## _cr15187

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### Recent economic developments and uptrend
- Upturn underway supported by euro depreciation and lower energy prices.
- Anticipation of ECB quantitative easing (QE) lowered interest rates and term spreads, weakened the euro, and, together with the drop in energy prices, helped overcome the unexpected slowdown of mid-2014.
- By end-2014 and into Q1 2015:
  - Investment picked up again.
  - Consumption supported by above-trend real disposable income growth.
  - Real compensation per employee increased by 1.7 percent in 2014.
  - Employment kept growing strongly; unemployment rate hit 4.7 percent (post-reunification low).
  - New minimum wage (introduced January 1, 2015, implemented over two years) had no visible impact on total employment so far.
- Capacity utilization above historical averages; business survey indicators suggest continued expansion.

### Prices and labor market
- Oil price drop brought inflation temporarily close to zero.
- Core inflation low and stable at around 1 percent.
- REER and exchange rate dynamics:
  - CPI-based REER roughly stable in 2014, then depreciated by 6 percent from its 2014 average (primarily due to nominal depreciation vis-à-vis the dollar and the renminbi).
  - REER depreciation since mid-2014 likely to put upward pressure on the current account in 2015.
- Labor market and income composition:
  - Continued strong immigration could counter negative natural demographic balance.
  - Secular decline in hours worked per employed has slowed.
  - Unit labor costs have been rising; labor share normalization noted.

### Balance of payments and external position
- Current account surplus reached 7.6 percent of GDP in 2014.
- Narrowing of the oil and gas trade deficit was main contributor to expansion in the surplus.
- Saving-investment balances:
  - Non-financial corporations and the general government increased their surpluses in 2014 relative to 2013.
  - Surplus of non-financial corporations at 2.2 percent of GDP—the highest level since reunification.
- NIIP continued to grow in 2014; portfolio investment remained the largest item in the capital and financial account.

### Fiscal developments and outlook
- Fiscal stance:
  - Mildly contractionary in 2014; expected to turn mildly expansionary in 2015.
  - Government presented a balanced federal budget for 2015, one year ahead of schedule.
- Fiscal metrics:
  - General government surplus rose to 0.6 percent of GDP in 2014—a structural improvement of 0.3 percent relative to 2013.
  - Debt ratio pushed down to 74.7 percent of GDP.
- Fiscal rules and projections:
  - Structural fiscal position for 2015 expected to remain within constitutional debt brake rule and European MTO (maximum structural deficits of 0.35 percent and 0.5 percent of GDP, respectively).
  - Under staff's macroeconomic outlook, a balanced 2015 federal budget would drive public debt under 60 percent of GDP by 2020.
- Public investment:
  - Government increased public investment commitments for the medium run; fiscal space remains for a more ambitious plan through the end of this legislature.

### Credit conditions, asset prices, and banking sector
- Interest rates and credit:
  - Yield on 10-year bunds reached a trough of 0.1 percent in mid-April, then rebounded but remains very low; negative yields extend up to the 3-year maturity.
  - Historically low bank lending rates fell further with anticipation of QE.
  - Credit growth tepid despite record-low interest rates, especially in the corporate sector; companies finance much investment from retained earnings and cash reserves.
  - Aggregate mortgage lending growth tepid; housing market dynamic in some “hot spots” with signs of acceleration.
- Asset prices:
  - Stock prices accelerated sharply.
  - Housing prices rising only modestly faster than disposable income in aggregate; apartment prices in the 10 largest cities show stronger movements.
- Banking sector health:
  - SSM Comprehensive Assessment revealed minor shortcomings in loan classification/provisioning, relatively low capital quality and leverage ratios in large-bank segment.
  - Higher provisioning needs concentrated in shipping finance and commercial real estate portfolios.
  - All assessed banks, except a relatively small one, passed the stress tests.
  - Many largest German banks had leverage ratios close to or below 4 percent.
  - EBA stress-test results: five German banks would have had a capital shortfall in the adverse scenario under a fully loaded common equity Tier 1 metric.

### Outlook, projections, and risks
- Growth drivers and projections:
  - Robust private consumption dynamics projected to persist, helped by lower energy prices and strong real wage growth.
  - Euro depreciation and lower real interest rate (as QE pushes up inflation expectations) should buttress exports and machinery and equipment investment.
  - Corporate credit demand expected to remain muted; QE-induced lower real interest rates should yield somewhat firmer credit growth.
  - Fiscal stance should remain slightly expansionary in 2016.
  - Employment growth should slow as effects of lower statutory retirement age kick in and unemployment is already low.
  - Key projections:
    - GDP is expected to grow by 1.6 percent this year and 1.7 percent next year.
    - Output gap should close this year and remain positive but small in the medium term.
    - German inflation expected to exceed that in the rest of the euro area throughout the forecast horizon, but not projected to rise above the ECB price stability objective.
- External projections:
  - Current account surplus expected to exceed 8 percent of GDP in 2015 and decline gradually to 6.7 percent in 2020.
  - Cyclically adjusted current account balance stood at 8.1 percent of GDP in 2014; staff norm assessed at 3–5 percent of GDP.
  - REER assessed as undervalued by 5–15 percent in 2014 (trade-elasticity approach: 7–12 percent; EBA REER level model: 16 percent).
- Risks to the baseline:
  - Upside: monetary policy and oil prices could prove more effective than expected.
  - Downside: protracted slower growth in advanced and emerging economies or deeper-than-expected slowdown in China; renewed euro-area stress; persistence/volatility of oil price shock; escalation of trade sanctions with Russia (Germany depends on Russia for 30 percent of oil and gas imports).
  - Market volatility, sudden declines in market liquidity, and low inflation/negative yields pose challenges for bank profitability and incentives for risk-taking.
- Scenario analysis — Impact of slower growth in Emerging Markets:
  - EM GDP 3 percent lower than baseline at end of fourth year.
  - German GDP drops by -1.5 percent at the trough.
  - Current account almost unaffected (-0.4 pp of GDP) as domestic demand and imports also drop.
  - Lower exports lead to higher unemployment, lower wages, lower inflation, higher real interest rates (given the zero lower bound), and a permanent decline in investment and consumption versus baseline.

### Structural and demographic challenges; policy priorities
- Demographics and potential growth:
  - Working–age population set to decline soon, putting downward pressure on potential growth.
  - Under current policies, German potential GDP growth should remain stable around 1.3 percent over the next few years but start a secular decline at the end of the projection horizon.
  - European Commission’s 2015 Aging Report projects potential GDP growth will fall to 0.9 percent during the 2020’s and to 0.8 percent in the following decade.
- Policy recommendations to strengthen medium- and long-term growth and generate positive outward spillovers:
  - Increase public investment in needed infrastructure (Fund previously recommended a 2 percent of GDP increase over four years).
  - Reduce regulatory uncertainty regarding the energy transition to spur private investment.
  - Reforms to increase productivity in the nontradable services sector and foster greater competition in services.
  - Improve planning processes for infrastructure; consider a coordinating agency to advise on contract design, improve PPPs, and manage fiscal risks.
  - Sector-specific infrastructure companies could be helpful if associated fiscal risks are appropriately managed.
  - Reduce disincentives for women to work full time:
    - If the difference in average hours worked by men and women were fully closed, potential output would increase by as much as 7.5 percent.
    - Recommendations: invest in after-school programs, reform tax-benefit system to encourage full-time work (lower tax wedge for secondary earners by moving closer to individual taxation; reduce differences in health-insurance premiums for working and non-working spouses; target cash support to poorer households).
  - Address services sector productivity by removing barriers to competition and reviewing regulated professions.
  - Energy sector: clarify long-run subsidy framework, secure conventional back-up capacity, expedite grid expansion; auctioning renewable subsidies expected to introduce competition and curb costs.

### Financial sector policies and macroprudential recommendations
- QE perceived negatively by German public but supportive for euro-area recovery.
- Housing market and mortgage risk:
  - Nominal housing prices grew at an annual pace of 3–4 percent over past five years—marginally faster than disposable income.
  - Mortgage loan growth modest; dynamic segments (apartments in large cities) deserve supervisory attention.
  - Bundesbank survey shows significant share of high reported loan-to-value ratios in dynamic segments.
- Macroprudential toolkit:
  - FSC examining expansion of toolkit; recommended instruments constraining mortgage loan eligibility (LTV, DTI, DSTI limits, minimum amortization).
  - Carefully designed communication strategy advised to maximize signaling value.
- Banking sector:
  - Large banks continued to build capital; one G-SIB targets a leverage ratio of 5 percent.
  - Low profitability due to legacy issues, litigation costs, adjustment to new regulatory environment, and low interest margins.
  - Supervisors asked banks not directly supervised by the ECB to run bottom-up stress tests over five-year horizons under various yield curve assumptions.
  - Harmonization of supervisory practices within SSM ongoing; harmonization of options and national discretions under way.
- Life insurance:
  - Transition to Solvency II begins January 1, 2016 (phase-in 16 years).
  - Life Insurance Reform Act (passed in July last year) reduced obligation to share unrealized gains, restricted dividends, and reduced minimum guaranteed rate on new contracts.
  - Bundesbank simulations: in a severe stress scenario market share of impaired insurers in 2023 would drop from 43 percent to 17 percent as a result of the reform; balance sheet shortfall would be EUR 1.8 bn.

