange rate shock: - Assumes 13 percent devaluation in real exchange rate in 2015 and examines the impact on debt through the inflation channel. - Additional stress test — Combined macro-fiscal shock: - Combines shocks to real GDP growth, the interest rate, the exchange rate, and the primary balance taking care not to double-count effects. - Additional stress test — Contingent fiscal shock: - Assumes a cumulative 3 percent of GDP (about €80 billion) additional support for the financial sector over 2015-2016 comprising: - additional re-capitalization needs in the banking system (€50 billion), - a call on half of capital shield guarantees (€20 billion), - worse than expected performance of portfolios of winding-down institutions (€10 billion). - Note: assumed magnitudes and timing are likely on the onerous side. ### Key DSA numeric projections and indicators (selected entries as presented) - Nominal gross public debt: 70.7 81.0 78.4 75 72 69 66 63 60 (years cover 2012–2019 in table format). - Public gross financing needs: 16.6 16.3 15.6 15.4 14.8 14.5 14.0 13.4 13.4 (2012–2019). - Real GDP growth (in percent): 1.3 0.9 0.5 1.9 1.7 1.5 1.4 1.4 1.3 (2012–2019). - Inflation (GDP deflator, in percent): 1.0 1.5 2.2 1.7 1.7 1.6 1.7 1.7 1.7 (2012–2019). - Nominal GDP growth (in percent): 2.3 2.2 2.7 3.6 3.6 3.2 3.2 3.1 3.1 (2012–2019). - Effective interest rate (in percent): 4.2 3.1 2.6 2.6 2.5 2.5 2.6 2.8 2.9 (2012–2019). - Change in gross public sector debt (cumulative): 2.1 1.1 -2.6 -3.3 -3.3 -3.0 -3.0 -2.9 -2.8 -18.4 (periods shown). - Identified debt-creating flows (cumulative): 1.0 -1.4 -2.0 -2.5 -2.5 -2.3 -2.3 -2.2 -2.1 -14.0. - Primary deficit (in percent of GDP): -0.2 -2.1 -2.0 -1.8 -1.7 -1.8 -1.9 -2.1 -2.1 -11.3. - Primary (noninterest) revenue and grants (in percent of GDP): 43.8 44.4 44.4 44.2 43.9 43.8 43.9 43.8 43.8 263.4 (note: table formatting preserved as in source). - Primary (noninterest) expenditure (in percent of GDP): 43.5 42.3 42.4 42.4 42.2 42.0 41.9 41.7 41.7 252.0. - Automatic debt dynamics contribution (in percent): 1.2 0.7 0.0 -0.7 -0.8 -0.5 -0.4 -0.2 -0.1 -2.7. - Real interest rate contribution (in percent): 2.1 1.2 0.3 0.7 0.5 0.6 0.6 0.7 0.7 3.8. - Real GDP growth contribution (in percent): -0.9 -0.5 -0.4 -1.4 -1.4 -1.1 -0.9 -0.9 -0.8 -6.5. - Residual, including asset changes (in percent): 1.2 2.4 -0.6 -0.8 -0.8 -0.7 -0.7 -0.7 -0.7 -4.4. ### DSA alternative scenarios and stress-test specific projections (selected values) - Baseline underlying assumptions (Real GDP growth / Inflation / Primary Balance / Effective interest rate): - 2014–2019 baseline: Real GDP growth: 1.9 1.7 1.5 1.4 1.4 1.3; Inflation: 1.7 1.7 1.6 1.7 1.7 1.7; Primary Balance: 1.8 1.7 1.8 1.9 2.1 2.1; Effective interest rate: 2.6 2.5 2.5 2.6 2.8 2.9. - Historical scenario underlying assumptions: - Real GDP growth: 1.9 1.3 1.3 1.3 1.3 1.3; Inflation: 1.7 1.7 1.6 1.7 1.7 1.7; Primary Balance: 1.8 0.7 0.7 0.7 0.7 0.7; Effective interest rate: 2.6 2.5 2.9 3.2 3.5 3.9. - Constant Primary Balance scenario: Primary Balance held at 1.8 across 2014–2019; other variables as baseline. - Stress-test snapshot examples (2014–2019): - Primary Balance Shock scenario for Real GDP growth / Inflation / Primary balance / Effective interest rate: Real GDP growth: 1.9 1.7 1.5 1.4 1.4 1.3; Inflation: 1.7 1.7 1.6 1.7 1.7 1.7; Primary balance: 1.8 0.9 1.0 1.9 2.1 2.1; Effective interest rate: 2.6 2.5 2.6 2.7 2.8 3.0. - Real GDP Growth Shock scenario for Real GDP growth / Inflation / Primary balance / Effective interest rate: Real GDP growth: 1.9 -0.8 -1.1 1.4 1.4 1.3; Inflation: 1.7 1.0 1.0 1.7 1.7 1.7; Primary balance: 1.8 0.3 -1.1 1.9 2.1 2.1; Effective interest rate: 2.6 2.5 2.6 2.9 2.9 3.1. - Real Interest Rate Shock: Effective interest rate rises to 2.6 2.5 3.1 3.6 4.1 4.6. - Real Exchange Rate Shock: Inflation spikes in 2015 to 2.1 (from 1.7) in table. - Combined Shock: Real GDP growth and other variables combine as in the table (e.g., Effective interest rate: 2.6 2.5 3.2 3.7 4.2 4.7). ### Stress test outcomes (summary