### Key macroeconomic indicators and projections (selected)
- Total population (2014): 81.1 (million)
- GDP per capita (2014): 47,615 (USD)
- Real GDP growth:
  - 2012: 0.6
  - 2013: 0.2
  - 2014: 1.6
  - 2015 (projection): 1.6
  - 2016 (projection): 1.7
- Output gap (percent of potential GDP):
  - 2012: 0.4
  - 2013: -0.6
  - 2014: -0.3
  - 2015: 0.0
  - 2016: 0.3
- Private consumption (percentage change): 2012: 0.6; 2013: 0.9; 2014: 1.2; 2015: 2.0; 2016: 1.5
- Exports of goods and nonfactor services (percentage change): 2012: 3.5; 2013: 1.7; 2014: 3.7; 2015: 4.1; 2016: 4.3
- Unemployment rate (percent): 2012: 5.4; 2013: 5.2; 2014: 5.0; 2015: 4.8; 2016: 4.7
- Consumer price index (harmonized): 2012: 2.1; 2013: 1.6; 2014: 0.8; 2015: 0.4; 2016: 1.3

### Public finances (selected)
- General government expenditure (in billions): 2012: 1,215; 2013: 1,245; 2014: 1,276; 2015: 1,326; 2016: 1,351
- General government expenditure (percent of GDP): 44.2; 44.3; 44.0; 43.8; 43.5 (2012–2016)
- General government revenue (in billions): 2012: 1,218; 2013: 1,249; 2014: 1,294; 2015: 1,342; 2016: 1,362
- Overall balance (percent of GDP): 0.1; 0.1; 0.6; 0.5; 0.4 (2012–2016)
- Public gross debt (percent of GDP): 79.3; 77.1; 74.7; 70.6; 67.9 (2012–2016)

### External sector and balance of payments (selected)
- Current account (in billions): 2012: 240.8; 2013: 241.7; 2014: 292.0; 2015: 284.8; 2016: 276.0
- Current account (percent of GDP): 6.8; 6.5; 7.6; 8.4; 7.9 (2012–2016)
- Trade balance (percent of GDP): 5.8; 5.8; 6.5; 7.7; 7.2 (2012–2016)
- Exports (percent of GDP): 39.1; 38.6; 38.7; 39.6; 40.4 (2012–2016)

### Public debt sustainability and stress tests — key conclusions
- Public debt-to-GDP ratio falls from 74.7 percent in end-2014 to less than 60 percent in 2020 under the baseline.
- Estimated gross financing needs marginally below 15 percent of GDP in 2014 and expected to fall through the forecast horizon.
- Under plausible macro-fiscal shocks, government debt would not surpass 75 percent of GDP and gross financing needs would remain below 15 percent of GDP.
- Growth shock (one standard deviation over 2016-17 of 2.9 percentage points): debt (gross financing needs) would peak at 75 (12) percent of GDP and converge to 66 (9) percent of GDP by 2020.
- Contingent fiscal shock (cumulative 3 percent of GDP, about 90 billion euros, to financial sector over 2016–2017): even with this shock, convergence to 60 percent is still achieved in 2020; gross financing needs would remain comfortably below 15 percent.

### Risk Assessment Matrix (selected risks, likelihood, impact, policy responses)
- I. Slowdown of external demand — Relative Likelihood: M; Impact: M; Policy response: If output gap widens significantly, invoking escape clause under fiscal rule could be appropriate.
- II. Reassessment of regional sovereign risk (euro-area financial stress) — Relative Likelihood: M; Impact: M.
- III. Energy prices volatility — Relative Likelihood: H; Impact: L.
- IV. Geopolitical tensions surrounding Ukraine (exposure given 40 percent of total gas consumption from Russia) — Relative Likelihood: M; Impact: M; Policy response: Revisiting Germany’s energy strategy may become necessary.
- V. Medium-term risk — Excessive risk-taking in low interest rate environment (housing overvaluation, search-for-yield) — Relative Likelihood: L; Impact: M; Policy response: Strengthen macroprudential framework and bank supervision; push large banks to reduce high leverage.
- VI. Medium-term risk — Life insurance solvency pressures from low interest rates — Relative Likelihood: M; Impact: L; Policy response: Supervisors should use additional early intervention powers granted by 2014 life insurance reform law.

### Authorities’ views (summary)
- Authorities agree moderate expansion likely to continue and support consumption-led upswing amid lower energy prices and solid wage growth.
- Bundesbank expects inflation to accelerate owing to exchange rate pass-through, minimum wage, and recent wage dynamics, reaching close to 2 percent in 2016.
- Authorities comfortable with current nominal and real wage growth; see public debt as well-anchored by EU and national fiscal rules but expect slower convergence to 60 percent than staff.
- Authorities favor measured public investment increases, stress maintaining buffers under fiscal rule, and support measures to improve municipal planning and execution capacity.

*International Monetary Fund — Excerpt from Germany Article IV Consultation staff report (content unit: _cr15187).*

### 1. Impact on Germany of Slower Growth in Emerging Markets __________________________________ 14

### 1. Impact on Germany of Slower Growth in Emerging Markets __________________________________ 14

### Recent Economic Developments and Uptrend
- An upturn is under way as the economy is enjoying the benefits of the euro depreciation and lower energy prices.
- Anticipation of the ECB’s quantitative easing (QE) significantly lowered interest rates and term spreads, weakened the euro, and, together with the drop in energy prices, helped overcome the unexpected slowdown of mid-2014.
- By the end of last year and into the first quarter of this year:
  - Investment picked up again.
  - Consumption was supported by above-trend real disposable income growth.
  - Real compensation per employee increased by 1.7 percent in 2014.
- Employment kept growing strongly; the unemployment rate hit another post-reunification low at 4.7 percent.
- The new minimum wage, introduced on January 1, 2015 and implemented over two years, has had no visible impact on total employment so far.
- Capacity utilization rates are above historical averages and business survey indicators suggest the pace of the expansion should continue.

### Prices and Labor Market
- The oil price drop brought inflation temporarily close to zero.
- Core inflation is low and stable at around 1 percent.
- The oil price and nominal effective exchange rate dynamics:
  - REER depreciated since mid-2014, likely to put upward pressure on the current account in 2015.
  - The CPI-based real effective exchange rate was roughly stable in 2014, but has since depreciated by 6 percent from its 2014 average primarily because of nominal depreciation vis-à-vis the dollar and the renminbi.
- Labor market and income composition:
  - Continued strong immigration over the next few years could counter the negative natural demographic balance (population and projection charts noted).
  - The secular decline in hours worked per employed has slowed down.
  - Unit labor costs have been rising; labor share normalization noted.

### Balance of Payments and External Position
- The current account surplus continued to grow in 2014, reaching 7.6 percent of GDP.
- The narrowing of the oil and gas trade deficit was the main contributor to the expansion in the surplus.
- The surplus vis-à-vis euro area economies (EA5 = Greece, Ireland, Italy, Portugal, Spain) with high borrowing spreads during the 2010-11 sovereign debt crisis was stable after declining substantially during the crisis.
- Saving-investment balances:
  - Non-financial corporations and the general government increased their surpluses in 2014 relative to 2013.
  - The surplus of non-financial corporations, at 2.2 percent of GDP, reached its highest level since reunification.
- Net international investment position (NIIP) continued to grow in 2014, reflecting stronger direct and portfolio investment positions, although monetary and financial institutions cut back their net foreign lending position, continuing a trend observed since 2009.
- Portfolio investment continued to be the largest item in the capital and financial account in 2014.

### Fiscal Developments and Outlook
- Fiscal stance:
  - Fiscal policy was mildly contractionary in 2014, while it is expected to turn mildly expansionary in 2015.
  - The government presented a balanced federal budget for 2015, one year ahead of schedule.
- Fiscal metrics:
  - The general government surplus rose to 0.6 percent of GDP in 2014—a structural improvement of 0.3 percent relative to 2013—owing to lower-than-expected interest payments and one-off revenue items.
  - A negative interest rate–growth rate differential pushed the debt ratio further down, to 74.7 percent of GDP.
- Fiscal rules and projections:
  - The structural fiscal position for 2015 is expected to remain comfortably within the boundaries set by the constitutional debt brake rule at the federal level and the European Medium-Term Objective (MTO) at the general government level (maximum structural deficits of 0.35 percent and 0.5 percent of GDP, respectively).
  - Under staff's macroeconomic outlook, a balanced 2015 federal budget would drive public debt under 60 percent of GDP by 2020.
- Public investment:
  - The government has increased public investment commitments for the medium run, but fiscal space remains for a more ambitious plan through the end of this legislature.

### Credit Conditions, Asset Prices, and Banking Sector
- Interest rates and credit:
  - The yield on 10-year bunds reached a trough of 0.1 percent in mid-April, then rebounded sharply but remains very low from a historical perspective, with negative yields extending up to the 3-year maturity.
  - Historically low bank lending rates have fallen further with the anticipation of QE.
  - Credit growth remains tepid despite record-low interest rates, especially in the corporate sector; companies finance much investment from retained earnings and cash reserves.
  - Aggregate mortgage lending growth has been tepid despite a more dynamic housing market in some “hot spots,” with signs of acceleration in recent months.
- Asset prices:
  - Stock prices have accelerated sharply.
  - Housing prices are rising only modestly faster than disposable income in aggregate; apartment prices in the 10 largest cities show stronger movements.
- Banking sector health:
  - The Single Supervisory Mechanism’s (SSM) Comprehensive Assessment revealed only minor shortcomings in loan classification or provisioning but showed relatively low capital quality and leverage ratios in the large-bank segment.
  - Higher provisioning needs identified by the asset quality review were concentrated in shipping finance and commercial real estate portfolios.
  - All assessed banks, except a relatively small one, passed the stress tests.
  - Many of the largest German banks had leverage ratios close to or below 4 percent; this level is emerging as the new regulatory minimum in a growing number of European countries (Netherlands, Switzerland, U.K.).
  - According to stress test results published by the European Banking Authority, a total of five German banks would have had a capital shortfall in the adverse scenario under a fully loaded (as opposed to phase-in) common equity Tier 1 metric.

### Outlook and Risks
- Outlook: Domestic demand momentum, improved external environment, capacity utilization above historical averages, and strong labor market conditions suggest continued expansion.
- Risks highlighted in analysis:
  - A slowdown in emerging markets could weigh on export growth despite REER depreciation.
  - Market volatility and sudden declines in market liquidity could affect yields and financial conditions.
  - Banking sector vulnerabilities: low capital quality, thin capital buffers under stress in the Comprehensive Assessment, and high leverage for some large banks.
  - Low inflation environment and negative yields pose challenges for bank profitability and incentives for risk-taking.

*International Monetary Fund — Staff Report excerpt: "GERMANY — Recent Economic Developments and Outlook" (content unit: 1. Impact on Germany of Slower Growth in Emerging Markets)*

### 7.      The more favorable external environment should support the growth momentum. The

### 7.      The more favorable external environment should support the growth momentum. The

### Growth outlook and drivers
- Robust private consumption dynamics of the past three quarters are projected to persist, helped by lower energy prices and strong real wage growth.
- Euro depreciation and lower real interest rate (as QE pushes up inflation expectations) should buttress exports and the recovery in machinery and equipment investment.
- Corporate credit demand is expected to remain muted given cash-rich corporate balance sheets and increasing profit margins for exporters, but QE-induced lower real interest rates should translate into somewhat firmer credit growth.
- The fiscal stance should remain slightly expansionary in 2016.
- Employment growth should slow as the adverse effect of the lower statutory retirement age for some categories of workers on labor force participation kicks in fully and the already low unemployment rate becomes harder to reduce further.
- Key projections:
  - GDP is expected to grow by 1.6 percent this year and 1.7 percent next year.
  - The output gap should close this year and remain positive but small in the medium term.
  - German inflation is expected to exceed that in the rest of the euro area throughout the forecast horizon, but is not projected to rise above the ECB price stability objective.

### Fiscal outlook
- Fiscal balances are set to remain comfortably within the boundaries of the fiscal rules.
- Budget plans for the remainder of the legislature (2015–17) and beyond are centered on a zero balance at the federal level with small surpluses for the general government, backed by buoyant revenue forecasts.
- Staff expects larger surpluses than the authorities, mostly on account of lower projected interest payments, enough to bring public debt below 60 percent of GDP by 2020.
- The structural fiscal balance is expected to decline by 0.6 percent of GDP through 2015–17.
- Debt sustainability analysis shows the medium-term position is well anchored by the fiscal rules.

### Current account and external position
- The current account surplus is projected to grow further in 2015 and decline only moderately in the medium term.
- Drivers:
  - The oil and gas trade balance is expected to continue to improve as energy prices remain lower on average than in 2014.
  - Real exchange rate depreciation of 6 percent in effective terms relative to 2014 will put upward pressure on the external balance.
- Key projections and levels:
  - The surplus is expected to exceed 8 percent of GDP (a record high) in 2015 and decline gradually to 6.7 percent in 2020.
- External assessment:
  - The cyclically adjusted current account balance stood at 8.1 percent of GDP in 2014; staff assesses the norm at 3–5 percent of GDP.
  - Hence, the current account is 3–5 percentage points of GDP stronger than the value implied by fundamentals and desirable policies.
  - The REER is assessed as undervalued by 5–15 percent in 2014.
    - Applying standard trade elasticities to the current account gap yields a REER undervaluation of 7–12 percent.
    - The EBA REER level model suggests an undervaluation of 16 percent.
  - Developments as of May 2015 (lower energy prices and depreciated REER) point to a further strengthening of the external position; preliminary EBA REER models based on projections point to a larger undervaluation in 2015 if the current depreciation of the euro is sustained.
  - The current account gap may remain stable because the EBA model norm is projected to increase as well, partly reflecting demographic factors.

### Risks to the baseline
- Overall, risks are more balanced than a year ago, but important sources of uncertainty remain.
- Upside risk:
  - Stimulus from monetary policy and oil prices could prove more effective than expected.
- Downside risks (external, with possible impact ranging from low to moderate):
  - A protracted period of slower growth in key advanced and emerging economies or a deeper-than-expected slowdown in China would dampen German activity. Germany is very open, with an exports-to-GDP ratio over 45 percent, and thus highly sensitive to external demand fluctuations.
  - Renewed stress in the euro area, triggered by policy uncertainty, faltering reforms, or political unrest in some countries, might erode confidence and postpone the projected investment recovery; further monetary stimulus at the euro area level would be forthcoming in this scenario, but may need reinforcement by demand-support measures in Germany.
  - Uncertainty about the persistence of the oil supply shock and the underlying price decline could undo part of the recent improvement in consumer and business confidence; this would be a low-impact shock.
  - An escalation of trade sanctions with Russia would hurt Germany because of its heavy dependence (30 percent) on oil and gas imports from that country and might require a reform of the energy strategy; other direct trade ties and financial exposures are limited. Germany could also experience safe haven inflows if tensions rise.

### Authorities’ views
- The authorities agreed with staff that the moderate expansion is likely to continue, expressing confidence in a consumption-led upswing amid lower energy prices and solid wage growth underpinned by a tight labor market and closed output gap.
- The Bundesbank underscored that prices were likely to accelerate owing to pass-through from exchange rate depreciation and the introduction of the minimum wage and recent wage dynamics, so that inflation would reach close to 2 percent in 2016.
- The authorities agreed that the current account surplus would decline only gradually and that public debt is well-anchored by EU and national fiscal rules, though they foresaw convergence to the 60 percent Stability and Growth Pact objective at a slower pace than staff’s projections.
- On risks, the authorities saw them as generally balanced:
  - Upside: private investment could turn out stronger than expected.
  - Downside: instability in the euro area as a result of renewed sovereign stress, possibly amplified by relatively low liquidity in some market segments, was seen as the most relevant risk; they noted the system is now much more resilient.
  - Heightened exchange rate volatility was also viewed as a source of risk by many German corporations.

### Scenario analysis: Impact of slower growth in Emerging Markets (Box 1)
- Scenario setup:
  - EM deceleration due to a permanent decline in the level of total factor productivity (with respect to baseline) initially perceived as cyclical.
  - EM monetary policy is loosened and currencies depreciate; as negative growth surprises persist, agents realize slowdown is structural and monetary loosening is gradually reversed.
- Impacts on Germany:
  - Germany is among the most affected economies in the euro area.
  - Lower growth in EMs (GDP is 3 percent lower than in the baseline at the end of the fourth year) spills over to the global economy and negatively impacts commodity prices.
  - German GDP drops by -1.5 percent at the trough.
  - The current account is almost unaffected (-0.4 pp of GDP) as domestic demand and imports also drop.
  - Lower exports lead to lower labor demand, higher unemployment, lower wages, lower inflation, and higher real interest rates (given the zero lower bound), resulting in a permanent decline in investment and consumption versus baseline.
  - EMs’ initial monetary loosening depreciates their currencies against the euro, further impacting Germany’s competitiveness and exports; as EMs normalize policy, Germany’s real exchange rate and current account converge back to baseline, but negative impacts on consumption, investment, and real GDP are more persistent.

### Structural and demographic challenges; policy priorities
- Demographics and potential growth:
  - The working–age population is set to decline soon, which will put downward pressure on potential growth.
  - Stronger immigration and modest upward trends in labor force participation by female and older workers have so far compensated, but aging will accelerate and high immigration flows may not be sustainable.
  - If trend total factor productivity remains constant and capital accumulation continues at its current modest pace, potential growth will decline rapidly after 2020.
  - Under current policies, German potential GDP growth should remain stable around 1.3 percent over the next few years but start a secular decline at the end of the projection horizon.
  - The European Commission’s 2015 Aging Report projects that potential GDP growth will fall to 0.9 percent during the 2020’s and to 0.8 percent in the following decade.
- Policy discussion and recommendations:
  - With a favorable cyclical position, progress is urgently needed on policies to strengthen growth in the medium and long term, while generating positive outward spillovers and reducing the large current account surplus.
  - Policies should focus on fostering potential growth while generating positive demand spillovers.
  - Staff’s model simulations from last year argued that increased spending on public investment in needed infrastructure, policies to reduce regulatory uncertainty regarding the energy transition, and reforms to increase productivity in the nontradable services sector would lift potential output and generate meaningful positive outward spillovers to the rest of the euro area, while reducing the current account surplus.
  - In particular, higher public and private investment (the latter brought about by energy sector reforms) were found to have especially large spillover multipliers.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 19.      Policies that directly target higher wages may generate negative outward spillovers if

### Policies that directly target higher wages may generate negative outward spillovers if they result in lower employment and weaker economic activity in Germany

### Wages, competitiveness, and spillovers
- The widening current account surplus in the mid-2000s coincided with labor market reforms that strengthened incentives for the unemployed to return to work; the reforms were accompanied by declining real wages and unit labor costs.
- Real wages and unit labor costs began to rise in 2008 and the labor share is back to its long-term average, but the current account surplus has not declined.
- Model simulations indicate:
  - Policies that directly target wage increases (such as a social pact or measures to strengthen the negotiating power of workers) would lead to a REER appreciation and a modest fall in the current account surplus, but would also bring about reductions in employment and production in Germany and negative growth spillovers to the rest of the euro area.
  - By contrast, wage increases resulting from positive demand shocks would be associated with higher output and employment and a lower current account surplus in Germany as well as positive growth and economic activity in the rest of the euro area.