visuals described in source) - Under Baseline and most single-shock stress tests, gross nominal public debt (in percent of GDP) declines from 2014 through 2019. - Under the Real GDP Growth Shock and Combined Macro-Fiscal Shock, gross nominal public debt shows an initial increase (peaking near or below early warning thresholds) before declining. - Public gross financing needs (in percent of GDP) remain at or below 20 percent across scenarios presented. ### Public DSA risk assessment and heat map indicators - Risk-assessment benchmarks and highlighting rules described: - Cell green if debt burden benchmark of 85% is not exceeded under specific shock or baseline; yellow if exceeded under specific shock but not baseline; red if benchmark exceeded under baseline. - Benchmark values cited: - Bond spreads: 400 and 600 basis points. - External financing requirement: 17 and 25 percent of GDP. - Change in the share of short-term debt: 1 and 1.5 percent. - Public debt held by non-residents: 30 and 45 percent. - Market perception measures: bond spread referenced as long-term bond spread over German bonds (average over last 3 months, 01-Jan-14 through 01-Apr-14). ### Fund relations, mission, and data governance (selected findings) - Mission: May 8–19, 2014 in Berlin, Bonn, and Frankfurt. - Staff team: Ms. Detragiache (Head), Mr. Elekdag, Ms. Raei, and Mr. Vandenbussche (all EUR). - Country interlocutors included Bundesbank President Weidmann, Minister of Finance Schäuble, senior representatives at the Chancellery, several ministries, the Bundesbank, and BaFin. - Germany: Joined IMF on August 14, 1952; Article VIII. - Data adequacy: Data provision is adequate for surveillance. - National accounts: Germany plans to adopt ESA 2010 in September 2014; Federal Statistical Office plans to recalculate all national accounts aggregates in full detail back to 1991. - Government accounts: Germany publishes general government revenue, expenditure, and balances on an accrual basis (ESA95) quarterly and submits annual data in GFSM 2001 format. - External sector statistics: Bundesbank compiles balance of payments statistics; from 2014 external sector statistics compiled based on BPM6. - Financial Soundness Indicators: Germany participates in the Coordinated Compilation Exercise; reports all 12 core FSIs though six on an annual basis, with plans to shorten periodicity to quarterly reporting in 2015. ### Executive Board assessment and policy recommendations - Executive Directors commended authorities for prudence in macroeconomic policies and commitment to strengthened European integration. - Key observations: - Germany has strong fundamentals: healthy balance sheets, strong fiscal position, historically low unemployment. - Medium-term growth prospects remain subdued due to weak international environment, uncertainty about future energy costs, and adverse demographic developments. - Policy recommendations emphasized by Directors: - Strengthen domestic sources of growth, promote private investment, and reduce the current account surplus. - Use available fiscal space to boost public investment in projects with true economic value, especially transport infrastructure and education, while adhering to European and national fiscal rules. - Increase competition in product markets and address energy sector challenges to encourage private investment in renewable energy and infrastructure. - Improve productivity and reduce barriers to competition in the services sector, especially professional services. - Implement new national minimum wage with care, mindful of potential adverse effects on employment across regions and sectors; explore well-targeted redistribution measures that raise labor market participation and minimize fiscal costs. - Encourage banks to build capital buffers ahead of the ECB Comprehensive Assessment; ensure robust domestic supervision during transition to the Single Supervisory Mechanism. - Remain vigilant to developments in the housing market and insurance sector; enhance the macroprudential