### Box 3 — The Hartz Labor Market Reforms: key findings
- The Hartz reforms (2003–05) eased regulation on temporary work agencies, relaxed firing restrictions, restructured the federal unemployment agency, significantly reduced benefits for long-term unemployed, and tightened job search and acceptance obligations.
- After the reforms, the unemployment rate declined steadily and is now at its lowest level since reunification.
- Existing studies and staff research find:
  - The reforms helped reduce unemployment and increased the efficiency of job search but lowered average wages and increased wage inequality.
  - Administrative-data analysis comparing workers in stable employment and displaced workers shows that after the reforms the earnings of displaced workers fell markedly while those of other workers remained flat, suggesting displaced workers were more willing to accept lower paying jobs to exit unemployment.
  - The reforms strengthened incentives to return to work, contributing to the sharp reduction in unemployment since 2005, but imposed a higher burden on workers experiencing unemployment in terms of reduced post-unemployment earnings.

### Authorities' views on wages and macro policy
- The authorities agree population aging is a primary concern and would be comfortable with a lower current account surplus, but emphasized that the current account balance is not a specific policy goal.
- They shared concerns about declining long-term growth rates and lackluster private investment despite low interest rates, and were open to policies that might improve the corporate sector’s willingness to invest to reduce the current account surplus.
- They rejected fiscal stimulus citing the closed output gap and limited outward spillovers.
- In a monetary union, they emphasized that monetary policy—but not fiscal policy—should be set for the union as a whole.
- Overall, they were comfortable with current nominal and real wage growth, viewing it as reflecting a tightening labor market and bringing about needed realignment of competitiveness within the euro area at an appropriate pace.

### Public investment: recent actions and assessment
- Fund recommendation from last year: a 2 percent increase in investment in infrastructure over four years.
- Government announced plans including:
  - 0.1 percent of GDP allocated to a new infrastructure fund for financially weaker municipalities in 2015 (plus a new allocation of about ½ this year’s size for 2017).
  - New spending mostly in public transportation, the digital infrastructure, and energy efficiency improvements totaling 0.4 percent of GDP over 2016–18.
- The 2015 German Stability Program foresees:
  - General government public capital spending to increase on average by 4.6 percent per year during 2015–19, against an average growth rate of 1.7 percent in 2011–14.
  - Public capital spending going from 2.2 percent of GDP in 2014 to 2.3 percent of GDP in 2019.
- If the proposed increase were fully financed through the budget and implemented during the current legislature, such a program would utilize most of the fiscal space available under the MTO, bringing the general government structural balance down to -0.3 percent of GDP by 2017.
- Assessment:
  - The new plans appear well short of last year’s Fund advice; delivering the remainder of the proposed increase would be desirable.
  - A coordinating agency to improve local planning and facilitate PPPs could advise on contract design, improve information transparency, and highlight fiscal risks and cross-project externalities.
  - Sector-specific infrastructure companies could be helpful if associated fiscal risks are appropriately managed (transfer of project risks to private sector or inclusion in the general government perimeter).

### Authorities' views on public investment
- The Ministry of Finance viewed new initiatives as a substantial investment expansion package and did not see merit in further increases given other priorities (such as income tax relief after years of “bracket creep”).
- The Ministry stressed the need to maintain buffers under the fiscal rule and the value of a budgetary anchor like a balanced federal budget.
- The Ministry agreed a coordinating agency could help mobilize investment at the local level but noted creation would take time and could be challenging given the federal framework.

### Structural reforms: services sector and energy
- Services sector:
  - Labor productivity growth in the services sector remains low, particularly in business services.
  - Barriers to competition exist in several large sub-sectors; their removal would boost productivity and potential growth.
  - Progress on reforms is slow; the EC-led transparency and mutual evaluation exercise on regulated professions will be completed in January 2016.
  - Government initiated a review of restrictions on equity investment in selected professions with results expected by year-end.
  - EC initiated pilot proceedings against Germany posing questions on the scale of fees of some professions.
  - Draft rail regulation law is being discussed as an opportunity to enhance regulatory powers to limit discriminatory practices by the incumbent operator.
- Energy sector:
  - Renewable Energy Act amended to help contain costs for retail electricity users; EC allowed continuation of subsidies for large companies at least until 2020.
  - Key unresolved issues: long-run certainty of the controversial subsidy, securing conventional back-up capacity as renewable capacity is expanded, and expediting grid expansion amid regional opposition.
  - Electricity costs are already among the highest in Europe; these challenges should be addressed rapidly to avoid further cost increases and reduce uncertainty for private investment decisions.

### Authorities' views on services and energy
- Authorities confident energy transition would be successfully managed; noted electricity price surcharge related to renewable sources had not increased in 2015 (partly reflecting statistical factors).
- Plans to auction off renewable subsidies are expected to introduce more competition and curb costs.
- On regulated professions, authorities agree scope exists for re-assessing parts of the regulation but note political support is generally weak and reviews must be case-by-case to protect quality standards.

### Countering adverse demographics: female labor force participation
- Female labor force participation is relatively high in Germany (above 70 percent), but about half of working women work part time, in part because women are the main holders of so-called mini-jobs.
- Constraints include insufficient supply of good quality child care services and afterschool programs, and disincentives from the tax-benefit system.
- Staff estimates:
  - If the difference in average hours worked by men and women were fully closed, potential output would increase by as much as 7.5 percent.
- Recent actions:
  - Federal government increased investment in the expansion of child care facilities by 0.1 percent of GDP in total over the last three years.
- Policy recommendations:
  - Make comparable investment in expansion of after school programs.
  - Reform the tax-benefit system to encourage full-time work, including:
    - Lowering the tax wedge for secondary earners by moving closer to a system of individual taxation.
    - Reducing differences in health-insurance premiums for working and non-working spouses.
    - Targeting cash support for non-working parents to poorer households.
  - Address both childcare/afterschool supply and fiscal disincentives simultaneously for a more effective response of female labor supply.

### Authorities' views on female labor force participation
- Authorities noted female participation is among the highest in advanced economies; prevalence of part-time work partly reflects social preferences.
- They agreed fiscal disincentives for secondary earners were high—particularly free health care coverage of spouses not working or working in a mini-job—but emphasized absence of widespread high quality child care and afterschool programs is likely the more important constraint.
- They highlighted progress made in increasing child care supply.

### Monetary and financial sector policies
- QE is expected to be very beneficial for the euro area recovery, but its perception by the German public is generally negative due to long-standing preference for low inflation and a relatively favorable cyclical position.
- German households hold a large share of wealth in nontradable fixed income assets (bank deposits and life insurance policies); typical mortgages have a fixed interest rate and home ownership rate is low relative to other advanced countries—so lower interest rates and higher asset prices from QE do not translate into stronger household balance sheets as much as in other advanced countries.
- Housing market developments:
  - Nominal housing prices at the aggregate level have grown at an annual pace of 3–4 percent for the past five years—only marginally faster than growth in disposable income.
  - Mortgage loan growth remains modest and lending standards appear stable despite falling lending rates.
  - No signs of overheating at the aggregate level, but dynamic segments (apartments in large cities) deserve particular supervisory attention.
  - Bundesbank survey shows a significant share of high reported loan-to-value ratios (LTVs) in dynamic segments.
- Macroprudential policy:
  - Financial Stability Committee (FSC) announced it was examining an expansion of the German macroprudential toolkit, as recommended by the FSB and the Fund.
  - Introducing instruments constraining mortgage loan eligibility, such as loan-to-value and debt-service-to-income limits, would be very helpful for future preparedness and for the signaling value of the policy decision.
  - A carefully designed communication strategy would help make the most of this signaling value.

*International Monetary Fund — Excerpt from Germany Article IV Consultation staff report*

### 31.      In the banking sector, large banks’ continued momentum to build up their capital

### _cr15187 - 31.      In the banking sector, large banks’ continued momentum to build up their capital

### Banking sector: capital building and profitability
- Large banks have continued to build up their capital position post SSM Comprehensive Assessment.
- One globally systemically important bank announced a new strategic plan targeting a leverage ratio of 5 percent.
- Germany’s second largest bank completed a capital increase that brings its capital ratios closer to European peers.
- Most other large domestically owned banks (unable to rely on markets due to corporate structure) are expected to build capital buffers through profit retention and/or refocusing on German core business.
- Strong capital is important given low bank profitability, reflecting:
  - Remaining crisis legacy problems (especially among banks under state aid procedures).
  - Litigation costs (in the two largest banks).
  - Need to adjust business models to the post-crisis regulatory environment (in all large banks).
  - Low interest margins (in the banking sector as a whole).
- Reform of the Landesbanken is ongoing; deleveraging is slowing as non-core legacy portfolios have already shrunk significantly and selective new business is being underwritten.

### Low interest rates — risks, monitoring, and bank behavior
- Net interest margins remain under pressure and are well below European peers.
- Banks are reluctant to charge fees to retail customers.
- A Bundesbank study suggests banks are increasing term transformation, exposing them to more interest rate risk.
- German supervisors have asked banks not directly supervised by the ECB to run bottom-up stress tests over five-year horizons under various yield curve assumptions.
- Further consolidation to cut costs among many small retail-focused institutions appears to be proceeding only slowly.

### New European supervisory and regulatory landscape
- ECB staff coordinates with German supervisory bodies within the SSM framework.
- SSM work ongoing to improve consistency of supervisory practices and develop a common supervisory culture.
- Supervisory priorities include review of business models, governance, and capital adequacy.
- Initiatives to harmonize options and national discretions in the European capital regulation and directive are ongoing.
- A resource-intensive review of banks’ internal models is being set up.
- Bank Recovery and Resolution Directive (BRRD) transposed; bail-in regulation in force since January 2015.
- Harmonization of Deposit Guarantee Schemes through the 2014 European Directive is forcing cooperative banks and savings banks (with Landesbanken) to reform joint protection schemes to be included in deposit guarantee schemes and recognized as statutory schemes.
- The forthcoming FSAP will be an opportunity to take stock of these transformations.
- Authorities expect the European Banking Authority to publish technical standards on MREL later this year; a draft German law under discussion would subordinate senior unsecured (tradable) securities to senior unsecured (non-tradable) liabilities in insolvency to provide greater legal certainty.

### Life insurance sector: solvency challenges and reforms
- The German life insurance sector is particularly vulnerable to a prolonged low interest rate environment; investment income may not be sufficient to meet returns guaranteed to policyholders over the medium-to-long term.
- Transition to Solvency II is set to begin January 1, 2016 (with a phase-in period of 16 years); Solvency II moves to market value and risk-based solvency, calculating interest rate risk capital surcharge and discounting insurance liabilities using risk-free rates.
- The Life Insurance Reform Act passed in July last year included:
  - Reduced obligation to share unrealized gains with policyholders upon expiry of their contract.
  - Strict restrictions on dividend payments.
  - Reduction of the minimum guaranteed rate on new contracts.
- Bundesbank simulations indicate the Act is expected to have significantly positive effects on the sector’s solvency.
  - Bundesbank study: in a severe stress scenario the market share of impaired insurers in 2023 would drop from 43 percent to 17 percent as a result of the reform, and the balance sheet shortfall would be EUR 1.8 bn. No capital shortfall estimate was provided.
- Fall in yields since the reform was calibrated has made the underlying problem on the stock of existing contracts more challenging.
- Insurers have mostly reacted by reinvesting into longer duration, higher yielding assets; further protection of capital buffers is needed.
- Vulnerable insurers should manage profit participation with policyholders very prudently.
- Supervisors’ new early intervention powers granted by the reform should be used to ensure prudence.
- Standard guaranteed rates products still represent about 80 percent of the flow of new contracts; industry would benefit from greater promotion of new products, such as unit-linked products, which embed much less interest rate risk.

### Authorities’ views
- Authorities agreed that risks from the low interest rate environment in Germany and other advanced economies should be closely monitored.
- Households display strong liquidity preference and risk aversion; growing share of highly liquid deposits in portfolios since 2008.
- Non-bank financial intermediaries show a certain appetite for yield.
- FSC announced it was reviewing the appropriateness of the current macroprudential toolkit and its ability to address possible housing market financial stability concerns.
- FSC strategy document published last year addressed a number of the 2014 FSB Peer Review recommendations; work on improving mortgage market databases is ongoing at the Bundesbank.
- Bafin emphasized Germany had been proactive, recalling the introduction of the interest rate reserve as early as 2011.
- Authorities emphasized progress in building stronger capital buffers and cautioned about too much harmonization of the capital framework within the SSM, noting some national options and discretions may be justified.
- Authorities reiterated position to abolish zero risk-weighting and apply a large exposures regime to sovereign bonds.
- A draft German law under discussion would change insolvency ranking of certain senior unsecured securities to provide greater legal certainty.

### Staff appraisal — macro and policy implications
- Upturn expected to continue in 2015, with growth lifted by the double stimulus of low energy prices and QE.
- Private consumption should be the largest contributor to growth, underpinned by a strong increase in real disposable income.
- Inflation should remain subdued in the medium term, consistent with an output gap close to zero.
- Further decline in the historically low unemployment rate and sound wage growth point to labor market tightening.
- Growth could be higher than forecast if transmission of lower energy prices and QE is more powerful than expected; downside risks include weaker-than-expected growth in trading partners or renewed euro area stress.
- Lower interest rates and strong labor market will continue to support the fiscal position.
  - Budget plans anchored on a zero balance at the federal level with small surpluses for general government.
  - Staff expects larger fiscal surpluses than the authorities, mostly on account of lower projected interest payments, which would bring public debt below 60 percent of GDP by 2020.
  - Structural fiscal balance should decline through 2015–17, while remaining comfortably above the Medium-Term Objective of the Stability and Growth Pact.
- External position remains substantially stronger than implied by medium-term fundamentals; project current account surplus to exceed 8 percent of GDP this year and decline slowly in the medium term.
- Recommendations and policy priorities:
  - Commit to more ambitious public investment: Fund previously recommended a public investment increase of some 2 percent of GDP over four years to address infrastructure needs.
  - Improve planning processes for infrastructure and take advantage of private sector expertise; consider sector-specific infrastructure companies if fiscal risks are appropriately managed.
  - Boost municipal investment via alternative financing/execution mechanisms (e.g., public-private partnerships) while managing local capacity constraints; consider a coordinating agency to advise on contract design and centralize information.
  - Reduce disincentives for women to work full time: address high overall marginal tax burden faced by secondary earners; provide additional and higher quality child care services and after-school programs; review policies favoring early retirement.
  - Foster greater competition in the services sector, including reviewing restrictive regulations for regulated professions and reinforcing regulator’s powers in rail transportation.
  - In the financial sector:
    - Monitor and assess effects of the low interest rate environment.
    - Address structurally weak bank profitability by reducing costs or increasing fee-based activities.
    - Continue close cooperation within SSM joint supervisory teams.
    - Monitor housing market hot spots and step up mortgage data collection; introduce instruments constraining mortgage loan eligibility (loan-to-value and debt-service-to-income limits) into the macroprudential toolkit.
    - Continue to protect life insurers’ capital buffers, promote products with limited interest rate guarantees, and fully use supervisors’ early intervention powers.

*Italic: IMF staff report content as presented in the source.*

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

### _cr15187 - 48.      It is recommended that the next Article IV consultation take place on the regular 12-month

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

### Key macroeconomic indicators and projections (selected)
- Total population (2014): 81.1 (million)
- GDP per capita (2014): 47,615 (USD)
- Real GDP growth:
  - 2012: 0.6
  - 2013: 0.2
  - 2014: 1.6
  - 2015 (projection): 1.6
  - 2016 (projection): 1.7
- Output gap (percent of potential GDP):
  - 2012: 0.4
  - 2013: -0.6
  - 2014: -0.3
  - 2015: 0.0
  - 2016: 0.3
- Private consumption (percentage change): 2012: 0.6; 2013: 0.9; 2014: 1.2; 2015: 2.0; 2016: 1.5
- Exports of goods and nonfactor services (percentage change):
  - 2012: 3.5
  - 2013: 1.7
  - 2014: 3.7
  - 2015: 4.1
  - 2016: 4.3
- Imports of goods and nonfactor services (percentage change):
  - 2012: 0.4
  - 2013: 3.2
  - 2014: 3.4
  - 2015: 4.8
  - 2016: 4.9
- Unemployment rate (percent):
  - 2012: 5.4
  - 2013: 5.2
  - 2014: 5.0
  - 2015: 4.8
  - 2016: 4.7
- Consumer price index (harmonized):
  - 2012: 2.1
  - 2013: 1.6
  - 2014: 0.8
  - 2015: 0.4
  - 2016: 1.3

### Public finances (selected)
- General government expenditure (in billions): 
  - 2012: 1,215
  - 2013: 1,245
  - 2014: 1,276
  - 2015: 1,326
  - 2016: 1,351
- General government expenditure (percent of GDP): 44.2; 44.3; 44.0; 43.8; 43.5 (2012–2016)
- General government revenue (in billions):
  - 2012: 1,218
  - 2013: 1,249
  - 2014: 1,294
  - 2015: 1,342
  - 2016: 1,362
- General government revenue (percent of GDP): 44.3; 44.5; 44.6; 44.4; 43.8 (2012–2016)
- Overall balance (net lending/borrowing, in billions): 34; 18; 16; 12; (2012–2015)
- Overall balance (percent of GDP): 0.1; 0.1; 0.6; 0.5; 0.4 (2012–2016)
- Structural balance (percent of GDP): 0.0; 0.5; 0.7; 0.4; 0.2 (2012–2016)
- Federal government overall balance (in billions): -15; -4; 13; 12; 11 (2012–2016)
- Public gross debt (Maastricht definition, in billions): 2,180; 2,166; 2,170; 2,135; 2,110 (2012–2016)
- Public gross debt (percent of GDP): 79.3; 77.1; 74.7; 70.6; 67.9 (2012–2016)