toolkit. ### Short-term outlook and selected macro projections (from press release and staff table) - Short-term growth outlook: - Output should increase by 1.9 percent in 2014 and 1.7 percent in 2015. - Current account surplus expected to begin to decline gradually. - Inflation to pick up and remain above rest-of-euro-area levels as residual slack is eliminated. - Germany: Selected Economic Indicators (2010–2015, selected entries): - Population (million, 2013): 80.8 - Per capita GDP ($, 2013): 44,999 - Real GDP growth (%) 2013–2015: 0.5 (2013), 1.9 (2014, staff estimate), 1.7 (2015, staff projection). - Unemployment rate (%, ILO): 5.3 (2013), 5.3 (2014), 5.4 (2015). - Inflation (%): 1.6 (2013), 1.1 (2014), 1.4 (2015). - Fiscal balance (% of GDP): 0.2 (2013), 0.2 (2014), 0.2 (2015). - Public debt (% of GDP): 78.4 (2013), 75.1 (2014), 71.8 (2015). - Current account balance (% of GDP): 7.5 (2013), 7.0 (2014), 6.7 (2015). - Exports (% of GDP): 32.2 (2013), 30.8 (2014), 30.1 (2015). - Reserves minus gold (billions of US$): 67.4 (2013 and projected). - External Debt (% of GDP): 269 (2012–2013 historical entries), projection to 255. ### Authorities’ (Executive Director) statement — policy priorities and views (selected points) - Authorities broadly agree with staff appraisal and welcome in-depth analysis. - Outlook: - Domestic demand expected to contribute strongly to growth: domestic demand growth projection of 1.8% in 2014 and 2.0% in 2015 (authorities’ figures). - Potential growth around 1½ % p.a. in 2014 and 2015 per authorities. - On the current account and external surplus: - Authorities argue surplus reflects market outcomes and non-price competitiveness; Germany has contributed to regional rebalancing and expects surplus to shrink as contributing factors diminish. - Fiscal policy stance: - Authorities emphasize need to maintain safety margin from national debt brake limits and medium-term objective (structural deficit of max. 0.5 percent of GDP for general government). - Authorities note debt-to-GDP ratio forecast to decline to below 70 percent of GDP by 2016. - Authorities cautious about large public investment push given potential pro-cyclicality and construction sector capacity utilization concerns. - Structural reforms priorities: - Labor market: Skilled Workers Strategy, family-friendly policies, childcare expansion, education and training, implementation of EU Directive on Highly Qualified Employment. - Minimum wage: statutory minimum wage effective 1 January 2015 expected to benefit some 3.7 million workers; specific groups exempted to contain adverse employment effects. - Pensions: new law leaves earliest pension without penalties at age 63; minimum retirement age will increase gradually up to 65 in 2029; periodic fiscal reviews included with first review in 2018. - Energy: focus on private investment in grid expansion and renewables; Renewable Energy Sources Act reform to enter into force on 1 August 2014; priority to security of supply, cost-efficiency, and environmental compatibility. - Infrastructure: Federal Government invested more than 10 billion euro per year in transport sector in recent years; an additional 5 billion euro between 2014 and 2017 for transport investment; authorities contest staff estimate of 0.2–0.4 percent of GDP per year need and cite German Council of Economic Experts estimate of 3.8 billion euro (~0.1 percent of GDP per year). - R&D: Federal Government spending on R&D rising; High-Tech Strategy areas include climate/energy, health/nutrition, communications, mobility, and security. - Financial sector: - Progress on capital and liquidity regulation, recovery and resolution frameworks, and Single Supervisory Mechanism is on track. - German Financial Stability Committee established; work on macroprudential strategy and instruments ongoing, including possible LTV- and DTI-requirements to address housing market risks. *Source: IMF staff report and informational annex as presented in the provided content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14216.pdf_