### External sector and balance of payments (selected)
- Current account (in billions): 240.8; 241.7; 292.0; 284.8; 276.0 (2012–2016)
- Current account (percent of GDP): 6.8; 6.5; 7.6; 8.4; 7.9 (2012–2016)
- Trade balance (percent of GDP): 5.8; 5.8; 6.5; 7.7; 7.2 (2012–2016)
- Exports (percent of GDP): 39.1; 38.6; 38.7; 39.6; 40.4 (2012–2016)
- Imports (percent of GDP): 31.9; 31.2; 30.8; 31.1; 32.2 (2012–2016)
- Net errors and omissions (percent of GDP): -1.0; 1.0; 0.9; 0.0; 0.0 (2012–2016)

### Financial sector soundness (selected)
- Regulatory capital to risk-weighted assets (total, percent):
  - 2009: 14.8
  - 2010: 16.1
  - 2011: 16.4
  - 2012: 17.9
  - 2013: 19.2
  - 2014: 18.0
- NPLs to gross loans:
  - 2009: 3.3
  - 2010: 3.2
  - 2011: 3.0
  - 2012: 2.9
  - 2013: 2.7
- Return on average assets (after-tax):
  - 2009: -0.1
  - 2010: 0.2
  - 2011: 0.3
  - 2012: 0.2
  - 2013: 0.2
  - 2014: 0.2
- Liquid assets to total short-term liabilities (percent):
  - 2009: 144.1
  - 2010: 137.0
  - 2011: 137.9
  - 2012: 144.2
  - 2013: 140.5
  - 2014: 145.5
- Deposit-taking institutions: capital to assets:
  - 2009: 4.8
  - 2010: 4.3
  - 2011: 4.4
  - 2012: 4.7
  - 2013: 5.5
  - 2014: 5.6
- Household debt to GDP:
  - 2009: 64.6
  - 2010: 62.0
  - 2011: 59.8
  - 2012: 56.2
  - 2013: 55.1
  - 2014: (not stated for 2014 in this series)

### Risk Assessment Matrix — risks, likelihood, impact, and policy responses
- I. Slowdown of external demand
  - Relative Likelihood: M
  - Impact: M
  - Policy response: If output gap widens significantly, depending on the size and nature of the shock, invoking the escape clause under the fiscal rule could be appropriate to support German growth.
- II. Reassessment of regional sovereign risk (euro area financial stress re-emergence)
  - Relative Likelihood: M
  - Impact: M
- III. Energy prices volatility
  - Relative Likelihood: H
  - Impact: L
- IV. Geopolitical tensions surrounding Ukraine (exposure given 40 percent of total gas consumption from Russia)
  - Relative Likelihood: M
  - Impact: M
  - Policy response: Revisiting Germany’s energy strategy may become necessary.
- V. Medium-term risk — Excessive risk-taking in low interest rate environment (housing overvaluation, search-for-yield)
  - Relative Likelihood: L
  - Impact: M
  - Policy response: Strengthen macroprudential framework and bank supervision; push large banks to reduce high leverage.
- VI. Medium-term risk — Life insurance solvency pressures from low interest rates
  - Relative Likelihood: M
  - Impact: L
  - Policy response: Supervisors should use additional early intervention powers granted by the 2014 life insurance reform law.

### Authorities’ response to past IMF recommendations (IMF 2014 Article IV)
- Fiscal policy recommendation: Increase public investment in infrastructure by 2 percent of GDP over four years.
  - Authorities’ response: Plans for additional public investment of some €17 billion (0.6 percent of GDP) have been announced so far.
- Financial sector recommendations:
  - Banks to strengthen capital ahead of ECB Comprehensive Assessment.
    - Response: Banks’ capital ratios have improved; largest banks raised fresh equity; a relatively small German bank had a capital shortfall.
  - Macroprudential framework readiness.
    - Response: Financial Stability Committee published strategy document and is examining specific instruments; may make recommendations to federal government.
  - Address solvency risk in medium-sized life insurers.
    - Response: July 2014 Life Insurance Reform Act strengthens solvency, but further decline in interest rates has exacerbated the problem.
- Structural reform recommendations:
  - Services sector regulation reforms to boost competition and productivity.
    - Response: No significant competition-enhancing reform taken; EC-led exercise to finish January 2016; government initiated review of shareholding rules of selected regulated professions.
  - Greater clarity on energy sector regulatory framework to encourage private investment.
    - Response: 2014 revision of the Renewable Energy Sources Act approved to contain cost increases and reduce uncertainties; Green Paper issued as first step toward future legislation.

*Source: IMF staff report excerpt (_cr15187).*

### Appendix III. Main Outstanding 2011 FSAP Update

### Appendix III. Main Outstanding 2011 FSAP Update

### Recommendations and Implementation Status — Financial Sector
- Continue improving stress testing in the banking and insurance sectors; ensure forward-looking identification of weaknesses leads to balance sheet strengthening and managerial action.
  - In 2014, 24 large banking groups (21 SSM banks and 3 banking groups later deemed as "less significant") participated in the 2014 Comprehensive Assessment/EBA EU-wide stress test covering all relevant risk factors except conduct risks, and reflecting adjustments from an asset quality review.
  - The macroeconomic top-down stress test has been significantly revised (more elaborated econometric techniques, inclusion of second-round effects).
  - The Bundesbank initiated a bottom-up exercise addressing profitability in a low-interest rate environment; it surveys projected income under target assumptions and different interest rate scenarios, and includes credit spread and credit risk stress components.
  - For insurance, the Bundesbank applied a top-down scenario analysis to assess the impact of the 2014 German Life Insurance Reform Act on solvency and financial stability.
  - In 2014 the Bundesbank developed an inverse stress testing model capturing an abrupt interest rate rise combined with policy holders lapsing contracts.
- Institute a harmonized and legally binding deposit guarantee of €100,000, backed by adequate prefunding.
  - Germany is required to transpose Directive 2014/49/EU into national law by 3 July 2015. The DGSD Implementation Act passed the Bundestag in March 2015 and will enter into force on 3 July 2015.
- Clarify interaction between the restructuring fund and deposit guarantee / mutual protection schemes.
  - The BRRD provides that resolution funds may only be used if no other private sector measures, including institutional protection schemes, would prevent failure.
  - The national restructuring fund's role is redefined by the SRM amending act (Abwicklungsmechanismusgesetz); the national fund will be used for firms within the scope of the BRRD but neither within the scope of the Delegated Act of the Commission nor within the scope of the SRM.
- Finalize strategies for exiting government support to banks; require affected banks to formulate strategic plans.
  - There are no SoFFin guarantees outstanding (31.12.2014).
  - SoFFin capital measures reduced from 17.1 billion euros (31.12.2013) to 16.8 billion euros ( 1.12.201 ).
  - Effective 19 December 201 , FMS Wertmanagement A R acquired DEPFA BA plc, Dublin — together with subsidiaries — from Hypo Real Estate Holding AG.
  - Erste Abwicklungsanstalt (EAA) is gradually winding down its portfolio. On 22.02.2015, EAA signed a share purchase agreement for sale of Westdeutsche ImmobilienBank AG to Aareal Group; the sale will reduce loans and securities in EAA's portfolio by approx. 10 billion € (EAA assets amounted to 80 billion euros as at 30.09.2014).
- Develop comprehensive strategy to improve efficiency and stability of banking system:
  - (a) Establish viable business models for the Landesbanken;
  - (b) Loosen regional constraints on local banks;
  - (c) Open up public banks to private participation;
  - (d) Strengthen governance to reduce noncommercial influences.
  - Status: Reform of the Landesbanken is ongoing; headcount, aggregate balance sheets and RWAs are still adapting. Legacy issues have been reduced in some cases; capital has improved; earnings remain relatively low with significant differences across institutions. Business models need review; sustaining restructuring efforts is key. There are no plans to loosen regional constraints, open up public banks to private participation, or reduce non-commercial influences.

*Italic line: Appendix IV follows with the Public Debt Sustainability Analysis (DSA).*

---

### Appendix IV. Public Debt Sustainability Analysis (DSA)

### Key Findings — Baseline and Outlook
- Public debt declined further in 2014 and is expected to continue to be sustainable given high primary surpluses and a favorable interest rate-growth differential projected through the medium term.
- Public debt-to-GDP ratio:
  - Falls from 74.7 percent in end 2014 to less than 60 percent in 2020 under the baseline.
  - Peak was 82.5 percent of GDP (post-2009 peak).
- Estimated gross financing needs:
  - Were marginally below 15 percent of GDP in 2014 and are expected to fall further through the forecast horizon.
- Macroeconomic baseline assumptions:
  - Real GDP growth expected to inch up to 1.8 percent in 2015-16 (non calendar-adjusted rate).
  - Medium-run potential growth estimated at 1.3 percent.
  - Inflation (GDP deflator) forecasted to temporarily rise to 2 percent in 2015 and converge lower thereafter.
  - Baseline average interest rate drops from 2.3 in 2014 to about 1½ percent in 2020.
- Germany is subject to higher scrutiny: public gross debt is still 15 percent of GDP above the DSA threshold of 60 percent.
- Realism of baseline:
  - Median forecast error for real GDP growth during 2006−201 is 0.15 percent.
  - Median forecast error for inflation (GDP deflator) is 0.54 percent.
  - Median forecast bias for the primary balance is 1.16 percent of GDP.

### Shocks, Stress Tests, and Main Quantitative Results
- Overall result:
  - Under plausible macro-fiscal shocks, Germany’s government debt would not surpass 75 percent of GDP, and gross financing needs would remain below 15 percent of GDP. Under all considered macro-fiscal stress tests, debt and gross financing needs either continue to fall or swiftly return to a downward path after the shock.
  - Debt dynamics are most sensitive to growth shocks.
- List of shocks / stress tests (as described):
  - Growth shock:
    - Real output growth rates are lower than baseline by one standard deviation over 2016-17, i.e. 2.9 percentage points.
    - Assumed decline in growth leads to lower inflation (0.25 percentage points per 1 percentage point decrease in GDP growth).
    - Interest rate is assumed to increase 25 basis points for every 1 percent of GDP worsening of primary balance.
    - Result: Debt (gross financing needs) would peak at 75 (12) percent of GDP and converge to 66 (9) percent of GDP by 2020.
  - Primary balance shock:
    - Dual shock of lower revenues and rise in interest rate, leading to a cumulative 1.6% deterioration in primary balance over 2016-17 (one standard deviation shock to primary balance).
    - Result: Modest deterioration of debt dynamics.
  - Interest rate shock:
    - Assumes an increase of 372 basis points in debt servicing costs throughout the forecast horizon, mimicking the historical maximum since 2005.
    - Result: Relatively modest effect on public debt and gross financing needs.
  - Additional stress test — Combined macro-fiscal shock:
    - Combines shocks to growth, interest rate, and primary balance while avoiding double-counting.
    - Impact on debt dynamics is slightly worse than that of a growth shock.
  - Additional stress test — Contingent fiscal shock:
    - Assumes a cumulative 3 percent of GDP (about 90 billion euros) additional support to the financial sector over 2016-2017, comprising:
      - additional re-capitalization needs in the banking system of 55 billion euros;
      - a call on half of capital shield guarantees of 25 billion euros;
      - worse than expected performance of portfolios of winding-down institutions of 10 billion euros.
    - Result: Even with this onerous shock, debt ratio impact is relatively limited; convergence to 60 percent is still achieved in 2020. Gross financing needs would remain comfortably below 15 percent.

### Selected Quantitative Time Series and Projections (2013–2020)
- Nominal gross public debt (percent of GDP) by year:
  - 2013: 70.2
  - 2014: 77.1
  - 2015: 74.7
  - 2016: 70.6
  - 2017: 67.9
  - 2018: 65.3
  - 2019: 62.6
  - 2020: 59.6
  - (final column listed as) 57.0
- Public gross financing needs (percent of GDP) by year:
  - 2013: 16.2
  - 2014: 15.5
  - 2015: 14.2
  - 2016: 11.0
  - 2017: 10.2
  - 2018: 7.9
  - 2019: 7.5
  - 2020: 6.4
  - (final column listed as) 6.4
- Real GDP growth (calendar-unadjusted, percent) series:
  - 2013: 1.4
  - 2014: 0.3
  - 2015: 1.7
  - 2016: 1.8
  - 2017: 1.8
  - 2018: 1.5
  - 2019: 1.3
  - 2020: 1.3
  - (final value) 1.2
- Inflation (GDP deflator, percent) series:
  - 2013: 1.1
  - 2014: 2.1
  - 2015: 1.7
  - 2016: 2.3
  - 2017: 1.1
  - 2018: 1.2
  - 2019: 1.3
  - 2020: 1.4
  - (final value) 1.4
- Effective interest rate (percent) series:
  - 2013: 4.0
  - 2014: 2.6
  - 2015: 2.3
  - 2016: 2.0
  - 2017: 1.8
  - 2018: 1.8
  - 2019: 1.7
  - 2020: 1.6
  - (final value) 1.6
- Change in gross public sector debt (cumulative) over projection:
  - Listed cumulative change: -17.8
  - Identified debt-creating flows cumulative: -13.4
  - Primary deficit cumulative: -8.8
  - Primary (noninterest) revenue and grants cumulative: 62.1
  - Primary (noninterest) expenditure cumulative: 53.3
  - Automatic debt dynamics cumulative: -4.6
  - Interest rate/growth differential cumulative: -4.6
  - Residual, including asset changes cumulative: -4.3

### Alternative Scenarios and Additional Assumptions (selected)
- Historical scenario and constant primary balance scenario assumptions are reported; examples include:
  - Constant Primary Balance Scenario primary balance: 1.7 (each projection year 2015–2020).
  - Historical Scenario primary balance listed: 1.7 (2015), 0.9 (2016–2020).
- Stress-test assumption examples:
  - Real GDP Growth Shock scenario real GDP growth path includes negative deviations in 2016 and 2017 (values shown as 1.8, -1.1, -1.4, 1.3, 1.3, 1.2).
  - Real Interest Rate Shock scenario effective interest rate path includes increases to 2.3, 2.4, 2.5, 2.6 in projections.

### Vulnerabilities and Risk Assessment (highlighted conclusions)
- A negative growth shock represents the largest risk to the debt outlook; debt would, however, swiftly return to a downward path after the shock.
- Realization of contingent liabilities related to future bank recapitalization needs or worse than expected performance of winding-down institutions would push debt up by about 3 percent of GDP and gross financing needs would rise to 12 percent of GDP in the near term.
- Interest rate or primary balance risks are important but their impact remains limited.

*Source: IMF staff (contents as presented in the provided document).*

### Appendix V. External Sector Report Country Page:  Germany

### Appendix V. External Sector Report Country Page: Germany

### Overall Assessment
- Germany’s net international investment position (NIIP) recovered since the beginning of the millennium and reached 33 percent of GDP at end-2014.
- The pace of NIIP build-up has fallen short of the cumulated current account surpluses, but returns (excluding revaluations) earned on assets have been higher than those paid on liabilities since 2004.
- Bundesbank accumulated large net claims on the Eurosystem (Target2), which stood at 16 percent of GDP at end-2014.
- Staff assessment for 2014: Germany’s external position was substantially stronger than implied by medium-term fundamentals and desirable policy settings.
- Subsequent developments as of May 2015 (energy import price declines and depreciation of Germany’s REER) point toward a further strengthening of the external position.
- Staff projects some medium-run rebalancing due to stronger wage growth relative to euro area trading partners and higher domestic demand.
- Potential policy responses (to generate positive demand spillovers to the rest of the euro area, boost growth potential, and reduce the German current account surplus):
  - Higher public investment.
  - Service sector reform.
  - Energy policy reform.
- Safe-haven status and strength of current external position limit immediate risks.

### Current Account
- Background facts:
  - The current account averaged 6.2 percent of GDP over the last decade and reached 7.6 percent of GDP in 2014, a 0.8 pp. increase relative to 2013.
  - Most of the 2014 increase is accounted for by an improvement in the gas and oil balance, with about equal contributions from declines in volumes and prices.
  - This improvement is expected to strengthen further in 2015 as energy prices should remain lower than in 2014.
  - REER depreciation since mid-2014 is expected to put further upward pressure on the current account, though it will partly offset the decline in the oil price.
  - On a geographic basis, the surplus vis-à-vis stressed countries in the euro area remained stable in 2014 after declining substantially in recent years.
  - The saving-investment balance of the non-financial corporations and the government each contributed about ½ percent of GDP to the improvement in the current account in 2014 relative to 2013.
- Assessment:
  - The cyclically-adjusted current account balance stood at 8.1 percent of GDP in 2014.
  - Staff assesses the norm at 3-5 percent of GDP.
  - The norm implied by the EBA model is 3.9 percent.
  - Staff assesses the 2014 cyclically-adjusted CA as 3–5 percentage points of GDP stronger than the value implied by fundamentals and desirable policies.

### Real Exchange Rate (REER)
- Background:
  - As of May 2015, the CPI-based real exchange rate has depreciated in effective terms by about 6 percent from its 2014 average, primarily because of nominal bilateral depreciations vis-à-vis the USD and the RMB.
  - Despite the recent depreciation trend, various measures of REER were 0-3.5 percent more appreciated in 2014 than in 2013 on an annual average basis.
  - These exchange rate movements are related to expected monetary tightening in the U.S. and implementation of quantitative easing in the euro area.
- Assessment:
  - Staff’s assessment for 2014 is of a REER undervaluation of 5–15 percent.
  - The EBA REER Level model yields an undervaluation of about 16 percent.
  - The undervaluation implied by the CA regression model using standard trade elasticities is 7-12 percent.
  - Note: The EBA REER Index model produced an implausible estimate of overvaluation (7.3 percent) for 2014 that was discarded from the assessment.

### Capital and Financial Accounts: Flows and Policy Measures
- Background:
  - Before the crisis Germany exported capital primarily via bank outflows.
  - During the crisis, capital flow reversals particularly affected portfolio investment.
  - In 2014, net portfolio and direct investment flows constituted about ½ and 1/3 of the capital and financial account balance, respectively.
  - The stock of Germany’s net (Target2) claims on the Eurosystem went down from a peak of €750 billion in August 2012 to €532 billion in April 2015.
- Assessment:
  - Lower exposure to the Eurosystem and a resumption of private capital outflows are associated with reduced euro area financial stress and a partial reversal of euro area financial fragmentation.

### FX Intervention and Reserves Level
- Background:
  - The euro has the status of global reserve currency.
- Assessment:
  - Reserves held by euro area countries are typically low relative to standard metrics.
  - The currency is freely floating.

### Financial Stability and Macroprudential Policy
- Recent developments and risks (information since issuance of staff report):
  - Following the expiration of the European program with Greece, risk of renewed euro-area stress increased; market reaction was relatively muted.
  - The yield on the 10-year Germany government bond fell by 26 basis points since issuance of the staff report.
  - The DAX stock market index declined by 6 percent, with bank stocks especially hard hit.
  - CDS spreads for the largest four banks increased by 14 basis points on average.
- Short-term risk for Germany: turmoil spreading and undermining confidence could weaken private consumption and delay recovery in private investment.
- Medium-term need: accelerate integration within the euro area and strengthen firewalls.
- Macroprudential toolkit:
  - Financial Stability Committee (FSC) recommended expanding Germany’s macroprudential toolkit.
  - FSC recommended legislation to give BaFin authority to introduce measures constraining mortgage loan eligibility (limits on loan-to-value ratios, debt-to-income ratios, debt-service-to-income ratios, and minimum amortization requirements).
  - Activation of such instruments is not envisaged at the moment.

### Technical Background Notes and Data
- Germany’s balance of payments statistics, including the IIP, are not comparable to last year’s country page due to the transition to BPM6.
- Demographics: The rapidly-aging population contributes 3.3 percentage points to the estimated EBA CA norm of 3.9 percent of GDP.
- Data adequacy:
  - Data provision is adequate for surveillance.
  - Germany adopted ESA2010 in September 2014.
  - Bundesbank compiles balance of payments, IIP, and related cross-border statistics according to BPM6 and ECB/Eurostat legal requirements.
  - Germany reports a comprehensive set of Financial Soundness Indicators (FSIs); of the 40 FSIs, Germany reports all except net foreign exchange exposure to equity (I31) and residential real estate prices (I37).
  - Germany is a subscriber to the Fund’s Special Data Dissemination Standards (SDDS) since December 2, 1996, and to SDDS Plus since February 2015.

*Appendix V. External Sector Report Country Page: Germany*

### 1. I would like to convey my authorities’ gratitude for productive and insightful

### _cr15187 - 1. I would like to convey my authorities’ gratitude for productive and insightful

### Overview
- Authorities found the assessment “candid, comprehensive, and well-balanced.”
- Staff reached out to a broad range of stakeholders during consultations; authorities’ views are documented in the staff report.
- Authorities emphasize key issues: strengthen productivity growth and improve conditions for stronger private investment.

### Recent Economic Developments and Outlook
- Staff growth projection: “1.6 percent this year and 1.7 percent next year.”
- Growth drivers in 2015 and 2016:
  - Mainly private consumption.
  - Robust real wage growth and higher employment bolstering consumption.
  - Investment pickup amid solid capacity utilization and good business sentiment.
- Potential output growth estimated at “around 1 ¼ percent.”
- External factors benefiting the economy: drop in crude oil prices, depreciation of the euro, recovery in export markets.

### Fiscal Policy
- Government strategy: prudent, medium-term oriented, and growth-friendly fiscal policies; maintain solid fiscal position and comply with EU and national fiscal rules with a safety margin.
- Policy stance: increase public investment while maintaining balanced budgets.
- Rationale for balanced budgets:
  - Further reduce government debt ratio (noted as “still substantially above the 60% ‘Maastricht’ ceiling”).
  - Safeguard fiscal position against increasing interest rates (which “have already started to rise from historically low levels”).
  - Prepare for upcoming demographic challenges expected to “kick in heavily at the end of this decade.”
  - Cyclical argument: “additional fiscal stimulus is not advisable.”
- Public expenditure commitments: increase expenditure in education, research, and infrastructure “by around €44 billion until 2019.”
- On expanding public investment:
  - Public infrastructure still considered “very good in international comparisons.”
  - Need to maintain quality and expand where clearly needed.
  - Constraints: limited administrative capacities for planning and implementing projects; high short-term pressure risks fund misallocation.
  - Recommendation: case-by-case project approach and structural/institutional measures to strengthen resources and knowledge transfer.
  - Government assessing proposals to create a service agency for municipalities to help planning, procuring and managing infrastructure projects to strengthen investment efficiency.

### External Assessment
- Authorities welcome refined external balance analysis that better captures demographic effects, but note substantial model ambiguity for Germany.
- Unexplained residual reported “about 3 percentage points” compared to “fiscal policy gaps” of “0.9 percentage points in other countries and 0.6 percentage points in Germany.”
- Possible explanations for large residuals: specific shocks to the savings rate or to world demand for German exports.
- Authorities view the estimated REER undervaluation as “too pronounced.”
- Emphasis that the German current account surplus likely reflects a complex set of market-driven factors, not distortions or targeted policy measures by the German government.
- On policy simulations:
  - Simulations targeting higher wages or fiscal expansion through lower taxes/higher consumption show positive spillovers are very limited or can become negative if they reduce employment and weaken German activity.
  - Simulations show policies fostering potential growth would generate meaningful positive outward spillovers, especially within the EU and the euro area.
- Authorities expect a decrease of the current account surplus over the medium term given solid growth, strong nominal and real wage growth, policies like the federal minimum wage and public investment initiatives, and note recent increase in the current account was driven to a large extent by lower oil prices.

### Strengthening Potential Output
- Agreement with staff that potential output growth was “more or less unaffected by the global financial crisis.”
- Stylized evolution of potential growth: declined contribution of capital compensated by larger contribution of labor due to higher participation rate and strong net migration.
- Demographics: population aging will weigh on potential output growth in the medium to long term.
- Authorities argue assuming constant trend factor productivity and fixed capital formation likely overstates slowdown; trend factor productivity could be more dynamic as migrants better integrate and mismatch declines.
- Policy priorities endorsed: service sector reform, increasing labor market participation, reducing uncertainty regarding the energy transition.
- Service sector deregulation:
  - Scope for further deregulation in professional services to increase efficiency, lower entry barriers and reduce red tape.
  - Need balance to retain justified regulations guaranteeing service quality, consumer protection, or serving social/health purposes.
  - Government examining applicable regulations (including within the Transparency Initiative at EU level).
- Rail sector: “Act to Strengthen Competition in the Rail Sector” expected to promote competition, boost efficiency, and help create a single European market; share of competitors to the incumbent operator in total turnover has “increased steadily in recent years.”
- Energy transition:
  - Renewable Energy Act from 2014 contributes to reforms, improves planning reliability for investors, and “contributes to dampen the cost increases for final users of electricity.”
  - Further measures under way in grid expansion, security of supply, and the future of the electricity market.
- Labor participation measures:
  - Female labor participation is among the highest in advanced economies; priority remains “sufficient and high-quality provision of child care facilities.”
  - Government providing a total of “€5.95 billion” in support to the Länder and municipalities for expansion of child care facilities for children under three.
  - Starting in 2015, government will provide “€845 million annually” towards ongoing operating costs of child day care, plus an additional “€100 million each year for 2017 and 2018.”
  - Tax system disincentives noted; social security contributions and free co-insurance of non-working family members often more relevant than treatment of couples in the income tax code.
- Additional measures to address labor shortages: increase effective retirement age and integrate highly skilled migrants.

### Financial Sector
- Authorities alert to risks associated with low interest rates.
- Banks not supervised by the ECB asked to run bottom-up stress tests covering a five-year earnings evolution.
- Low profitability may warrant corrective action; mergers are a potential option to cut costs.
- Ongoing consolidation among savings banks and cooperative banks; branch networks being reduced; announcements by two large banks to reduce branch networks indicate process continues.
- Housing market: house price overvaluation signs limited to big cities; monitor closely.
- Macro-prudential toolkit:
  - Current toolkit “may not be sufficient” to address residential mortgage market risks and “should be further developed.”
  - German FSC recommended federal government provide legal foundations to apply additional macro-prudential tools to regulate loans for construction or purchase of residential real estate.
  - Recommendation to create the option of activating LTV, DTI, DSTI, and an amortization requirement should such restrictions be necessary to safeguard financial stability.
  - Authorities stepped up efforts to collect data from commercial lenders to help apply and calibrate macro-prudential measures.
- Insurance sector:
  - Persistent low-interest environment is a stability risk for German life insurers; Solvency II will make the challenge more salient.
  - Measures to increase resilience: insurers should reinforce capital buffers, manage policy holders’ profit participation share, and reduce dependence on interest rate risk by selling more policies with a flexible guaranteed return or no guaranteed return.
  - Authorities agree the Life Insurance Reform Act is “an important contribution to improve the resilience of life insurers and thus the stability of the life insurance sector as a whole.”

*IMF staff report: authorities’ response and policy views (as contained in the provided content).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15187.pdf_